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May 17th, 2008

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Not so 'EUR-phoric'

Czechs still skeptical of new currency, even though it could soon be everywhere else
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March 19th, 2008 issue

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By Tomáš Sedláček

Of all the newcomers to the European Union, the Czechs seem to be the ones least enthusiastic about the euro.

The president, the rest of the government and the Czech National Bank all give off the impression that the euro zone is something to stay out of as long as possible. The only voices that can be heard supporting the new currency come from a few independent economists and commentators. Why is this? All other new countries are trying to adopt the euro as soon as they can.

Three of the 10 new EU countries have already adopted the euro (Slovenia, Malta and Cyprus) and the fourth (Slovakia) is likely to start using it in less than nine months.

Poland complies with all necessary criteria, and after the recent change of government, wants to adopt the euro by 2012. A Reuters poll estimates that all Baltic countries will enter the euro zone by 2012.

The year 2012 also stands as a target date for new EU member Bulgaria. Romania is shooting for 2014. These are, by all standards, very ambitious dates. But as the pundits say: Aim at nothing, hit nothing.

That leaves us with the last two neophytes — neither of whom seems to want an entry date: Hungary and the Czech Republic.

But, while the two countries have their aversion to euro adoption in common, there cannot be starker differences between their two economies.

In Hungary, inflation is high and interest rates are, too. Deficits and debt are even higher. To put it succinctly, Hungary does not comply with a single euro criterion set by the EU.

This makes Budapest the only EU27 capital with such poor results. Combine this with weak growth of the economy and unimpressive currency results and you will see why the Hungarian economy has won the economic label of “the sick man of Europe.”

In 2004, when Hungary joined the EU, its politicians were the most eager to start using the euro. It was the weak state of the economy that did not allow them to do so. To use an old axiom: The spirit indeed is willing, but the economy is weak.

The Czech situation has been exactly the opposite: The economy has been strong but the spirit is weak.

The economy has been comfortably close to complying with all criteria since 2004, and it is quite likely to continue to comply in coming years. In fact, it’s catching up with the EU average (Czech purchasing power is now at 82 percent of the wealth of the EU average) and the currency is as strong as ever. Despite the world-record appreciation of the Czech crown, exports are growing undisturbed at an outstanding pace.

So, what are the main reasons for the lack of euro-appetite from the Czech side?

From a distance, it would appear that all reasons point toward adoption: a small, competitive, well-established and export-oriented economy would surely reap the benefits of euro adoption. Most Czech exports are paid for in euros — and almost all of them will be when surrounding countries join.

On top of that, the euro has proved to be a successful project, not only in Europe, but also globally. The euro has more than exceeded all expectations, and joining such a strong currency now is, unlike in its somewhat risky beginning, an extremely risk-free and safe thing to do.

Furthermore, Czechs love to travel. Euro adoption would surely make that easier and cheaper as well as further increase the attractiveness of Czech Republic as a tourist destination. Companies would not have to spend tens of billions of crowns in currency operations and lose sleep over the yet another surprise development of the exchange rate.

So why isn’t it “let’s euro” for Czechs?

Inflation is the largest fear of the general public. Politicians and central bankers, on the other hand, fear the loss of monetary sovereignty. But the strongest argument so far has been that, the stronger the crown is, the more it helps Czech residents.

Catching up with the West is most comfortably done through this channel. Furthermore, thanks to strong results of the crown, petrol prices have remained stable in our country, sometimes even going down. That gives us the impression that the worldwide shock of oil at more than $100 per barrel oil is just not happening in the Czech lands.

In addition, inflation has been historically maintained at low levels thanks to the strong crown.

This is all very helpful, but, like everything in economics, it has its price.

We are slowly learning about the dark side of the force of a strong currency. Higher wages on a global scale decrease our competitiveness. Exporters (especially those who are not re-exporting) are finding themselves in ever more difficult positions. On a global scale, we are becoming richer, our wages are rising dramatically in euro-terms, but only those who travel out of the country really notice.

As the crown has abruptly strengthened, it has also caused worries, even with the usually strong-currency-happy Czech National Bank — for what rises quickly cannot quickly fall. And such waves are not healthy by any standard.

Inflation fears shared by the general public are also mostly exaggerated. The popular German tales of the “teuro” (meaning expensive) have proved optical illusions: Only the price of daily observables rose dramatically, while other (less noticeable) prices fell. Overall, adopting the euro has led to a temporal increase of a maximum of 2 percentage points in the most sensitive countries.

In Slovenia, the government estimated that the euro has contributed 0.6 percentage points to inflation. European institutions came up with an even lower estimate.

Adopting the euro, of course, is a political decision. Economists should look at the costs and benefits of any changeover. Weighing the pros and cons is a sensitive and altogether subjective matter.

The Czech problem, however, seems to be that official representation is almost solely one-sided. All top representative bodies that are concerned speak in one voice about the threats and dangers of “rushed” (although we seem to be last in the line) euro adoption. Positive remarks about the euro are rare and, if any, serve only as an obligatory introduction to the much more substantial part of the message, which is critique.

This strategy can backfire. Leaving all euro advocacy (and, frankly, most EU-related issues) solely to the nongovernmental sector is hardly a wise strategy.

One day, when the government finally decides on euro-timing, it could find itself trapped in its own rhetoric. How will it rally political support for the euro after spending years highlighting the fears of the population? And, while we are at it, how does the government plan to win political points (domestic as well as international) over the EU presidency, with mostly negative rhetoric about the European Union? Nine months before the Czech Republic takes control of the EU presidency is not too long of a time to start showing a friendlier face.

— The author is the chief macroeconomic strategist at ČSOB and a member of the “Euro Team,” an expert group put together by the European Commission office in Prague to discuss euro adoption in the Czech Republic.

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