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Economic and Monetary Union and the Euro

6. Developments in 2010-11

In 2009, the euro celebrated its tenth birthday in impressive shape. Having succeeded in holding its own during a period of severe market turmoil, it seemed that it had finally proven itself as a solid reserve currency, second only to the US dollar.

By mid-2010, however, the situation had changed. Exposure of eurozone debt problems provoked a sudden loss of confidence among international investors, sending the single currency plunging. The euro was suddenly faced with its biggest test yet.

German chancellor Angela Merkel summed up the situation in May 2010. “The euro is in danger … If the euro fails, then Europe fails,” she said, facing German lawmakers voting on the country’s €150 billion contribution to an unprecedented eurozone rescue package for struggling member states.

The debt crisis began in Greece, which had been spending profligately ahead of its elections in 2009. Eurozone countries and the International Monetary Fund responded by setting up an emergency loan package of €110bn to prevent the crisis from spilling over into other debt-stricken states, namely Portugal, Spain and Italy.

At the core of the problem is the group’s excessive reliance on foreign capital to balance their books. The euro had become popular among central banks looking to diversify their holdings away from the US dollar. But, news of recent woes has provoked doubts over eurozone creditworthiness.

The crisis has laid bare the failings of the stability and growth pact, aimed at limiting budget deficits to 3% of gross domestic product (GDP) and public debt to 60% of GDP. To avert further destabilisation, member states and EU institutions have introduced a series of new measures aimed at strengthening economic governance of the eurozone.

• EU finance ministers hammered out a €750bn financial rescue package. This would include a €500bn stabilisation fund, including plans to raise €60bn from EU bonds. The International Monetary Fund (IMF) is to supplement the package with a €250bn contribution. The package would be jointly managed by the member states, the European Commission and the IMF.

• The European Central Bank (ECB) announced plans to buy government bonds, a move intended to convince international investors that eurozone debt is effectively insured. It would also offer banks unlimited cash at fixed interest rates during its financing operations, opening credit lines with the central banks worldwide. As a side note, the ECB’s move to buy the debt load of eurozone governments has placed its much-vaunted political independence and its determination to fight inflation in question.

• The European Commission unveiled plans for strengthening EU economic governance, suggesting that budget plans and economic reforms should be subject to peer review before reaching national parliaments. Breaches could be punished with much more severe sanctions than what have been seen in the past.

• The European Council convened the first meeting of a special task force aimed at improving eurozone governance. Proposals include tougher penalties for states that repeatedly break the EU's budgetary rules. The task force presents its final proposals to EU leaders in October 2010, with the possible inclusion of plans to expand EU controls over national budgets. A major debate among EU member states is whether such steps towards fiscal federalism would require treaty changes. Germany, in particular, would be in favour of re-opening the Lisbon Treaty.

The challenge now for heavily indebted eurozone countries is to reduce their budget deficits, while adopting painful structural reforms. Greece has pledged to slash its budget deficit by more than 10 percentage points of GDP by 2014. Spain has pledged to cut last year’s deficit of 11.2% by slashing civil servants pay and reducing public investments. Portugal, which ran a deficit of 9.4% last year, has promised to delay plans to build a new airport.

Despite current concerns about the stability of the currency bloc, Estonia’s application to adopt the euro was endorsed by the European Commission in May. Although current conditions are far from ideal, the EU has to be careful to meet its commitments to allow in new members who have undertaken tough spending cuts to meet strict euro entry requirements.

Other countries currently in line are Bulgaria, the Czech Republic, Latvia, Lithuania, Hungary, Poland, Romania and Sweden. Estonia, which has made painful sacrifices to remain within the Maastricht Treaty criteria, is perceived as a test case for euro aspirants.

Estonia joins the euro club

EU finance ministers confirmed on 13 July 2010 that the $19 billion economy of Estonia was ready to join the $12.5 trillion eurozone.

Less than half a year later, at midnight local time on 1 January 2011, Estonia became the 17th EU member state to adopt the euro. This Baltic nation of 1.3 million people is also the third ex-communist state, after Slovenia and Slovakia, to adopt the single currency.

Despite the euro’s plunge on financial markets amid the bailouts of Greece and Ireland, Estonia’s centre-right government pushed ahead with plans to replace the kroon with the euro, saying it would prevent devaluation and therefore attract more foreign investment.

“The euro is first and foremost a guarantor of our security,” said Prime Minister Andrus Ansip, adding that “the euro will definitely support Estonia's trade”.

To qualify for the eurozone Estonia has had to make huge cuts in public spending, and further structural reforms are still needed to harmonise living standards with Western Europe. All this comes on the back of a 16 per cent jobless rate and a 14 per cent contraction in the country's economy in 2009.

Analysis and public opinion
Casting the changeover in a different light, financial analyst Annika Lindblad said that “over the longer term there is less risk of uncertainties and instability in the euro area than in the Baltic region”.

Price hikes were among the biggest concerns for the general public in Estonia, as in other countries which had previously changed to the single currency. In a Eurobarometer survey of 2010, some 81 per cent of Estonian respondents expected prices to increase, while barely one in 10 expected prices to remain stable.

However a Flash Eurobarometer survey released in December 2010 found that a majority (55%) of Estonian businesses expected positive medium to long term results from joining the eurozone.

‘Rethinking’ the euro?
Seven other countries in Eastern Europe — Poland, Romania, Hungary, Czech Republic, Bulgaria, Lithuania and Latvia — agreed to work towards adoption of the euro when they joined the EU in 2004.

Although none have a deadline for joining, in February 2011 President Van Rompuy made a point of visiting all of these countries – and Estonia – “to soothe nerves over a Franco-German economic masterplan”. Already much criticised, this long-term plan aims to resolve the euro crisis by further integrating the EU on economic issues.