economics

May 13, 2010

Estonia and the euro Long euros Estonia gets a step closer to adopting the single currency

Filed under: Uncategorized — ktetaichinh @ 12:36 pm
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SURPRISES are Estonia’s stock in trade. Its return to the world map in 1991 after a 51-year absence startled outsiders. So did what came next: a fast-growing economy, based on flat taxes, free trade and a currency board. It confounded pessimists’ expectations by joining the European Union (in 2004) and NATO (in 2004). Now the country of 1.4m people is set to pull off another coup, gaining green lights from the European Commission and the European Central Bank for its bid to adopt the euro on January 1st 2011.

Many thought that highly unlikely. Only two years ago a property bubble collapsed, rocking the banking system and sending GDP plunging by 14.1% in 2009 (see story). Doom-mongers said devaluation was inevitable. But they were wrong. Flexible wages and prices have helped the economy stabilise: unit labour costs fell by 7.5% in the final quarter of 2009. Exports were up by a sixth in the first quarter of 2010 and the central bank forecasts growth this year of 1%. Estonia easily meets the euro zone’s rules on public finances. Its gross debt in 2009 was only 7.2% of GDP, and the government deficit is 1.7%. The only real concern is whether inflation will stay low: in the past 12 months the average was negative, at -0.7% comfortably below the 1% target. But the ECB report called for “continued vigilance” on that.

The real problem for Estonia is political, not economic. Some euro zone members (France is often mentioned) think that allowing an obscure and volatile ex-communist economy to join a currency union that has too many dodgy members already should not be a priority. If Estonia is really so solid, why not wait a year to be sure?

Yet that would send a perverse message. Estonia is one of two countries in the whole EU that actually meets the common currency’s rules (Sweden being the other). All the rest (even those that use the euro) have gaily breached the deficit and debt limits. The grit shown by Estonian politicians and the public in shrinking spending, raising taxes, and cutting wages has left outsiders awestruck (see leader). Punishing Estonia which obeyed the rules, while bailing out Greece which has breached them flagrantly, would do little for the euro’s credibility with governments and investors alike.

Estonia has two more hurdles to jump before it can humiliate the scoffers. An EU committee meets at the end of May, followed by a finance ministers’ summit in early June. Few think that France and other doubters will actually block its euro bid: a combination of persuasion and horse-trading will probably bring agreement. Then the decision will be irrevocable. That will give heart to Latvia and Lithuania too, who hope to join the euro later in the decade. Like Estonia, their currencies are pegged to the euro, so they have all the pain of a rigid monetary regime, but miss out on the lower borrowing costs and higher investment that the euro zone brings.

The longer-term question is what Estonia focusses on next. On May 10th it passed another benchmark, joining the Organisation for Economic Cooperation and Development, a Paris-based rich-country thinktank—the first country from the former Soviet Union to do so. The hunt is on for a new national project. Estonia’s presidency of the EU in 2018 will coincide with the country’s 100th birthday. Finding something to surprise outsiders then is a pleasant challenge for the future.

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