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ECB Casts Doubt On Euro-Zone Readiness Of New Members

by Ulrika Lomas,, Brussels

12 December 2006

Last week the European Central Bank published its assessment of the economic and legal convergence of a number of new EU Member States, concluding that while Slovenia can join the eurozone next year, only Cyprus and Malta among the other nine states might be ready to join by 2008.

The European Commission also published a convergence report, finding that none of the nine new member states was ready to sign up to the euro. The Commission said that the Czech Republic, Cyprus, Poland and Sweden were the only countries to meet the Maastricht inflation criterion, while Estonia, Cyprus, Latvia and Sweden met the debt criterion (60% of GNP) and the public deficits of the Czech Republic, Hungary, Malta, Poland and Slovakia were in excess of the reference level of 3.0% of GNP.

According to the ECB's report, over the reference period from November 2005 to October 2006, the 12-month average rate of HICP inflation in Cyprus was 2.3%, i.e. below the reference value of 2.8% for the criterion on price stability. On the basis of the most recent information, the 12-month average rate of HICP inflation is expected to remain broadly stable in the coming months.

In the reference year 2005 the general government budget balance showed a deficit of 2.3% of GDP, i.e. below the 3% reference value. The general government debt-to-GDP ratio was 69.2%, i.e. above the 60% reference value. Compared with the previous year, the deficit ratio decreased by 1.8 percentage points and the public debt ratio decreased by 1.1 percentage points. In 2006, the deficit ratio is forecast by the European Commission to decrease to 1.9% and the public debt ratio is projected to decrease to 64.8%.

The ECB said that since 1996 a pattern of volatile but recently improving outturns has been observed in the deficit-to-GDP ratio, which was below the 3% reference value in 2005 for the first time since 2001. Starting from a level of 3.2% in 1996, the deficit ratio deteriorated to 5.0% in 1997 before gradually improving to 2.3% in 2000 and 2001. The deficit then deteriorated again rapidly to 6.3% in 2003 before rebounding to 2.3% in line with the fiscal consolidation efforts outlined in the government’s convergence programme.

European Commission estimates indicate that cyclical factors have had only a relatively small impact on the change in the fiscal balance in recent years. Between 2002 and 2005 they contributed negatively to the fiscal balance, albeit to a decreasing extent. The change in the fiscal balance, which was sizeable in some years, was therefore driven mainly by non-cyclical factors. Non-cyclical changes in the government budget balance could reflect either a lasting structural change or the effect of temporary measures. Available evidence suggests that temporary measures had no impact in 2004 but, mainly through a tax amnesty, improved the deficit ratio by 1.7 percentage points in 2005. Without the measures the
2005 deficit would have amounted to 4.0% of GDP.

The ECB indicated that on current trends, Cyprus is unlikely to fulfil the Maastricht criteria in time to join the eurozone in 2008, as currently planned. The Nicosia government is however insistent that it will succeed in matching the criteria, and planning is continuing for eurozone entry on a confident basis.

Concludes the ECB: ' With regard to the fulfilment of the commitments undertaken upon ERM II entry, the following observations can be made. The fiscal situation in Cyprus has improved, albeit largely due to temporary measures in 2005, while structural measures have started to be implemented in 2006. Public sector basic wages were frozen in 2005, but overall wage growth is currently above productivity growth. Monetary policy has been tightened with a view to curb credit growth and some changes have been made in the area of financial supervision. Finally, no significant progress has been made with the implementation of structural reforms.'

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