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The Czech Republic’s integration into the EU – monetary and economic policy

  1. The establishment and stages of Economic and Monetary Union prior to the introduction of the euro
  2. The economic crisis and the search for new ways forward
  3. Rescue mechanisms/ESM
  4. The Czech Republic in the EMU

1. The establishment and stages of Economic and Monetary Union prior to the introduction of the euro

The push for integration which started in Western European countries after World War II did not originally involve economic and monetary policy. The primary objective at that time was to rebuild the economy after the War and, to that end, to lift trade barriers and expand markets.

Stronger integration in the 1980s, the Maastricht Treaty

The idea of more intensive monetary integration was tabled in the late 1980s after the adoption of the Single European Act (1987), which set a course towards full integration of the single internal market. In this light, a single currency seemed to be one of the fundamental attributes of the single internal market. The main political steps towards the future monetary union included the meeting of the European Council in Hannover in 1988, the Delors Report of 1989 and the Maastricht meeting of the European Council in December 1991, which, on the basis of the Delors Report, approved the plan for creating the Economic and Monetary Union. The legal foundations of the Economic and Monetary Union were laid down in a set of agreements signed in February 1992 in Maastricht, commonly referred to as the Maastricht Treaty . These documents came into force on 1 November 1993. Under the Treaty the changeover to the single currency was to take place in three stages – two preparatory stages and a third and final stage of euro adoption.

Convergence criteria

To check whether the conditions had been created for moving to Stage Three of Economic and Monetary Union (EMU), involving the actual introduction of the single currency, the Treaty laid down convergence criteria. These criteria were defined on the basis of theoretical considerations about the conditions needed to ensure sustainability of a single currency in a group of countries. They include in particular requirements for low inflation and long-term stability of mutual exchange rates (with respect to balance of payments equilibrium). The other criteria focus on ensuring public finance sustainability by setting a maximum ratio for the public budget deficit as a percentage of GDP and a maximum ratio for the absolute volume of public debt as a percentage of GDP at market prices. A criterion leading to convergence of the interest burden of long-term public borrowing was also defined. The relatively detailed fiscal criteria stemmed from the fact that although the political negotiations on the conditions of operation of the new currency had resulted in support for the idea of a single currency and a single monetary policy, no corresponding measures had been taken in the economic and fiscal policy area, where coordination became the main method of cooperation.

The Treaty provides for a derogation regime (a temporary exemption allowing later entry into Stage Three) for countries that have not yet satisfied the convergence criteria.

The changeover scenario

The scenario for the changeover to the single currency, which was given the name the “euro”, was defined at the Madrid meeting of the European Council in December 1995. In line with the Treaty timetable, 1 January 1999 was set as the start date of Stage Three of EMU.

Stability and Growth Pact

At the time the Maastricht Treaty – which, among other things, stipulated an excessive deficit procedure – entered into force, most EU countries were not compliant with the two criteria limiting excessive deficits. There were also doubts about whether the public finance deficit requirements were merely an eligibility criterion for euro adoption or whether they would also have to be met in the future. On the basis of this debate, the European Council adopted a Resolution on the Stability and Growth Pact (SGP) at its meeting in Amsterdam in June 1997 confirming the general validity of the deficit requirements after euro adoption and declaring the validity of the procedures and measures laid down in the Treaty.

The changeover to the euro

As expected, an extraordinary EU summit held in early May 1998 approved the membership of 11 countries in the euro area (commonly called the Eurozone), although a more tolerant interpretation of the Treaty was applied in the case of compliance with the fiscal criteria in some countries. Greece joined the euro area on 1 January 2001, although it turned out later that some of the statistical documents it had submitted, especially in the public finance area, had been intentionally distorted and had not reflected the actual situation of the Greek economy. The legal acts completing the changeover to the euro were passed in 1997–1998.

The non-cash changeover at the start of 1999 proceeded smoothly. During the changeover weekend, government finances were converted to the euro and most government securities were redenominated in the euro. Commercial banks were also ready to provide services in the new currency. The national legislation allowing the euro area countries to introduce the euro as their national currency took effect on 1 January 1999. The national currencies, which continued to exist for another three years, technically became subdivisions of the euro (“non-decimal denominations”).

The period 1999–2001 saw preparations for the cash changeover. The situation at that time was made easier by the fact that the necessary institutions and mechanisms – in particular the European Central Bank, which created the monetary policy of the euro area and coordinated the preparations for issuing euro banknotes and coins – had already been established. The situation was also simplified by dual display of prices during the transition period, as this prepared the public for the new prices of goods after euro adoption. For these reasons it was possible to shorten the originally planned changeover period from six to two months.

Current composition of the euro area

The twelve countries that adopted the cash euro in 2002 were joined by Slovenia in 2007, Malta and Cyprus in 2008, Slovakia in 2009, Estonia in 2011 and Latvija in 2014. These countries introduced the euro under the “Big Bang” scenario, i.e. the euro started to be used for both cash and non-cash payments on the changeover date, with no non-cash transition period). This took the number of euro area countries to 17.

2. The economic crisis and the search for new ways forward

The first ten years of the euro can be described as a period of relative calm, despite gradually growing imbalances between individual countries. This calm was aided chiefly by the following factors: the smooth start of the new currency; its timing (a period of globally low inflation); the relatively smooth running of the single monetary policy, especially in the initial period ((link to the ECB website); falling long-term interest rates in most member countries; gradual appreciation of the euro against the dollar; and rising use of the euro as an international trading and reserve currency. In the same period, however, the member countries showed increasing structural imbalances arising mainly from their different levels of competitiveness. These imbalances were manifested, among other things, in different inflation rates and growing balance of payments deficits/surpluses.

One disappointment was that the expectations of higher economic growth and labour productivity failed to materialise, a fact confirmed in the European Commission 2008 evaluation report “Successes and challenges after ten years of Economic and Monetary Union” (pdf, link to the European Commission website).
The public in the euro area countries felt that prices – especially of services – had gone up, even though the actual act of euro adoption and the price conversion process were meant to have been price neutral.

The financial and economic crisis and its implications for the euro area

The outbreak of the financial and economic crisis was a turning point in the development of EMU. In the second half of 2008, the crisis manifested itself in an increased number of bankruptcies, most of them outside the EU (the United States, Iceland) but with direct impacts on the assets of most Western European banks. The banking sector crisis spilled over to other sectors. This necessitated a massive increase in state subsidies and interventions, resulting in the fiscal Maastricht criteria being exceeded far beyond the levels stipulated in the Treaty. At the same time, the imbalances which had long been accumulating were revealed in full. At the start of 2010, therefore, we can say that the crisis entered a new phase – a public debt crisis (see below). This crisis was most acute on the southern periphery of the EU and also in Ireland.

In response, decisions were taken to immediately stabilise the situation in these countries (see the section European financial stabilisation mechanism) and measures were adopted to implement a long-term reform of economic governance of the EU and to enhance coordination of the member states’ economic policies.

Remedial measures

At the March 2010 meeting of the European Council a discussion took place about the need for longer-term measures to correct the fiscal situation and imbalances in the euro area. The European Council decided to establish a Task Force on Economic Governance headed by the President of the European Council Herman Van Rompuy. In October 2010, the Task Force submitted a final report containing the following recommendations:

  • greater fiscal discipline by tightening the Stability and Growth Pact and applying it more consistently,
  • stronger fiscal rules and frameworks,
  • better quality statistical data,
  • a new system of surveillance of macroeconomic imbalances, including a sanction mechanism,
  • deeper coordination of economic policies by implementing the “European semester”,
  • a permanent stability mechanism for euro area countries in the medium term,
  • stronger (or new) institutions to provide independent macroeconomic and fiscal analysis at both EU (EC) and national level.

The European semester was approved by the European Council in June 2010. The semester is a cycle of economic policy coordination that involves aligning the dates of submission of stability/convergence programmes and national reform programmes by the member states. As from 2011, these programmes will be submitted by the end of April of the current year. The European semester should result in better coordination of the economic policies of EU countries, as it will be possible to incorporate Council recommendations into draft national budgets and their medium-term outlooks in the current year.

The tightening of the SGP, the introduction of surveillance of macroeconomic imbalances and the setting of minimum requirements for national fiscal frameworks were the subject of six legislative proposals issued by the European Commission in September 2010.

In addition to the above measures aimed at enhancing budget policy responsibility, two programme documents focusing on economic policy coordination were recently adopted: the Europe 2020 Strategy and the Euro Plus Pact.

The Europe 2020 Strategy is the basic development strategy for the EU as a whole until 2020. It was approved by the European Council in June 2010 and contains five headline (quantified) objectives and ten integrated guidelines.

Based on the national reform programmes the European Commission will in 2011 prepare a Common Strategic Framework, which is designed convert the objectives of the Europe 2020 Strategy into investment priorities of future EU cohesion policy after 2013; it should bring together the Cohesion Fund, the European Regional Development Fund, the European Social Fund, the European Agricultural Fund for Rural Development and the European Maritime and Fisheries Fund.

The Euro Plus Pact

The original informal French-German proposal to establish a Competitiveness Pact was replaced by a joint proposal of the President of the European Council and the President of the European Commission, which was subsequently modified into the final form of a Pact for the Euro agreed by top euro area representatives at a summit on 11 March 2011. The document was approved at the European Council meeting on 24–25 March 2011 as the Euro Plus Pact (link to the Council of the European Union website).

The pact is consistent with existing economic instruments or proposals (such as the Europe 2020 Strategy, the European Semester, the Stability and Growth Pact and the new macroeconomic surveillance framework). It develops them by setting more ambitious political objectives at the highest political level in several key areas. The proposal pursues four goals:

  • to foster competitiveness,
  • to foster employment,
  • to contribute to the sustainability of public finances,
  • to reinforce the financial stability of EU member states.

The countries will voluntarily adopt specific commitments and, at their discretion, set their own choice of actions to achieve them, always for a timeframe of 12 months. If a member state can show that action is not needed in one or the other areas, it will not include it. No concrete figures have been set yet for the indicators of achievement of the basic goals.

The Czech government’s position on the Pact’s proposals was broadly positive, but it decided that the Czech Republic would not sign up for the time being, mainly because the Czech Republic had not been invited to participate in the preparation of the Pact, and some of its consequences, for example in the tax area, were not yet clear. The UK, Sweden and Hungary also opted out of the Pact. However, it is possible to join at a later date.

3. Rescue mechanisms/ESM

At the start of 2010, the financial and economic crisis in the EU entered a new phase – a public debt crisis in some countries. Owing to adverse developments in Greece, steps had to be taken to safeguard financial stability in the euro area and to create a framework for assisting those EU countries whose debt problems might prevent them from obtaining further financing in the market. In May 2010, Greece was provided with a loan of €110 billion (€80 billion in bilateral loans from the euro area members and €30 billion from the IMF). These steps did not definitively end the “Greek problem”, as the debt crisis resurfaced in mid-2011. In the meantime, serious problems also emerged in other countries, which – owing mainly to their difficult public finance situation – gradually became the focus of financial market attention.

Euro area rescue mechanisms

In May 2010, ECOFIN approved a rescue mechanism totalling €750 billion, comprising €440 billion from the European Financial Stability Facility (EFSF) and €60 billion from the European Financial Stabilisation Mechanism (EFSM) supplemented by an expected IMF contribution of up to 50% of the EU contribution on an individual basis. This rescue mechanism was applied for the first time in November 2010, when Ireland ran into serious debt problems after bailing out its banks (total amount of the rescue package – €85 billion). In May 2011 financial assistance totalling €78 billion was granted to Portugal. In July 2011 Greece was granted further financial assistance amounting to €109 billion, including contributions from the private sector in addition to EFSF and IMF funds.

The Czech Republic is not a euro area member and so was not obliged to contribute in any way to the EFSF. By contrast, loans from the EFSM – which is a European Commission facility that operates on a similar principle as the Balance of Payments facility (intended for non-euro area EU member states) and applies to all EU member states – are guaranteed from the EU budget, to which the Czech Republic also contributes (its share in the guarantees was CZK 6.7 billion for the loan to Ireland and CZK 7.7 billion for the loan to Portugal).

As the aforementioned assistance framework was in place only until 2013, discussions started in 2010 about creating a permanent facility to safeguard the financial stability of the euro area. The December 2010 meeting of the European Council agreed on the creation of a permanent European Stability Mechanism (ESM) to replace the temporary EFSF and EFSM facilities in 2013 (see below). The establishment of this mechanism was enabled by an addendum to Article 136 of the Treaty on the Functioning of the European Union. The ESM was eventually launched earlier than planned (on 15 October 2012).

The wording of this addendum and the general provisions on the ESM were approved at the European Council meeting on 24–25 March 2011 (see the conclusions of the European Council, 24/25 March, Annex II, Term Sheet on the ESM (pdf, link to an external website)).

Characteristics of the ESM

The ESM was established by a treaty between the euro area member states as a new international financial institution to be activated if indispensable to safeguard the stability of the euro area as a whole. The ESM has capital of €700 billion. Of this amount, €80 billion was deposited by the euro area members in cash and €620 billion will take the form of callable capital. However, the lending capacity of the ESM will be “only” €500 billion, as €200 billion will be necessary to secure the highest (AAA/Aaa) rating. Financial assistance is provided on the basis of strict policy conditionality under a macroeconomic adjustment programme and rigorous analysis of debt sustainability, which are conducted by the European Commission together with the IMF and in liaison with the ECB. ESM assistance has already been drawn by Spain (€40 billion out of a total of €100 billion; this programme has now been concluded) and Cyprus (€9 billion from the ESM pledged, €4.6 billion drawn so far).

In addition, the possibility of direct recapitalisation of banks established in the euro area using the ESM was approved in 2014.

The Czech Republic and the ESM

The Czech Republic is not obliged to participate in the ESM, nor has it been invited to do so. Non-euro area countries can, however, contribute to the loans provided by the ESM on an ad hoc basis. As regards the impact of any enlargement of the euro area on the ESM, euro adoption is not conditional on ESM participation. Access to the ESM is a consequence of joining the euro area. It is assumed that a member state will become a member of the ESM with full rights and obligations on adopting the euro. Turning to the ESM contribution key, the standard key was based on the paid-in capital key of the ECB. New euro area countries (i.e. potentially also the Czech Republic if it joins the euro area) will be subject to a potentially more advantageous regime that will take into account whether the country has a GDP per capita of less than 75% of the EU average for a temporary period of 12 years (after establishment of the ESM/entry into the euro area).

Private sector involvement is envisaged in the form of encouraging private investors to maintain their exposures when ESM funds are being used to resolve a crisis.

The Czech Republic ratified the ESM Treaty in April 2013.

4. The Czech Republic in the EMU

On joining the EU on 1 May 2004 the Czech Republic became an EMU member with a derogation as regards the introduction of the euro (see the Act concerning the conditions of accession of the Czech Republic and nine other countries and the revisions to the Treaties on which the European Union is founded (pdf, link to the EUR - Lex Access to European Union law website)).

The euro should be introduced after the Czech Republic fulfils the necessary conditions (the Maastricht criteria). Whether the necessary conditions for adopting the euro have been satisfied is analysed and assessed in accordance with Article 140 of the Treaty on the Functioning of the European (link to the EUR - Lex Access to European Union law website) Union by the European Commission (link to the European Commission website) and the European Central Bank (link to the ECB website) in their Convergence reports, which are issued once every two years or at the request of a member state with a derogation. The final decision on the fulfilment of the conditions is made at the EU Council level (assumption: in the composition of the ministers of economy and finance – ECOFIN). Unlike Denmark and the UK, the Czech Republic was not able to negotiate a permanent opt-out clause. Its derogation is therefore only “temporary”.

Each EU country with a derogation has its own euro adoption strategy. This contrasts with the twelve original euro area countries, which adopted the euro in a coordinated manner.

Accession of the Czech Republic to the euro area

The Czech Republic formulated its vision for euro adoption in 2003, when the Czech government approved its Euro-area Accession Strategy (pdf, 130 kB) (“Eurostrategy”). The strategy set an indicative euro adoption date of 2009–2010.

An authority for the coordination of legislative and technical measures for the adoption of the euro – the National Coordination Group – was established in 2005 (link to the Zavedení eura v České republice website). In 2006 the government approved a single-step changeover scenario and in 2007 a National Changeover Plan (pdf, link to the Zavedení eura v České republice website).

The date of euro adoption in the Czech Republic was meant to have been specified on the basis of regular assessments of the fulfilment of the Maastricht convergence criteria and the degree of economic alignment of the Czech Republic with the euro area, which have been prepared by the Czech National Bank and the Ministry of Finance every year since 2005. This assessment results in a recommendation to the Czech government on whether the Czech Republic should, or should not, join ERM II in the coming year. To fulfil the Maastricht criteria, it is necessary to participate in ERM II for at least two years. It is therefore necessary to enter it at least three years ahead of the actual changeover date (two years in the system + one year needed for evaluation and technical preparation). The Czech government made no decision on ERM II entry in the period during which the original version of the Eurostrategy was valid. The main reasons at the time were public finances, which were not compliant with the relevant Maastricht criterion, and insufficient alignment of the Czech economy with the euro area. The original indicative deadline for euro adoption (2009–2010) was therefore not met.

The updated and still valid Eurostrategy of 2007 no longer contains any indicative target date. The degree of economic alignment of the Czech Republic with the euro area and the fulfilment of the Maastricht criteria continue to be assessed on a regular basis.

The global economic crisis and the economic situation in some weaker euro area members (Greece, Ireland and Portugal) have made the debate on the sustainability of the euro project increasingly relevant. The discussion of the advantages and disadvantages of adopting the euro has therefore logically become more intense in the Czech Republic as well. Given this situation, the present Czech government has not set any target date for euro adoption. It has stated, however, that it will lay the groundwork for euro adoption on condition that the euro develops as a meaningful project. In addition, introduction of the euro will only be possible if Czech public finances are successfully consolidated.

The current internal and external situation thus does allow for the decision on the date of adoption of the euro in the Czech Republic to be made in the near future. For this reason, the practical preparations for the introduction of the single currency going on within the National Coordination Group (link to the Zavedení eura v České republice website) have been scaled down.

The adoption of the euro in the Czech Republic will therefore depend not only on the implementation of necessary reforms, but also to a large extent on how the euro area copes with the present challenges affecting the fundamentals of its operation.