A joint document of the Ministry of Finance of the Czech Republic and the Czech National Bank.
Approved by the Government of the Czech Republic on 12 December 2018.
Besides being required to harmonise their legislation with Articles 130 and 131 of the Treaty on the Functioning of the European Union (the Treaty) and the Statute of the European System of Central Banks and the European Central Bank, EU Member States are required to achieve a high degree of sustainable convergence in order to join the euro area. The degree of sustainable convergence is assessed according to the Maastricht convergence criteria, which are set out in Article 140 of the Treaty and detailed in Protocol No. 13 annexed to the Treaty on the European Union and the Treaty on the Functioning of the European Union. These comprise a criterion on price stability, a criterion on the government financial position, a criterion on the convergence of interest rates and a criterion on participation in the exchange rate mechanism. The Czech Republic undertook to take steps to be prepared to join the euro area as soon as possible by signing the Act concerning the conditions of accession of the Czech Republic to the European Union.
Setting the date for joining the euro area is within the competence of the Member State concerned and depends on its preparedness. Besides undoubted benefits, such as a reduction in transaction costs and the elimination of exchange rate risk, adopting the euro entails giving up independent monetary policy and the flexible exchange rate of the koruna as effective stabilising macroeconomic instruments. The preparedness of the economy to join the euro area must therefore be assessed not only from the perspective of its economic alignment and structural similarity with the monetary union, but also from the point of view of its ability to absorb asymmetric shocks and adjust appropriately to them, in particular via effective fiscal policy, the labour market and the financial sector, after the loss of independent monetary policy.
The countries of the European Union are continuing their discussions on deepening integration. In response to the financial and subsequently economic crisis in 2010–2013, an extensive reform of the rules for fiscal supervision and economic policy coordination has been carried out in order to strengthen the stability of the euro area. Financial solidarity mechanisms have been created and the foundations of a banking union have been laid for the same purpose. These measures imply new institutional and financial obligations for countries adopting the single currency. The work of the countries of the European Union on deepening integration, especially in the economic and fiscal policy areas, saw no substantial progress over the last year. The negotiations on some of the pillars of the banking union have yet to be finalised and the reduction of risks in banking sectors also remains incomplete. There is also a continuing debate about how to increase the euro area’s resilience to possible crises. The outcome of the negotiations with the UK on future mutual – particularly economic – relations is unclear. Risks to economic and financial stability, relating among other things to high public debt in some countries, persist. Although they cannot be accurately estimated at the moment, the impacts of these issues on the Czech Republic and the other EU countries will have to be weighed in the future decision about the timing of monetary union entry. The new institutions and regulations created in previous years in response to the economic and financial crisis have fundamentally changed the form of the euro area and hence also the content of the euro adoption obligation assumed by the Czech Republic on acceding to the EU. Their functioning must therefore be properly assessed.
In line with the Czech government decree on the Czech Republic’s Updated Euro-area Accession Strategy of 2007, this document focuses on economic rather than political aspects of adopting the single European currency and is divided into three sections. The first deals with the fulfilment of the Maastricht convergence criteria and the second with the Czech Republic’s economic alignment with the euro area. The third section is devoted to current events in the euro area countries, focusing on institutional developments and the related obligations for its member states.
The Czech Republic should be compliant with the criterion on price stability in 2018, despite ranking among the countries with higher inflation in the EU context in 2018. Inflation is currently in the upper half of the tolerance band around the Czech National Bank’s target. This reflects continued buoyant growth of the Czech economy and related very low unemployment and especially rapid wage growth. According to the inflation outlook, it will be compliant with this criterion in 2019–2021 as well.
The Czech Republic is compliant with the criterion on the government financial position in both the budget balance and debt components. It is likely to remain compliant with it in the medium term. Compliance with the medium-term objective (MTO) is a condition for not exceeding the deficit threshold of the Maastricht convergence criterion even in a recession of the usual depth. Compliance with the MTO is also desirable as regards public finance sustainability, especially given the long-term costs of population ageing. The Czech Republic has de facto been compliant with the MTO since 2013 and is expected to remain so over the entire forecast horizon.
The Czech Republic has long been comfortably compliant with the criterion on the convergence of interest rates and, according to the outlook, is likely to remain so until 2021.
The Czech Republic is formally non-compliant with the criterion on participation in the exchange rate mechanism, as it has not joined the mechanism. Assessment of this criterion will only be possible after the Czech Republic joins the mechanism and the central rate of the koruna against the euro, against which exchange rate fluctuations would be monitored, has been set. The length of stay in the exchange rate mechanism is set at a minimum of two years before the assessment of preparedness to adopt the euro. The Czech Republic’s September 2003 Euro-area Accession Strategy and its August 2007 update state that the Czech Republic should stay in ERM II for the minimum required period only.
The characteristics of the Czech economy as regards its economic preparedness to adopt the euro can be divided into three groups. The first group consists of economic indicators suggesting a relatively low level of risk associated with euro adoption in the area analysed. They have long included the high degree of openness of the Czech economy and its close trade and ownership links with the euro area. These factors provide for the existence of benefits of euro adoption, such as the aforementioned reduction in transaction costs and the elimination of exchange rate risk. The strong trade and ownership integration also fosters a high degree of alignment between the Czech and euro area business cycles, although that has decreased somewhat in recent years. The Czech koruna is aligned with the euro with respect to the US dollar, and inflation inertia is not a barrier to joining the euro area either. Some indicators are also suggesting preparedness for adopting the euro as regards the adjustment mechanisms of the Czech economy. They include the current favourable condition of Czech public finances, which – unlike in the past – is creating potential room for fiscal policy to fulfil its macroeconomic stabilisation role in the future. Increasing labour market flexibility (mainly a growing rate of economic activity and a falling long-term unemployment rate) and a stable banking sector resilient to economic shocks are also positive factors.
The second group consists of indicators with a neutral message. These include the small differences in the level of interest rates from the longer-term perspective and the overall similarity of monetary policy transmission in the Czech Republic and the euro area. The Czech Republic differs from the monetary union average in some financial indicators, such as depth of financial intermediation, private sector debt and the balance sheet structure of non-financial corporations and households, but this cannot be considered a disadvantage or a fundamental barrier to euro adoption. The spontaneous euroisation of the Czech economy has increased slightly, but remains relatively small in scale and does not tilt the balance of arguments in the debate about joining the euro area in one direction or the other. Some labour and product market indicators, such as geographical mobility and labour market efficiency, and the assessment of the competitiveness of the Czech economy are also neutral.
The third group consists of indicators suggesting economic risks associated with euro adoption in the area analysed. They include the unfinished process of real economic convergence of the Czech Republic towards the euro area. Although it has renewed in recent years, the gaps in most key indicators remain significant. Lower structural similarity of the economies of the Czech Republic and the euro area could be a source of asymmetric shocks. The sustainability of Czech public finance has also yet to be resolved, including with regard to the possible tightening of the MTO by comparison with the current situation in the event of euro adoption. Labour market flexibility may be reduced in future by the configuration of the tax and social benefit system. Misalignment of business cycles is also a barrier to euro adoption. Growth in residential property prices and property purchase loans remains a risk to the Czech banking sector. This risk can be addressed more effectively if domestic monetary policy, macroprudential policy and banking supervision are independent.
In addition to benefits, the adoption of the single currency also entails costs, which must be taken into account when deciding on the timing of euro area entry. The total financial costs that will be associated with euro adoption in the future are not known yet. The estimated financial obligations for the Czech economy, which were not known when the Czech Republic joined the EU, mainly include a capital deposit in the European Stability Mechanism (almost CZK 50 billion payable within four years, with an additional contingent liability of up to CZK 365 billion in the extreme scenario) and a transfer of CZK 25.1 billion in contributions from banks registered in the Czech Republic to the Single Resolution Fund (collected now in the National Resolution Fund).
To sum up, the Czech Republic should be compliant with the criterion on the government financial position, the criterion on the convergence of interest rates and the criterion on price stability in 2018. It is thus non-compliant only with the criterion on participation in the exchange rate mechanism in the long term. The preparedness of the Czech Republic itself to adopt the euro has improved further compared to previous years, although some shortcomings – especially the incomplete process of real economic convergence – persist. The economic situation in the euro area is stabilised, but the level of economic development in euro area countries remains uneven and convergence is ongoing in only some of the new member states. Moreover, unresolved debt and structural issues persist in a number of countries. The fiscal indiscipline of some members is a long-standing problem in the euro area. Discussions are continuing about the future institutional set-up of the European Union and the euro area.
In view of the above facts, the Ministry of Finance and the Czech National Bank, in line with the Czech Republic’s Updated Euro-area Accession Strategy, recommend that the Czech government should not set a target date for euro area entry for the time being. This recommendation implies that the government should not aim for the Czech Republic to join the exchange rate mechanism for the time being.
- Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro Area (December 2018)PDF (473kB)