REPORT BY THE (ECOFIN) COUNCIL TO THE EUROPEAN COUNCIL IN NICE
ON THE EXCHANGE RATE ASPECTS OF ENLARGEMENT
1. This report presents the views of the Council (Ecofin) on exchange rate strategies for the twelve candidate countries with which accession negotiations are underway (hereafter "accession countries").
2. The Council (Ecofin) has drawn on a report prepared by the services of the Commission, a contribution of the European Central Bank and the report which the Economic and Financial Committee had presented to the Informal Ecofin meeting in Versailles and which had met with a broad consensus.
3. The Council (Ecofin) identified three distinct stages for the full monetary integration of candidate countries: the pre-accession stage; the accession stage, covering the period from accession to the Union to the adoption of the euro, and finally the adoption of the euro. The implications of each stage for the choice of the exchange rate policy are discussed below.
Prior to accession, there are no formal restrictions on the choice of an exchange rate regime.
4. Exchange rate regimes should not be looked at in isolation, as they are part of the overall economic and monetary policy framework of candidate countries. Policies should be oriented towards achieving real and thereby sustainable nominal convergence. They need to focus on structural adjustment and microeconomic reform so as to facilitate the fulfilment of the (economic) Copenhagen criterion of "the existence of a functioning market economy able to cope with competitive pressures and market forces within the Union". Without such policies, there is a risk that any exchange rate strategy will run into serious difficulties and macroeconomic stability will be difficult to achieve and maintain.
5. The consistency of economic policies, including the choice of exchange rate regime, and their suitability to the economic situation of the accession country are crucial. The choice of an exchange rate regime on the path from pre-accession to accession must therefore take into account several factors. Among these are: achieving macroeconomic stability, facilitating transition, growth and real convergence, preparing for integration into the EU and participation in the Single Market, adjusting to real shocks, maintaining external balance, and dealing with capital flows. Given the diversity of these factors, the appropriate policies are those aimed at creating the right conditions for the proper functioning of markets and for the success of the economic transformation process. In this context, the choice of the exchange rate regime should be consistent with and support an overall economic strategy geared towards achieving these goals.
6. During the pre-accession stage , the choice of a specific exchange rate regime is the responsibility of the individual candidate country. A plurality of approaches (i.e. different exchange rate regimes) seems to be feasible, as was already the practice with the countries that have already joined the EU. Exchange rate regimes should be compatible with the economic situation and characteristics of the country concerned and the state of transition. This does not mean the EU would treat these choices with indifference. In the context of the European Agreements, the EU monitors closely whether economic policies, including the exchange rate regime, are contributing to macro-economic stability and promoting real and nominal convergence.
7. Fixed exchange rate regimes, including Currency Board arrangements, can be sustainable in small and open economies with sufficient wage and price flexibility, strict fiscal discipline and sound financial systems. The existence of some successful experiences with Currency Board arrangements thus far, however, does not imply that such arrangements should be generally seen as a panacea. Indeed, much of their future success depends on the willingness of the countries involved to cope with the internal discipline imposed by this particular exchange rate arrangement. All twelve accession countries will undergo, to different degrees in the years ahead, a process of catching-up (i.e. real convergence). This should go along with improvements in their terms of trade and thus is likely to imply some trend real exchange rate appreciation. In the case of a fixed exchange rate regime this would result in a somewhat higher level of inflation than would be the case if the nominal exchange rate were allowed to appreciate. A clear path towards lower inflation will facilitate future nominal convergence.
8. Accession countries will also have to cope with increasing capital inflows, in particular given the orderly capital movement liberalisation that the adoption of the EMU acquis requires already in the pre-accession phase. Capital flows may be easier to tackle with some exchange rate flexibility. When dealing with external imbalances in a context of free capital movements, fiscal policy is generally a most appropriate instrument of adjustment.
9. Potential EU members wishing to join ERM II relatively swiftly after accession are already now expected to consider their policies with a view to their prospective membership in ERM II. In this context, it should be made clear that any unilateral adoption of the single currency by means of "euroisation" would run counter to the underlying economic reasoning of EMU in the Treaty, which foresees the eventual adoption of the euro as the endpoint of a structured convergence process within a multilateral framework. Therefore, unilateral "euroisation" would not be a way to circumvent the stages foreseen by the Treaty for the adoption of the euro.
Upon accession, new Member states shall treat their exchange rate policy as a matter of common interest
10. Candidate countries will enter the EU as Member States with a derogation. In principle, it should be possible for them to bring in with them their existing exchange rate regime. Most, if not all, of the economic policy considerations that determine the choice of an exchange rate regime in the pre-accession phase will continue to apply.
11. In accordance with Article 124 of the Treaty, the new Member States shall be required to treat their exchange rates as a matter of common concern. In practice, this means that, in order to protect the smooth functioning of the Single Market, competitive devaluations are not allowed. As Member States with a derogation, the new countries will also participate in the co-ordination of economic policies to the extent required by the Treaty and will be expected to work towards fulfilling the Maastricht convergence criteria.
After accession, although not necessarily immediately, accession countries are expected to join the ERM II.
12. The new Member States will be expected to enter ERM II, established by the European Council Resolution of 16 June 1997. The key features of the ERM II are that it has stable but adjustable central rates to the euro for the participating currency with fluctuation bands of +/- 15 % around the central rate and that it uses a common procedure for the main decisions relating to the conditions of participation of a country in the mechanism. A new Member State may join ERM II, upon request, any time after accession, subject to agreement on the central parity and fluctuation band in accordance with the common procedure referred to above. Most accession countries have stated their intention to join the mechanism as soon as possible after entry into the EU.
13. The multilateral nature of the above-mentioned common procedure implies that, ultimately, final decisions related to a request for participation can only be taken on a case-by-case basis at the time of entry in the mechanism. At the same time, the ERM II is flexible enough to accommodate the features of a number of existing exchange rate strategies. The only clear incompatibilities with the ERM II that can be identified already at this stage are the cases of free floating (or managed floats without a mutually agreed central rate), crawling pegs, and pegs against anchors other than the euro.
14. When a country with a Currency Board pegged to the euro wants to join ERM II, the decision on the compatibility of a particular Currency Board arrangement with participation in ERM II could only be taken on the basis of a careful assessment of the appropriateness and sustainability of the Currency Board in question. This conclusion follows logically from the procedure foreseen in the ERM II Resolution concerning the adoption of central rates. Although Currency Board arrangements cannot be regarded as an acceptable substitute for participation in ERM II, they may in some circumstances constitute an appropriate unilateral commitment within ERM II. Such a unilateral commitment would not impose any additional obligation on the ECB beyond those deriving from the ERM II resolution and the Central Bank Agreement.
After application of the procedure provided for in the relevant parts of the Treaty, the new Member States will adopt the euro in a manner that ensures equal treatment with the initial participants in the euro area.
15. Finally, the participation in the euro area of the new Member States will be decided as soon as it complies with the conditions for the adoption of the single currency, defined by the Treaty establishing the European Community. The assessment process will ensure equal treatment between future Member States and the current participants in the euro area. The Council will adopt the rate at which the euro will be substituted for the currency of the Member State and the Member State will prepare for the introduction of the euro.