Posted in Finance Articles, Total Reads: 2690
, Published on 05 March 2012
Economies are like the game of snakes and ladders in which a good economic decision can take you up through the ladder of success while poor ones pull you down. Poland is on crossroads where their decision to adopt euro can boost the economy take them up the ladder in the game, however if the decision turns out to be a bane for the country, it would result in the economy becoming a victim of the big, venomous snake called recession. The theme of this article revolves around the same snakes and ladders game; I renamed it as “Euro game”.
Since 2004, when they became a part of the Euro Union, the debate on this question has been going on. There have been two groups, first the modern and forward looking one which favors the adoption of euro as they believe it would result in the growth and development of the economy and the standard of living, and the second the orthodox and reserved ones believe that it would take away their rights and control on their economy and would turn out to be a disaster.
These groups have been mainly formed on political grounds. The two parties of their political system, Kaczyński brothers’ the Law and Justice (PIS) party, which was the previously ruling party was skeptical about rushing into joining and it still believes in taking it slow and weighing the pros and cons, and wanted to go through a referendum on the situation. Whereas, the party currently ruling the nation, Prime Minister Donald Tusk’s Civic Platform (PO), has been intent on adopting it sooner. A similar conflict has been between the people. The support for the euro has been higher in the larger cities while lower in the relatively rural areas.
The Governor of the National Bank is of the opinion believes that haste could be harmful to the country’s economy but still suggests that Poland should join in. And so is the belief of Saryusz-Wolski, who in line with German Chancellor Angela Merkel's aims affirmed the necessity to change the EU treaty regarding the size of loans that member states can take among themselves, so that “no one goes into debt at the expense of somebody else.”
Poland will have to postpone this convergence which they were hoping to happen in 2012, owing to the recession which has hit the economy resulting in failure in meeting the conditions set by the European Monetary Union. To join the game of Euro, Poland will have to qualify first. The first of two main barriers (conditions) are the requirements of the Maastricht Treaty and secondly they have to take part in the European exchange rate mechanism (ERM II) under the European Monetary System (EMS) for a period of two consecutive years, which means that exchange rate of Poland cannot fluctuate more than 15% against the euro during that time.
After swimming through these oceans, other small canals have the criteria to include an inflation rate of no more than 1.5 % points above that of the 3 members of the European Union showing lowest inflation. The deficit to GDP ratio ( i.e. Ratio of the annual government deficit to gross domestic product ) must not exceed 3 percent (or at least be at a level close to 3%) at the end of the fiscal year before joining, which currently is 7.9% for the country. Government debt ratio to GDP should be less than 60% at the end of the fiscal year before joining, or should be approaching this figure at a ‘satisfactory rate’; this condition is being satisfied by achieving a 51% ratio. Finally, nominal long-term interest rates should be less than two percentage points above the 3 members of the European Union showing lowest inflation.
These targets are very difficult to achieve especially in the prevailing economy conditions, few countries already members of the Euro zone are finding it difficult to achieve them.
European Central Bank even though asked by IMF to relax its regulations, does not want to do so as after the euro crisis all the member countries have become very particular about the countries being added as they do not want to pay the loans of any other non-performing country. Every financial decision has two sides to it, the country has to weigh both the sides and decide whether the prospect’s advantages surpass its disadvantages or not. Adopting euro comes with its fair share of pros and cons and both having long-term and short-term effects.
First, let’s have a look at the bigger picture, the long term positives and negatives. Proponents for the adoption of the euro would be the potential benefits that a common currency will bring, especially the increase forecasted in country’s trade and growth resultant of monetary integration with the rest of Europe. Different costs related to zloty / euro exchange rate connections would be eliminated along with the exchange rate risk in the trade with countries of Euro zone.
The exchange rate risk elimination is expected to not only have a positive and direct effect on business, but is also been anticipated to remove this type of risk for Poles who normally borrow in foreign currencies to fund large ticket items such as infrastructure needs like houses and apartments. Since the Euro zone crisis began, the Polish zloty experienced a decline while losing approximately 1/3rd of its value in relation to Europe’s more stable currencies and to the dollar. This had a particularly adverse affect on the many Poles who took out mortgage loans in currencies like Swiss francs to buy homes and who, as a result ended up paying many thousands zloty more for their new purchases in real terms.
From the above graph we can clearly see that there is a significant in the GDP growth rate of Poland and that of the euro zone. Thus, the policies in the euro zone would be chartered by taking into consideration all the countries and would not prove beneficial for Poland which is growing at a higher rate than the members of the zone.
There is a lot of excitement amongst the public regarding the euro. The decisions for its adoption are yet to be taken and it has already started affecting the interest rates and currency at which households take loans, and corporate and the government issue bonds. The lowering of the interest rates to meet the conditions set has already resulted in an increase in investments. But this comes with its own bit of risks.
This lowering of interest would have taken the country to the euro zone desired interest levels had the economic boom continued. But the reverse happened resulting in higher interest rates and a drying-up of foreign financing. This anticipation behavior of euro adoption is leading to one more problem, people have started taking loans other currencies than their own. This would lead to domestic monetary policy gradually losing its ability to influence the economy. Also, borrowing in foreign currency exposes them to the risk of an exchange rate depreciation. Euro adoption would eliminate such currency mismatches and thus relieve both borrowers and investors from the risk that the exchange rate will move against them. It is thus a win-win situation for both sides.
Portugal’s experience suggests that the “structural” fiscal deficit—the deficit corrected for the economic cycle—should be well below the 3 percent Maastricht limit, especially for countries like Poland where the level of public debt is still high. This would allow the government to deal with economic shocks—such as the loss of competitiveness experienced by Italy’s and Portugal’s textile industry—without ending up in the EU’s excessive deficit procedure and experiencing a rise in public debt.
Becoming a part of the world’s second largest economy does bring large economic payoffs, but this does not mean that they reduce their fiscal deficit to 3% and joining the exchange rate mechanism, the two Maastricht criteria that are not met currently. Giving up monetary policy requires sharpening the remaining tools at the policy maker’s disposal--a fiscal policy characterized by small deficits, low debt and flexible spending, as well as creating a nimble, business-friendly environment. Now it’s for Poland to decide whether they see Euro as a ladder which would take them further or a snake waiting to bite them. And only time can unfold the secrets of the game, I call it “Euro game”.