FRANKFURT (MNI) – The European Central Bank warned on Wednesday
that the inflation convergence of Estonia, the next country in line for
EMU accession, may not be sustainable.

The central bank also said that the economic crisis has highlighted
some key challenges countries need to address before meeting monetary
union convergence criteria.

More broadly, the ECB appeared to be taking a cautious stance on
expanding the Eurozone into additional peripheral countries in the face
of the sovereign debt crisis and the questions it has raised as to
whether the currency union may have expanded too quickly without
assessing certain countries — such as Greece — carefully enough.

Estonia is scheduled to join the Eurozone at the beginning of next
year. In contrast to the ECB’s assessment, the European Commission today
said Estonia had satisfied the entry criteria “and is ready to adopt the
euro on January 1 2011.”

But the ECB, focusing on price stability concerns, said the current
low inflation levels in Estonia mainly reflect temporary factors. Over
the medium term, maintaining low inflation rates will be “very
challenging given the limited room for manoeuvre for monetary policy,”
the ECB report said.

“The catching-up process is likely to have a bearing on inflation
over the coming years, given that GDP per capita and price levels are
still lower in Estonia than in the euro area. Once output growth
resumes, with a fixed exchange rate regime, the underlying real
adjustment is likely to manifest itself in higher inflation,” the
central bank said.

The report said that the experience over the past few years with
strong growth highlighted the difficulties Estonia would have achieving
price stability in the absence of an independent monetary policy.

“In sum, there are concerns regarding the sustainability of
inflation convergence in Estonia,” The ECB warned.

It also said that developments in financial markets suggest “a
mixed assessment” with a number of indicators showing that “market
participants had significant concerns regarding the sustainability of
convergence in Estonia.”

While the ECB appeared less critical on other convergence criteria,
its airing of inflation concerns is a blow to Estonia, which has been
very enthusiastic about its aim of joining the monetary union in January
2011. But the ECB gives only its opinion on the matter, leaving
recommendations on new members up to the European Commission and
decisions up to European politicians.

Looking ahead, the ECB said that in creating an environment
conducive to sustainable convergence, Estonia needs to conduct “economic
policies geared towards ensuring overall macroeconomic stability,
including sustainable price stability.”

“Given the limited room for manoeuvre for monetary policy under the
currency board arrangement, it is imperative that other policy areas
provide the economy with the scope to cope with county-specific
[problems] and to avoid a re-occurrence of macroeconomic imbalances,” it
asserted.

The ECB raised a more general question about the readiness of
several smaller EU countries, mostly in eastern Europe, to join the
euro.

“In many countries important challenges have come to the fore
related to previously accumulated imbalances and vulnerabilities, which
have led to a deep adjustment process over recent years,” the report
said.

The bi-annual ECB report examined convergence progress in nine EMU
member states including Bulgaria, the Czech Republic, Estonia, Latvia,
Lithuania, Hungary, Poland, Romania and Sweden. “Exacerbated by the
global financial and economic crisis, real GDP in most countries under
review collapsed or declined strongly,” the report said.

“While this weakening of economic activity together with external
influences contributed to dampening inflation, fiscal positions
deteriorated sharply, and country risk premia, as evidenced by long-term
interest rates, rose significantly,” it added.

–Frankfurt newsroom, +49-69-720-142; jtreeck@marketnews.com

[TOPICS: M$$EC$,M$X$$$,MT$$$$,M$$FX$,MGX$$$,M$$CR$]