ECB's Stark-New EU states must converge sustainably

...there are question marks over whether this is sustainable, a top European Central Bank official said.

ECB Executive Board member Juergen Stark said central and eastern European countries had made rapid progress on improving their standards of living in the last two decades but to adopt the euro, they had to ensure convergence was sustainable.

Experience showed that countries with hard pegs to the euro -- Bulgaria and the Baltic nations -- faced different economic challenges to those with more flexible currency regimes, namely the Czech Republic, Hungary, Poland, Romania and Slovakia.

Growth in Bulgaria and the Baltic states of Latvia, Lithuania and Estonia in the last two years had been almost twice as fast as the other new EU members, and inflation 1-1/2 times as fast. In these countries, labour shortages were driving up wages, credit growth was rapid, house prices were booming and high private consumption boosted current account deficits.

"In principle, (this) could be seen as an indication that, for some of these countries, the current situation might not be sustainable," Stark said in a speech to a conference on convergence, published on the ECB's Web site overnight.

"This makes it all the more necessary to look more deeply at the macroeconomic developments and challenges ahead."

The 10 countries that joined the EU in 2004, and Romania and Bulgaria which joined this year, are obliged to work toward joining the euro.

So far only three -- Slovenia, Malta and Cyprus -- have passed the euro entry tests, which require countries to meet benchmarks on inflation, public finances and currency stability on a sustainable basis.

Stark said the question of which exchange rate regime was the best suited for a stable convergence process had to be answered on a country-by-country basis but the answer did not absolve countries of the need for budget and structural reforms.

Countries with flexible exchange rates tended to have excessively high budget deficits and faced the risk of accelerating inflation as the catching-up process gained pace.

For these countries, Stark said, central banks had to be ready to raise interest rates to keep prices stable and fiscal consolidation was vital.

* To read the speech, go to the ECB's Web site http://www.ecb.int/press/key/date/2007/html/sp071001_1.en.html

[FRANKFURT/Reuters/Finance.cz]