(Adds detail on Commission report)
FRANKFURT, May 7 (Reuters) - The European Central Bank said
on Wednesday it has "considerable concerns" about whether
Slovakia can keep inflation under control in the longer term if
it adopts the euro in January as the country plans.
At face value, Slovakia met the euro entry tests on
inflation, public finances, currency stability and interest
rates when the snapshot of its economy was taken in March.
But in its latest convergence report, the ECB queried
whether Slovakia can avoid higher inflation if it does join the
single currency region, saying there were upside price risks.
"To sum up, although the 12-month average rate of ...
inflation in Slovakia is currently well below the reference
value, there are considerable concerns regarding the
sustainability of inflation convergence," the ECB said in a
report on EU countries' readiness to join the euro.
The ECB does not make a formal recommendation on whether
countries should be allowed to adopt the euro or not. A separate
report prepared by the European Commission on Wednesday proposed
Slovakia be allowed to adopt the euro in 2009.
The Commission's recommendation has to be backed by European
Union finance ministers and then approved by political leaders,
a decision expected in June.
Most economists expect a positive verdict for the central
European country, which would then become the 16th country to
formally adopt the euro and join on Jan. 1 next year.
The ECB said Slovakia also needs to cut its budget deficit
faster, tackle a gummed-up labour market and keep a lid on wage
rises if it is to avoid excessive inflation when it is no longer
able to set its own interest rates or revalue its currency.
The ECB report showed that, as expected, Slovakia currently
met the formal criteria on joining the single currency, with
moderate inflation, low public debt, a shrinking budget deficit,
fairly stable currency and low long-term interest rates.
INFLATION A WORRY
But the ECB -- whose main goal is to keep euro zone
inflation just below 2 percent -- has been stung by a sharp rise
in inflation in Slovenia, the only other ex-Communist state to
join the euro zone.
Though Slovenia met the entry criteria before it joined in
2007, its inflation is now the highest in the euro zone at 6.2
percent in April.
Slovak inflation hit 3.6 percent in March but the average
over the previous year, which is used to assess eligibility, was
2.2 percent, well below the 3.2 percent maxiumum allowed.
The ECB nonetheless said it was concerned that Slovak
inflation had been kept down partly by the appreciation of the
Slovak crown <EURSKK=>, which will no longer be possible if
Slovakia adopts the euro.
The ECB noted estimates that the dampening effect of
currency appreciation may have been as high as 1 percentage
point in 2007, although the Slovak central bank estimated the
impact at 0.3-0.5 percentage points.
"Looking ahead, the latest available inflation forecasts
from major international institutions ... suggest that annual
average inflation is likely to rise considerably in 2008 and
decrease slightly in 2009," the ECB said.
"In view of current developments in global energy and food
markets, and given ongoing strong growth in domestic demand, as
well as the tightening of labour market conditions, the balance
of risks to these forecasts for Slovakia is on the upside."
Slovak central bank governor Ivan Sramko -- who will join
the ECB's Governing Council if his country adopts the euro --
disputes the idea that the strength of the crown had played a
major role in controlling Slovak inflation.
"The fulfilment of the inflation criterion is no one-day
wonder, but the expression of a sustainable development," he
told Germany's Frankfurter Allgemeine Zeitung in an interview
published ahead of the report on Wednesday.
(Reporting by David Milliken and Krista Hughes; editing by
Stephen Nisbet)
