Euro Adoption: Chance and Challenge for Romania
Like the other Central and Eastern European countries, Romania committed itself to adopting the euro as soon as it will meet the necessary conditions. The candidates have, however, a considerably large margin of manoeuvre in determining the moment when they will adopt the euro. Especially two accession criteria to the Monetary Union – harmonization of the legal framework with the Eurozone standards and the prior participation in the European Exchange Rate Mechanism II (ERM) – are entirely under the sovereign control of the states. On the other hand, the institutions of the Eurozone have an important role in the euro adoption process, notably when it comes to assessing the extent to which a certain country is ready to participate in the ERM II.
Five former communist countries (Slovenia, Slovakia, the Baltic countries) have already adopted the single European currency. Other countries (Bulgaria, Czech Republic, Croatia, Poland, Romania and Hungary) have not solved this issue yet, but some of them (Hungary, Poland, and most recently Romania) show some reluctance in establishing a precise date for this operation. However, it must be stated that Bulgaria and Croatia are, to a certain extent, part of the European Monetary Union, because they have linked their currencies to the euro: Bulgaria – through the “currency board” monetary regime and Croatia – through the “tightly managed quasi-peg” regime. In other words, the monetary regime of Bulgaria and Croatia presents some features of the situation in which these countries have officially already adopted the euro. Unlike these countries, the Czech Republic, Poland, Romania and Hungary seem to be determined to apply sine die the current monetary policy strategy, called “inflation target”, which allows the floating of the exchange rates. This is the reason why the IMF (2016) included the Hungarian forint and the Romanian leu in “floating” category of currencies, and the Polish złoty in the category of “free floating” currencies. Finally, it is noteworthy that the euro is used with the EU’s permission in Andorra, Monaco, San Marino and the State of Vatican, and other two states from the Western Balkans – Kosovo and Montenegro – adopted the euro without EU’s permission.
Positive effects of the euro adoption
The perspectives of the future of the euro and the Eurozone have been, until recently, uncertain, but current political events in France and Germany, from the European Commission and the European Central Bank, as well as the developments in the world financial markets show that the European Monetary Union will not disintegrate, but it will continue to strengthen, contributing to the transformation of Europe’s economy into a more inclusive, more competitive and more resilient and prepared for the future economy. In this context, the President of the European Commission, Jean-Claude Juncker, recently said that he wishes to see more EU member states joining the Eurozone and that the countries that are already in this area should help those countries that aspire to join to meet the needed conditions for this purpose. Therefore, it is not the euro that threatens Romania’s future, as suggested by some speeches in the Romanian public space that do not lack in xenophobic, nationalist, demagogic, anti-capitalist and anti-Western tendencies. On the contrary, a sine die postponing of the euro adoption seriously affects Romania’s interests, by excluding the Romanian authorities from the decision-making process regarding the European construction and by encouraging the anti-reform and isolationist forces of Romanian society.
The President of the European Commission, Jean-Claude Juncker, recently said that he wishes to see more EU member states joining the Eurozone and that the countries that are already in this area should help those countries that aspire to join to meet the needed conditions for this purpose.
The main positive effect of the euro adoption is the stimulation of the foreign trade, which can lead to a faster economic growth and, thus, to an impetus to close the gaps with the developed countries, to create new jobs and to a higher welfare on a wider scale. This conclusion is supported by numerous empirical studies, which show that a monetary union leads to an important increase of the trade volume between member states, with all the implications in production, income and standards of living.
Another major effect is the improvement of the way foreign investors perceive the country risk, which is important, especially in countries where institutions are weak. So, the euro adoption eliminates the currency risk, increases the access to last resort credit, open in a global reserve currency and, generally, it increases the credibility of the monetary instrument. Hence, all of these factors determine, among other things, the decrease of the cost of financing economic activities.
The third effect is the elimination of monetary distortions resulting from the predominance of foreign currencies (dollars, euros) in certain types of domestic transactions, particularly in some lending operations. And, as the events brought up front by recent legislative initiatives (the Law of Payment and the Law of Conversion for the Swiss Franc Loans), these distortions can easily be transformed in political tensions with unpredictable consequences.
Along with the mentioned direct advantages of adopting the European currency, there are a series of indirect effects, highly important, because they contribute to the completion of the integration process, meaning Romania’s return to the European civilization. So, the introduction of the euro creates a more stable environment for the entire economy, which can attract foreign direct investments. In turn, these investments create a faster growth of the GDP and a decrease of unemployment, enhancing foreign trade and, finally, increasing the living standards to European level.
Disadvantages of the euro adoption
The main disadvantage of the euro adoption is losing the monetary autonomy, meaning giving up to the possibility of adapting the monetary policy to respond to external shocks. But there are a number of factors suggesting that, in a peripheral economy, with a relatively high degree of openness and free movement of capital, like Romania’s economy nowadays, the monetary policy has a limited sphere of action. Losing the independent monetary policy would be, therefore, less troubling than it is ordinarily assumed.
The main positive effect of the euro adoption is the stimulation of the foreign trade, which can lead to a faster economic growth and, thus, to an impetus to close the gaps with the developed countries, to create new jobs and to a higher welfare on a wider scale.
In Romania, capital movement is completely free, and capital and financial flows exceed significantly imports and exports of goods and services. This circumstance is beneficial, because, having a less developed economy and in a prolonged state of transition, Romania desperately needs foreign capital. However, it is true that, alongside foreign direct investments, capital inflows include also less stable forms, such as external loans, including governmental ones (“sovereign” debt) and portfolio investment. In these conditions, the international capital flows in which Romania’s economy is inserted are influenced by internal and external factors. The most important internal factors are: the interest rate differential (particularly between Romania and the Euro Area); profits; exchange rate developments and country risk premiums etc.
The external factors, namely those factors that are in the economies of capital exporting countries, or in the host-countries’ economies that compete with Romania to attract foreign capital, are: the market imperfections; monopoly (oligopoly) advantage; outsourcing production as an alternative to the imperfections of the internal market; governmental policies to attract direct investment, etc. Related to these factors, the domestic monetary policy can influence only the short-term interest rates and, partially, the exchange rate. Other internal policies can also influence, to a certain extent, some of these factors, such as the profits obtained by the foreign investors in Romania, but their ability to promptly address some inflections in the size and orientation of capital flows is significantly lower than that of the monetary policy.
There are a series of indirect effects, highly important, because they contribute to the completion of the integration process, meaning Romania’s return to the European civilization.
The truly complicated issue is that, besides the factors mentioned above, situated more or less at the intersection of the domestic economy with the global economy, the evolution and structure of capital flows are strongly influenced by a series of factors that are completely outside the incidence sphere of the Romanian authorities’ policies. From these uncontrollable factors, the following ones can be mentioned: the evolution of interests at a global level; regional influences and the perception of the regional situation by the international investors; global liquidity etc.
However, it can be assumed that after the leu’s entry into the ERM II, regional evolutions will have a relatively low effect on the exchange rate, considering that an essential characteristic of this mechanism is the obligation of states to maintain their currencies’ exchange rate within a ±15% boundaries. The downside is that the monetary policy will not be able to use the exchange rate to influence the domestic economic activity.
The conclusion that emerges is that, in the case of economies with free capital movement, but low global importance (unlike, for instance, the US economy), the monetary policy cannot ensure at the same time an internal and an external equilibrium, meaning it cannot ensure a correct level of the exchange rate and of the interest rate. Therefore, such economies are placed into a situation known as the “incompatibilities’ triangle”, where there can be no simultaneous free capital flows, fixed exchange rates and an autonomous monetary policy. There are sound reasons for this, and a supposed incompetence of the central bank does not factor into them.
Such economies are placed into a situation known as the “incompatibilities’ triangle”, where there can be no simultaneous free capital flows, fixed exchange rates and an autonomous monetary policy. There are sound reasons for this, and a supposed incompetence of the central bank does not factor into them.
Finally, the euro adoption is sensitive to modifications of the other components of the macroeconomic policies mix, especially the fiscal policy that has to respect the provisions of the “European Stability and Growth Pact” and the regulations of the banking sector, which have to be in line with the rules of the European Banking Union. Considering the recent uncertainties about Romania’s compliance regarding the budgetary deficit and public debt criteria, the obligation to meet these requirements can stop the populist drifts of the Romanian authorities.
In conclusion, for Romania, the advantages of adopting euro are significantly higher than its disadvantages, thus, this country should adopt the euro as soon as possible. There are some clues that this objective is not as unrealistic as it might seem at a first glance. The recent political events at EU level and the relations between EU and Romania show that some important European countries seem to be willing to reconsider Romania’s situation as a peripheral country. This would be the third crucial moment in Romania’s recent history, after the fall of communism and joining the Euro-Atlantic structures.