beyondbrics

By Mujtaba Rahman, Europe analyst at Eurasia Group

While much of the mainstream debate regarding the EU’s sovereign debt crisis has focused on the core (creditor) and peripheral (debtor) countries, less attention has been paid to the implications for central and eastern Europe, despite important political/policy shifts that are taking place across the region well below the radar.

Historically, the carrot of EU entry has always provided a strong incentive for internal reform. When the ten countries of CEE joined the EU in 2004, alongside Romania and Bulgaria in 2007, this came on the back of a decade’s worth of political and economic structural change, as these countries adopted the infamous acquis communautaire – 35 chapters of EU law that ensure compliance with the EU’s “Copenhagen Criteria”, on democracy, the market economy and human rights.

Yet since their admittance, the momentum behind domestic reform has slowed – understandable given that EU negotiators lose the most critical element of their leverage. This explains why the French and Germans have been reluctant to admit Romania and Bulgaria into the Schengen zone of internal EU visa-free travel – it is seen as the only near-term carrot that will encourage additional reforms in these countries with respect to their judiciaries and corruption, now that they have been formally admitted into the EU.

Yet while Schengen is important, only Euro adoption and membership of the Euro-group has the potential to anchor and incentivise movement on very broad and deep structural reforms akin to those undertaken by countries when they aspire to EU membership.

Historically, CEE countries have been very keen to adopt the Euro for both push and pull reasons. Regarding the former, CEE countries – especially the larger countries in the ex-Vizegrad bloc – have all had relatively unhappy experiences with freely floating exchange rates; while on the latter, rising degrees of intra-industry trade with Western Europe – especially Germany – have created an important export/business constituency which stands to gain from the elimination of exchange rate uncertainty that Euro adoption would entail.

Yet having said this, the timetable for Euro adoption has slipped, and with it, the risk that domestic discipline to reforms will as well. (While joining the Euro is in principle a legal obligation, candidate countries are simply able to delay their entry into ERM II, which is a pre-requisite for succession, thereby delaying their entry timetable).

In Poland, the governing coalition of the Civic Democrat (PO) and Polish Peasant Party (PSL) last year dropped its 2012 target date and is yet to announce a new one (although 2015 has been floated unofficially); in Hungary, Viktor Orban, Fidesz’s populist prime minister, has stated that Euro entry does not look like a realistic proposition until the end of the decade; the three-party Czech coalition has yet to announce a new entry date since the original 2010 date was jettisoned by a previous administration, while Vaclav Klaus, the Eurosceptic president, has questioned whether the government’s legal obligation to join is still valid given the Euro area’s crisis; Romania’s 2015 entry date remains more aspirational than real.

Legitimate questions remain over the EU’s Euro adoption reform agenda (given that the Maastricht Convergence Criteria primarily relate to ex-ante convergence on fiscal/debt levels as well as interest/inflation rates, it is questionable whether such reforms actually improve the ability of countries to adopt the Euro in a sustainable way).

Nonetheless, it still would have represented an economic policy/outlook improvement compared to the status quo. The absence of near-term Euro entry – and with it important incentives for internal reform – brings with it new risks for the region and the EU alike.

Related reading:
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