For all its flaws, the euro zone’s gravitational pull is proving hard to resist.
Croatia and Bulgaria became the latest countries to inch closer to the bloc when they got the green light on Friday to enter the so-called waiting room to join the single currency. They would be the 20th and 21st members; Romania, another former communist state, hopes to be the 22nd.
Less than a quarter of century since it was created, the euro area has been repeatedly buffeted by financial meltdowns that could have easily shattered the entire project.
Yet those episodes also spurred governments to allow the European Central Bank to boost its powers in an effort to keep the bloc together. That’s proved to be a strong-enough argument for some that a shared currency — which all European Union members are technically supposed to adopt, though Denmark has an opt-out and others have resisted — still holds appeal.
“It’s a tremendous vote of confidence in the EU and the euro if more countries want to join — it’s a confidence booster,” said Gilles Moec, chief economist at AXA. “It may be a bit of a headache for the central bank, but expanding the euro area should boost its credibility as a currency for the entire EU.”
Croatia and Bulgaria will now spend at least two years with their currencies pegged to the euro before they can become full members.
When they do, they’ll gain full access to the massive financial backstop of the ECB, which has repeatedly stepped in to calm crises. As the coronavirus pandemic hit Europe, it announced a highly flexible bond-buying programme specifically to keep down government borrowing costs in stressed economies such as Italy’s.
They’ll also adopt the world’s second-biggest reserve currency, replacing a Croatian kuna and Bulgarian lev that never fully won public trust. Close to 80 per cent of savings in Croatia are in euros, and at an event last year to mark the 25th anniversary of
the kuna, central bank governor Boris Vujcic said he hoped it would never reach its 30th.
The nations are essentially pursuing a policy of being stronger inside a club, and choosing to look west in doing so, as other eastern European nations did before them.
Slovenia was first to join in 2007. Slovakia grappled with currency instability before it entered in 2009. The Baltic republics of Estonia, Latvia and Lithuania, after massive economic meltdowns during the global financial crisis, joined from 2011 to 2015 in part due to geopolitical concerns related to their proximity to Russia.
Croatia and Bulgaria are two of the EU’s poorest members, and both rely heavily on foreign tourism that has been crushed by the pandemic. They’ve already turned to the ECB to set up swap lines to access euros.
“First and foremost, it’s a part of a political process,” said Simon Quijano-Evans, chief economist at Gemcorp Capital in London. “But it makes complete economic sense as well.”
Still, membership has its risks. The loss of control over exchange rates means that euro members can’t devalue their way out of a crisis. Instead, they could be forced into a damaging spiral of falling prices and wages, as happened for southern European economies in the euro zone’s sovereign debt crisis.
There is little sign that euro-zone membership alone drives a convergence in living standards. Italy has yet to regain the level of economic output from 2007, before the last financial crisis. That’s one reason why enthusiasm for the currency isn’t universal.
Poland, the largest EU economy outside the bloc, says it won’t consider dumping the zloty until Polish living standards are equal to those in western Europe. Hungary’s central bank wants stronger membership criteria, including higher productivity, a more mature financial system and a close alignment of economic cycles. Czech prime minister Andrej Babis has repeatedly said he doesn’t want to help bail out struggling nations like Italy.
The ECB’s own progress report published last month showed that Bulgaria and Croatia still have plenty of work to do before they can join the euro, especially on inflation and the health of public finances. Concerns have also been raised over whether Bulgaria has adequately fought corruption and money laundering, after financial crimes hit the region in recent years.
For the central bank in Frankfurt, the new entrants raise the prospect that it’ll one day be called on yet again to step into prevent a localized financial crisis from spreading to the rest of the bloc. They may have tiny economies, but Greece still came close to splintering the currency union in 2015 despite accounting for less than 2 per cent of euro-zone GDP.
For Croatia and Bulgaria, better that than the alternative.
“This crisis showed us that those that are in the euro zone and its waiting room will have access to billions of euros for recovery,” said Bulgarian prime minister Boyko Borissov. “Those who aren’t will take on debt, and with huge interest.”