Case Study - Influence of Euro Adoption on the Slovak Economy

"Slovakia is going to join the Eurozone", - this statement can be said for sure. The aim of this analysis is to point out the experience of some EU countries which have adopted the Euro, how it can influence further macroeconomic indices, population consumption habits and their satisfaction with new changes e.g. wages, inflation, changeover costs.

For comparison, I have chosen Slovenia. It's a small and very open economy mainly because of its size, except that the GDP growth was and still is on an admirable level, similar to Slovakia. And finally, it has a socialistic background, too. Slovenia was the first post-communist country to adopt the Euro.

At the same time, Ireland or Portugal could be chosen as an example. Alhough its economic size and indices are comparable to Slovakia, Portugal has had structural and competitive problems for the last decade. The Irish success was mostly based on the IT sector growth and cohesion with the US and the UK. And the main discrepancy is that Ireland is post-industrial country, while Slovakia is still a transitive one according to the EBRD. Concerning the Euro adoption Ireland has thrived while others, such as Portugal, have floundered. This shows that giving up one's independent monetary policy can come at a price, unless accompanied by broader policy changes. Portugal's experience suggests that the "structural" fiscal deficit-the deficit corrected for the economic cycle-should be well below the 3 percent Maastricht limit, especially for countries like Poland where the level of public debt is still high. This would allow the government to deal with economic shocks-such as the loss of competitiveness experienced by Italy's and Portugal's textile industry-without ending up in the EU's excessive deficit procedure and experiencing a rise in public debt.

Regarding Slovenia, it adopted the Euro on the 1^st of January 2007. Contrary to the first group of countries that started by fixing irrevocably the conversion rate of their currency into the Euro in 1999 (2001 in for Greece) and got the Euro cash only three years later (one year for Greece), Slovenia went for a 'Big Bang' scenario where the two took place simultaneously.

Slovenia's changeover from the tolar to the Euro was a swift and smooth affair. The fact that Slovenians were already familiar with the Euro owing, in particular, to their proximity with Euro-area members Austria and Italy also contributed to a rapid changeover process. Before €-day, the vast majority (more than 90%) had already seen Euro banknotes and coins and most of them had even used the single currency. I think the same scenario will take place in Slovakia.

Based on the preliminary information reported by the Slovenian statistics office, Eurostat put the total impact of the changeover on consumer price inflation during and after the changeover period at 0.3 percentage points, which was similar to the experience of the first-wave changeover. A separate study by the Office for Macroeconomic Analysis and Development of Slovenia estimated the effect of the changeover on inflation at 0.24 percentage points.

According to a survey conducted at the end of January, 95% of Slovenians believed that the changeover took place smoothly and efficiently. At the same time, more than nine out of ten Slovenian citizens felt well informed about the Euro and were satisfied with the level of information they had been provided by the national authorities.

Several months after the successful changeover inflation started to grow. Experts continued to argue whose fault it was. Slovenia's Finance Minister Andrej Bajuk said that increases in oil and food prices were to blame for giving Slovenia the highest inflation in the Euro zone, almost double the average of other member countries Only ten months after joining the euro zone and less than a month before assuming the presidency of the European Union, Slovenia, once a model EU country, saw its 12-month inflation jump to 5.8 percent in November from 2.4 percent in November 2006.

This prompted concern from European Monetary Affairs Commissioner Joaquin Almunia, who argued that Slovenia's inflation was setting a bad example for other Euro area candidates and that it was "not clearly linked with membership in the euro zone." Inflation in Slovenia has been fuelled by oil and food prices, which increased twice as much as in other EU countries due to a lack of competition in the market and as a consequence of the Euro changeover, Bajuk argued. "Everybody was concentrating on the rounding up, but nobody really had in mind to check the prices (of seasonal products) compared to October," Bajuk said. He rejected criticism by some Slovenian economists and centre-left opposition parties, who blame the government's fiscal policy for an overheated economy that is reflected by high economic growth and inflation."Household expenditures have not moved from normal fluctuations over the last decade ... Public finances have been lowered over the last three years by three percentage points" and were expected to fall to 43.6 percent of GDP by year-end, according to Bajuk.

Except for the inflation rate it is also interesting to have a look at some other economic indices. As we see it is difficult to say how Euro adoption can influence inflation in Slovakia. In 2007 Republic of Slovenia experienced the fastest GDP growth since 1991. It reached 6,1% (in Slovakia last year it was 10,4% and in the 1^st quarter of this year 8,7%). So the inflation could be pulled by the product growth. Very positive fact is that the export increase was one of the reasons of the GDP growth. I hope Slovakia will experience the same phenomenon though there are some reasons to expect overheating of the economy.

From the point of the macroeconomic view (table #1) we can see only positive results of the accession to the Euro zone (except inflation). And as I mentioned the reason of its growth is very debatable among economists. The GDP and wages growth are obvious, except that unemployment decreased.

Risk reduction in foreign trade had some positive results and some side effects. Export growth and its positive effect on the product is undisputable, but import rise was much stronger which caused the decline of foreign exchange reserves. So I have come to a conclusion that it is difficult to say definitely what the impact of the Euro accession on the Slovenian economy will be. The same is true  about  Slovakia, but I am in a positive mood and I strongly  believe that the adoption of the Euro will bring an avalanche of new opportunities to entrepreneurial people.

Table #1 - Macroeconomic indexes

Source: Statistical Office of Slovenia

Table #2 - Foreign trade of Slovenia (mil. EUR)

Source: Statistical Office of Slovenia

by J. Babinec