No hope for a boost from the Euro

TALLINN - Many economists and fringe nationalists are skeptical about the effect of the euro on the Estonian economy, and claim that there will be little, if any, economic gain, Bloomberg reports.
Estonia will become the 17th member of the euro zone in January next year. Having the euro will cement Estonia’s drive to become a full-fledged member of the European family.

Neil Shearing, the analyst at Capital Economics in London, said: “Any sense in which this is going to be a panacea for Estonia’s problems is likely to be dashed”.
From 2004-2007, Estonia’s economy overheated and expanded at a rate of over eight percent annually, with inflation reaching ten percent in 2008. As a result, Estonia lost its competitiveness, with labor becoming overpriced, says Shearing.

“Frankly whether you’re in the euro, out of the euro, pegged to the euro, the result is still the same. You’re going to have to undergo a protracted period of wage and price adjustment to restore competitiveness,” he says.
Estonia committed to joining the euro when it joined the EU in 2004. It has no opt-out clause, as does Great Britain, which still uses the pound.

But since the commitment has no deadline, Estonia could keep its kroon currency a bit longer while waiting to see whether the euro area sorts out its troubles. Troubled government finances in Ireland, Greece, Portugal and Spain have shaken the foundations of the currency union, while the euro’s exchange rate has been surging recently as other countries seek to lower their currencies and promote their exports. A higher euro will dampen eurozone exports, and possibly growth.

By adopting such a wait-and-see approach, Estonia could keep the flexibility in economic policy that could help it catch up to European living standards, skeptics argue. The euro rules prevent it from running higher budget deficits allowing higher levels of inflation, or adjusting interest rates to suit its own economy.
A poll in September by TNS Emor, a pollster, showed that 50 percent of Estonians support euro adoption, while 38 percent were against and the remaining 12 percent indifferent.

“I think it’s a good thing. It will be easier for tourists to have the same money,” says Maila Mansberg, 31, who manages a luggage boutique in Parnu, a resort town on the Baltic Sea that attracts throngs of Finnish and German tourists.
“The bad thing is that prices are increasing,” she adds. “They’ve even gone up in this store.”
The country has a lot of catching up to do. It will be the poorest member in the euro club - at roughly two-thirds the average gross domestic product in the euro area in terms of purchasing power, according to Eurostat.
Perhaps worse, Estonia, which regained its independence as the Soviet Union fell apart in 1991, will be joining after its worst recession on record. In 2008 GDP slumped nearly 14 percent, while unemployment exceeded 18 percent in the second quarter this year.

“We need to wait - we’re not ready,” says Ivar Raig, an economics professor at Tallinn University. “The problem is that the monetary union is very restrictive for growth, and our economic cycle is not similar to most other member countries,” says Raig.

He believes that Estonia should join the euro, but only at the “top of the next growth cycle” - or in about six or seven years. “We need higher growth, higher inflation, and higher salaries to catch up with the average living standard,” he says.
Analysts also argue that for such a tiny, open economy like Estonia, monetary union could slow growth since eurozone means accepting the one-size-fits-all interest rates set by the European Central Bank.

“This could also be the case for Estonia. When they join the interest rate will never be set appropriately for Estonia - it will be set for some average of the eurozone, meaning it will probably be too low for Estonia,” says Anders Svendsen, chief analyst at Nordea Bank in Copenhagen.
The Baltic state would need a higher interest rate in order to attract the capital and investment to catch up with the rest of Europe, says Svendsen.

Another key issue is that the kroon has been pegged to foreign currencies - the Deutschmark before the euro - since its inception in 1992, which essentially means Estonia has been in the eurozone for years.
“In a sense our monetary policy has been made in Frankfurt for as long as we’ve operated as an independent entity,” says Hardo Pajula, an economist with the bank SEB in Estonia.

“And what we’ve had so far is all the disadvantages of the single currency without having all the benefits. So I don’t think that in this situation ‘wait-and-see’ would have been sensible,” says Pajula.
For the troubled euro area, letting in a new country - just months after members agreed to a one trillion dollar rescue package to keep markets from tanking the currency - shows the attractions of the currency.

ECB President Jean-Claude Trichet said in Tallinn, Estonia’s capital, last month that “there is no better way to demonstrate that the euro area is not a closed shop” than opening it to countries who meet the criteria.
Estonia will have the lowest level of debt among all euro area members and, after running a budget surplus for eight years straight, exemplary fiscal discipline. So the risk of the Baltic state becoming a new headache for the euro area is all but ruled out.

Allowing Estonia in shows that the monetary union is a lasting, dynamic project, says Svendsen: “It’s a sign that most of Central and Eastern Europe will eventually join, and I think that is where we’re going to see a lot of growth over the next 10-20 years.”