Investor confidence grows on Estonia's euro goal

TALLINN - Interest rate spreads between Estonian and eurozone money market rates have fallen to the lowest in 17 months on growing investor confidence that the Baltic country will adopt the common currency next year, reports Bloomberg. The difference between the cost of borrowing kroons and euros for three months, based on asking prices, fell to 129 basis points (1.29 percent) on Feb. 26. Three-month kroon deposit rates were at 1.6 percent on March 1, down from a nine-year high of 7.15 percent in October 2008. This compares with a 0.5 percent euro deposit rate.
“We expect the Estonian spread to the euro area to narrow over the coming year, but the current forecast does not see the spread in the three-month rate disappearing until the beginning of 2011,” said Helsinki-based Nordea economist Annika Lindblad.

Estonia’s fixed exchange rate to the euro means that money market rates are a key indicator of risks perceived by investors. The currently converging rates mean investors are becoming more confident that Estonia will adopt the euro next year. Estonia, which aims to become the third east European euro region member, after Slovenia and Slovakia, has fulfilled all entry conditions, said Finance Minister Jurgen Ligi and Prime Minister Andrus Ansip last month. The European Commission and the European Central Bank will report on the country’s eligibility in May, and EU nations will make a decision on accession in June.
Estonia doesn’t have any government bonds outstanding, which could be used to estimate the country’s credit quality, though a market for credit default swaps on its debt exists.

The cost of insuring against a default fell 3 basis points, to 137 basis points on Feb. 26, the lowest level since June 2008. The nation’s credit-default swaps have been the fifth-best performer globally this year.
Twelve-month kroon forward currency contracts traded at 15.7109 per euro the morning of March 1. This compares with a record-high of 17.6118 in December 2008. The contracts, which traded below the spot price for most of February, indicate investors see declining risk of the currency depreciating in the coming year, from today’s spot exchange rate of 15.6469.
European Union authorities will check Estonia’s compliance with euro currency entry conditions “with more vigor than ever” after Greek budget problems raised concern about further euro region expansion, said Barclays Capital economist Christian Keller last month. “Greece creates headwinds, but the 2011 date remains realistic.”

Meeting the EU’s budget deficit limit of 3 percent of GDP remains the biggest question, Nordea’s Lindblad said. Failing to join the euro area in 2011 would “weigh on confidence and the atmosphere in Estonia and the Baltics as a whole, potentially harming the incipient recovery.”