thoughts on developments in euro area ilmārs rimšēvičs governor of the bank of latvia june 8,...
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Thoughts on developments inEuro area
Ilmārs Rimšēvičs
Governor of the Bank of Latvia
June 8, 2010
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The European dream – a common currency
April 1989 – Delors report: three stages for the establishment of Economic and Monetary Union.
July 1990 – Stage one: capital controls abolished.
November 1993 – Maastricht Treaty operates.
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The European dream – a common currency
January 1994 – Stage two: European Monetary Institute created.
May 1998 – The 11 Member States were authorized to introduce the euro.
June 1998 – The European Central Bank was established.
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The European dream – a common currency
January 1999 – Stage three: • Irrevocable fix of the exchange rates;• Non-physical introduction of the euro;• The ECB – central bank for the euro;• The Stability and Growth Pact comes into force;• ERM II replaces the European Monetary System.
January 2001 – Greece joins the third stage of EMU.
January 2002 – Euro notes and coins in circulation.
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Initially euro fell below the parity with US dollar, yet it recovered in the subsequent years
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Maastricht convergence criteria: a meaningful framework for smooth participation in single
currency area
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Greece has failed to comply with the Maastricht criteria already from the very beginning
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Other large member states have also experienced difficulties with meeting fiscal targets
General government budget balance (% of GDP)
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The same problem persisted with public debt
General government debt (% of GDP)
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However, the problem was “solved” by weakening SGP rather than strengthening fiscal
positions of the respective member countries
• The SGP rules were applied inconsistently - the Council of Ministers failed to apply sanctions against France and Germany, despite punitive proceedings being started when dealing with Portugal (2002) and Greece (2005).
• In 2005, the SGP was reformed: under the pressure of France and Germany - the rules were relaxed; the decision to declare a country in excessive deficit became more conditional (a significant departure from the original emphasis on simple rules and strict compliance).
• The SGP did not succeed in preventing the occurrence of excessive deficits in many euro area countries; at present, 13 no 16 are subject to EDP.
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Result: most EU countries are in excessive deficits
General government budget balance (% of GDP)
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Result: debt levels are high and raising, above the threshold for the Euro area as a whole
General government debt in 2009 (in % of GDP)
Maastricht criteria
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Result: the Euro area fiscal numbers are clearly outside the “comfort zone” …
Greece
Portugal
Spain
Ireland
Italy
Euro area
0
20
40
60
80
100
120
140
-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0
Deb
t % o
f GD
P
Deficit, % of GDP
SGP “comfort
zone”
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… And markets have ceased to tolerate unsustainable fiscal developments
5 year EUR CDS spreads
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Response: extraordinary steps taken to remove immediate pressures
• Temporary European stabilization mechanism established allowing for overall financial support of up to EUR 750 billion from the EU and the IMF, subject to strong conditionality.
• Extraordinary measures taken by the ECB• Suspending minimum rating requirements for collateral
eligibility on debt instruments guaranteed or issued by Greece;
• Injecting liquidity by conducting interventions in the euro area public and private debt securities markets (Securities Market Programme).
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Response: fiscal consolidations across Europe
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Strong commitment to fiscal consolidation is crucial to achieve fiscal sustainability
A significant tightening of fiscal policy is critical to restore fiscal sustainability and market confidence;
Strict compliance with recommendations under EDP should be ensured;
Economic reforms to raise growth and thereby generate tax revenues are essential;
However, besides the urgent need for fiscal consolidation, the surveillance and prevention of budgetary risks should be strengthened.
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The present framework might not be sufficient to ensure fiscal sustainability in medium to long run
• Sanctions should be strengthened so that they are more severe and effective;
• A mechanism for the exclusion of an individual member state from the monetary union in case rules are seriously breached might be one of the possible solutions.
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Latvia: ambitious fiscal consolidation and adoption of 2010 budget helped to restore calm in financial market;
Interest rates down to below pre-crisis level
Money market rates (%)
0%
5%
10%
15%
20%
25%
30%
RIGIBOR 3M RIGIBOR 6M RIGIBOR 12M
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2011 budget will be the centerpiece in restoringconfidence and putting economy back on sustainable path
General government consolidated budget (% of GDP, ESA’95)
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2011 budget scenario
Nominal GDP
Revenue Expenditure BalanceBalance, %
of GDP*
12830.1 4288.5 5490.3 -1201.8 -9.4%
Agreed budget deficit target for 2011
6.0% = 769.8 mln LVL
Required consolidation to reach deficit target
432.0 mln LVL
BoL: general government budget forecast for 2011, ESA’95
* - no policy change scenario
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Meeting fiscal targets would qualify Latvia for Euro introduction in 2014
Measure-ment EUROBudget strategy
General government consolidated budget (% of GDP)