Analytics, Economics, EU – Baltic States, Financial Services

"Unilateral euroisation wouldn't solve eastern Europe's problem," David Lubin, chief emerging-markets economist at Citigroup Global Markets in London, in a research note today. "We don't think this idea will be developed further."

The International Monetary Fund has recommended the EU's eastern members consider adopting the euro, even without formally joining the euro region, known as "euroisation", to help them repay foreign-currency debt, the Financial Times said yesterday, citing a confidential IMF report. The fund declined to comment on the article.

The EU's eastern members are speeding up preparations to adopt the euro after their currencies slumped as the worldwide credit crisis prompted investors to flee emerging markets for safer assets. Latvia, Hungary and Romania are relying on bailouts from the IMF and EU to avert defaults, writes LETA.

Unilateral adoption of the euro wouldn't alleviate strains on servicing external debt, the analysts said. East European countries are struggling to refinance foreign-currency loans taken out by borrowers during years of prosperity through 2007, when economic growth averaged more than 5%. Tumbling currencies and a deepening recession have raised the risk of default on those obligations.

It would "at the margin reduce the risk of non-payment, but the underlying reason why companies or individuals would not be able to meet external debt obligations would not necessarily be resolved", said Zsolt Papp, an emerging markets economist at KBC Groep NV in London, in a research note.

Members of the 16-country single currency bloc are opposed even to fast-tracking the eastern states toward euro use. Euro- area finance ministers last month rejected calls from some of the bloc's eastern members for accelerating the process, or easing the terms of adopting the single currency, to help them cope with financing shortfalls.

"The position of the European Central Bank is very well known: we consider the implementation of the treaty criteria to be indispensable," said an ECB spokeswoman yesterday in response to the leaked IMF document. She spoke on condition of anonymity. Euro requirements were drawn up by the Maastricht Treaty of 1992.

To qualify, nations need to keep inflation, public debt and budget deficits in check.

Applicants also have to lock their currencies in the so-called exchange-rate mechanism, which allows limited movement around a central rate to the euro.

"It would undermine the EU's institutional framework by eroding the value of the Maastricht criteria, which remain the gate through which EU members must pass in order to adopt the euro," Lubin said. "This in itself could undermine confidence in the euro."

Adopting a different currency is technically possible. Montenegro, which is not a member of the EU, adopted the euro in 2002. Ecuador began using the dollar in 2000, after its own currency, the sucre, lost about two-thirds of its value the previous year.

If a central bank has enough foreign exchange reserves to swap them for the liabilities on its balance sheet, the switchover could be carried out, Lubin said. Hungary, Romania and Bulgaria "may be good candidates" as their foreign exchange reserves cover more than 100% of the sum of currency in circulation plus banks' deposits at the central bank, he said.

The IMF raised the issue of immediate euro adoption for Latvia in a report after it provided aid for the country. The report said EU authorities ruled out that option.

Latvian Finance Minister Einars Repse is opposed to a unilateral euro adoption that would leave the country without full rights as a euro area member, daily Dienas Bizness reported.

Repse said unilaterally adopting the euro could be viewed "negatively" and the country would become a sort of "satellite state" of the euro area and not a full member, the newspaper said today. "I completely reject such action," he said.

Giving up their own currencies would strip these countries of independent monetary policy. It would remove a "buffer" to limit the depth of the recession through weaker currencies and they would need to further curtail domestic demand, said Michal Dybula, a Warsaw-based emerging Europe economist at BNP, in a research note yesterday.

It would also not help reverse a drop in export revenues and inward investment in the region, said Neil Shearing, an emerging markets economist at the London-based research firm Capital Economics.

"Euroisation would not be a panacea for the region's problems," Shearing wrote in a note. He forecasts emerging European economies will, on average, contract 6% this year and 1% in 2010.