Eastern European Needs a Carrot, Not a Stick

by: Claus Vistesen

"Only takes one tree, to make 1000 matches. Only takes one match, to burn a thousand trees, a thousand trees" - Stereophonics

I have on occasion been turning to the lyrics of the English rock group Stereophonics when events in the economy and the market have eluded and essentially confused me. This time is no different and for the life of me I am unable to the see the rationale in the recent messages emanating from key European policy makers in the context of the ongoing crisis on the European continent and specifically the impending collapse of Eastern Europe's economy.

However, let us go back to the EU summit held extraordinarily to address the issues in Eastern Europe. As the eternal first stab at tackling a "newly" emerged crisis, the results were painfully scarce as is customary with these kinds of events. Cutting to the bone, two messages could be derived from the summit. One was the idea that some Eastern European countries could be allowed into the ERM-2 without strict adherence to the two year criteria otherwise attached to such privilege. The second was the narrative that in whatever light we chose to discuss the debacle in Eastern Europe, we should not view the region as a whole.

As I noted at the time, I agreed with the former and not the latter.

A week is a long time in the current market environment and since then, the news from Eastern Europe has been nothing but appalling. For starters, it seems that the time Latvia has left before she crumbles can (potentially) be counted in months, and this will be after all her reserves will have been burnt up defending the Lat's Euro peg. Meanwhile, Edward details in his regular meticulous manner how the Estonian economy is also heading towards the inevitable. Of course, I could go on and on here which would simply solidify the point that while everybody can agree that CE Economies are not the same, they are however all passengers on the same sinking ship; a ship whose vortex may drag down the entire European economic edifice.

One would think that the message slowly but surely would have trickled down to the desks of European policymakers by now. Yet, amazingly this does not seem to be the case. Consider, for example, the same Juncker and his recent comments after hosting a meeting with the EU's finance ministers.

European Union countries hoping for milder terms on which to adopt the euro faced a rebuff on Tuesday from eurozone finance ministers, who said the credibility of Europe’s monetary union required sticking to EU rules. “Given the current volatility of the situation, this would not be the right time to launch a debate on this,” said Jean-Claude Juncker, Luxembourg’s prime minister and head of the 16-nation eurozone finance ministers’ group.

The ministers’ decision is likely to be interpreted in some of the EU’s central and eastern European states, especially Hungary, as a sign that richer western European countries are failing to meet the challenge of helping their new democratic neighbours in the most difficult hour of their post-communist history. Hungary last month raised the idea of shortening the two-year spell that a eurozone candidate country is obliged to spend in the EU’s exchange rate mechanism, known as ERM-2.

The proposal has won support from Thomas Mirow, president of the European Bank for Reconstruction and Development, who said last week the waiting time should be reduced on condition that a candidate country met all the EU’s rules on budgetary discipline. The ERM-2’s purpose is to establish that a country’s currency is stable enough to justify eurozone membership. But Hungary contends that the world financial crisis is so serious that some economically battered central and eastern European states need the protection offered by the eurozone sooner rather than later. At an informal EU summit on March 1, Angela Merkel, Germany’s chancellor, suggested that she was open to reconsidering the ERM-2 process, but not to relaxing other tests for eurozone candidate countries on budget deficits, inflation, interest rates and public debt.

Mr Juncker said on Monday night that the eurozone finance ministers had agreed that careful adherence to the rules was essential, because the eurozone, unlike the US and other single-currency areas, lacked a central government and fiscal authority. “We have a monetary union which doesn’t have a central state. It must be based on a set of rules. They are made up of the [EU’s governing] treaty and the stability and growth pact, and there is no question of changing the criteria or changing the amount of time that an aspirant must stay in the ERM-2, to bring it down from two years to one year,” Mr Juncker said.

“The credibility of monetary union is at stake,” he declared.

Mr Juncker was speaking after discussions during which EU policymakers confirmed that Romania was seeking a EU financial aid package similar to those arranged late last year for Hungary and Latvia, its fellow former communist member-states. The EU recently doubled to €25bn the resources of a fund that helps non-eurozone EU countries address their balance of payments problems. Hungary and Latvia have both drawn on the fund.

But Mr Juncker made clear that eurozone finance ministers had no appetite for a much bigger, across-the-board financial aid package for central and eastern Europe, as proposed by Hungary. “We refuse to accept that they represent one bloc. That has no longer applied since the fall of the Berlin Wall,” he said.

For the sake of argument, I have pasted the entire FT piece above so that nothing is left out. One is tempted to ask what the heck has happened to Juncker. I mean, didn't he just say that these countries could be allowed in on a swifter time scale only one week ago, and Merkel too. Well, as you can see above, this is exactly what he said and one wonders what exactly is going on here. As one close to me suggested, being considerably calmer than me, this might just be static on the road towards the inevitable that the EU will have to act on the CEE as a whole some way or the other. I wholeheartedly share this view since it is in fact only a question of time. Moreover, Juncker may not exactly be a heavyweight here and in any case, he is evidently quite volatile.

However, I am still not happy. What we need at this point is a carrot for Eastern Europe and not a stick and although I agree that these economies shouldn't simply be allowed into the Eurozone's and EU's inner circle without demands, most would agree that in a game of carrots and sticks the former need to be presented before the latter. With respect to the details, the Hungarian plea was once again rebuffed which is not surprising, I think, since caving into a unilateral request for aid on behalf of the CEE is not going to be way this is going to work. However, I am still bemused by the explicit call by the finance ministers that Latvia and Hungary need to make sure that they adopt measures to make sure they abide by the budgetary demands of the Maastricht Treaty. For one, there is of course the blatant and laughable moral standards in the point that e.g. Italy's finance minister moans about others' fiscal indiscipline, but a more subtle point is just why the EU would want to be kicking economies who are already visibly on the ground close to bleeding out.

Say that Again ...

Now, judged by the other messages from the EU finance ministers, all this could seem as warmongering leading up the G20 meeting and I would not be surprised to see a considerably more dovish message from the EU after they have convened. Yet, the wheel is turning and the more we get this kind of rubbish on the pages of the FT and the like, the more difficult it will be to actually do something based on a coherent message. As Juncker said; it is the credibility of the Eurozone which is at stake. I agree, but it is also at this point its survival and if it took one group of bold politicans to come up with the European idea back in the 1950s, it will only take one group of stupid ones to pass by the chance of acting before it is too late.