Emerging European currencies are set to weaken further as investors increasingly call into question the credibility of governments’ ambitious euro entry plans.
The global financial crisis has burnished the euro’s appeal to European Union members that are outside the euro zone but deteriorating economic conditions are also making the tests they must meet to join monetary union more challenging for them. “Investors have always been skeptical about official time lines for euro membership but things have gotten a lot messier in recent weeks. There are big question marks on countries such as Hungary and Poland,” said Edwin Gutierrez, emerging markets portfolio manager at Aberdeen Asset Managers.
Poland, Hungary and Romania are among the countries that have become noticeably more enthusiastic about adopting the euro and have set out ambitious three- to six-year targets. Hungary said last week it could join as earlier as 2011 while Romania has set a 2014 date to adopt the euro. Poland, which appeared in no particular hurry to adopt the euro after joining the EU in 2004, last month launched a roadmap to enter the monetary union in 2012. But few investors are paying much heed to such rhetoric.
Hungary’s five-year interest rate swaps on a five-year forward basis are trading 210 basis points above the euro zone’s German government benchmark, beyond the 100 basis points that marks the top end of the range for euro zone economies. Five-year/five-year forward rates are typically used as a gauge of where euro-aspirants’ debt yields would be in five year’s time. “Hungarian yields are wider than the euro zone’s. It suggests the market is pricing in a reduced probability that it gets into the euro zone in five years,” said Jon Harrison, foreign exchange strategy director at Dresdner Kleinwort.
Before the September collapse of Wall Street giant Lehman Brothers sent global markets into a tailspin, central and eastern European currencies were among the strongest foreign-exchange performers this year. The EU’s July move to fix the conversion rate of Slovakia’s koruna (SKK) to the euro in 2009 helped to bolster regional currencies but that afterglow has been all but extinguished.
Hungary narrowly averted a financial crisis last month after securing some $25 billion in financing from the International Monetary Fund and the EU to shore up its wobbling bank sector. Hungary’s forint (HUF) fell from its all-time high of 227.70 in mid-July to a record low of 286.15 against the euro at end-October.
Romania, the only EU member to have a “junk” sovereign credit rating over doubts over its ability to service its debt, saw its leu (RON) slide to a record low of 3.986 in early October, down 15% from a one-year high set two months earlier.
“The euro convergence story is diminished now. After Slovakia, it’s difficult to see which currency would be next ready to join,” said Nigel Rendell, emerging markets strategist at Royal Bank of Canada. Capital outflows from the region has left it with a severe hard currency shortage, taking a toll even on the currencies of countries on a firmer path to adopting the single currency. Slovakia’s koruna is trading more than 1% weaker from its conversion rate of 30.1260 per euro. Such a large divergence suggests the market is not 100% certain it will join the euro zone next year, said Lars Christensen, chief analyst at Danske Bank.
Doubts over whether governments in the region can meet their euro entry timetable has also been fueled as the fiscal discipline required for joining the single currency is under strain as economic activity slows. For instance, analysts question whether Poland can keep its 2009 fiscal deficit below 3% of gross domestic product. Countries must have deficits below this level to qualify for euro entry.
Romania’s current account deficit is set to exceed 14% of GDP this year. The country also fails to comply with the EU requirement that euro entrants’ inflation rate should be no more than 1.5 percentage points above the average of the three lowest inflation rates among its 27 members. Fiscal restraint is also unlikely to be a policy priority given Romania’s parliamentary elections on November 30. “The euro zone is one of the toughest clubs in the world to join,” said Marcus Svedberg, chief economist at East Capital Asset Management. (Reuters)