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IMF report says EU eastern states should adopt euro

  Struggling eastern EU members should switch to the euro without full euro zone membership, the Financial Times reported on Monday, citing an IMF report, but a European Central Bank board member said it would be impossible.

The paper cited the report as saying the 16-member euro zone could relax entry rules so the states could join as quasi-members without European Central Bank seats, the FT said.

But the European Commission, which recommends if a country can join the euro zone, said the report appeared to be only an internal paper, while ECB member Ewald Nowotny said unilateral adoption was legally impossible and would hurt the euro zone.

“This is not realistic. The membership for European monetary union has very clear rules and these rules have to be followed,” Nowotny told Reuters in an interview. “From an economic point of view, it would not be a good signal (for) the confidence ... towards the euro.”

The paper said the report had been prepared to support an unsuccessful push by the IMF, the World Bank and the European Bank for Reconstruction and Development to support a region-wide anti-crisis strategy for the European Union and eastern Europe.

“For countries in the EU, euroization offers the largest benefits in terms of resolving the foreign currency debt overhang (accumulation), removing uncertainty and restoring confidence,” said the report. “Without euroisation, addressing the foreign debt currency overhang would require massive domestic retrenchment in some countries, against growing political resistance.”

STRAINS

It did not cite which countries had been specified as becoming euro zone joiners quickly.

Latvia, Lithuania, Estonia and Bulgaria have pegged their currencies to the euro and market speculation has focused on whether they will devalue the pegs or hold them steady. All have said they plan to keep their pegs, worried devaluing would strain those who have borrowed in Swiss francs and euros by significantly pushing up their costs of repaying those loans, and also put banks under pressure.

Euro zone entry could remove that threat but could make recovery harder because exports would be more expensive.

The other countries -- Poland, Hungary, Romania and the Czech Republic -- have floating currencies that have fallen by at least 13% since last July against the euro and hit foreign currency borrowers in the first three. The economic crisis has pushed up budget deficits and fuelled currency instability across the region, complicating countries’ efforts to comply with Maastricht.

Analysts also said any idea of fast euroization had probably been overtaken by an agreement at last week’s G20 meeting to triple the IMF’s lendable funds to $750 billion and its creation of flexible credit lines for better-run emerging markets. Poland said on Monday it may be interested in that facility in the future but for now saw no such need.

“It is not clear when the leaked report was written or how ‘official’ it is. Nonetheless, it seems to have been overtaken by events,” wrote Neil Shearing, from Capital Economics. “Instead the debate has moved on to whether policymakers in Eastern Europe can overcome mounting public opposition to the reforms attached to IMF funds.”

Slovakia adopted the euro this year. According to a Reuters poll, no country will do so again until 2013 at the earliest.

ERM-2 RISKS

The EU’s executive noted EU governments in the last month had doubled funds for non-euro zone members with financial problems to €50 billion ($67.7 billion) and boosted the EU’s contribution to the IMF, which helps some states in the region.

Officials from the Commission and the European Central Bank have spoken openly against any unilateral euroization, and no EU country is expected to go against their wishes.

Poland and Hungary, as well as other non-euro zone members, have expressed interest in speeding up adoption and have lobbied for the Commission for more flexibility. But ECB President Jean-Claude Trichet and Jean-Claude Juncker, chairman of the Eurogroup of finance ministers, have also said all euro aspirants must meet the strict criteria.

Nowotny said it would be an option to speed up admission to the pre-euro ERM-2 waiting room where currencies trade in a band against the euro, but he said it would not be without dangers.

“You have to be aware that being in ERM-2, having the responsibility to maintain stable exchange rates for a period of time, could be an invitation for counter-speculation against your currency,” he said. “This is a path that is not without risk.”

The report, covering eastern Europe, ex-communist states and Turkey, expects a 2.5% fall in gross domestic product for the region this year, versus a 4.25% forecast in autumn. It said the region would have to roll over $413 billion of maturing external debt in 2009 and finance $84 billion in current account deficits.

In the last six months the IMF has pledged over $60 billion in loans to the region, with Hungary, Latvia, Romania, Serbia and Ukraine among those with programs. (Reuters)