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Slovakia still on course for euro entry after koruna revaluation

The OECD said Slovakia remains on course to join the euro in 2009 after the recent revaluation of the koruna in the ERM2 exchange rate mechanism.

The koruna's central rate in the ERM2 mechanism was revalued 8.5% last month. „This step was well-founded and timely. It will support the authorities in maintaining macroeconomic stability,” the OECD said in a report on the Slovak economy. Slovakia is still on course to adopt the euro in Jan 2009, it said. The euro entry criteria require a currency to be in the ERM2 mechanism for at least two years without devaluation and „without severe tensions”. Economists believe that orderly currency appreciation would be regarded as compatible with this condition.

The koruna has been in the ERM2 system since Nov 2005. Currencies are allowed to fluctuate 15% above or below their central rate in the system. The OECD said Slovakia should satisfy the other criteria for euro entry without too many difficulties. Inflation fell to around 2.25% in early 2007 and is likely be below the euro entry reference value when the country's application is assessed, it said. The reference value is calculated by adding 1.5 percentage points to the inflation rates of the three lowest inflation EU countries, and the Slovak authorities expect the reference rate to be 2.9% when they apply for euro entry.

The country's expected 2007 fiscal deficit of 2.9% of GDP will be below the euro entry limit of 3.0%, while the debt condition will easily be met, the OECD said. Debt was 33% of GDP in 2006 compared with a euro entry reference value of 60%. Slovakia's long-term bond yields are only 40 basis points above those of Germany and the criterion on long-term interest rates should be met without difficulty, the OECD said. However, the organization said Slovakia could be faced with the problem of an overheating economy once it joins the euro. The decline in real interest rates associated with euro entry would be expected to boost growth, increase inflation and widen the current account deficit, it said. The resulting loss of competitiveness would then slow the economy down eventually, it said.

The Slovak government should use fiscal policy to avoid this scenario, the OECD said. „It would be desirable to take whatever actions are possible to forestall such a boom-bust cycle,” it said. „In the event that the economy nevertheless appears to be overheating, an even stronger counter-cyclical policy stance would be required,” it said. The OECD said growth is likely to remain robust in the run-up to euro entry. It reiterated its previous forecasts that the Slovak economy will grow 8.0% this year and 5.7% next year. (