VZCZCXRO2039
RR RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHSL #0216/01 1331545
ZNR UUUUU ZZH
R 121545Z MAY 08
FM AMEMBASSY BRATISLAVA
TO RUEHC/SECSTATE WASHDC 1712
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 BRATISLAVA 000216 
 
SENSITIVE 
SIPDIS 
 
USDOC for 4232/ITA/MAC/EUR/MROGERS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD LO
SUBJECT: SLOVAKIA TO ADOPT EURO IN 2009 
 
¶1. (SBU) SUMMARY: The European Commission's Convergence Report, 
released on May 7, recommended Slovakia for entry into the Euro zone 
as of January 1, 2009.  The report noted that Slovakia's fulfillment 
of the Maastricht economic criteria (price stability, sound public 
finances, exchange rate stability and convergence in interest rates) 
is sustainable, confirmed that Slovak legislation is compatible with 
Economic and Monetary Union rules and stressed only "concerns 
regarding the sustainability of inflation convergence" as a future 
potential risk.  PM Fico used the occasion to announce several new 
government measures to reduce the risk of speculative price 
increases that have been associated with other countries when 
adopting the Euro. The Convergence Report will next be discussed by 
EU finance ministers on June 2-3, and then by EU Heads of State at 
their Summit on June 19-20.  The European Parliament will also 
provide an opinion in June.  The formal decision will be taken by EU 
finance ministers on July 8, at which time the new Slovak Koruna / 
Euro conversion rate will be set.  Slovak officials do not expect 
any difficulties with the remaining steps given the strong 
recommendation by the EC.  The positive report boosted the Slovak 
crown, which broke through SKK 32 per Euro for the first time. End 
Summary 
 
CONVERGENCE REPORTS: MIXED MESSAGES, BUT NO DOUBT ABOUT RESULT 
------------------------------ ------------------------------- 
¶2. (U) In its May 7 Convergence Report, the European Commission (EC) 
said that Slovakia has met all necessary conditions for adoption of 
the Euro in 2009.  The positive assessment was broadly expected, as 
Slovakia has easily met all the nominal Maastricht economic 
criteria.  The European Central Bank (ECB) issued its own 
Convergence Report on May 7, which takes a more critical stance, 
noting that "there are considerable concerns regarding the 
sustainability of inflation convergence."  However, the large buffer 
with which Slovakia met the inflation limit (12 month inflation in 
March was 2.2 percent, well below the reference limit of 3.2 
percent) persuaded the EC that Slovakia's low inflation was based on 
sound fundamentals, and was not just accidental.   Indeed, the EC 
forecasts (also released last week) showed that the Commission 
expects inflation to stay below the Maastricht limit in the 
forecasted horizon (till the end of 2009).  Now it should take only 
formal procedure to get final approval by the European authorities. 
EU finance ministers are scheduled to take the final decision and 
set the conversion rate on July 8, 2008. 
 
EURO CRITERIA HAVE BEEN GOOD FOR POLICY 
--------------------------------------- 
¶3. (U) The long-awaited green light was not seen as guaranteed even 
a couple of weeks before the official announcement. European 
institutions were more cautious during the assessment of Slovakia's 
Euro request for two reasons.  The first is the lesson learnt from 
Slovenia, the first new EU member state, which experienced high 
inflation after entry into the Euro zone. The second reason was that 
Slovakia will serve as a benchmark for the assessment of other CEE 
candidates with flexible exchange rate regimes and relatively low 
price levels.  Slovakia is one of the most open economies in the 
EU-27 in terms of the share foreign trade in GDP, almost half of 
which is done with Euro zone countries.  The economic benefits have 
been strongly communicated, mainly by the National Bank.  Also, the 
Ministry of Finance has been actively pushing the process forward, 
as a fixed timeframe was supportive in its consolidation effort. The 
argument "we want to adopt the Euro in 2009" has effectively reigned 
in government spending, which has surprised Smer's critics, who had 
assumed that Fico's social-welfare policies would lead to ballooning 
deficits. Without having an explicit goal to adopt the Euro in 2009, 
it is unlikely that this or any other government would have 
delivered such strong fiscal consolidation. 
 
DEBATE SHIFTS TO THE CONVERSION RATE AND POLITICS 
--------------------------------------------- ---- 
¶3. (U) PM Fico used the EC's positive recommendation to begin his 
campaign for a strong conversion rate, noting that it "should be as 
advantageous as possible for the people."  This is the prevailing 
view of the ruling coalition, which stressed that a strong 
Koruna/Euro rate "will be manageable by the business environment 
without any difficulties".  The opposition SDKU, which initiated 
Slovakia's entry into ERM II in November, 2005, also supports a 
strong conversion rate, arguing that it will help to restrain price 
growth in the next couple of years.  Outside of the business 
community, few are arguing for a weak convergence rate.  The 
consensus view of major Slovak banks on the EUR/SKK final conversion 
rate for Euro entry on January 1, 2009, has moved to 31-32 EUR/SKK 
recently, with some analysts considering 30.3 EUR/SKK to be an 
equilibrium exchange rate.  The official parity rate, which was 
revalued in March, 2007, is 35.44 SKK/EUR. 
 
¶4. (SBU) PM Fico has been a strong supporter of Euro adoption since 
his post-election conversion in July, 2006, but he is now shifting 
his focus to minimizing any potential political fallout.  In 
response to the DCM's May 8 congratulatory remarks that the EC's 
 
BRATISLAVA 00000216  002 OF 002 
 
 
decision was good news, PM Fico, perhaps anticipating a negative 
reaction among his political supporters, responded with a shrug and 
a slight grimace, saying only:  "We'll see."  He made similar 
comments in a recent meeting with a large U.S. investor in Slovakia, 
noting that he "does not want the Euro to be (his) political 
suicide." 
 
¶5. (U) A recent public opinion poll showed that almost three 
quarters of Slovaks fear the Euro will be bad for them due to 
associated price increases.  Amid such concerns, Slovak politicians 
of all stripes will have to consider the potential inflationary 
effect in advance of the 2010 general parliamentary elections.  On 
the same day as the EC and ECB reports were released, the cabinet 
announced additional measures to track pricing as well as to produce 
a monthly report on public opinion related to the Euro.  PM Fico 
considers Euro adoption to be a "serious historic decision", but at 
the same recalls "respect for 'impacts'".  His recent stump speeches 
include statements about "punishing those raising prices without 
valid reasons" and "classifying ungrounded price increases as 
criminal acts." 
 
REGIONAL VIEWS 
-------------- 
¶6. (U) Fico also used the EC announcement to criticize the process 
for entering the Euro zone, arguing that the Maastricht criteria are 
unfair to new EU member states. The current definition of inflation 
criterion, calculated from the pool of all EU countries instead of 
just Euro zone members, is also criticized by economists.  For 
comparison, the average reference limit since 1998 would have been 
0.3 percentage points higher if it was based on EMU-12 and not on 
the EU-27. The stronger emphasis on sustainability is not clearly 
defined and therefore represents another challenge.  Slovakia will 
enter the Euro zone as the member with the lowest price level, 
implying further price convergence as a side effect of income 
growth.  The EC explicitly mentions in the report that Slovakia "has 
a potential for further price level convergence in the long-term, as 
income levels rise towards the EU average".  The Koruna appreciation 
played a significant role in the process. Once the exchange rate is 
fixed, the only way to narrow existing price differences is through 
higher price growth at home than abroad.  As a consequence, 
inflation in Slovakia is expected to be higher compared to Euro zone 
over the next 10-20 years. 
 
¶7. (U) The positive assessment of Slovakia by the European 
Commission is viewed in the region as increasing the hope that the 
Euro zone project will not be stopped.  However, analysts expect a 
long pause (at least three years) until the next CEE country 
qualifies for the Euro zone. A recent poll by Reuters shows market 
expectations about possible Euro adoption first in Lithuania and 
Estonia in 2012, than in Poland, Latvia and Czech Republic in 2013, 
Hungary and Bulgaria in 2014 and Romania in 2015. The assessment of 
Slovakia confirmed that nominal appreciation is tolerated within the 
ERM II and disinflation achieved partially thanks to currency 
appreciation can be acceptable.  New member states share features 
that make them prone to above-average inflation, and meeting the 
price criterion when needed will remain a challenge.  Specifically, 
their price levels have still not caught up to the Euro zone level, 
while their economic growth exceeds that of old Europe. 
 
COMMENT 
------- 
 
¶8. (SBU) There is widespread relief throughout the government - and 
especially at the Finance Ministry and the National Bank - that 
Slovakia was able to overcome concerns about the sustainability of 
inflation and receive a strong recommendation from the EC.  The 
Prime Minister, however, recognizes that he will have to share the 
upside of adopting the Euro with the opposition, who set the process 
in motion through economic reforms and early entry into ERM II, 
while Fico's Smer party is more likely to be viewed as responsible 
for the downside risk of inflation.  Fico has made keeping food and 
energy prices down a center of his rhetoric for the past year, and 
is likely to continue his vigorous campaign for the foreseeable 
future.  End Comment. 
 
OBSITNIK