ERM 2 Strategy For Accession Countries

ERM 2 Strategy For Accession Countries

Published Jan 2003

Author

V. Lavrac

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Should accession countries join the Exchange Rate Mechanism immediately, or are the risks too great?

This paper examines institutional aspects of the monetary integration process for the accession countries in their run-up to joining the European Monetary Union (EMU) and adopting the euro. Should accession countries aim at an early or a delayed entry in the EMU? What are economic and other arguments for an early or late inclusion in the EMU? What are the institutional external constraints which may prevent an early inclusion of accession countries in the EMU?

The paper focuses on the second phase of monetary integration -the Exchange Rate Mechanism (ERM2). Participation in the ERM 2 for at least two years, to fulfil the Maastricht exchange rate stability criterion, is a necessary precondition for joining the Euro. The author explores the experience of existing members of the EU including those who are not in the EMU and outlines the characteristics of the ERM 2 to draw lessons for accession countries. The author argues that now is the right time for the accession countries to define their strategies towards joining ERM 2 and provides advice on whether countries should join early or later.

The author argues that the ERM 2 is basically an adjustable peg type of exchange rate system. Consequently it can turn out to be a dangerous waiting room for the accession countries because:

  • the intermediate or soft peg exchange rate regime it requires leaves the country vulnerable to currency speculation , exchange rate volatility and even financial crises
  • it offers no protection against high or low exchange rates
  • accession countries can not know in advance whether they will be able to get out of the ERM 2 and join the euro area in just two years or whether they will be stuck unable to fulfil the Maastricht criteria
  • the interpretation and application of the ERM 2 rules and procedures are not clear nor is it clear when the EU will actually want to admit the accession countries to the Euro area

However, given that the accession countries have no choice but to participate in the ERM 2 for at least two years if they want to join the Euro , the author recommends that they should:

  • opt for early participation in the ERM 2, more or less immediately after their EU accession, although this might be risky
  • try to make their participation in the ERM 2 as short as possible, i.e. limited to two years only although this is also not a riskless strategy.
  • seek greater transparency, equal treatment and less discretion from the EU institutions

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