ANALYSIS OF THE EFFECTS OF EURO IMPLEMENTATION IN SLOVAKIA FROM ASPECT OF STABILITY OF EMU

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1 ANALYSIS OF THE EFFECTS OF EURO IMPLEMENTATION IN SLOVAKIA FROM ASPECT OF STABILITY OF EMU Dana Kiseľáková, Alexander Kiseľák ABSTRACT This paper focuses on the empirical analysis of effects of euro implementation after entering Slovakia into European monetary union from 2009 until 2011 using selected macroeconomic indicators. The main attention is devoted to evaluation a summarization of positive and negative effects on economy of Slovakia and tendency of risks inflation and loss of an independent monetary policy as two of main negative effects at point of stability. In the end are discussed trends and the tendency to euro preservation or euro breakup in European monetary union. KEY WORDS Empirical Analysis. European Monetary Union. Effects of Euro. Inflation Risks. JEL classification: E50. INTRODUCTION Entering monetary union brings for each country many effects - benefits, positive effects and costs, negative effects and risks [3, s.85]. One of the biggest negative effects is considered the loss of an independent monetary policy, including the loss of exchange rate policy, constrains the ability to stabilize the domestic economy in the event of asymmetric shocks and crises [9, s.4]. This leads to more volatile economic and business cycles and hence lower utility of risk averse in the economy. On the other hand, the common, across-the board currency can reduce transaction costs, thus increasing economic growth, trade, export and business. Are there more benefits or costs from the aspect of stability of economies and European monetary union (EMU)? The recent financial crisis exposed the euro area to crucial test of long term sustainability. The original bold plan of creating currency union, of achieving nominal and consequently real convergence of its member states economies has not been fulfilled. The word economy already affected by the financial crisis now stands in the precipice of potential next wave of global economic slowdown, subsequent development as sovereign debt crisis and euro crisis, and the threat of sharp increase in inflation and global unemployment. The euro changeover in Slovak 112

2 Republic on January 1 st, 2009 occurred during fallout from the global financial crisis, and sparked important concerns about the induction of inflation directly as a result of the currency shift. We examine the potential concerns about the inflationary consequences of euro changeover in the following pages and positive and negative effects of euro implementation in Slovakia in years This paper is worked out under research grant VEGA No. 1/0541/11, researched and solved at Faculty of management, University of Prešov in Prešov. MATERIALS AND METHOD The objective of this paper is to analyze the positive and negative effects of euro implementation in context of macroeconomic development in the Slovak Republic and EU through selected macroeconomic indicators at point of stability of EMU which occurred in the context of global crisis, as well as the stability of the euro and euro area is endangered. To complete the study, we often referred to special economic literature, empirical studies and electronically available database of the National Bank of Slovakia (NBS), European Central Bank (ECB), Statistical Office of Slovak Republic (ŠÚ SR) and EUROSTAT. The following where the main methods used to complete the study: - empirical analysis, comparisons, synthesis and trend analysis of various indicators (inflation rate measures, price level measures, GDP per capita in purchasing power parity terms) using economic time series constructed using these indicators and the economic analysis using coefficient of changes, and growth. The following research question was addressed: to analyze the changes and the effects of euro and risk inflation on the economy from the standpoint of stability of European monetary union in the context of the stability changes as a result of sudden increase in the inflation risks as a result of euro implementation in Slovak Republic. RESULTS AND DISCUSSION Empirical analysis of macroeconomic development and medium-term prediction in EMU One of the main global threats to economic growth and stability of euro area is the possibility of increasing sovereign debt and then increasing of inflation and price level. In the context of current developments of consumer prices, as well as the expected growth of commodity, food, services and energy prices, it possible to expect an increasing rate of inflation growth (Mediumterm prediction NBS, 2012). Increasing growth of inflation is expected in 2012 mainly as a result of increasing prices of food due to current economic trends and increasing commodity prices. As a 113

3 result of continuous invigoration of economic activity and domestic demand we can expect an increase in inflationary pressures in Slovakia. In the context of Eurozone and EU, these tendencies could be observed in the changes of HICP. The following tables present the changes in the average inflation (table 1) compared to EU and EA 16, and prediction of changes in Slovakia and EA (table 2). Table 1 Comparison of inflation rate in Slovakia, EU-27 a EA-16 Year Inflation rate in Slovakia (HICP) % Rate of growth (X t /X t-1 ) Inflation rate EA 16 (HICP) % Rate of growth (X t /X t-1 ) Inflation rate EU (HICP) % 8,4 7,5 2,8 4,3 1,9 3,9 0,9 89,29% 37,33% 153,57% 44,19% 205,26% 23,08% 2,1 2,2 2,2 2,2 2,1 3,3 0,3 104,76% 100,00% 100,00% 95,45% 157,14% 9,09% 2 2 2,2 2,2 2,3 3,7 1 Rate of growth (X t /X t-1 ) Source: researched and calculated by authors according the ŠÚ SR a Eurostat, ,00% 110,00% 100,00% 104,55% 160,87% 27,03% Changes inflation during year 2004 through 2008 differed, with the average inflation declining in all countries during 2009 as a result of the global financial crisis, according to European Central Bank (ECB). The factors influencing the decline in EU included lower price of goods due weaker domestic and global demand, and the stagnating demand due to increasing unemployment. Average inflation in Slovakia was 0,7 % in year 2010, but it has negative increased in 2011 at 4,1 %. Table 2 Predicted calculus of inflation rate and real GDP in % in Slovakia and EA-17 Indicator Actual Slovakia 2010 Actual EA 2010 Actual Slovakia 2011 Actual EA 2011 Predicted calculus Slovakia 2012 Predicted calculus EA 2012 Inflation rate 0,7 1,6 4,1 2,7 3,5 2,1-2,3 (HICP) Annual - 228,57 % 256,25 % change Real GDP 4,2 2,0 3,3 1,5 1,8-0,3 Annual change - 47,62 % 165,0 % Source: researched by authors according Medium-term predicted calculus NBS, 2012 Year on year changes in the main interest rate EURIBOR in the context of financial policy affect the economic activity and inflation through changes in market interest rates in global macroeconomic environment. In the medium-term horizon, a potential risk for economic and financial stability connected to existing developments of export capacity of Slovakia and slower domestic demand, together with capacity of 114

4 domestic demand to absorb another shock and with the regional fiscal developments. Medium term risks in the domestic macroeconomic environment of Slovakia and the financial markets have a tendency to increase largely due to negative developments in the external environment. Domestic environment helped the economic and financial stability in Slovakia, though an inevitable slowdown in business sphere occurred. While increased openness of the economy was beneficial in the context of stable growth, economic crisis revealed risks that come from orienting a focus of Slovak economy on a relatively narrow spectrum of industries. It is clear that the industries, which rely on domestic consumption, are not able to compensate for the declines in the activity of exporting sectors of the economy. One of the main questions after the implementation of euro in Slovakia was the possibility of inflationary pressures due to increasing prices and products, goods and services and the protection of economic interests of households and citizens [2, s.55]. The concerns arose from the potential convergence of price levels in SR and other EU countries. The inflation rate before the introduction of Slovakia tended to increase even in the context of financial crisis (3.9% in 2008), but was followed by a slow down to 0.9% in 2009, as mentioned in table 1. One of the main tools used to protect citizens was the dual display of prices and other tools. Economic growth, supported by data from Slovakia, suggests that introduction of euro did not present a reason for an increase in price level [5]. Table 3 Development of selected indicators of real convergence Slovakia to EU Year/Indicator GDP/per capita in s. p. in ths. EUR Regional GDP/per capita in s. p. in PPP Price level rate of Slovakia to EU Ratio of GDP/per capita to average EU in PPP (EU 27=100) 8,59 9,15 9,91 10,94 11,55 10,95 11,39 11, x x x 52,9 53,9 57,1 63,2 69,3 70,7 71,7 72,4 57,2 60,5 63,7 67,6 68,6 68,5 72,3 74,7 Source: EUROSTAT, SLOVSTAT, OECD Comments: s.p. = stable prices of year 2005, method ESNÚ 95 Data in table 3 document a tendency towards real convergence in both GDP per capita in terms of PPP, but also the price level in relation to the average of EU countries. This relationship correlates with economic level that is characterized by the fraction of regional HDP per capita in PPP and comparable price level in Slovakia, especially during the year Changes in the development and a slight slowdown occurred in 2009 and 2010 as a result of global financial crisis. 115

5 We have to emphasize that the convergence of price levels is an integral part of the process of economic convergence that increases compatibility of Slovak economy with EU [4, s.73]. The increase by itself indicated a growth of purchasing power on the European market, and an increase in economic development, even though economic growth has to continue to grow faster than the prices. Positive and negative effects of euro in Slovakia Entering of Slovakia into the Eurozone on January 1 st 2009 helped decrease some of the risks posed by unstable financial markets. Slovakia gained the ability to by financial instruments in both domestic and foreign currency, bypassing any currency risks, lowering costs of borrowing, but also giving up control over monetary policy and losing the ability to meaningfully absorb economic shocks. It is necessary to continue the process of consolidation of public finances and increasing the flexibility of labor markets given that these represent two key means to absorb shocks in the monetary union. Considerably, euro will contribute towards increased domestic economic activity as well as allow for further integration with the EU. Defining advantages of Eurozone membership are closely connected to economic stability, lower inflation, and lower long term interest rates, removal of currency risks and lower transactions costs for business and increased capital mobility, increased price transparency and improved conditions for businesses and investments [6, s.43]. The economy is expected to grow at 1% faster with the euro than otherwise, reflecting a cumulative effect of lower transaction costs, elimination of currency risk relative to euro, decreased risk premium on interest rates, and increase in employment and disposable income. International trade, investments and competitiveness will also benefit from decreased exchange rate risk between Slovak crown and euro, and lower transaction costs during monetary exchanges [7, s.9]. Direct lowering of exchange rate risk will benefit directly many mutual funds and pension funds. Banks and pension funds close their open positions using derivatives, and they should benefit from lower cost to insure against currency risks. The loss of monetary independence is the main negative associated with the euro, given that Slovakia will no longer be able to use NBS to control its own currency. Rather ECB now controls the euro for the benefit of all member states, which may in times be contradictory. The main interest rate of NBS (BRIBOR) was substituted with EURIBOR. EURIBOR is less volatile potentially aiding market interest rates, through lower interest rate risks. Beginning on January 1 st 2009 NBS became part of Euro system, ESCB in collaboration with ECB and other central banks of the Eurozone, and will contribute towards stable currency developments, financial stability, and growth 116

6 of the Eurozone. NBS will keep some roles: ensuring the execution of monetary policy, currency operations, printing euro bank notes, and coins, monetary exchange, and international cooperation of the Eurozone central banks. Additionally, NBS in the context of global crisis will retain some oversight over the financial markets. Another negative associated with the euro was the decline in profitability of banks in the international arena (lower interest gains from exchange bank transactions). Compared to 2008, bank income from international bank loans, and currency operations declined substantially, and contributed approximately 77% of the decline in profitability. Lower profitability was caused by an increase in costs of obtaining international bank loans, increased risk management costs and write offs of non-performing loans reflecting the credit risk in the bank portfolios. The effects of euro implementation are summarized in table 4 below. Table 4 Summary and overview of the positive and negative effects of euro implementation in Slovakia Positive Effects Extent of effect Lower transaction costs Savings of approx. 3% GDP Lower administration costs Savings of approx. 06% GDP Reduction of currency risk relative to EURO Savings of approx. 0.02% GDP (range % GDP) Reduction in volatility relative to other trading Lower total effective volatility to 0.35% (from partners 0.63% for years ) Lower cost of capital Decline in interest rates by about 2% to about 1-1.5% Increased international trade with Slovakia Increased trade by approx. 50% Increased GDP per capita as a result of increased Increased GDP by 7-15% in the long run trade Increased price transparency and competitiveness Increased downward pressure on price level Negative effects Technical and organizational costs associated with One time cost of approx. 0.3% GDP currency transition Specific costs of the banking sector Costs associated with free conversion between Slovak crown and euro, and a decline in income previously coming from the operations Loss of monetary policy tools no tools to reduce - asymmetric shocks Possible increased inflation in the long run 1.5% per year above and beyond the Eurozone inflation average Source: adapted from Analysis of the consequences of euro implementation in Slovakia (NBS) [8]. We can observe and quantify these positive effects of euro implementation in Slovakia during three years: increased GDP per capita, increased price transparency and competiveness, as mentioned in table 3. We can state in generally the reduction of currency risk and volatility relative to other trading partners, lower transactions costs, too. One of the main disadvantages of the entry 117

7 into the Eurozone was the loss of monetary policy tools. Theoretical analysis and the practical experience suggest that in the context of liberalized capital markets and currency regime, the options for monetary tools are already limited. By virtue of country being exposed to global capital markets leads to a degree of instability. For a small, open economy like Slovakia, an attractive alternative was to join a larger monetary union. The possibility for Slovakia to meaningfully contribute to the development of the common monetary policy is small given the mechanism in place to form this policy. More important is the potential to coordinate the public policy with other states along the monetary policy. In the context of public discussion it has often been suggested that entering in the Eurozone could contribute towards disadvantaging of citizens, not because of early fixing of the currency exchange rate, but also due to increased inflation and lower interest rates. In this context, it is important to remind the reader that the conversion to euro was imposed not only on the savings, but also on the price of goods and services purchased with those savings, and there was no reason to believe that there would a meaningful effect on the purchasing power of the savings. Based on the overview of EU studies, the concerns related to potential increases in price level due to and after EU introduction did not manifest. Negative developments during caused a global recession in 2009, 2010 and 2011 however pointed towards a minor invigoration of economic activity. The growth of developing economies will be slower than their potential for a period of time. Risks exist that the world economy will delve further into depression following this minor invigoration due to increased price pressure of energy, oil and food, public finance deficits, and increased risk stemming for highly indebted states (Greece, Ireland, Spain, Italy and Portugal) [1, s.83]. In the states of the EU the pattern of years held as well. Uncertainty associated with further growth is a definite risk for Slovakia. CONCLUSION This paper focused on the empirical analysis of positive and negative effects of the implementation of euro in Slovakia, from the point of view of economic stability of EMU, selected economic risks and their effects on economic stability from the point of view of increased total risk in the context of global changes. The conclusion of the analysis were reached using empirical trend analysis using economic time series that allowed at least partially, to address some of the outstanding questions. In the context of the trends, we examined the trends using the rate of change in the selected indicators. Year on year changes in the main interest rate EURIBOR affect economic activity and inflation through the changes in market interest rates in the global macroeconomic environment. The main interest rates began to increase slightly in year We can assume that 118

8 bank sector and commercial activities of banks will it is possible that banks transfer the burden of higher interest rates to the households that consume the bank products and services. The inflationary environment gleamed from the time series was weakening, due to stagnating domestic and especially household consumption during the crisis. The concerns about the effects of euro implementation in Slovakia on inflation and increased prices did not materialize. Given the uncertainty of the international financial markets, the changeover of euro on January 1 st 2009 did contribute to the resilience and stability of Slovak economy during the crisis, maintain both a high level of investment and trade and had more benefits. Nonetheless, Slovakia did not avoid a decline in economic growth, during the recession taking in the Eurozone, given the open economy of Slovakia. Slight declines in investment, production, increase in unemployment, and decrease in consumption, and lower back activity did indeed follow. In the context of global financial crisis, the risks of further fallout and complications abound. The maintenance of relatively positive environment in the worldwide financial markets largely depends on effective currency management, and the developments associated with the brewing sovereign debt crisis. One can conclude that the overall global environment was a positive element on the developments in the financial markets during 2010 and 2011, which further improved global demand. As discussed, additional long-term benefits or negative effects of euro in Slovakia, lowering of risks and positive trends for global developments are indeed likely to continue in the future. The European common currency has come under pressure from large national debs, problem of stability EMU towards euro area crisis and impacts of global crisis, ultimately requiring a rescue package close about trillion Euros. Are the EU authorities preparing for a euro breakup or for euro preservation? The answer brings for all economies only the future. BIBLIOGRAPHY [1] BAGUS, P Tragédia eura. TRIM Broker, a.s., s. ISBN [2] BALKO, L Než k nám príde euro. Bratislava: Epos, s. ISBN [3] BARÁŇOVÁ ČIDEROVÁ,M. LIBERČAN,A Euro výhody a riziká. Prešov: Vydavateľstvo M. Vaška, ISBN [4] DOBROVIČ, J. - RAJNOHA, R. - MACOZSEK, R Price competitiveness of Slovak companies during the period of economic crisis and after entry of Slovak republic into Eurozone. In: INTERCATHEDRA 2009, Annual Bulletin of Plant Economic Department of 119

9 the European Wood Technology University Studies, Poznaň: Poland, ISSN [5] HEČKOVÁ, J. CHAPČÁKOVÁ, A International comparison of price levels and GDP in the Balassa-Samuelson Effect context. Euro, prices and Price Perception in Slovak Republic during the Global Financial Crisis. Prešov: Faculty of Management, University of Prešov in Prešov, ISBN [6] KISEĽÁKOVÁ, D Eurostratégia SR do eurozóny teoretické a praktické aspekty. Euro strategy Slovakia into euro area theoretical and practical aspects. Prvé vydanie. Prešov: Fakulta manažmentu, Prešovská univerzita v Prešově, s. ISBN [7] LALINSKÝ,T Konkurencieschopnosť podnikov po zavedení eura na Slovensku. Výskumná štúdia NBS. 41 s. ISSN [8] NBS: Analysis of the consequences of euro implementation in Slovakia. Bratislava, NBS, [9] ZEMAN, J Costs and benefits of Slovakia entering the Euro area. A quantitative evaluation. NBS Working paper. P.31. ISSN [10] European Central Bank: Monthly Bulletin, September 2012 [online]. [cited ] ISSN Accessible at www: < This paper is worked out under research grant VEGA No. 1/0541/11, researched and solved at Faculty of management, University of Prešov in Prešov. *The scientific paper was presented at International Scientific Correspondence Conference EAEP 2012, which took place in the period from 26th to 30th November 2012 (Prešov, Slovak Republic). CONTACT ADDRESS Associate Professor Ing. Dana Kiseľáková, PhD., Fakulta Manažmentu PU, ul. Konštantínova 16, Prešov dana.kiselakova@unipo.sk Ing. Alexander Kiseľák, Fakulta Manažmentu PU, ul. Konštantínova 16, Prešov alkis@stonline.sk 120