Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro Area - 2022
A joint document of the Ministry of Finance of the Czech Republic and the Czech National Bank.
Approved by the Government of the Czech Republic on 21 December 2022.
The Czech Republic undertook to adopt the euro by signing the Act concerning the conditions of accession of the Czech Republic to the European Union. One of the conditions that must be fulfilled by each Member State in the process of joining the euro area is the achievement of a high degree of sustainable convergence, which is assessed according to compliance with the Maastricht convergence criteria. This document assesses the Czech Republic's compliance with these criteria.
Setting a specific date for joining the euro area is fully within the competence of each Member State, but it should ideally depend on its degree of preparedness. Besides undoubted benefits, such as a reduction in transaction costs and the elimination of exchange rate risk, adopting the euro entails giving up independent monetary policy and the exchange rate of the koruna as stabilising macroeconomic instruments. The preparedness of the economy to join the euro area must therefore be assessed from the perspective of its economic alignment and structural similarity with the monetary union, and also from the point of view of its ability to absorb asymmetric shocks using other mechanisms, in particular via fiscal policy and the labour market, after the loss of independent monetary policy.
Next year will mark the 20th anniversary of the signing of the Accession Treaty. Since then, the euro area and the European Union as a whole have experienced the economic recession of 2008 and 2009, followed by the euro area debt crisis. In 2020 and 2021, the world was paralysed by the Covid-19 pandemic, and this year it has been hit by an energy crisis, caused by Russia’s military aggression against Ukraine. These and other events shaped euro area integration that aims at strengthening economic and fiscal coordination and completing the banking union and the capital markets union. As a result, new institutions and rules keep changing the form of the euro area and the content of the euro adoption obligation. These facts also need to be properly assessed and considered in decisions about the timing of monetary union entry.
In addition to assessing legal compatibility, the assessment of a country’s preparedness for euro adoption and the related rights, obligations, privileges and commitments includes an assessment of compliance with the convergence criteria: the achievement of a high degree of price stability, the sustainability of the government financial position, the observance of the normal fluctuation margins of the exchange rate, and the durability of convergence being reflected in the long-term interest-rate levels.
The analysis contained in this document reveals that the Czech Republic will very probably not fulfil any of the convergence criteria in 2022 and 2023. The Czech economy is one of the EU countries with the highest inflation. This is being fuelled by strong supply and demand pressures, and increased inflation expectations. The differences in the intensity of price level growth and the approaches of the Czech National Bank and the European Central Bank to monetary policy have also led to differences in interest rates. Public finances are running high structural deficits following the introduction of a series of support measures during the Covid-19 epidemic. Further measures aimed at reducing the impact of the energy crisis on households and businesses have also contributed to these deficits. Last but not least, the exchange rate fluctuation criterion has not been formally met, as the Czech Republic has not joined the exchange rate mechanism.
As regards the Czech economy’s alignment with the euro area and its ability to adjust to possible asymmetric shocks without its own monetary and exchange rate policy, the characteristics of the Czech economy can be divided into three groups.
The first group consists of economic indicators suggesting a relatively low level of risk associated with euro adoption in the area analysed. It has long included the Czech economy’s close trade and ownership links with the euro area and the high degree of its openness. These factors represent preconditions for the benefits of euro adoption and also foster alignment between business cycles. The use of the euro by Czech households has long been very low, however Czech companies have rapidly increased their euro financing in the last year, also due to the large difference between koruna and euro interest rates. The Czech koruna and the euro remain aligned vis-à-vis the dollar, while the stability of the exchange rate of the koruna against the euro was affected by the CNB’s interventions in the foreign exchange market. Inflation persistence, which is relatively low in the Czech Republic, is not a barrier to joining the euro area either. As regards the adjustment mechanisms of the Czech economy, the high participation of the Czech population in the labour market and the low long-term unemployment rate can be positively assessed. The domestic banking sector remains resilient. Its profitability increased last year and this year and its capitalisation and liquidity position remain robust.
The similarity of monetary policy transmission in particular falls into the category of indicators with a neutral message. Although the Czech Republic differs from the monetary union average in some financial indicators such as the financial assets and liabilities structure and the loans structure of companies and households, this cannot be considered a fundamental barrier to euro adoption. The depth of financial intermediation and the level of private sector debt in the Czech Republic are well below the euro area average and thus do not represent a systemic risk. The alignment of the Czech and euro area financial cycles, which has increased slightly, and the convergence of interest rates, which has decreased due to a stronger tightening of domestic monetary policy, are also assessed as neutral. The observed higher volatility of the Czech koruna against the euro and the decrease in the alignment of the Czech and euro area financial markets, which are a result of geopolitical uncertainty and worse sentiment and are thus probably only temporary, cannot be regarded as a major risk either. As regards labour market flexibility, the geographical mobility of the labour force is rising gradually due to an increase in the share of foreign nationals in the population, while the share of part-time employees is stagnating.
The third group consists of indicators suggesting economic risks associated with euro adoption in the area analysed. These include the unfinished process of economic convergence of the Czech Republic towards the euro area, especially as regards the convergence of the price and wage levels. In the event of euro adoption, a risk may also arise from the lower structural similarity of the Czech economy with the euro area consisting in an above-average share of industry in domestic GDP. The configuration of taxes and benefits on the Czech labour market still contains elements that reduce the incentive to seek employment. The need to stabilise the epidemic-hit economy using fiscal policy tools and several other expansionary fiscal steps was reflected in the Czech Republic’s large government deficits and a marked increase in government debt. This has further intensified the persistent problem of Czech public finance sustainability stemming, among other things, from an ageing population and the lack of reforms of the pension and health systems.
The design and functioning of the economic and monetary union are evolving over time, so these processes continue to require monitoring and assessment. In addition to benefits, the adoption of the single currency also entails obligations, which must be taken into account when deciding on the timing of euro area entry. The total financial costs that will be associated with euro adoption in the future may change. The currently estimated financial obligations for the Czech economy, which were not known when the Czech Republic joined the European Union, mainly include a subscription of capital to the European Stability Mechanism and a transfer of contributions from banks registered in the Czech Republic to the Single Resolution Fund.
The assessment of the Czech Republic’s economic preparedness for euro adoption has become considerably more difficult following the Covid-19 crisis and due to the ongoing Russian invasion of Ukraine.
In view of all the above facts, the Ministry of Finance and the Czech National Bank recommend that the Czech government should not set a target date for euro area entry for the time being. This recommendation implies that the government should not aim for the Czech Republic to join the exchange rate mechanism either.