Fitch report: Risks of euro-adoption delays rise

Fitch Ratings said in a report titled "EMU Convergence Report: 2005" it expects Estonia, Lithuania and Slovenia to meet the Maastricht criteria in mid-2006 and become the first of 10 new European Union member states to join the euro area in January 2007.

However, the risk of a delay to the euro adoption timetable of these frontrunners and Latvia has risen in the past year mainly due to an increase in inflationary pressures.

"In some respects, there has been a 'deconvergence' over the past 12 months in that a majority of countries met fewer of the Maastricht criteria in mid-2005 than in mid-2004," said Edward Parker, senior director in Fitch's Sovereign Group.

"The main problem has been with meeting the inflation criterion, as low inflation rates in some EU countries have dragged down the reference rate.

"The challenge is particularly acute for the Baltic states where inflation has increased owing to rising cost pressures from oil prices, indirect tax and administered price hikes, and strong underlying pressures from rapid GDP, wage and credit growth as their economies continue to catch up with 'Old Europe', while their exchange rates are tightly pegged to the euro," Parker said.

Fitch added it regards the eventual adoption of the euro as a positive factor for the external creditworthiness of the new EU member states that could lead to further one to two notch upgrades of their long-term foreign currency ratings in the future.

The agency noted last year it upgraded the ratings of Estonia, Latvia, Lithuania and Slovenia by one notch based on their euro adoption prospects. However, Fitch added it is making no changes at this time.

Despite the risk from inflation, Fitch said its central expectation is for Estonia, Lithuania and Slovenia to adopt the euro in January 2007.

The report noted Latvia, Cyprus and Malta joined the European Exchange Rate Mechanism II in April, indicating their commitment to euro adoption in 2008. However, Fitch said it revised Latvia's long-term foreign currency rating outlook to stable from positive in August, as inflationary pressures mean there is a risk of a delay in its euro timetable to 2009 from 2008.

Euro adoption remains a more distant prospect for the larger Central European countries and, therefore, has no direct impact on the outlook at this time, the agency added.

In contrast to the Baltic states, public finances are likely to be the main constraint. Nevertheless, Fitch said it regards Slovakia's convergence program and 2009 euro adoption date as credible.

The agency said Poland has made progress on convergence over the past 12 months in terms of inflation, bond yields and public finances and it could still meet its target of joining the euro in 2009 - but that would require a clear policy commitment and rapid fiscal adjustment by the next government after elections in September. In result, Fitch said it views 2010 as a more likely and central forecast.

Hungary has also seen a marked decline in inflation and bond yields over the past 12 months. However, fiscal targets continue to slip such that Fitch views 2011 as a more realistic euro adoption date than the government's 2010 target.

Fitch said it assesses the Czech Republic's chances of joining the euro in 2010 as about even. It also requires difficult public finance reforms as well as a clear commitment to the goal of 2010 entry.

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