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Slovenia Business Week no. 25/2005: First Year of ERM II Smooth for Slovenia

It will be one year on 28 June since Slovenia joined the ERM II exchange rate mechanism, the waiting room for the euro

It will be one year on 28 June since Slovenia joined the ERM II exchange rate mechanism, the waiting room for the euro. There have been no shake-ups so far: the exchange rate is steadily hovering around the central parity rate of SIT 239.64 per euro, and the central bank has had to intervene only once on the monetary market.

"The Bank of Slovenia assesses the first year in the ERM II as successful. Economic growth, the situation in individual markets and preserved macroeconomic balances confirm that the preceding adjustment to the business conditions maintained in Europe by the European Central Bank was sustainable," central bank Vice-Governor Andrej Rant told STA.

The exchange rate has remained close to the central parity rate throughout the year. The market rate was at SIT 239.54 on Friday, 17 June and has been just below the parity rate since the end of April. According to central bank data, the average gap between the market and parity rates has been 0.01%. The bank intervened on the market just once, one month after ERM II entry, when it sold foreign exchange to respond to rate growth.

According to Rant, "this intervention arose from a need for a signal that the existing concept of exchange rate policy had indeed been brought to an end with Slovenia's entry in the ERM II." He says the banks were initially complacent, so they were given the signal.

Slovenia intends to introduce the euro on 1 January 2007 according to the "big bang" scenario of overnight changeover. Banks will accept tolar bills until February 2007, while the central bank will impose no limitations.

The reason why Slovenia opted for this scenario is the good experience that it had when Yugoslav dinars were replaced first by coupons and then by tolars in the early 90s. Moreover, the ECB has assessed that two months of dual legal tender in the 12 members that introduced the euro in 2002 was too long.

To be eligible for the euro, Slovenia has to stay in the ERM II for another year and keep the exchange rate within plus or minus 15% of the central parity rate. Moreover, it has to fulfil the convergence criteria of low inflation, public debt and interest rates.

Efforts to meet the criteria have been successful so far, except for inflation, which is only slowly coming down to the desired level. In May, inflation was 0.9 percentage points above the Maastricht threshold for that month.

Yet the central bank is confident that inflation will be curbed sufficiently in time. "The forecasts of the Bank of Slovenia as well as other domestic and foreign institutions show that Slovenia will meet the inflation criterion in the reference period," Rant said.

While inflation is the only criterion that Slovenia is yet to fulfil, the one-year reference period starting in June will be challenging nevertheless. The EU has noted that figures are not all that counts: the country's overall economic condition will also undergo thorough scrutiny.

According to Rant, the second year in the ERM II will require close monitoring of wages and productivity. "The occurrence of a negative gap between the two is not a good sign," he emphasised. The focus will therefore be on current actions in ensuring the stability of public finances and managing labour costs.

"Considering the uncertain oil prices, cost management is especially important and the changed economic conditions with forecasts of lower economic growth in Europe will be a challenge for public finances. Their flexibility could be put to a test," Rant added.

Slovenia is gearing up for the euro in other areas as well. Companies do not expect any major shocks, as most are already doing business with eurozone countries. Moreover, over 60 percent of all exports end up in the EU.

Indeed, businessmen expect benefits rather then difficulties, notably lower overhead costs, lower risk and greater attraction for foreign investment. Some problems are expected in the public and service sectors, especially retail.

A heated debate has been under way about double pricing. Retailers initially insisted that double price tags are out of the question until the exchange rate is cemented, but this is theoretically possible only after the two-year ERM II period expires.

The government and the Bank of Slovenia have come up with a solution that they believe will provide sufficient information for consumers while not putting too much pressure on retailers: price labels will include euros as of March 2006 according to the central parity rate, while double price tags will remain in place six months after the changeover to the euro.

Source: Slovene Press Agency STA

Author: STA