COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 16.10.1996 
COM(96) 498 final 
COMMUNICATION FROM THE COMMISSION TO THE COUNCIL 
REINFORCED CONVERGENCE PROCEDURES AND 
A NEW EXCHANGE RATE MECHANISM 
IN STAGE THREE OF EMU 

1. Introduction 
1.1. The Madrid European Council in December 1995 requested that the Ecofin Council, 
together with the Commission and the European Monetary Institute (EMI) in their 
respective fields of competence, study the range of issues raised by the fact that some 
Member States may not initially participate in the Euro area. In particular, issues related to 
monetary instability were to be examined. Consideration of the relationships between 
Member States participating in the Euro area (the "ins") and the non-participant Member 
States (the "pre-ins") has focused on the need for an appropriate and voluntary exchange-
rate arrangement between the euro and the remaining national currencies. 
1.2. The Ecofin Council first discussed the new exchange rate arrangement at its informal 
meeting of 12/13 April, 1996 in Verona and progress reports were provided to the Florence 
European Council on 21/22 June, 1996 by the Ecofin, the EMI and the Commission. 
Building upon the consensus reached in Florence, the Ecofin Council reached a broad 
understanding upon the main elements of a new exchange rate mechanism - based on the 
existing exchange rate mechanism (ERM) - at its informal meeting in Dublin on 
20/21 September, 1996. 
1.3. The Commission is convinced of the need for a new ERM in stage three so as to 
provide for the prospect of full participation in the euro area and to protect the single 
market. The new mechanism will demonstrate monetary solidarity within the Union, while 
fostering convergence and exchange rate discipline among the "pre-ins". In this context, the 
Commission welcomes the understanding reached on the main elements of the new 
mechanism, which may be summarized as follows: 
• The new ERM will be composed of bilateral links between the euro and the "pre-in" 
currencies; this so-called "hub-and-spokes" model will clearly identify the euro as the 
anchor of the mechanism and will focus on the need to achieve convergence among the 
"pre-ins" toward the high standard of macro-economic stability in the euro area. 
• Central rates and fluctuation margins will be set in a common procedure involving 
Ministers, Governors of the European Central Bank (ECB) and of the non-participant 
national central banks (NCBs), and the Commission; fluctuation margins will be wide, 
while not excluding closer links between the euro and "pre-in" currencies based on 
progress in convergence and established by the same common procedure; 
• Intervention support, with appropriate financing facilities, will be automatically 
available at the margins but the ECB or relevant NCB will have the right to suspend 
intervention if its overriding policy objective of price stability is jeopardized; practical 
ways to limit the fluctuation between the currencies of the "pre-ins" within the standard 
margins are also envisaged. 
• Realignments should be made in a timely manner and by common procedure; all 
parties involved in the common procedure will have the right to trigger a procedure 
which might result in a realignment. 
2-
2. The role of reinforced convergence procedures in the new ERM 
2.1 The Commission notes that the exchange-rate stability enjoyed since Spring 1995 
reflects the substantial progress in convergence achieved by all the Member States. The 
success of these convergence efforts - evident both in terms of decelerating inflation rates 
and improved budgetary performance - bodes well for the operation of the new ERM 
Moreover, the progress in convergence already achieved confirms the Commission's view 
that the "pre-in" status of any Member State after 1 January, 1999 will be merely 
transitional. The new ERM should be viewed, therefore, as a framework to support the final 
steps in convergence among the "pre-ins" ahead of participation in the euro area. 
2.2 Experience has shown that exchange rate stability depends more than anything else upon 
sound macroeconomic management. The quality of macroeconomic management among 
the "pre-ins" in stage three will be reflected in their steady progress toward achieving a high 
degree of sustainable convergence. Accordingly, the successful implementation of a 
credible convergence programme would be expected to minimize the risk of sustained 
weakness in the exchange rate of a "pre-in". With this in mind, the Commission proposes to 
reinforce existing convergence procedures for the "pre-ins". 
2.3 Given the linkage between exchange rate stability and convergence, the Commission would 
foresee a role for reinforced convergence programmes in the management of the new ERM. 
For example, the progress achieved by a "pre-in" toward its convergence objectives might 
be used as a reference in deciding on the sustainability of central rates. A favourable 
performance relative to convergence objectives would be expected to strengthen the case for 
support for a "pre-in" currency in the event of speculative pressures. However, the use of 
convergence programmes as a reference in the context of the new ERM would not interfere 
with the ECB's prerogative to safeguard its price stability objective with respect to its 
intervention obligations. This convergence-based approach to operating the new ERM 
would preserve flexibility while ensuring an appropriate level of exchange rate discipline. 
Moreover, as a more "preventive" than "corrective" approach, it also seems well-suited to 
the needs of the "pre-ins". 
3 Reinforced convergence procedures 
3.1. With a view to ensuring full participation in the euro area at the earliest possible date, 
convergence efforts by the "pre-ins" will need to be underpinned in the third stage. In 
particular, there is already an understanding that the submission of convergence programmes 
for consideration by the Council should become a formal obligation for the "pre-ins" in 
parallel with the obligatory stability programmes proposed for the "ins". The Member 
States concerned would be required to submit new convergence programmes (to replace the 
existing generation) before the beginning of stage three on 1 January, 1999 with a common 
structure and information content so as to ensure a comparable standard against which to 
judge performance. 
3.2 Objectives for the inflation rate, the government budget balance and the government 
debt ratio would be included in the convergence programmes, together with a clearly-
-3 
specified multi-annual adjustment path towards these objectives. Prospects for the exchange 
rate and long-term interest rates would also be considered so as to complete the coverage of 
the convergence criteria in the Treaty. Measures taken or proposed to achieve the 
convergence objectives would be described and accompanied by indications of 
supplementary action in the event of significant slippage. The main economic assumptions 
underlying the convergence strategy - perhaps including some sensitivity analysis - would 
be made explicit so that the conditions in which the strategy is likely to be implemented may 
be understood and their realism assessed. 
3.3. The time horizon for new convergence programmes should, in principle, be very short in 
view of the degree of convergence likely to have already been achieved by the "pre-ins" on 
1 January, 1999. Nevertheless, a medium-term focus - in particular, establishing a budget 
deficit target below 3% of GDP - would seem appropriate, facilitating the conversion of a 
convergence programme to a stability programme as soon as the relevant "pre-in" qualified 
for participation in the euro area. Convergence programmes would be updated each year. 
Updating of programmes would involve a review of the implementation of the programme, 
confirmation of convergence objectives and the relevant adjustment paths, and, in the event 
of observed slippage, â description of additional measures to be taken. The macroeconomic 
assumptions underlying the programme would also be reviewed, with the implications of 
any revisions to be fully reflected in the convergence strategy. 
3.4. Strengthened convergence procedures at the Community level are also envisaged. 
Notwithstanding the primacy of national responsibility for convergence, the Council and 
Commission would exploit to the maximum the surveillance procedures provided for under 
Article 103 of the Treaty. The Council would be required to complete an examination of a 
convergence programme within two months of its submission and would be given the right 
to endorse the programme upon a recommendation from the Commission and after 
consulting the Monetary Committee/Economic and Financial Committee. This would 
indicate a mutual commitment: a commitment from the "pre-in" Member State to proceed 
quickly toward the conditions necessary for the adoption of the euro and a commitment 
from the Union to support the Member State's efforts. 
3.5. The implementation of the convergence strategy would be monitored on a regular basis 
at the Community level. Major slippage from targets would be identified and a 
recommendation would be made that corrective action be taken by the time of the next 
update of the programme at the latest. Moreover, the budgetary objectives laid down in the 
convergence programme would become the basis for establishing recommendations where 
these are required under the excessive deficit procedure and in assessing compliance with 
those recommendations. 
p. m. The legal basis for reinforced convergence procedures 
The legal basis for strengthening the existing convergence procedures would derive from 
Article 103(5) which allows the Council to "adopt detailed rules for the multilateral 
surveillance procedures". As in the case of ensuring budgetary discipline in stage three, 
secondary legislation can be adopted with a view to strengthening those aspects of multilateral 
surveillance relevant to convergence. 
II1IMU J.U1 
ISSN 0254-1475 
COM(96) 498 final 
DOCUMENTS 
EN 09 01 10 
Catalogue number : CB-CO-96-516-EN-C 
ISBN 92-78-10191-5 
Office for Official Publications of the European Communities 
L-2985 Luxembourg