COMMUNICATION FROM THE COMMISSION TO THE COUNCIL - REINFORCED CONVERGENCE PROCEDURES AND A NEW EXCHANGE RATE MECHANISM IN STAGE THREE OF EMU
Date: 1996-10-16
Institutions: European Commission
Subjects: Economic and Monetary Union, economic convergence, euro, exchange transaction, single market

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. 

2.1 

The role of reinforced  convergence procedures in the new ERM 

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 
implementation  of  a 
degree  of  sustainable  convergence.  Accordingly,  the  successful 
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, 
In 
convergence  efforts  by  the  "pre-ins"  will  need  to  be  underpinned  in  the  third  stage. 
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. 

I I 1 I MU  J . U1 

ISSN 0254-1475 

COM(96) 498 final 

DOCUMENTS 

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09  01  10 

Catalogue number  : CB-CO-96-516-EN-C 

ISBN 92-78-10191-5 

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