Report from the Commission - Convergence report 2000 (prepared in accordance with Article 122(2) of the Treaty)
Date: 2000-05-04
Institutions: European Commission
Subjects: Economic and Monetary Union, Greece, Sweden, economic convergence, exchange rate

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 3.5.2000
COM(2000) 277 final

REPORT FROM THE COMMISSION

CONVERGENCE REPORT 2000

(prepared in accordance with Article 122(2) of the Treaty)

TABLE OF CONTENTS

TABLES.......................................................................................................................... 4

GRAPHS......................................................................................................................... 5

1. INTRODUCTION AND MAIN FINDINGS ....................................................... 6
Introduction.................................................................................................. 6
1.1.
Main findings ............................................................................................. 10
1.2.
Greece.................................................................................................... 10
1.2.1.

1.2.2.

Sweden................................................................................................... 11

2. GREECE ............................................................................................................ 13
Compatibility of national legislation with the Treaty and the Statute of the
2.1.
European System of Central Banks ............................................................... 13
2.1.1.
Assessment of compatibility in 1998 ...................................................... 13
2.1.2. Legislative action taken since 1998 and overview of the legislation in
force ............................................................................................................. 13

2.1.3.
2.2.
2.2.1.
2.2.2.
2.3.
2.3.1.

2.3.2.
2.4.
2.5.
2.6.
2.6.1.
2.6.2.
2.6.3.

Assessment of compatibility ................................................................... 14
Price stability.............................................................................................. 14
Inflation developments ........................................................................... 14
Underlying factors and sustainability of inflation.................................... 16
Government budgetary position.................................................................. 20
Excessive deficit procedure .................................................................... 20

Current budgetary situation and prospects .............................................. 21
Exchange rate stability................................................................................ 26
Long-term interest rate ............................................................................... 29
Additional factors....................................................................................... 31
Results of the integration of markets....................................................... 31
Balance of payments on current account................................................. 33
Unit labour costs and other price indices................................................. 34

3. SWEDEN............................................................................................................ 35
Compatibility of national legislation with the Treaty and the Statute of the
3.1.
European System of Central Banks ............................................................... 35
3.1.1.
Assessment of compatibility in 1998 ...................................................... 35
3.1.2. Legislative action taken since 1998 and overview of the legislation in
force ............................................................................................................. 35
Assessment of compatibility ................................................................... 36
Price stability.............................................................................................. 37
Inflation developments ........................................................................... 37
Underlying factors and sustainability of inflation performance ............... 39

3.1.3.
3.2.
3.2.1.
3.2.2.

2

3.3.

3.3.1.
3.3.2.
3.4.
3.5.
3.6.
3.6.1.
3.6.2.

3.6.3.

Government budgetary position.................................................................. 40

Excessive deficit procedure .................................................................... 40
Current budgetary position and prospects ............................................... 41
Exchange rate stability................................................................................ 44
Long-term interest rate ............................................................................... 46
Additional factors....................................................................................... 47
Results of the integration of markets....................................................... 47
Balance of payments on current account................................................. 49

Unit labour costs and other price indices................................................. 49

ANNEX A: COMPATIBILITY OF NATIONAL LEGISLATION ........................... 50

ANNEX B: INFLATION CRITERION ...................................................................... 52
Treaty provisions........................................................................................ 52

B.1.

B.2.
B.3.
B.4.

Reference value for inflation....................................................................... 52
Recent methodological developments in HICP ........................................... 56
Additional tables on other price and cost indicators .................................... 58

ANNEX C: GOVERNMENT BUDGETARY DATA ................................................. 61
Shift to ESA 95 and revision to Regulation (EC) No 3605/93 ..................... 61

C.1.

C.2.

Additional tables on the public finances...................................................... 63

ANNEX D: EXCHANGE RATE CRITERION .......................................................... 66
Treaty provisions and ERM II .................................................................... 66
Application of exchange rate criterion in Stage 2 of EMU .......................... 67
Application of the exchange rate criterion in Stage 3 of EMU..................... 68

D.1.
D.2.
D.3.

D.4.

Fulfilling the exchange rate criterion in the current examination ................. 70

ANNEX E: LONG-TERM INTEREST RATE CRITERION .................................... 71

3

TABLES

2.1 Greece: average inflation rate (HICP) and the reference value

2.2 Greece: other inflation and cost indicators

2.3 Greece: government surplus/deficit , debt and investment expenditure

2.4 Greece: composition of budgetary consolidation between 1995 and 1999

2.5 Greece: updated convergence programme projections for GDP growth,

government surplus/deficit and debt

2.6 Greece: spread of GRD against the median ERM currency and against the euro

2.7 Greece: long-term interest rates

2.8 Greece: product markets

2.9 Greece: external indicators

3.1

3.2

3.3

3.4

3.5

3.6

3.7

Sweden: average inflation rate (HICP) and the reference value

Sweden: other inflation and cost indicators

Sweden: government surplus/deficit , debt and investment expenditure

Sweden: composition of budgetary consolidation between 1995 and 1999

Sweden: updated convergence programme projections for GDP growth,
government surplus/deficit and debt

Sweden: long-term interest rates

Sweden: product markets

B.1

Inflation convergence-HICP

B.2 Development of average HICP inflation rates in EU Member States and the

reference value

B.3 Evolution of the inflation reference value and the three best performers

B.4 Price deflator of private final consumption expenditure in EU Member States

B.5 Labour costs in EU Member States

B.6

Import prices in EU Member States

C.1 Government surplus/deficit in EU Member States

C.2 Government debt in EU Member States

C.3 Updated stability/convergence programme projections

for

government

surplus/deficit in EU Member States

E.1 Long-term interest rates in EU Member States

4

GRAPHS

2.1 Greece: annual inflation rate (HICP)

2.2 Greece: comparison of average inflation rate (HICP) with reference value

2.3 Greece: inflation and wage trends

2.4 Greece: government deficit and debt

2.5 Greece: spread of GRD against the median ERM currency and against the euro

2.6 Long-term interest rates - Greece and EUR-11

2.7 Greece: comparison of average long-term interest rate with reference value

3.1

3.2

3.3

3.4

3.5

Sweden: annual inflation rate (HICP)

Sweden: comparison of average inflation rate (HICP) with reference value

Sweden: inflation and wage trends

Sweden: government surplus/deficit and debt

SEK/EUR exchange rate

3.6 Long-term interest rates - Sweden and EUR-11

3.7

Sweden: comparison of average long-term interest rate with reference value

5

1.

INTRODUCTION AND MAIN FINDINGS

1.1. Introduction

The move into the third stage of economic and monetary union (EMU) and the
introduction of the single currency, the euro, on 1 January 1999 was a major step
forward in European economic integration. It followed several years of successful
but often difficult adjustment efforts by the Member States during the second stage
of EMU to achieve the high degree of sustainable convergence required for EMU
participation and needed for the stability and success of the new currency. The
decision1 by the Council (of Heads of State or Government) on 3 May 1998 in
Brussels on the 11 Member States ready to participate in the single currency from the
beginning had, in accordance with the Treaty (Article 121(4); ex Article 109j(4))2,
been prepared by the Ecofin Council on a recommendation from the Commission
and was based on the two convergence reports made by the Commission3 and the
European Monetary Institute (EMI).4 These reports, prepared in accordance with
Article 121(1) of the Treaty (ex Article 109j(1)), examined in considerable detail
whether the Member States satisfied the convergence criteria and met the legal
requirements5.

Those Member States which were assessed in 1998 as not fulfilling the necessary
conditions for the adoption of the single currency are referred to as "Member States
with a derogation". Two Member States fell into this category, Greece and Sweden,
and they are the subject of this new report. Article 122(2) (ex Article 109k(2)) of the
Treaty lays down provisions and procedures for re-examining the situation of
Member States with a derogation (see Box: Article 122(2)). At least once every two
years, or at the request of a Member State with a derogation, the Commission and the
European Central Bank (ECB) are required to prepare new convergence reports on
such Member States. Greece submitted a request on 9 March 2000 for
its
convergence situation to be re-examined. Two years have elapsed since the last
reports were made by the Commission and EMI (25 March 1998) and since the
Council decided on which Member States would initially adopt
the euro
(3 May 1998), and so Greece and Sweden are both due for
re-examination.
Article 122(2) additionally sets out the procedure by which the Council shall decide
on the admission to the single currency of a Member State with a derogation now
judged to fulfil the necessary conditions (see box); the steps of this procedure differ
somewhat
from those for the decision of 3 May 1998, which was based on
Article 121(4).

1

2

3

4

5

OJ L 139, 11.5.1998, pp. 30-35.
With the entry into force of the Amsterdam Treaty on 1 May 1999, the numbering of the articles of the
Treaty was changed.
Report on progress towards convergence and recommendation with a view to the transition to the third
stage of economic and monetary union, COM(1998)1999 final, 25 March 1998.
Convergence Report, European Monetary Institute, March 1998.
Denmark and the United Kingdom were not the subject of a formal assessment because of their opt-out
arrangements.

6

BOX: Article 122(2) (ex Article 109k(2))

At least once every two years, or at the request of a Member State with a derogation,
the Commission and the ECB shall report to the Council in accordance with the
procedure laid down in Article 121(1). After consulting the European Parliament
and after discussion in the Council, meeting in the composition of the Heads of State
or Government, the Council shall, acting by a qualified majority on a proposal from
the Commission, decide which Member States with a derogation fulfil the necessary
conditions on the basis of the criteria set out in Article 121(1), and abrogate the
derogations of the Member States concerned.

Two other Member States do not participate in the euro. Denmark and the United
Kingdom negotiated opt-out arrangements before the adoption of the Maastricht
Treaty (Protocols No 26 (ex 12) and No 25 (ex 11),
these
Member States indicate that they wish to participate in the third stage and join the
single currency, they are not the subject of an assessment by the Council as to
whether they fulfil the necessary conditions. Although the 1998 convergence report
gave a considerable amount of information about the convergence situation in these
two countries, the Commission made no judgement on whether they fulfilled the
criteria and achieved a high degree of sustainable convergence. The present report by
the Commission is limited to Greece and Sweden and does not deal with Denmark
and the United Kingdom.

respectively). Until

The reports to be prepared by the Commission and the ECB are, like the earlier
reports, governed by Article 121(1) (see Box). This requires that the reports shall
examine the compatibility of national legislation with the Treaty and the Statute of
the European System of Central Banks (ESCB) and shall also examine the
achievement of a high degree of sustainable convergence by reference to the
fulfilment of
the
government budgetary position, exchange rate stability and the long-term interest
rate as well as in the light of some additional factors.6

the four convergence criteria dealing with price stability,

The four convergence criteria and the relevant periods over which they are to be
respected are developed further in a Protocol annexed to the Treaty (see Box:
Protocol (No 21 (ex 6)) on the convergence criteria). Detailed explanations of the
way in which the criteria were being interpreted and applied were given in the 1998
convergence report.

6

Among the factors of which the reports also have to take account is "the development of the ECU". On
1 January 1999, every reference to the ECU was replaced by a reference to the euro at a rate of one euro
to one ECU. Since there are no country-specific elements of this factor, it is not examined further in this
report.

7

BOX: Article 121(1) (ex Article 109j(1))

1. The Commission and the EMI shall report to the Council on the progress made in
the fulfilment by the Member States of their obligations regarding the achievement of
economic and monetary union. These reports shall include an examination of the
compatibility between each Member State's national
including the
statutes of its national central bank, and Articles 108 and 109 (ex Articles 107 and
108) of this Treaty and the Statute of the ESCB. The reports shall also examine the
achievement of a high degree of sustainable convergence by reference to the
fulfilment by each Member State of the following criteria:

legislation,

– the achievement of a high degree of price stability; this will be apparent from a
rate of inflation which is close to that of, at most, the three best performing
Member States in terms of price stability;

– the sustainability of the government financial position; this will be apparent from
is

having achieved a government budgetary position without a deficit
excessive as determined in accordance with Article 104(6);

that

– the observance of the normal fluctuation margins provided for by the exchange
rate mechanism of the European Monetary System, for at least two years, without
devaluing against the currency of any other Member State;

– the durability of convergence achieved by the Member State and of

its
participation in the exchange rate mechanism of the European Monetary System
being reflected in the long term interest rate levels.

The four criteria mentioned in this paragraph and the relevant periods over which
they are to be respected are developed further in a Protocol annexed to this Treaty.
The reports of
the
development of the ECU, the results of the integration of markets, the situation and
development of the balances of payments on current account and an examination of
the development of unit labour costs and other price indices.

the Commission and the EMI shall also take account of

One of the principles which has been followed in the preparation of this report is that
Member States with a derogation not yet participating in the euro area are to be
assessed as far as practicable in the same way as the first wave of euro area
participants. This is the principle of equal treatment which implies that, wherever
possible, the Treaty provisions on the convergence criteria should be interpreted and
applied in the same way as in 1998. However, the assessment of some of the
convergence criteria has to take into account the introduction of the euro. This is
particularly the case for the exchange rate criterion, where, with the establishing of
the euro in place of the ECU and the replacement of the original exchange rate
mechanism by the new ERM II at the beginning of 1999, there is a changed frame of
reference. Similarly, the existence of a single monetary policy in the new euro area
may have implications for the assessment of inflation developments. Where there
have been some necessary changes in approach from the 1998 report, these are
spelled out in detail in this report and its annexes.

8

BOX: Protocol (No 21 (ex 6)) on the convergence criteria referred to in
Article 121 of the Treaty establishing the European Community

THE HIGH CONTRACTING PARTIES,

DESIRING to lay down the details of the convergence criteria which shall guide the
Community in taking decisions on the passage to the third stage of economic and
monetary union, referred to in Article 121(1) of this Treaty.

HAVE AGREED upon the following provisions, which shall be annexed to the
Treaty establishing the European Community.

Article 1

The criterion on price stability referred to in the first indent of Article 121(1) of this
Treaty shall mean that a Member State has a price performance that is sustainable
and an average rate of inflation, observed over a period of one year before the
examination, that does not exceed by more than 1½ percentage points that of, at
most, the three best performing Member States in terms of price stability. Inflation
shall be measured by means of the consumer price index on a comparable basis,
taking into account differences in national definitions.

Article 2

The criterion on the government budgetary position referred to in the second indent
of Article 121(1) of this Treaty shall mean that at the time of the examination the
Member State is not the subject of a Council decision under Article 104(6) of this
Treaty that an excessive deficit exists.

Article 3

The criterion on participation in the exchange-rate mechanism of the European
Monetary System referred to in the third indent of Article 121(1) of this Treaty shall
mean that a Member State has respected the normal fluctuation margins provided for
by the exchange-rate mechanism of the European Monetary System without severe
tensions for at least the last two years before the examination. In particular, the
Member State shall not have devalued its currency's bilateral central rate against any
other Member State's currency on its own initiative for the same period.

Article 4

The criterion on the convergence of interest rates referred to in the fourth indent of
Article 121(1) of this Treaty shall mean that, observed over a period of one year
before the examination, a Member State has had an average nominal long-term
interest rate that does not exceed by more than 2 percentage points that of, at most,
the three best performing Member States in terms of price stability. Interest rates
shall be measured on the basis of long-term government bonds or comparable
securities, taking into account differences in national definitions.

9

Article 5

The statistical data to be used for the application of this Protocol shall be provided by
the Commission.

Article 6

The Council shall, acting unanimously on a proposal from the Commission and after
consulting the European Parliament, the EMI or the ECB as the case may be, and the
Committee referred to in Article 114, adopt appropriate provisions to lay down the
details of the convergence criteria referred to in Article 121 of this Treaty, which
shall then replace this Protocol.

The introductory section of this chapter is followed by a summary of the main
findings about convergence in Greece and Sweden. The report then continues with
two main chapters, one on Greece and one on Sweden. Within each of these chapters,
fulfilment of each the convergence criteria and other requirements is examined in the
order that they appear in Article 121(1). Common material and other background
information not specific to Greece and Sweden but relevant to the assessment are
contained in a set of annexes which completes the report. Throughout this report
there are frequent references to the 1998 Commission convergence report, and the
current assessment of Greece and Sweden has to be seen in the context of the earlier
report. The current report does not repeat in full the explanations of the 1998 report,
preferring to focus on the specific situations in Greece and Sweden and to indicate
any necessary changes in the way the criteria are applied and in methods for the
provision of data.

1.2. Main findings

1.2.1. Greece

In the 1998 convergence report the Commission assessment was that Greece fulfilled
none of the four convergence criteria. However, legislation in Greece was considered
to be compatible with the Treaty and the ESCB Statute, despite an imperfection
relating to the timing of the central bank's integration in the ESCB.

During the last two years Greece has achieved striking progress towards convergence
and the assessment in this report is positive.

Legislation in Greece continues to be compatible with the Treaty and the ESCB
Statute, and once further draft
legislation is adopted by parliament even the
imperfection identified earlier will have been removed.

The average inflation rate in Greece during the 12 months to March 2000 was 2.0%,
below the reference value of 2.4%. The Greek inflation rate has been equal to or
below the reference value since December 1999. The improvement in price stability
is based on sound foundations, but there are risks associated with the reduction in
short-term interest rates and movement of the exchange rate to its conversion rate in
the approach to adoption of the euro; it will be necessary to maintain a tight
budgetary policy stance and to secure continued wage moderation to prevent a
possible resurgence of inflationary pressures. Greece fulfils the criterion on price
stability.

10

The Council decision of 26 September 1994 on the existence of an excessive deficit
in Greece was abrogated in 1999 (Council decision of 17 December 1999). On the
latest available figures, the government deficit was brought down from 10.2% of
GDP in 1995 to 1.6% in 1999, below the 3% reference value. The government debt
ratio reached its highest level in 1996 at 111.3% of GDP and has since declined
every year to 104.4% in 1999; the debt ratio is expected to continue declining and to
fall below 100% of GDP in 2001. Greece fulfils the criterion on the government
budgetary position.

The Greek drachma participated in the ERM from March 1998 until December 1998
and in the ERM II since January 1999, a total period which is longer than two years
at the time of this examination, and has not experienced severe tensions during the
period under review. The central rate of the Greek drachma was revalued against the
euro in January 2000. During the review period the Greek drachma traded most of
the time beyond a ±2.25% fluctuation range around its central rate (initially against
the median currency in the ERM, and subsequently from January 1999 against the
euro). However, the deviation of the Greek drachma was above its central rate. It
reflected, inter alia, the higher interest rates in Greece and was not indicative of
severe tensions in the examination period. Greece fulfils the exchange rate criterion.

The average long-term interest rate in Greece in the year to March 2000 was 6.4%,
below the reference value of 7.2%. The narrowing of interest rate differentials in
1998 and 1999 brought the average rate in Greece down gradually and it fell below
the reference value from October 1999 onwards. Greece fulfils the criterion on the
convergence of interest rates.

In the light of its assessment on the fulfilment of the convergence criteria the
Commission considers that Greece has achieved a high degree of sustainable
convergence.

1.2.2. Sweden

In the 1998 convergence report the Commission assessment was that Sweden already
fulfilled three of the convergence criteria (on price stability,
the government
budgetary position7 and the convergence of interest rates) but that it did not fulfil the
exchange rate criterion. Furthermore, legislation in Sweden was considered not
compatible with the Treaty and the ESCB Statute.

In November 1998 Sweden adopted legislation amending the Constitution and Acts
dealing with the Riksbank that was not significantly different from the drafts on
which the examination in the 1998 convergence report was based. Legislation in this
field has remained unchanged since then in Sweden. Consequently, the assessment
on legal convergence in the 1998 report still stands, i.e. legislation in Sweden is not
compatible with the Treaty and the ESCB Statute.

The average inflation rate in Sweden during the 12 months to March 2000 was 0.8%,
below the reference value of 2.4%;
the three
best-performing Member States used for the calculation of this reference value. The

indeed Sweden was one of

7

Subject to approval by the Council of the Commission recommendation, made at the same time as the
adoption of the 1998 convergence report, for abrogation of the excessive deficit decision for Sweden.

11

Swedish inflation rate has been below the reference value throughout the period from
December 1996. Sweden continues to fulfil the criterion on price stability.

The Council decision of 10 July 1995 on the existence of an excessive deficit in
Sweden was abrogated in 1998 (Council decision of 1 May 1998). On the latest
available figures, the government deficit was brought down from 7.9% of GDP in
1995 to 2.0% in 1997, and a government surplus of 1.9% was achieved in 1998 and
1999. The government debt ratio peaked in 1994 and has since declined every year to
reach 65.5% of GDP in 1999; the debt ratio is expected to continue declining in 2000
and in future years. Sweden fulfils the criterion on the government budgetary
position.

The Swedish krona has never participated in the ERM nor in the ERM II; in the two
years under review the krona has fluctuated against the ERM currencies and the euro,
reflecting, inter alia, the absence of an exchange rate target. Sweden does not fulfil
the exchange rate criterion.

The average long-term interest rate in Sweden in the year to March 2000 was 5.4%,
below the reference value of 7.2%. The reference value has been respected
throughout the period since December 1996. Sweden continues to fulfil the criterion
on the convergence of interest rates.

In the light of this assessment the Commission concludes that there should be no
change in the status of Sweden as a Member State with a derogation.

12

2. GREECE

2.1. Compatibility of national

legislation with the Treaty and the Statute of the

European System of Central Banks8

2.1.1. Assessment of compatibility in 1998

Legislation in order to comply with the Treaty and statute requirements was adopted
by the Greek parliament in December 1997. The amendments in the new law were
incorporated in the statute of the Bank of Greece by the shareholders of the Bank of
Greece in December 1997. The amended statute was finally adopted by parliament in
May 1998.

In its 1998 convergence report the Commission concluded that legislation in Greece
was compatible with the requirements of the Treaty and the ESCB Statute.

However, an imperfection noted was that the amended statute on the central bank
included some powers of the Bank of Greece which it would only have as long as
Greece had not adopted the euro and the bank was not an integral part of the ESCB.
This concerned two points: first, the power of the Bank of Greece to impose
minimum reserves and penalties in the case of non-compliance, a provision which
did not recognise the ECB’s competence in this field; and second, the participation of
the central bank in international monetary and economic organisations without a
reference to the ECB’s right of approval.

2.1.2. Legislative action taken since 1998 and overview of the legislation in force

The legislation on which the assessment was based in 1998 has remained in force
since then.

On 25 April 2000 the General Meeting of the shareholders of the Bank of Greece
agreed to a number of draft amendments to the Statute of the Bank of Greece. Most
of them concern technical adaptations to align with the monetary policy framework
of the ESCB. Among the draft amendments are the two points which were identified
as an imperfection in the 1998 convergence report. The new statute will recognise
the powers of the ECB in these matters as from the date when Greece is part of the
euro area. The proposed amendments are expected to be adopted by parliament well
before the end of 2000.

– Objectives

The primary objective of the Bank of Greece shall be to ensure price stability.
Without prejudice to this primary objective, the Bank shall support the general
economic policy of the government. As from when Greece adopts the single
currency, the bank as part of the ESCB shall pursue the primary objective of
maintaining price stability in accordance with the terms set out in Article 105(1) of
the Treaty.

8

See Annex A for a brief description of the Treaty requirements in this area, in particular for central bank
independence.

13

– Independence

The central decision making body is the Monetary Policy Council, which shall
“define and implement monetary policy and decide on matters pertaining to the
conduct of exchange rate policy, the operation of payment systems and the issue of
banknotes”. The Monetary Policy Council consists of the governor, two deputy
governors and three other members. Their term of office is six years. The General
Council, a second decision making body, assumes the other tasks conferred upon it
by the statute of the central bank, except for matters falling within the duties of the
ESCB for which the governor is responsible.

Article 5A of the statute of the Bank of Greece stipulates that “…neither the Bank of
Greece nor any member of its decision-making bodies shall seek or take instructions
from the government nor any other political authority shall seek to influence the
decision making organs of the bank in performance of their duties”.

– Integration in the ESCB and other legislation

As from when Greece adopts the single currency, the central bank shall act in
accordance with the guidelines and instructions of the ECB as stipulated in
Article 105(2) and (3) of the Treaty and Articles 3 and 14.3 of the ESCB Statute.

Article 12.17 of the law of December 1997 includes a catch-all clause in order to
ensure compatibility. It reads as follows: “As from the date of adoption of the euro
legal provision which contravenes primary or secondary EU legislation on the
operation of the ESCB and/or of the ECB shall cease to be valid”.

2.1.3. Assessment of compatibility

Legislation in Greece is compatible with the requirements of the Treaty and the
ESCB Statute.

The imperfection noted in the convergence report of 1998 will have been removed if
the draft amendments to the central bank statute are adopted in their present form.

2.2. Price stability9

2.2.1.

Inflation developments

– Situation in the 1998 convergence report

Greece did not fulfil the criterion on price stability in the 1998 convergence report.
The average inflation rate (HICP) in Greece during the 12 months to January 1998
was 5.2%, well above the reference value of 2.7%. The Greek inflation rate had
exceeded the reference value throughout the period from December 1996, although
the differential had narrowed.

9

See Annex B for the calculation of the reference value, a discussion of other inflation standards, and a
short description of improvements in the harmonized indices of consumer prices (HICP).

14

– Recent trends

trend

downward

trend was

The
in
inflation in Greece, which had
been evident on the basis of
HICP data since 1996, has
continued in the last two years.
This
interrupted
briefly in mid-1998 following
the devaluation of the drachma
on
the ERM in
March 1998. Since the final
months of 1999 the annual
inflation rate has
increased,
influenced mainly by the rise
in oil prices as has also been
the case
in other Member
States.

entering

Graph 2.1 Greece - annual inflation rate (HICP)
(percentage change of monthly index on a year earlier,M/(M-12))

%

11
10
9
8
7
6
5
4
3
2
1
0

EL

EUR-11

01
96

05

09

01
97

05 09

01
98

05

09

05

09

01
99

01
00

Source : Eurostat .

– Respect of the reference value

The 12-month average inflation rate which is used for the convergence assessment
has been steadily declining since the end of 1996, when it was as high as 8% (see
Table 2.1). The differential from the reference value has progressively narrowed and
fell to zero in December 1999. In the succeeding three months to March 2000, the
average inflation rate in Greece has remained below the reference value (see
Graph 2.2).

Graph 2.2 Greece - comparison of average inflation rate

(HICP) with reference value (%)

8

7

6

5

4

3

2

1

0

%

Reference value

EL

Average of the three best performers

12
96

03
97

06

09

12
97

03
98

06

09

12
98

03
99

06

09

12
99

03
00

Note: The grey band represents 1.5 percentage points interval between the average

rate in the three best performers in terms of price stability (bottom of the
band) and the reference value (top of the band).

Source: Eurostat , Commission services .

15

in

In March 2000, the reference
value was 2.4%, calculated as
the arithmetic average of the
inflation
average
12-month
three
the
rates
best-performing
Member
States
(France, Austria and
Sweden) plus 1.5 percentage
The
corresponding
points.
average
for
rate
inflation
Greece was 2.0%, below the
(see
reference
Table 2.1).

value

– Performance

relative

to

other inflation standards

Table 2.1

Greece : average inflation rate (HICP)
and the reference value a)
( % change )

1996

1997

1998

1999

EL
EU-11
EUR-15
Reference value b)

7.9
2.2
2.5
2.5

5.4
1.6
1.7
2.7

4.5
1.1
1.3
2.2

2.1
1.1
1.2
2.1

March
2000
2.0
1.4
1.4
2.4

a) Measured by the arithmetic average of the latest 12 monthly
indices relative to the arithmetic average of the 12 monthly
indices of the previous period.

b) Unweighted arithmetic average of the three best performers

in terms of inflation plus 1.5 percentage points ; same method
as used in the 1998 convergence report , see tables in Annex B.

favourable

Source: Eurostat , Commission services.

in Greece
by reference

inflation
is
to
standards of

The
performance
confirmed
other possible
price stability (see Annex B). For example, a reference value calculated on the basis
of the three best-performing Member States in the euro area (i.e. excluding Sweden
and including Germany) would be 2.5%, implying a slightly improved relative
performance in Greece. The Greek average inflation rate is currently just at the upper
limit of the ECB's definition of price stability and is 0.6 of a percentage point above
the euro-area average. Indeed, it is worth noting that two of the euro-area Member
States currently have average inflation rates above the rate in Greece.

2.2.2. Underlying factors and sustainability of inflation

Since early in the 1990s, stability-oriented economic policies, steadily pursuing
nominal convergence, have played a central role in disinflation in Greece. From
close to 20% in 1990, the rate of increase of consumer prices (deflator of private
consumption) was more than halved by the mid-1990s. Until 1996, the anti-inflation
strategy relied primarily on the so-called hard-drachma policy: the primary objective
of monetary policy was the reduction in inflation using an intermediate target of
maintaining a broadly stable average exchange-rate for the drachma against the ECU.
At the same time budgetary consolidation was pursued with the assistance of lower
debt servicing costs as well as measures to enhance fiscal revenues and combat tax
evasion: the general government deficit, which stood at almost 16% of GDP in 1990,
was reduced to 7.8% of GDP in 1996.

At the end of 1996, a new phase was initiated, when it appeared that a tighter and
more balanced policy-mix was required. Using the exchange-rate as a nominal
anchor had proved to be a successful strategy in reducing inflation in Greece; yet,
with accelerating activity,
labour costs pressures were rising entailing a large
appreciation of the effective exchange rate in real terms and an ensuing loss of
competitiveness. In the framework of the budget for 1997, the budgetary strategy
was decisively oriented towards retrenchment measures to control current primary
expenditure. By 1999 the government deficit was reduced to 1.6% of GDP and the

16

primary surplus was increased significantly to 5.8% of GDP (see section 2.3).
Monetary policy remained relatively tight after 1996. Inflation, as measured by the
deflator of private consumption, was reduced by a further 5.7 percentage points to
2.5% in 1999.

– Wages and labour costs

Following a period of moderate increase in 1990-93, unit labour costs accelerated in
the years up to 1997. Public sector wage increases well above ex-ante norms in that
period spilled over into wage developments in the private sector, which was
benefiting from accelerating activity and healthy profits.

Graph 2.3

Greece - inflation and wage trends

In March 1998, following the entry of the drachma into the ERM, more emphasis
was placed on the role of incomes policy as a key component of the anti-inflation
strategy. The restrictive stance of wage policy in the public sector was significantly
strengthened in 1998 with the implementation of a wage increase norm of 2.5% for
that year and increases related to expected inflation for the following years. In May
1998, a two-year national wage agreement for the private sector was signed; it
provided for
increases in minimum wages that would not compensate for
productivity gains during 1998 and 1999 and included a compensation clause for
inflation in excess of the
announced targets for
the
end of each year. This
agreement was viewed as an
important step towards the
establishment of a culture of
wage moderation in Greece.
Indeed,
agreement
resulted in a deceleration in
nominal compensation of
labour
employees and unit
costs in 1998 and 1999,
despite relatively buoyant
activity and the activation
of the compensation clause
(see
and
Table 2.2
Graph 2.3).

( 3-year moving average of annual percentage change)

Private consumption deflator

Compensation per employee

Unit labour costs

the

92

95

20

15

94

10

99

98

93

90

91

97

96

0

5

00 (*)

(*) Spring 2000 economic forecasts.
Source : Commission services.

17

– External influences on domestic prices

to

largely

The policy of targeting a stable
drachma exchange rate has
helped to ensure that imported
inflation was not
a major
source of inflation pressure in
the last decade. More recently,
the disinflation process has
been assisted by low or even
negative import price inflation
falling
due
commodity prices (excluding
inflationary
oil). Also,
the
impact
drachma
of
devaluation in March 1998 on
be only
prices proved
temporary,
fully
absorbed in the course of the
second half of 1998. Rising oil
prices pushed consumer price
inflation higher at the end of
1999, but tended to affect the
price of goods
than
services (partly reflecting some
deregulation of more sheltered
sectors of the economy).

to
being

rather

the

– Changes in indirect taxation

Table 2.2

Greece : other inflation and cost indicators
(annual % change)

1995

1996

1997

1998

1999

2000*

Private consumption deflator
8.9
EL
2.9
EUR-11
2.9
EU-15

8.2
2.5
2.6

5.5
1.9
2.0

Labour costs:
Nominal compensation per employee

EL
EUR-11
EU-15

12.9
3.4
3.4

8.8
3.1
3.3

12.4
2.4
2.9

1.2
1.8
1.7

Labour productivity
2.8
EL
1.3
EUR-11
EU-15
1.3
Nominal unit labour costs
5.9
11.5
EL
1.8
1.6
EUR-11
EU-15
2.0
1.6
Import prices**
6.8
EL
3.0
EUR-11
3.5
EU-15

5.0
0.6
0.4

3.8
1.8
1.8

8.4
0.5
1.0

2.2
2.6
1.1

4.7
1.3
1.6

5.8
1.5
2.3

0.3
1.3
1.3

5.5
0.2
1.0

2.5
1.4
1.6

4.8
2.2
2.7

2.2
1.0
1.0

2.5
1.2
1.7

5.0
-1.2
-1.9

0.6
0.0
-0.3

2.5
1.8
1.9

4.7
2.5
3.0

2.5
2.0
2.1

2.1
0.5
0.9

6.1
3.5
2.8

* Spring 2000 economic forecasts.
** Deflator of imports of goods and services .

tax

several

Source: Commission services.

In the last quarter of 1998 and
the government
during 1999,
introduced
in
cuts
rates, which
indirect
brought down the measured
inflation rate through their mechanical impact on consumer prices. These measures
were not intended to be removed at a later stage, implying a permanent impact on the
level of prices. The overall direct impact of the indirect tax rate cuts, under the
assumption of a full pass-through to consumer prices, is estimated on an annual basis
at 0.7 percentage points in 1998 and 0.95 percentage points in 1999. Part of the
impact of the measures adopted in 1999 is still influencing measured inflation rates.
It is important to note that these measures, which were adopted for the most part
towards the end of each year, also exerted an indirect favourable impact on wage
developments, as they helped to reduce the inflation rate used for the calculation of
the compensation clause mentioned above.

18

– Medium-term prospects

The considerable progress in disinflation achieved in recent years gives evidence that
the foundations for price stability seem to be established in Greece.

Monetary conditions are likely to ease in the run-up to adopting the euro, as interest
rates converge to euro-area levels, the exchange rate moves to the conversion rate
and reserve requirements are lowered. While this easing of monetary conditions
might be expected to give a stimulus to domestic demand, its impact should be
diminished by the extent to which the movement in domestic interest rates and the
exchange rate has been discounted by economic agents. Indeed, longer-term interest
rates have already declined significantly in anticipation of euro adoption.
Furthermore, as the income effect of lower interest rates is significant, the implied
decline in household disposable income should dampen the stimulus to demand.
Indeed, a large share of government debt is held by domestic households at variable
rates. According to estimates by the Bank of Greece, interest rate convergence will
reduce income of households by 3% of GDP. However, in the longer term, the
impact of low interest rates, in combination with access to wide and deep euro-based
financial markets, will probably have a demand-stimulating effect.

In this environment, other economic policies should contribute with determination to
safeguarding price stability. The Council, in its opinion on the updated convergence
programme of Greece, covering the period 1999-0210, urged the Greek government
to strengthen the anti-inflationary stance of the policy instruments at its disposal,
including budgetary and incomes policies. The 1999 updated convergence
programme makes explicit the commitment of the Greek authorities to continue to
pursue stability-oriented policies in the medium term in order to curb inflation
further. The role of budgetary policy is enhanced: a tightening in the budgetary
stance is projected in particular for 2001, when the effects of the monetary easing are
more likely to emerge. The updated convergence programme also builds the anti-
inflationary strategy on continuation of wage moderation in both public and private
sectors; in the 2000 budget, the wage norm for the public sector has been maintained
at the level of 2.3%. In the private sector, wage negotiations covering the next two
years are still under way. An appropriate bi-annual national wage agreement in 2000
would help moderate unit labour costs. The government is clearly committed to
promote such a settlement; the tax and benefit package decided in September 1999
allowing an increase in disposable income may facilitate moderate wage agreements.

programme

Structural policies are expected to complement efforts towards maintaining price
stability. The updated convergence
government's
commitment towards accelerating the pace of reform with a view to enhancing
competitive conditions and the operation of labour, goods and capital markets.
Although structural reforms generally take time to produce tangible results, the
liberalisation of the electricity and telecommunications markets in early 2001,
following the implementation of Community Law, will affect short-term price
developments and also reinforce the lasting character of price stability.

restates

the

In all, some acceleration in consumer prices is to be expected in Greece in coming
quarters; however, such a development is likely to be transient and should not reach

10

OJ C 60, 2.3.2000, p. 4.

19

an order of magnitude which might seriously undermine price stability in the
medium term. The Commission currently forecasts consumer prices in Greece, as
measured by the HICP, to accelerate from 2.1% in 1999 to 2.3% in 2000 and 2001.

The much improved inflation performance of Greece appears sustainable, provided
budgetary policy remains tight and wage moderation is pursued. Greece has
respected the reference value for inflation since December 1999. Greece fulfils the
criterion on price stability.

2.3. Government budgetary position

2.3.1. Excessive deficit procedure

In the 1998 convergence report Greece did not fulfil the criterion on the government
budgetary position. Greece was still the subject of a decision on the existence of an
excessive deficit (Council decision of 26 September 1994). While there had been a
very large reduction in the government deficit from 13.8% of GDP in 1993 to 4.0%
in 1997, the deficit was still well above the 3% reference value. The government debt
ratio was high and had reached a peak of 111.6% of GDP in 1996 before declining
for one year to 108.7% in 1997.

In the last two years Greece has made further progress in reducing its government
deficit and debt ratios. On the basis of the data available11 in the autumn of 1999, the
government deficit was estimated to have narrowed to 2.5% of GDP in 1998 and was
expected to decline further to 1.9% of GDP in 1999. The government debt ratio
declined further to 106.0% of GDP in 1998 (some 6 percentage points below its peak
in 1996) and was expected to fall to 104.5% in 1999.

recommendation

from the Commission,

On a
on
17 December 1999 to abrogate its former decision on the existence of an excessive
deficit in Greece.12 As Greece is no longer the subject of a Council decision under
Article 104(6) of the Treaty that an excessive deficit exists, Greece now fulfils the
criterion on the government budgetary position.

the Council decided

The remainder of this section reviews the current budgetary situation and prospects
in Greece using the latest available data.

11

12

Still on an ESA 79 basis, the same as used for the abrogation of the decisions on the existence of an
excessive deficit in other Member States. These data took account of the information reported by the
Greek authorities in September 1999 in accordance with Council Regulation (EC) No 3605/93. The
compliance of these data with ESA rules and other Eurostat recommendations was examined by
Eurostat, which validated the data reported by Greece.
OJ L 12, 18.1.2000, p. 24.

20

2.3.2. Current budgetary situation and prospects13

– Government deficit

retrenchment

In 1999, the general government
deficit was reduced further
to
1.6% of GDP. The stance of fiscal
policy was tightened in order to
pressures
inflation
contain
stemming from the exchange rate
adjustment of
the drachma on
entering ERM in March 1998 and
additional
in
primary expenditure was planned.
showed
final
results
However,
in the
improvement
the
that
budgetary position in 1999 mostly
resulted from buoyant budget
revenues, while a decline in debt
offset
servicing
higher
general
investment; primary
government
declined
expenditure
current
marginally as a share of GDP and
the primary surplus reached 5.8%
of GDP.

expected

partly

costs

than

Table 2.3

Greece : government surplus/deficit , debt
and investment expenditure
(as % of GDP)

1995

1996

1997

1998

1999

2000*

General government net lending (+) / net borrowing (-)

EL
EUR-11
EU-15

-10.2
-4.9
-5.1

-7.8
-4.2
-4.2

-4.6
-2.6
-2.4

-3.1
-2.0
-1.5

-1.6
-1.2
-0.6

-1.3
-0.9
-0.4

General government gross debt

EL
EUR-11
EU-15

108.7
71.4
69.5

111.3
74.7
72.1

108.5
74.5
71.0

105.4
73.0
69.0

104.4
72.2
67.6

103.7
70.3
65.1

General government investment expenditure **

EL
EUR-11
EU-15

3.2
2.7
2.6

3.2
2.6
2.5

3.5
2.4
2.3

3.7
2.4
2.2

4.2
2.5
2.3

4.3
2.5
2.3

* Spring 2000 economic forecasts.
** General government gross fixed capital formation.

Source: Commission services.

The Budget for 2000 targets a
government deficit of 1.2% of GDP,
in line with the updated convergence
programme projections. The Commission services forecast the government deficit at
1.3% of GDP for 2000. The primary surplus is expected to remain at a high level.
Lower debt servicing costs are expected to compensate less buoyant budget
revenues.

13

As from March 2000, data on the basis of ESA 95 are being used for the purposes of the excessive
deficit procedure and budgetary monitoring in general (see also Annex C). The changeover to ESA 95
implies an upward revision of the deficit ratio in Greece in 1998, estimated by Eurostat at
0.7 percentage point. The revision is mainly due to a clearer treatment in ESA 95 of general government
transactions with public enterprises; some flows previously treated as financial transactions have been
reclassified as capital transactions, with an influence on the deficit.

21

Graph 2.4

Greece - government deficit and debt

Actual and cyclically adjusted deficit
( % of GDP)

1995

1996

1997
Actual deficit

1998

1999

2000 (*)

Cyclically adjusted deficit

Reference value

Government debt
( % of GDP)

11
10
9
8
7
6
5
4
3
2
1
0

130

120

110

100

90

80

70

60

50

1995

1996

1997

1998

1999

2000 (*)

(*) Spring 2000 economic forecasts.
Source : Commission services

22

-

Influence of the cycle

In the period from 1995 to 1999, the largest part of progress in reducing the general
government deficit
in Greece resulted from discretionary tightening and lower
interest payments rather than from cyclical influences. According to calculations
made by the Commission services, the output gap has been closing during the period
to 1999 and is expected to become positive from 2000. When adjusted for the
influence of the cycle, the deficit reduction was marginally smaller than the change
in the actual balance. The positive impact of the business cycle on the government
deficit in the period 1995-99 is less than 1 percentage point of GDP out of a total of
8.6 percentage points improvement in the actual balance.

Table 2.4

Greece : composition of budgetary consolidation
between 1995 and 1999
(Cyclically adjusted, as % of trend GDP )

of which :

of which :

Change in
overall
balance

Change in
interest
payments

Change in
primary
balance

Change in
revenue

Change in
primary
expenditure

(1)=(3)-(2)

EL
EUR-11
EU-15

7.7
4.0
4.7

(2)

-3.5
-1.3
-1.3

(3)=(4)-(5)

(4)

4.2
2.7
3.4

5.2
1.2
1.1

(5)

1.0
-1.5
-2.3

Source: Commission services.

– Size and composition of budgetary adjustment

The reduction in the government deficit from 1995 has largely benefited from the
continuous decrease in interest payments as percentage of GDP: this was made
possible by the progressive decline in interest
rates, stemming from reduced
inflation, active debt management operations and the beginning of reduction in the
debt ratio. However, this effect was flanked by renewed stabilisation efforts which
have provided substantial adjustment, particularly from 1996 onward.

Since 1995, fiscal consolidation has been building on corrective measures, some of
them adopted in preceding years, and others at various stages and implemented with
different promptness. First, measures were adopted in 1994 aiming at widening the
tax base and combating tax evasion as well as improving the efficiency of tax
assessment and collection. Then in 1996-97, an important package of measures,
considered to be of structural nature, were adopted. Among these fiscal revenue
enhancing measures aimed at broadening further the tax base, including a reduction
or elimination of a number of tax breaks, increasing the corporate tax rate of
financial institutions, introducing a real property tax and a 15% withholding tax on
interest from government paper.

23

Other important measures included in the package were oriented at containing
primary expenditure and at improving spending efficiency. A more transparent wage
structure and a stricter hiring norm in the public sector were aimed at limiting current
expenditure. At the same time, it was attempted to reduce the size of the public sector
and rationalize spending in this area while limiting and controlling the growth of
State guarantees.

Since 1997 the consolidation effort has fallen primarily on current expenditure
retrenchment. In particular a strict wage policy in the public sector adopted in 1998
and based on expected inflation resulted in a virtual freeze in real terms until 2000
and possibly beyond.

the
An acceleration in budgetary consolidation resulted from these policies:
government primary surplus increased from 1.0% of GDP in 1995 to 5.8% in 1999.
However,
revenues,
this improvement mainly proceeded from higher budget
particularly buoyant in 1998 and 1999, and an increased tax burden. These were
partly offset by greater investment expenditure only partly financed by faster
absorption of EU structural funds resources. Wages and other current primary
expenditures made almost no contribution to the overall deficit reduction in the
period 1995-1999, showing some rigidity.

Fiscal consolidation in Greece builds primarily on reductions of
the central
government deficit. The other sub-sectors of the general government, and in
particular the social security funds, show surpluses over 2% of GDP. This situation
results from the 1990-1992 reform of the social security system which provided for a
progressive increase in contributions and the rationalisation of expenditure.

Government investment expenditure in Greece, largely co-financed by EU Structural
Funds financial resources, has been high and increasing in recent years. In terms of
GDP, the share of government investment has increased from 3.2% in 1995 to 4.2%
in 1999. Furthermore, since 1998, government investment has been greater than the
government deficit.

24

– Medium-term prospects

1999

by
at

aimed

update

defined

the
achieving

the Greek
The
of
the
restates
convergence programme
previous
strategy
programme
the
completion of nominal convergence at
the beginning of 2000 and to allow
Greece to qualify for entry to the euro
area on 1 January 2001. It also aims at
the medium term a
achieving
the
meeting
budgetary
requirements of the Stability and Growth
Pact.

position

in

in

1999,

favourable

results
Starting from the
achieved
budgetary
consolidation is expected to reduce the
government deficit to 0.2% of GDP in
the government balance should
2001;
then turn into a surplus of 0.2% of GDP
in 2002.

Table 2.5

Greece : updated convergence
programme projections for
GDP growth, government
surplus/deficit and debt

1999
GDP-growth , annual % change
3.5
EL

2000

3.8

2001

2002

4.1

4.3

General government net lending (+)/borrowing (-) ,
as % of GDP

EL
-0.2
General government debt , as % of GDP

-1.5

-1.2

0.2

EL

104.2

103.3

99.5

98.0

Source: Updated convergence programme of Greece ;

see also Annex table C.3 .

During the period to 2002, reductions in interest payments are expected to be the
main source of the improvement in the government balance; the primary surplus
should remain broadly unchanged at a high level close to 6% of GDP.

– Debt trends

The government debt ratio in Greece peaked at the high level of 111.3% of GDP in
1996 and has since been declining. It reached 104.4% of GDP in 1999 and is forecast
by the Commission services to decline to 103.7% in 2000. The updated convergence
programme expects the debt ratio to fall by 6.2% of GDP in the period 1999-2002,
moving below 100% of GDP from 2001 onwards. Thus a clear downward trend has
been established, but the debt ratio remains very high and well above the 60%
reference value.

The decline in the debt ratio has been and is projected to continue at a slower pace
than might be expected given the now lower size of the deficit and the relatively
strong growth of GDP. This reflects the impact, often called the "stock-flow
adjustment", of a series of factors which can add to the stock of debt, such as changes
in the value of foreign currency denominated debt, changes in net holdings of
financial assets, and other statistical adjustment. This debt-increasing adjustment was
very high in Greece in the early 1990s and still averaged 3% of GDP per year in the
period 1994-98.

Since 1998, the reduction in the stock-flow adjustment is partly due to the greater use
of privatisation proceeds to pay off public debt. Privatisation efforts have been
planned since the beginning of the current stabilisation phase, but were delayed until
1998. The package of accompanying measures announced on the entry of the
drachma into the ERM in March 1998 included a wide ranging privatisation plan, to
be implemented by the end of 1999. Consequently, financial resources amounting to

25

2.5% of GDP, according to the estimates of the 1999 update of the Greek
convergence programme, were allocated to pay off public debt in 1999.

The maturity structure of the debt has been progressively lengthened in the last few
years, with a view to making the public finances less vulnerable to interest rate
shocks. The average maturity of new debt issues increased from 1.6 years in 1994
over 6 years in 1999.

From the information presented in this section, it can be seen that the budgetary
position of Greece, which is not at present the subject of an excessive deficit
decision, has improved further in 1999 and is likely to do so again in 2000. There is
no reason for the Commission to reopen the excessive deficit procedure for Greece.

2.4. Exchange rate stability

In the 1998 convergence report Greece was assessed not to fulfil the exchange rate
criterion. While the Greek drachma had entered the ERM in March 1998, it had not
participated in the mechanism during the two years under
review (up to
February 1998). The drachma had been relatively stable against the ERM currencies
in the review period but had at times experienced tensions which were counteracted
by increases in domestic interest rates and by foreign exchange intervention.

The assessment of the exchange rate criterion in this report is carried out on the basis
of the analytical framework presented in Annex D, which takes into account the
regime change which occurred with the introduction of the euro at the beginning of
1999. As in the 1998 convergence report, exchange rate stability in the period prior
to the introduction of the euro is assessed by examining the behaviour of the drachma
vis-à-vis the median ERM currency14. From 1 January 1999 onwards, the spread
against the euro becomes the relevant indicator. Graph 2.5 and Table 2.6 summarise
the behaviour of these spreads in the review period.

The two-year period relevant for the present assessment extends from April 1998 to
March 2000. The Greek drachma entered the exchange rate mechanism (ERM) on
16 March 1998, hence just before the two years covered by the present assessment.
the drachma has participated in the new exchange rate
Since 1 January 1999,
mechanism (ERM II).

rate of

On its entry into the ERM, the
the drachma
central
against the DEM was set some
12.4% below the average market
rate in the ten preceding days.
As the market exchange rate did
not decline to the central rate,
the de facto devaluation was
somewhat smaller.

In the period that followed, the
exchange rate of the drachma

Graph 2.5 Greece - spread of GRD against
the median ERM currency and against the euro

10%

ERM - until end 1998

Euro - from January 1999

8%

6%

4%

2%

0%

-2%

-4%

04/98

07/98

10/98

01/99

04/99

07/99

10/99

01/00

Source : Commission services.

14

The median currency within the ERM is defined as the currency closest to its central rate against the
ECU at the exchange rate fixing on any given day.

26

was supported by tight budgetary and monetary policies aiming at consolidating
public finances and bringing down inflation, and thus accelerating macroeconomic
convergence towards the euro area performance. In particular, the Bank of Greece
kept nominal and real interest rates well above the rest of the prospective euro area in
order to rein in price inflation15. Despite short-lived speculative pressures in April
1998 due to rumours of a possible drachma devaluation to coincide with the May
decision on EMU participation, the shift in policy rapidly gained credibility in the
financial markets, leading to large capital inflows which bid up the exchange rate. By
early August 1998, the drachma was some 8% above its central rate against the
median ERM currency (see Graph 2.5), and during the summer the Bank of Greece
started to sterilise part of the capital inflows in order to prevent a further appreciation
of the drachma.

The appreciation was temporarily interrupted by the turbulence in international
financial markets in the summer and autumn of 1998, triggered by the Russian debt
moratorium in August. Pressures originated mainly in the Greek bond market, but
were then rapidly transmitted to the money and exchange rate markets. Market
interest rates rose sharply, in contrast with the prevailing trend in the rest of the EU,
and the drachma fell by some 4% in the course of August 1998. The Bank of Greece
did not raise interest rates, but it intervened in the foreign exchange market in order
to avoid too wide fluctuations of the currency.16

Table 2.6

Greece : spread of GRD against the median ERM currency
and against the euro

Maximum

Minimum

Standard
deviation

Days < -2.25%

(%)

(%)

8.20

9.16

9.16

2.41

1.78

1.78

1.52

2.17

2.01

0

0

0

Average

(%)

5.74

6.76

6.38

Average
of
absolute
values
(%)

5.74

6.76

6.38

ERM a)
ERM IIb)
Whole period

a) ERM , 1.4.98-31.12.98.
b) ERM II, 1.1.99-31.3.2000.

Source: Commission services.

15

16

The average for the Greek three-month money market rate was 13.9% in 1998 and 10.3% in 1999, as
compared to 3.9% and 3.0% in the euro area.
In the aftermath of the Russian crisis in August 1998, Greek market interest rates rose considerably.
The three-month interest rate went up by 5-6 percentage points in the course of the month, temporarily
approaching 18.5% at the end of August. Correspondingly, the spread on three-month rates over
Germany widened to nearly 15 percentage points at the end of August. Such increases were however
short-lived, and the spread soon came down to the pre-crisis level of around 9.5 percentage points. The
rise in long-term yields was smaller, about 2 percentage points, but more persistent. The long-term
spread over Germany widened in August from 2.9 to 4.2 percentage points, it peaked at 4.7 percentage
points in October 1998, and it came back to pre-crisis levels only at the beginning of 1999.

27

By the beginning of 1999, the Greek drachma had fully recovered and it started the
year some 7% above its ERM II central rate against the euro of GRD/EUR 353.109.
The appreciation continued in January 1999, taking the drachma up to a maximum of
9.2% above the central rate at the end of that month. From then, the drachma started
moving towards its ERM II central rate, in line with a narrowing of the short-term
interest rate differential with the euro area. On 14 January 2000, with the market
exchange rate still more than 6% above the central rate, the Greek authorities
the central parity. The new parity was set at
requested a revaluation of
implying a 3.6% revaluation of the
GRD/EUR 340.75 as of 17 January 2000,
drachma vis-à-vis its central rate.

Following the revaluation and favourable inflation data, the Bank of Greece lowered
the key 14-day deposit rate by 100 basis points to 9.75% on 28 January 2000 and
then by a further 50 basis points on 8 March 2000. The three-month spread over the
euro area fell correspondingly from 6.1 percentage points at the start of 2000 to
5 percentage points in mid-March, supporting the rapprochement of the drachma to
its new ERM II central rate. At the end of the review period the drachma was trading
1.8% above the central rate.

During the review period, the average deviation of the drachma market rate from its
central rate against the median currency and then the euro was 6.4%. The exchange
rate of the drachma (against
the euro
thereafter) has generally experienced relatively low and diminishing volatility during
the review period, with the exception of the period of financial market turmoil in the
latter part of 1998.

the DEM until 31.12.1998 and against

Summarising the evidence presented above:

• the drachma has participated in the ERM and subsequently in the ERM II for a

total period of more than two years;

• the drachma traded above its ERM central parity against the median currency in
the whole period April-December 1998. Since the introduction of the euro and the
ERM II, the drachma has always remained above its ERM II central rate against
the euro;

• during the review period, there has been no devaluation of the drachma’s central

parity in either the ERM or the ERM II;

• although the drachma underwent some tensions at the height of the Summer 1998
turbulence in international financial markets, such pressures were only temporary
and did not significantly alter the position of the Greek currency in the ERM.

Greece therefore fulfils the exchange rate criterion.

28

2.5. Long-term interest rate17

In the 1998 convergence report Greece did not fulfil the criterion on the convergence
of interest rates. The average long-term interest rate in Greece in the year to
January 1998 was 9.8%, clearly above the reference value of 7.8%.

Graph 2.6

Long-term interest rates

Greece and EUR-11 ( monthly averages )

During the 1990s, the Bank of Greece has been pursuing a disinflationary strategy
based on a rigorous monetary policy stance and a strong exchange rate. After the
entry into the ERM in March 1998 short-term interest rates were kept relatively high,
both in nominal and real
terms, and the drachma
stood above its bilateral
central rates in the ERM
grid.
the
As
process
disinflationary
and
gained
consolidation
fiscal
long-term
progressed,
started
interest
the
declining
levels prevailing in the
countries,
euro
although
spread
the
remained sizeable (see
Graph 2.6).

rates
towards

Source : Commission services.

EL
EUR-11

credibility

0
01/94

area

01/95

01/99

01/98

01/97

01/96

10

20

25

15

%

5

01/00

The period of turbulence in international financial markets in Summer/Autumn 1998,
temporarily interrupted convergence. After the Russian debt moratorium in August
1998, tensions emerged in the Greek bond market, leading to a sharp widening of the
yield spread between Greek and the average for euro area ten-year benchmark bonds
from 2.9 percentage points at the end of July to 4.2 percentage points at the end of
August. The spread peaked in October, when it reached 4.7 percentage points. By
January 1999, the spread was back to pre-crisis levels, and since then, long-term
interest rate convergence has progressed. In March 2000,
the ten-year spread
between Greece and the euro area was down to around 80 basis points.

17

See Annex E for information on the calculation of the reference value for the long-term interest rate and
on the data employed.

29

Graph 2.7 Greece - comparison of average long-term

interest rate with reference value

%

16

14

12

10

8

6

4

EL

12
96

03
97

06

09

12
97

03
98

06

09

12
98

03
99

06

09

12
99

03
00

Note: The grey band represents a 2 percentage points interval between the average
interest rate in the three best performers in terms of price stability (bottom of the band)
and the reference value (top of the band).

Source: ECB , Commission services .

Graph 2.7 shows the development in the twelve-month average long-term interest
rate in Greece, which is relevant for the assessment of the Treaty criterion,
in
comparison with the evolution of the reference value (the upper bound of the corridor
in the graph). Having declined steadily since 1996, the average rate in Greece
reached the reference value in October 1999 and has since been below it. In
March 2000, the latest date for which data are available, the reference value, given
by the average of long-term interest rates in France, Austria and Sweden plus
2 percentage points, stood at 7.2% (see Annex E). The twelve-month average of the
yield on ten-year Greek benchmark bonds stood at 6.4%, hence below the reference
value. Therefore, Greece fulfils the criterion on long-term interest rate convergence.

Table 2.7

Greece : long-term interest rates
(12-month averages)

1995

1996

1997

1998

1999

17.0

14.5

---

9.1

9.9

8.0

8.5

6.6

6.3

6.8

March
2000 a)
6.4

7.2

EL
Reference
value b)

a) Average of April 1999-March 2000.
b) Average of interest rates of the three best performing

Member States in terms of price stability plus 2 percentage points;
see Annex table E.1.

Source: ECB , Commission services.

.

30

2.6. Additional factors

2.6.1. Results of the integration of markets

– Development in product markets

Trade and foreign direct investment (FDI) statistics show that the Greek economy is
not as integrated in European product markets as other Member States. The Greek
intra-EU trade to GDP ratio18 of 10% for the period 1996-98 is the lowest in the EU,
which may be attributed in part to Greece’s peripheral location. Moreover, the trade
to GDP ratio has declined slightly since the early 1990s (from 11.3 % in 1990 to
9.7% in 1997). This decline may well be explained by the political problems in the
neighbouring former Yugoslavia. In 1998, however, the ratio rose again to 10.4%,
which is indicative of the recent economic reforms undertaken by the Greek
government. FDI inflows are relatively low as well. The intra-EU FDI to GDP ratio
for the period 1996-98 equalled 0.7%, which was well below the EU average of
1.7%. It is also a reflection of the fact that cross-border merger and acquisition
activity involving Greek companies is still of relatively little importance. However,
again an increasing trend may be emerging. While the intra-EU FDI to GDP ratio
was consistently below 0.5% over the period 1993-96, it rose to 0.7 % in 1997 and
0.9% in 1998.

The relatively low level of integration of the Greek economy in European product
markets may be associated with a lack of competitive pressures on Greek product
markets and result in relatively high price levels. Aggregate pre-tax price levels in
Greece are higher than would be expected for a country with a comparatively low
standard of living. While manufactured goods prices in 1997 were just below the EU
average, an indication that the Greek manufacturing sector was nevertheless exposed
to competition from the other EU countries, price levels19 for some equipment goods
such as office machinery and computers were relatively high. Price levels in the
services and construction sectors were well below average EU levels, as expected.
The price of purchased transport services, an extreme case, was less than half the EU
average.

Greece has also been relatively late in launching the economic reform process. As a
result, there are a number of obstacles that still need to be removed to allow the full
integration of Greece in European product markets:

– Greece has made slow progress in transposing Single Market legislation and the
November 1999 non-transposition rate was higher than in any other EU Member
State.

– A liberalisation process is taking place opening up the network industries to
competition, albeit at a slower pace than in other Member States. However, within
the domestic market, publicly owned companies continue to play an important
role.

18

19

Defined as: (intra-EU imports + intra-EU exports)/(2*GDP).
Greek price levels are not administratively controlled except
pharmaceuticals.

for

refined oil products and

31

However, recently, a number of reforms have been initiated which will improve the
situation:

– A relatively high share of public procurement calls for tenders are published in the

Official Journal.

– The privatisation of public

enterprises has progressed, mainly within
telecommunications, petrol refineries, water, supporting services to air transport
and banking. Also, public enterprises are increasingly exposed to market forces
and the provision of services has been gradually rationalised.

Table 2.8

Greece : product markets

Extra-EU trade GDP ratio (%)
Intra-EU trade GDP ratio (%)
Intra-EU FDI share (%)
Cross-border M&A share
Single Market Directives a)
Value of tenders in the O.J.
Aggregate price level
Prices level manufacturing
Prices level services
Prices construction

Labour productivity
Employment in SMEs

Greece
1997
6.2
9.7
0.7
0.3

5.2
43.3
80
96
74
72

75
86

1996
6.3
9.9
0.4
0.1

7.5
37.9
76
96
71
68

:
87

1998
6.2
10.4
0.9
0.4

6.2
44.7
76
:
:
:

:
:

EU-15
1997
9.7
15.6
1.0
100

14.9
12.8
100
100
100
100

100
66

1996
8.9
15.1
0.9
100

26.7
11.2
100
100
100
100

:
66

1998
9.7
16.1
1.7
100

12.6
13.1
100
:
:
:

Comments:

(Exports + imports)/(2xGDP)

“

FDI inflows as a % of GDP
% of EU total (1998, 9months)

% not yet implem. (1997-1999)
% of total public procurement
EU-15=100, 1998 estimated
EU-15=100
“
“

:
:

PPS, EU-15=100
As a % of tot.empl.in Ind.&Serv

a) For EU-15, percentage rate of Internal Market Directives not yet transposed across the whole of the Union.
Source: OECD, AMDATA, BACH , Eurostat and Commission services.

– Developments in financial markets

The Greek government securities market has developed rapidly in recent years. A
system of primary dealers was introduced in 1997, which includes domestic as well
as foreign banks. An electronic secondary market trading system was introduced in
1998 which from January 1999 also includes the primary market (government
auctions). In February 2000, Greece launched its first bond since the establishment of
a new debt management agency; this was also Greece's first bond issue in euro. This
marked a new development in strategy, using targeted international bonds to attract
more international investors into its government bond markets ahead of an eventual
adoption of the euro. The euro-denominated bond issue is Greece's first "parallel"
bond, indicating that it will become fungible with the drachma benchmark bond,
carrying identical terms and conditions, issued in March 2000. In the event that
Greece adopts the euro, Greece intends to re-denominate its domestic government
bonds into euro, thereby creating large and liquid bond issues.

32

Important structural reforms have been implemented in the stock exchange in the last
year. In particular, the terms and conditions for listing shares have been made more
flexible and harmonized with those of other EU countries. Other reforms include an
extension of trading hours, the introduction of an electronically integrated trading
system, the integration of the derivatives exchange and the planned creation of a new
stock market for high growth SMEs. In 1999 twice as many companies (156) raised
funds through the Athens stock exchange as the year before, with the total amount
raised rising four-fold to over GRD 3 300 billion.

The last two years have seen considerable structural adjustments in the banking
sector. A number of state-owned banks have been privatised, and further
privatisation is planned for this year. In addition, the banking sector is undergoing
continuous rationalisation as a result of mergers and acquisitions. Profits in the
Hellenic banking sector have risen in the last year, partly responding to the strong
growth of the sector during the latter part of the 1990s.

2.6.2. Balance of payments on current account

In 1999, the Greek current account balance showed a deficit of 1.4% of GDP.20 The
trade balance was in a deficit of 13.1% of GDP while the services balance was in
surplus to the tune of 5.7% of GDP. Net factor income and transfers totalled 6% of
GDP. Net transfers include Structural and Cohesion Funds from the EU of almost
3% of GDP.

The current account performance deteriorated in 1996 and 1997 due to real exchange
rate appreciation and comparatively strong domestic demand growth relative to
trading partners. Following the devaluation of the Greek drachma and ERM entry in
March 1998, export performance strengthened. Despite economic growth above the
EU average, the current account balance improved in 1998 and 1999. With continued
strong domestic demand growth and the effects of the devaluation having come
through, the deficit on current balance is expected to widen to around 2% of GDP
this year.

Gross fixed capital formation in Greece has risen markedly to reach some 23% of
GDP in 1999 (this compares with an average investment rate in the euro area of
about 21% of GDP). Greek government saving turned positive in 1999 and private
sector saving amounted to 19% of GDP in 1999, just below the EUR-11 average.
Based on these indicators, the Greek current account deficit now seems related to
strong investment rather than to a deficiency of national saving (see Table 2.9).

20

The data in this section are based on national accounts statistics according to ESA 95.

33

Table 2.9

Greece : external indicators
( as % of GDP )

Current account
Current account
Trade balance

Saving and investment
Gross fixed capital formation
Gross saving
of which: government saving
of which: private saving

1995

1996

1997

1998

1999

-0.9
-12.2

-2.4
-13.2

-2.3
-13.4

-1.9
-13.3

-1.4
-13.1

18.6
18.0
-6.8
24.8

19.5
17.4
-5.2
22.7

21.0
18.7
-1.3
20.0

22.1
20.1
0.0
20.1

23.1
20.9
2.0
18.9

Source: Commission services , national accounts definition ( ESA 95 ).

The large deficit on the trade balance, the substantial surplus on the services balance
and the positive net balance of income and transfers are all long-standing features of
the Greek current account. In a longer-term perspective, as the Greek economy
approaches the EU average in terms of productivity and living standards, there is
likely to be a decline of EU transfers from the level secured in part under the Third
Community Support Framework 2000-06. Meanwhile, the structure of Greece’s
export earnings differs from other euro economies due to heavy reliance on tourism
and very modest manufacturing exports. Manufacturing exports to the euro area
correspond to little more than 3% of GDP. Better Greek export performance over the
medium term requires improvements on the supply-side in terms of
labour
productivity and the range of products produced.

2.6.3. Unit labour costs and other price indices

The examination of the development of unit labour and other price indices, required
by Article 121(1), is included in the section on price stability (see 2.1.2).

34

3. SWEDEN

3.1. Compatibility of national

legislation with the Treaty and the Statute of the

European System of Central Banks21

3.1.1. Assessment of compatibility in 1998

In its 1998 convergence report the Commission concluded that legislation in Sweden
was not compatible with the requirements of the Treaty and the ESCB Statute. The
following incompatibilities were noted:

– the legislation did not provide for independence of the central bank;

– legislation under preparation included an amendment of the Constitution, which
for constitutional reasons had to be finally approved by the new parliament after
the general elections of September 1998. Therefore it was clear that the central
bank of Sweden would not be independent at the date of the establishment of the
ESCB;

– the draft legislation did not ensure full integration of the central bank in the
ESCB; in particular, the provisions regarding the Riksbank’s competence in the
monetary policy area did not recognise the ESCB’s competence in this field.

Apart from these incompatibilities, the Commission also noted two imperfections
with respect to the draft legislation in the spring of 1998:

– the draft Constitution retained the exclusive right

to issue banknotes to the
Riksbank; this provision failed to recognise the ESCB’s competence in this field
as laid down in Article 106 of the Treaty;

– the prohibition imposed on the Riksbank by draft legislation to seek or take
instructions only covered monetary policy and did not extend to all ESCB related
tasks as specified in Article 105 of the Treaty.

3.1.2. Legislative action taken since 1998 and overview of the legislation in force

The government had put forward to parliament in November 1997 a proposal to
amend the Constitution, the Riksdag Act and the Riksbank Act. The amendment of
the Constitution required approval by two consecutive parliaments. The parliament
adopted the amendments to the Constitution for the first time in March 1998 and for
the second time in November 1998, after the general elections On this occasion,
parliament also adopted the amended Riksdag Act, Riksbank Act and a new Act on
exchange rate policy by which the competence for exchange rate policy was
transferred from the central bank to the government. All new legislation entered into
force on 1 January 1999.

21

See Annex A for a brief description of the Treaty requirements in this area, in particular for central bank
independence.

35

The legislation adopted in November 1998 was not significantly different from the
drafts on which the examination in the 1998 convergence report was based.

– Objectives

The objectives of the Riksbank are defined as follows:

“The objective of the Riksbank’s operations shall be to maintain price stability. In
the Riksbank shall promote a safe and efficient payment system.”
addition,
(Riksbank Act, Chapter 1, Article 2).

– Independence

Pursuant to the amended Riksbank Act, an Executive Board was established with the
task of defining monetary policy. The Executive Board comprises six members
including the governor who are all appointed for a six-years period by the General
Council. The latter comprises eleven members appointed by the Riksdag. The
General Council has a supervisory function with no monetary policy competence.

The reform of 1998 included further essential elements in order to make the central
bank independent. In particular, public authorities are prohibited from giving the
central bank instructions on monetary policy through a provision in the amended
Constitution. The Riksbank Act in turn prohibits members of the Executive Board of
the Riksbank from seeking or taking instructions in monetary policy matters. Prior to
the reform of 1998, the Riksbank was obliged to consult the Government before
taking policy decisions; this has been changed in the amended Riksbank Act to a
requirement to inform the government before taking important monetary policy
decisions.

– Integration in the ESCB and other legislation

The competence for monetary policy is attributed to the Riksbank without reference
to the competence of the ESCB in this field. The right of the bank to impose
minimum reserves for monetary purposes is also defined without such a reference.

3.1.3. Assessment of compatibility

Legislation in Sweden is not compatible with the requirements of the Treaty and the
ESBC Statute. The following incompatibility is to be noted:

• the legislation applicable since 1 January 1999 does not ensure full integration of
the Riksbank in the ESCB; in particular, the provisions regarding the Riksbank’s
competence in the monetary policy field do not recognise the ESCB’s competence
in this field.

Furthermore the following imperfections remain:

• the definition of the objectives of the Riksbank includes price stability but omits a
reference to supporting the general economic policies in the Community, an
objective which according to Article 105(1) of the Treaty the ESCB shall pursue,
without prejudice to the objective of price stability;

36

• the Riksbank's exclusive right to issue banknotes does not recognise the ESCB’s

competence in this field;

• the prohibition of public authorities to give and of the members of the Riksbank’s
decision-making bodies to seek or take instructions in the Riksbank Act itself only
covers monetary policy issues. The application of this rule to all ESCB-related
tasks is only mentioned in the Explanatory Memorandum to the Act.

3.2. Price stability22

3.2.1.

Inflation developments

– Situation in 1998 convergence report

Sweden already fulfilled the criterion on price stability when assessed in the 1998
convergence report. The average inflation rate in Sweden during the 12 months to
January 1998 was 1.9%, below the reference value of 2.7%. The Swedish inflation
rate had been below the reference value throughout the period from December 1996,
and for the months from December 1996 to September 1997 Sweden had been one of
the three best-performing Member States in terms of price stability.

– Recent trends

earlier

After rising during 1997, the
annual inflation rate in Sweden
(as measured by the change in
the monthly HICP index from
(see
12 months
Graph 3.1))
fell back during
1998 and reached zero in the
autumn of 1998. In 1999, the
annual rate remained subdued
during the first half of the year,
but accelerated towards
the
end of the year and reached
1.4% in March 2000.

– Respect of

the reference

value

Graph 3.1 Sweden - annual inflation rate (HICP)
(percentage change of monthly index on a year earlier,M/(M-12))

%

5

4

3

2

1

0

-1

S

EUR-11

01
96

05

09

01
97

05

09

05

09

01
98

01
99

05

09

01
00

Source : Eurostat.

The 12-month average inflation rate which is used for the convergence assessment
has fluctuated in Sweden but has continued to be below the reference value. After
rising to just over 2% in the first half of 1998, the average inflation rate declined
sharply to a very low level. Since February 1999 Sweden has been one of the three
best-performing Member States in terms of price stability (see Graph 3.2).

22

See Annex B for the calculation of the reference value, a discussion of other inflation standards, and a
short description of improvements in the harmonized indices of consumer prices (HICP).

37

3

5

2

4

%

Reference value

(HICP) with reference value (%)

Graph 3.2 Sweden - comparison of average inflation rate

the
In March 2000
three
best-performing
Member States in terms
of price stability were
and
France, Austria
Sweden itself, and the
arithmetic
simple
average
the
of
average
12-month
inflation rates in these
countries was
three
reference
0.9%. The
value, calculated in the
in the
same way as
1998
convergence
report, was 2.4%. The
average inflation rate in
Sweden in March 2000 was 0.8%, well below the reference value (see Table 3.1 and
Graph 3.2).

rate in the three best performers in terms of price stability (bottom of the
band) and the reference value (top of the band).

Note: The grey band represents 1.5 percentage points interval between the average

Source: Eurostat , Commission services .

Average of the three best performers

03
97

12
99

12
98

12
97

12
96

03
99

03
98

06

06

09

09

09

06

S

1

0

03
00

– Performance relative to other inflation standards

good

inflation
The
performance in Sweden is
also
when
apparent
comparison is made with
other possible standards for
Annex
inflation
(see
Table B.1).
Excluding
Sweden from the calculation
of the reference value and
using
best
performers in the euro area
gives a slightly higher value
of 2.5%. Furthermore,
in
March 2000 Sweden was the
best
performing Member
State in the EU as a whole.
Sweden's
inflation
average
rate was well below the 2%
the ECB's
upper
definition of price stability.

limit of

three

the

Table 3.1

Sweden : average inflation rate (HICP)
and the reference value a)
( % change )

1996

1997

1998

1999

S
EU-11
EUR-15
Reference value b)

0.8
2.2
2.5
2.5

1.8
1.6
1.7
2.7

1.0
1.1
1.3
2.2

0.6
1.1
1.2
2.1

March
2000
0.8
1.4
1.4
2.4

a) Measured by the arithmetic average of the latest 12 monthly
indices relative to the arithmetic average of the 12 monthly
indices of the previous period.

b) Unweighted arithmetic average of the three best performers

in terms of inflation plus 1.5 percentage points ; same method
as used in the 1998 convergence report , see tables in Annex B.

Source: Eurostat , Commission services.

38

3.2.2. Underlying factors and sustainability of inflation performance

employee

A successful reduction in the inflation
rate was achieved in Sweden during
the first half of the 1990s, and since
1995 inflation has been maintained at
a low level. The disinflation process
was helped by the very slow increase
in unit labour costs, especially in 1993
and 1994 (see Graph 3.3). Since then
compensation
has
per
increased at a moderate pace, and
coupled with favourable productivity
labour
the increase in unit
growth,
costs has remained low (see also
Table 3.2). As in other Member States
there has been some upward pressure
on inflation in recent months,
coming from the
impact of
higher oil prices on import
prices, but in general in recent
years the cost of imports has
also been a restraining factor for
inflation.

Graph 3.3

Sweden - inflation and wage trends

( 3-year moving average of annual percentage change)

10

8

6

4

2

0

90

91

92

93

94

95

96

97

98

99

00 (*)

Private consumption deflator

Unit labour costs

Compensation per employee

(*) Spring 2000 economic forecasts.
Source : Commission services.

Table 3.2

Sweden : other inflation and cost indicators
(annual % change)

1995

1996

1997

1998

1999

2000*

target

inflation

Since 1992 Sweden has had an
explicit
for
monetary policy and a flexible
regime.
rate
exchange
Commitment to price stability as
the objective of monetary policy
was further underlined by the
new legislation on the status of
the Riksbank that came into
force in 1999. The Riksbank's
inflation target is 2%, based on
the national
consumer price
index (CPI), with a tolerance
interval of ±1 percentage point.
the
October 1999
Since
Riksbank has specified that
it
bases
current monetary
policy on the assessment of
underlying inflation as measured
by UND1X23.

its

Private consumption deflator
2.9
S
2.9
EUR-11
2.9
EU-15

1.4
2.5
2.6

2.2
1.9
2.0

Labour costs:
Nominal compensation per employee

S
EUR-11
EU-15

2.8
3.4
3.4

6.8
3.1
3.3

2.3
1.8
1.7

Labour productivity
S
1.7
EUR-11
1.3
1.3
EU-15
Nominal unit labour costs
5.0
S
0.5
1.8
EUR-11
1.6
2.0
1.6
EU-15
Import prices **
5.7
S
3.0
EUR-11
3.5
EU-15

-4.2
0.6
0.4

3.1
2.4
2.9

2.6
1.8
1.8

0.5
0.5
1.0

1.4
2.6
1.1

1.0
1.3
1.6

3.3
1.5
2.3

1.7
1.3
1.3

1.6
0.2
1.0

-0.3
-1.2
-1.9

0.7
1.4
1.6

1.4
2.2
2.7

1.5
1.0
1.0

-0.1
1.2
1.7

1.3
0.0
-0.3

1.4
1.8
1.9

4.1
2.5
3.0

2.5
2.0
2.1

1.5
0.5
0.9

1.1
3.5
2.8

* Spring 2000 economic forecasts.
** Deflator of imports of goods and services .

Source: Commission services.

23

UND1X is defined as the CPI excluding interest expenditure and direct effects of altered indirect taxes
and subsidies.

39

The underlying inflation rate has been below the Riksbank's inflation target for a
number of years, but within the tolerance interval. Underlying inflation has been
1.5% on average since 1996. Medium-term inflation expectations are firmly
anchored around the inflation target and thereby close to 2%. In March 2000, the
UND1X stood at 1.6% year-on-year.

It should be noted that the framework for achieving price stability in Sweden is
different from that in the euro area. Whereas the Governing Council of the ECB has
defined price stability as the year-on-year increase in the HICP for the euro area of
below 2% in the medium term, the Swedish definition, by contrast, is symmetric
around 2% with a tolerance interval of ±1% point. The target indicators are also
different from the HICP, being either the CPI or, as at present,
the UND1X.
Although so far this has not been a source of difficulty, the issue will need to be
addressed by the Swedish authorities at some stage, particularly if the existence of
the two targets were to give rise to an appreciable inflation differential between
Sweden and the euro area.

Sweden has respected the reference value for inflation throughout the period from
December 1996 and since February 1999 has been one of the three best-performing
Member States in term of price stability. Sweden therefore continues to fulfil the
criterion on price stability.

3.3. Government budgetary position

3.3.1. Excessive deficit procedure

In the 1998 convergence report the Commission considered that the excessive deficit
situation in Sweden had been corrected. On the data then available, there had been a
very large and continuous reduction in the government deficit from 12.2% of GDP in
1993 to 0.8% in 1997, below the reference value, and a surplus was expected in
1998. The government debt ratio had peaked in 1994 at 79.0% of GDP and had since
declined every year to reach 76.6% in 1997 and was expected to continue declining
in 1998 and in future years. In the light of this assessment and in parallel with the
adoption of the report, the Commission made a recommendation to the Council that
the decision on the existence of an excessive deficit in Sweden (Council decision of
10 July 1995) should be abrogated.

Acting on this recommendation the Council adopted on 1 May 1998 a decision
abrogating the decision on the existence of an excessive deficit in Sweden.24 As
Sweden is not the subject of a Council decision under Article 104(6) of the Treaty
that an excessive deficit exists, Sweden fulfils the criterion on the government
budgetary position.

The remainder of this section reviews the current budgetary situation and prospects
in Sweden using the latest available data.

24

OJ L 139, 11.5.1998, p. 19.

40

3.3.2. Current budgetary position and prospects25

There has been a significant improvement in the public finances in Sweden in recent
years with a government deficit of 11.9% of GDP in 1993 turned into a surplus of
1.9% in 199826 and 1999. A larger surplus of 2.4% of GDP is forecast by the
Commission services for 2000 (see Table 3.3 and Graph 3.4). In the years between
1995 and 1998 almost all of the improvement was structural in nature, and the
influence of the cycle has been relatively limited. However,
the underlying
improvement came to an end in 1999 and, in a context of strong economic growth,
there are indications of a relaxation in the fiscal stance in 2000, with some narrowing
of the cyclically adjusted surplus.

Table 3.3

Sweden : government surplus/deficit , debt
and investment expenditure
(as % of GDP)

1995

1996

1997

1998

1999

2000*

General government net lending (+) / net borrowing (-)

S
EUR-11
EU-15

-7.9
-4.9
-5.1

-3.4
-4.2
-4.2

-2.0
-2.6
-2.4

General government gross debt
76.6
S
71.4
EUR-11
69.5
EU-15

76.0
74.7
72.1

75.0
74.5
71.0

1.9
-2.0
-1.5

72.4
73.0
69.0

General government investment expenditure **

S
EUR-11
EU-15

3.4
2.7
2.6

3.0
2.6
2.5

2.6
2.4
2.3

2.7
2.4
2.2

1.9
-1.2
-0.6

65.5
72.2
67.6

2.8
2.5
2.3

2.4
-0.9
-0.4

61.3
70.3
65.1

2.5
2.5
2.3

* Spring 2000 economic forecasts.
** General government gross fixed capital formation.

Source: Commission services.

25

26

As from March 2000, data on the basis of ESA 95 are being used for the purposes of the excessive
deficit procedure and budgetary monitoring in general (see also Annex C).
A one-off sale of pension fund real estate, amounting to 0.9% of GDP, increased the surplus in 1998.

41

Between 1995 and 1999, the cyclically adjusted government balance improved by
9.4% of GDP (see Table 3.4). A small part of the improvement was due to declining
interest payments, but the largest share was due to an increase in the primary balance
of 7.8% of GDP; more than half of this resulted from a reduction in the primary
expenditure ratio (including a fall in fixed capital spending), but the rise in the
revenue ratio up to 1998 also made a strong contribution. The substantial budgetary
consolidation in recent years has thus been primarily based on lower expenditure but
has also relied significantly on increases in tax pressure.

Table 3.4

Sweden : composition of budgetary consolidation
between 1995 and 1999
(Cyclically adjusted, as % of trend GDP )

of which :

of which :

Change in
overall
balance

Change in
interest
payments

Change in
primary
balance

Change in
revenue

Change in
primary
expenditure

(1)=(3)-(2)

S
EUR-11
EU-15

9.4
4.0
4.7

(2)

-1.6
-1.3
-1.3

(3)=(4)-(5)

(4)

7.8
2.7
3.4

3.7
1.2
1.1

(5)

-4.1
-1.5
-2.3

Source: Commission services.

42

Graph 3.4
Sweden - government surplus/deficit and debt

Actual and cyclically adjusted surplus/deficit
( % of GDP)

Deficit

Surplus

1995

1996

1997

1998

1999

2000 (*)

Actual surplus/deficit
Cyclically adjusted surplus/deficit
Reference value

Government debt
( % of GDP)

10

8

6

4

2

0

-2

-4

90

80

70

60

50

1995

1996

1997

1998

1999

2000 (*)

(*) Spring 2000 economic forecasts.
Source: Commission services

43

cuts

Table 3.5

Sweden: updated convergence
programme projections for
GDP growth, government
surplus/deficit and debt

The updated convergence programme for Sweden was adopted by the government in
November 1999 and assessed by the Council in January 200027. It covers the years to
2002 and foresees government surpluses of about 2% of GDP in each year, in respect
of Stability and Growth Pact requirements (see Table 3.5). The budgetary strategy
continues to be based on strict
spending
control of government
and a
in the
decline
further
expenditure/GDP ratio. At the same
are being
in taxes
time
introduced, reversing the trend in
the years up to 1998. Budgetary
discipline is reinforced by nominal
ceilings approved by the parliament
for central government expenditure
for three years ahead, and by a
legal obligation on local authorities
from 2000 onwards to balance their
budgets. Furthermore, the recently
introduced pension reform - which
of
higher
involves
individual funding - will enable the
pension system to cope better, in
the medium term, with business
cycle fluctuations and, in the long
term, with the
the
population.

1999
GDP-growth , annual % change
3.6
S

General government net lending (+)/borrowing (-) ,
as % of GDP

S
2.0
General government debt , as % of GDP

Source: Updated convergence programme of Sweden;

see also Annex table C.3 .

ageing of

degree

2001

2000

2002

54.1

66.1

58.8

52.0

1.7

3.0

2.0

2.0

2.2

2.1

a

S

After rising strongly in the early 1990s the government debt ratio in Sweden reached
a peak in 1994 and has since been declining. There was a sharp fall in the ratio in
1999, to 65.5% of GDP and a further decline in 2000 is forecast by the Commission
services to 61.3%, close to but still slightly above the reference value (see Table 3.3
and Graph 3.4). With the government balance remaining in surplus, the updated
convergence programme projects a further rapid decline in the debt ratio to 52.0% by
2002.

From the information presented in this section, it can be seen that the budgetary
position of Sweden, which is not at present the subject of an excessive deficit
decision, has remained strong in 1999 and is likely to improve further in 2000. There
is no reason for the Commission to reopen the excessive deficit procedure for
Sweden.

3.4. Exchange rate stability

In the 1998 convergence report Sweden was assessed not to fulfil the exchange rate
criterion. The Swedish krona had not participated in the ERM, and in the two years
under review (up to February 1998) the krona had fluctuated against the ERM
currencies, reflecting among other factors the absence of an exchange rate target.

27

OJ C 60, 2.3.2000, p. 5.

44

Sweden has continued not to participate in the ERM during the current review period
(two years up to March 2000). The monetary framework of explicit
inflation
targeting implies that the Swedish krona is left floating almost freely in the exchange
rate market. The absence of an explicit exchange rate commitment means that the
stability of the exchange rate of the krona cannot be assessed in the same way as for
the Member States participating in the ERM (i.e. on the basis of deviations from that
commitment).

Since

Graph 3.5

SEK/EUR exchange rate
(SEK/DEM at conversion rate before 1/1/99)

Between Spring 1996 and the outbreak of the international financial crisis in late
Summer 1998, the exchange rate of the krona did not show any clear trend. The
krona was severely hit by the international financial crisis. Against the DEM, it
from
depreciated
SEK 4.50 at the end
of
to
July 1998
about SEK 4.90 in
October, a level not
seen since autumn
1995.
the
beginning of 1999,
the krona has largely
been
an
on
trend
appreciating
euro,
the
against
rising by more than
12% from SEK 9.47
to SEK 8.28 against
the euro at the end
of March 2000 (see
Graph 3.5).

10.0
9.8
9.6
9.4
9.2
9.0
8.8
8.6
8.4
8.2
8.0

Source : Commission services.

10/98

01/99

07/99

07/98

04/99

04/98

01/00

10/99

The volatility of the krona exchange rate has diminished in the second half of the
1990s, as credible and sustainable fiscal and monetary policy provided the
preconditions necessary for a stable exchange rate in the medium run. The krona has
been more stable and less volatile against EMU currencies and the euro than against
non-EMU currencies. Volatility was generally limited during the review period,
although there was a steep but temporary increase during the Summer/Autumn 1998
financial crisis. Nevertheless, the absence of an exchange rate anchor was reflected
in relatively higher volatility than in the exchange rate of the two ERM II currencies.

The Swedish krona has not participated in the ERM and subsequently in the ERM II
during the review period and it has fluctuated against the ERM currencies and the
euro, also reflecting the absence of an exchange rate commitment. Hence, as was the
case at the time of the 1998 assessment of convergence, Sweden does not fulfil the
exchange rate criterion.

45

3.5. Long-term interest rate28

already
Sweden
fulfilled the criterion
on the convergence of
interest
rates in the
1998 convergence
report. The average
long-term interest rate
in Sweden in the year
to January 1998 was
the
6.5%,
reference
of
7.8%.

below

value

Graph 3.6

Long-term interest rates

Sweden and EUR-11 ( monthly averages )

%

14

12

10

8

6

4

2

S
EUR-11

0
01/94

01/95

01/96

01/97

01/98

01/99

01/00

Table 3.6

Source : Commission services.

Sweden: long-term interest rates
(12-month averages)

Sweden’s
good
inflation record and
impressive
consolidation of public finances in the past years have been reflected in declining
long-term interest rates (see Graph 3.6). More recently, Swedish long-term interest
rates (the yield on the 10-year benchmark bond) have followed the upward trend in
international bond markets, increasing by some 150-200 basis points since the trough
in
reached
January 1999
at
about 4%. Over the
last year, the spread
over
area
euro
long-term yields has
between
fluctuated
30
70 basis
and
points. The main
contributing factors
to the variation in
the spread may have
been changes in the
perceived
of
probability
joining
Sweden
EMU within
the
near-term future and
expectations on the cyclical position of Sweden relative to the euro-area economy.
However, on 9 March 2000, the spread relative to Germany fell to a low of 12 basis
points as the Swedish National Debt Office announced a buy back of government
bonds due to substantially higher public sector net savings this year partly resulting
from privatisation revenues.

Member States in terms of price stability plus 2 percentage points;
see Annex table E.1.

a) Average of April 1999-March 2000.
b) Average of interest rates of the three best performing

Source: ECB , Commission services.

S
Reference
value b)

March
2000 a)
5.4

1998

1997

1996

1999

1995

10.2

8.0

9.1

5.0

6.6

8.0

5.0

6.8

7.2

6.6

---

28

See Annex E for information on the calculation of the reference value and on the data employed.

46

Sweden has continued to have a twelve-month average interest rate below the
reference value. In fact, Sweden has had long-term interest rates below the reference
value ever since December 1996, the first date for which this comparison can be
provided (see Graph 3.7 and Table 3.6).

Graph 3.7 Sweden - comparison of average long-term

interest rate with reference value

%

16

14

12

10

8

6

4

S

12
96

03
97

06

09

12
97

03
98

06

09

12
98

03
99

06

09

12
99

03
00

Note: The grey band represents a 2 percentage points interval between the average
interest rate in the three best performers in terms of price stability (bottom of the band)
and the reference value (top of the band).

Source: ECB , Commission services .

In March 2000, the latest month for which data are available, the reference value,
given by the average of long-term interest rates in France, Austria and Sweden plus
two percentage points, stood at 7.2% (cf. Annex E). The twelve-month average of the
yield on ten-year Swedish benchmark bonds stood at 5.4%, hence below the
reference value. Therefore, Sweden continues to fulfil the criterion on long-term
interest rate convergence.

3.6. Additional factors

3.6.1. Results of the integration of markets

– Development of product markets

Sweden is increasingly integrated in the EU economy. Sweden’s intra-EU trade to
GDP ratio for the period 1996-98 of 18.2% was comparable to that of Austria and
Finland, which entered the EU at the same time. Moreover, the trade ratio has been
rising, although it remained below the 1998 average for the smaller EU Member
States. The intra-EU FDI to GDP ratio for the period 1996-98 was above the average
for the smaller Member States. Sweden's share in EU cross-border mergers and
acquisitions (M&As) is well above what one would expect for a country of its size.

Over the recent years, a number of structural policy reforms have been introduced
facilitating the rising integration of Sweden in EU product markets:

– Sweden has an excellent record in transposing and applying Single Market

legislation.

– Measures have been taken to open up public procurement.

47

– A lot of effort has been made to deregulate the network industries.
in the EU. Nevertheless,
Telecommunications prices are amongst
mergers and acquisitions combined with only limited entry have created a highly
concentrated supply structure in some of these industries.

the lowest

– Sweden is well integrated in the European research area and it is one of the
forerunners in the developing information society. R&D spending is the highest in
the EU and more than 70% of this was conducted by businesses.

In spite of the significant progress made in opening up the product markets to
competition, both from within and from outside the country, price levels in Sweden
remain high compared to those in most other Member States. The high relative price
levels may be attributed in part to the high levels of indirect taxation in Sweden, but
more importantly to a lack of competition in certain sectors such as construction,
pharmaceuticals, food retailing and some of the network industries. The market
domination of few retailers is among the highest in the EU.

Table 3.7

Sweden : product markets

Extra-EU trade GDP ratio (%)
Intra-EU trade GDP ratio (%)
Intra-EU FDI share (%)
Cross-border M&A share
Single Market Directives a)
Value of tenders in the O.J.

Aggregate price level
Prices level manufacturing
Prices level services
Prices construction

Sweden
1997
13.1
18.3
1.5
7.2

1.5
13.7

120
114
132
124

1998
13.2
19.1
7.9
6.7

2.1
15.3

117
:
:
:

1996
11.8
17.3
1.4
7.2

6.2
13.2

123
120
133
126

EU-15
1997
9.7
15.6
1.0
100

14.9
12.8

100
100
100
100

1996
8.9
15.1
0.9
100

26.7
11.2

100
100
100
100

1998
9.7
16.1
1.7
100

12.6
13.1

100
:
:
:

Comments:

(Exports + imports)/(2xGDP)

“

FDI inflows as a % of GDP
% of EU total (1998, 9months)

% not yet implem. (1997-1999)
% of total public procurement

EU-15=100, 1998 estimated
EU-15=100
“
“

Labour productivity
Employment in SMEs
a) For EU-15, percentage rate of Internal Market Directives not yet transposed across the whole of the Union.
Source: OECD, AMDATA, BACH , Eurostat and Commission services.

PPS, EU-15=100
As a % of tot.empl.in Ind.&Serv

100
66

:
61

:
66

89
61

:
:

:
:

48

– Developments in financial markets

The Swedish money and bond market has been well established for almost two
decades with high liquidity and active participation of both domestic and foreign
financial intermediaries. The major part of government debt, around 70%, is in SEK.
Of the remaining 30%, approximately half is in euro with about one fifth each in US
Dollar and Japanese Yen.

In August 1999, the Oslo Stock Exchange decided to join Norex, the common market
for shares established through collaboration between the OM Stockholm Exchange
and the Copenhagen Stock Exchange. A shared trading platform and harmonized
trading rules should help to promote a more efficient stock market with greater
liquidity.

Structural changes in the financial system are well underway, driven by increased
competition, globalisation and the introduction of the euro. In the past years, several
mergers and acquisitions have taken place, both within Sweden and across borders.
The Swedish banking system is characterised by a high degree of concentration, but
competition appears to remain strong. Furthermore, Swedish banks are at
the
forefront of the development of internet banking.

3.6.2. Balance of payments on current account

In the 1970s and 1980s Sweden emerged as a significant international net debtor as a
combination of
low private and public saving and recurring competitiveness
problems created substantial current account deficits. Sweden’s position changed
after the deep recession at the beginning of the 1990s. The large depreciation in
November 1992 and continued depressed private domestic demand in combination
with consolidation of public finances generated large current account surpluses.
Since 1997, when the current account reached its highest surplus at about 3% of
GDP, it has fallen somewhat to about 2% of GDP as the recovery in private domestic
demand accelerated. Current and prospective external surpluses in combination with
high growth suggest that the competitiveness of the Swedish economy is currently
strong.

3.6.3. Unit labour costs and other price indices

The examination of the development of unit labour costs and other price indices,
required by Article 121(1), is included in the section on price stability (see 3.1.2.).

49

ANNEX A: COMPATIBILITY OF NATIONAL LEGISLATION

According to the second sentence of Article 121 of the Treaty, the report drawn up
under this article “shall include an examination of the compatibility between each
Member State’s national legislation, including the statutes of its national central
bank, and Articles 108 and 109 of this Treaty and the Statute of the ESCB”.

According to Article 109 of the Treaty, each Member State shall ensure, at the latest
at the date of the establishment of the ESCB, that its national legislation including
the statute of its national central bank is compatible with this Treaty and the Statute
of the ESCB.

Following the approach chosen in the convergence report of 1998, the examination is
divided into three areas:

– objectives of national central banks;

– independence;

– integration in the ESCB and other legislation.

Objectives of national central banks

The objective of a national central bank must be compatible with the objectives of
the ECB as formulated in Article 105(1) of the Treaty (and Article 2 of the Statute of
the ESCB):

“The primary objective of the ESCB shall be to maintain price stability. Without
prejudice to the objective of price stability, the ESCB shall support the general
economic policies in the Community with a view to contributing to achievement of
the objectives of the Community as laid down in Article 2”.

References in national
to specific
macroeconomic objectives are not incompatible provided that the primacy of the first
and second objectives of Article 105 of the Treaty is respected.

law to the policy of

the government or

Independence

Article 108 of the Treaty ensures that the ESCB will operate free from instructions
from third parties:

“When exercising the powers and carrying out the tasks and duties conferred upon
them by this Treaty and the Statute of the ESCB, neither the ECB nor national
central bank, nor any member of the their decision-making bodies shall seek or take
instructions from Community institutions or bodies, from any government of a
Member State or from any other body. The Community institutions and bodies and
the governments of the Member States undertake to respect this principle and not to
seek to influence the members of the decision making bodies of the ECB or of the
national central banks in the performance of their tasks”.

50

The various aspects of independence are described in more detail in the convergence
report of 1998.

Integration of national central banks in the ESCB and other legislation

According to Article 9.2 of the Statute of the ESCB, the ECB shall ensure that the
tasks conferred upon the ESCB are implemented either by its own activities or
through the central banks. Furthermore, according to Article 14.3, the central banks
are an integral part of the ESCB and shall act in accordance with the guidelines and
instructions of the ECB. Therefore, provisions in the statutes of the central banks,
which stand in the way of the central banks assuming their role, need to be adapted
under Article 109.

The examination in this report recalls the result of the examination in 1998, describes
legislative action since the earlier examination, summarises the essential elements of
central bank legislation in force and concludes with an assessment of compatibility.
The statement on compatibility concludes that a country’s legislation either is or is
not compatible with the Treaty and the ESCB Statute. Legislation is not compatible
where incompatibilities exist which infringe upon principles of the Treaty. In some
cases, imperfections have been identified which are either of technical nature or are
ambiguities rather than obvious inconsistencies. The judgement on compatibility is
not affected by the reference to such imperfections.

51

ANNEX B: INFLATION CRITERION

This Annex discusses implications of the third stage of EMU for the operational
definition of the price convergence criterion and describes recent methodological
developments in the harmonized consumer price indices.

B.1.

Treaty provisions

The Treaty requires the achievement of a high degree of price stability as a
prerequisite for entering the third stage of EMU. According to Article 121(1) of the
Treaty, the convergence reports of the Commission and the ECB shall “examine the
achievement of a high degree of sustainable convergence by reference to the
including “the
fulfilment by each Member State of
achievement of a high degree of price stability; this will be apparent from a rate of
inflation which is close to that of, at most, the three best-performing Member States
in terms of price stability”.

the following criteria”,

This rule is developed further in Article 1 of Protocol No 21 (ex 6) the first sentence
of which reads as follows: “The criterion on price stability...shall mean that a
Member State has a price performance that is sustainable and an average rate of
inflation, observed over a period of one year before the examination, that does not
exceed by more than 1½ percentage points that of, at most, the three best-performing
Member States in terms of price stability”.

Article 1 of Protocol No 21 also specifies that “Inflation shall be measured by means
of the consumer price index on a comparable basis, taking into account differences
in national definitions”. To meet this requirement, Harmonized Indices of Consumer
Prices (HICP) have been produced in each Member State since January 1997 using a
harmonized methodology developed by national statistical offices and Eurostat.

B.2.

Reference value for inflation

The assessment of the price convergence criterion as laid down in Protocol No 21 of
the Treaty requires an operational definition of the reference value against which the
price performance of Member States with a derogation will be assessed. In the
Commission’s Convergence Report of March 1998,
the reference value was
calculated as the arithmetic average of the inflation rates of the three best performing
Member States plus 1.5 percentage points.

The Treaty makes no distinction between initial and later entrants to the euro area as
regards the application of the criteria. The principle of equal treatment implies that,
as far as possible, Member States joining later should not be confronted with
additional hurdles, nor be allowed to join on looser terms than the first-round
entrants.

Within this framework, it needs to be examined whether the fact that the third stage
of EMU is underway - which was not the case at the time of convergence assessment
in March 1998 - might have implications for the application of the price convergence
criterion. For instance, the question arises whether countries not participating in the

52

euro should be considered when the average of the best-performing Member States is
used to calculate the reference values for the inflation and long-term interest rate
criteria.

The context in which the inflation (and interest rate) criteria were devised must be
recalled. When drafting the convergence criterion on inflation, the Treaty negotiators
had to choose a reference performance which could be expected to satisfy the
criterion of “a high degree of price stability”. No widely accepted definition of price
stability existed at the time. In referring to the “best performers in terms of price
stability”, it was assumed that these countries would provide the most appropriate
standard available before the start of monetary union.

Since the start of the third stage of EMU, price stability in the eleven participating
Member States is pursued at euro area level by means of the monetary policy of the
Eurosystem. Moreover, the ECB has provided its interpretation of price stability:
“price stability shall be defined as a year-on-year increase in the Harmonized Index
of Consumer Prices (HICP) for the euro area of below 2%”.29It therefore seems
desirable that the assessment of “a high degree of price stability” should also take
into consideration the price stability performance of the euro area as well as the
ECB’s definition of price stability. This is all the more so since the euro and the euro
area economy constitute the economically relevant benchmarks to which countries
aiming to join the euro should orient their convergence efforts.

As an additional consideration, it is possible to envisage situations in which the
average of
the three best performers would not constitute an economically
meaningful benchmark. This could be the case if the average inflation performance
in the three best-performing Member States was very close to zero or substantially
below the average of the euro area. In consequence, the calculated reference value
could be below 2%, or it could lead to a reference value below the euro average. If
such cases should arise, a careful appraisal would have to be made in the light of the
ECB’s definition of price stability and the inflation performance of the euro area with
a view to not including countries with a non-representative inflation performance in
the reference group in order to better reflect the Treaty’s intentions in providing a
yardstick for the achievement of a high degree of price stability.

Although the Treaty is not specific on whether Member States outside the euro area
should be part of the group of reference countries or not, continuation of previous
practice would speak in favour of doing so. From an economic point of view,
however, there is no reason why the decision on whether a Member State fulfils the
conditions for adopting the euro should depend on the inflation and interest rate
performance of countries which are not in the euro area.

29

The ECB has made it clear that negative inflation rates, should they occur, would not be consistent with
price stability. Price stability in the euro area is to be maintained over the medium term.

53

shows

assessment

These
considerations
may be relevant in future
of
applications
the
convergence
criterion
but they do not have any
practical bearing on the
present
of
inflation convergence in
and Greece.
Sweden
Table B.1
the
12-month average rate of
inflation in March 2000
for each Member State.
The
best-
three
Member
performing
in the EU are
States
Sweden (0.8%), France
(0.9%)
Austria
and
(0.9%). The unweighted
arithmetic average of the
inflation rates in these
three countries is 0.9%.
The resulting reference
calculated
value,
to
according
the
operational
definition
used in the March 1998
convergence assessment,
is therefore 2.4%.

Table B.1

Ireland
Spain

Denmark

Greece

Netherlands
Portugal
Italy
Luxembourg
Finland

Belgium

United
Kingdom
Germany

Austria
France
Sweden

Inflation convergence -HICP
(March 2000) a)

3.1
2.5

2.4

2.0

1.9
1.9
1.9
1.8
1.8

1.4

1.2

1.1

0.9
0.9
0.8

2.5

2.4

2.0

1.4

1.0
0.9

Reference value 3 best euro MS

Reference value 3 best EU MS

Upper limit of ECB definition
of price stability

euro area average

Average value 3 best euro MS
Average value 3 best EU MS

a) Percentage change in the arithmetic average of the latest 12 months

harmonized indices of consumer prices (HICP) relative to the arithmetic
average of the previous 12 months.

Source : Eurostat , Commission services.

Given generally low inflation in the EU and a 12-month average inflation rate of
1.4% in the euro area, none of the three best-performing EU Member States is
considered to have a non-representative inflation performance.

However, Sweden is not part of the euro area. On the basis of a definition which
excludes non-euro Member States from the group of reference countries,
the
12-month average inflation rate of the three best-performing euro area Member
States is 1.0%, giving a reference value of 2.5%.

Table B.1 also shows the 12-month average inflation in the euro area for March 2000
as well as the upper limit of the ECB’s definition of price stability, both of which are
relevant in assessing the “achievement of a high degree of price stability”.

54

Table B.2

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15
Average of
3 best b)
Reference
value c)

Jan.99
1.0
0.6
1.7
0.6
2.2
1.9
0.7
1.8
0.7
2.3
1.2
1.1
1.3
4.4
0.8
1.6
1.3

0.6

2.1

Development of average HICP inflation rates
and the reference value a)

Feb.99
1.0
0.5
1.7
0.6
2.3
1.9
0.7
1.8
0.7
2.4
1.2
1.0
1.2
4.3
0.7
1.6
1.2

0.6

2.1

Mar.99
1.0
0.5
1.8
0.6
2.4
1.8
0.6
1.8
0.6
2.5
1.1
1.0
1.2
4.2
0.6
1.6
1.2

0.6

2.1

Apr.99
1.0
0.5
1.8
0.5
2.4
1.7
0.6
1.8
0.5
2.6
1.1
1.0
1.3
4.0
0.5
1.5
1.2

0.5

2.0

May99
0.9
0.5
1.8
0.5
2.4
1.7
0.6
1.8
0.5
2.6
1.1
1.0
1.3
3.8
0.4
1.5
1.1

0.5

2.0

Jun.99
0.9
0.4
1.8
0.4
2.3
1.7
0.6
1.8
0.4
2.5
1.0
0.9
1.3
3.5
0.3
1.5
1.1

0.4

1.9

Jul.99
0.8
0.4
1.8
0.4
2.3
1.6
0.5
1.8
0.4
2.4
1.1
0.9
1.4
3.2
0.2
1.4
1.1

0.3

1.8

Aug.99
0.8
0.4
1.9
0.4
2.2
1.6
0.6
1.9
0.4
2.4
1.1
0.9
1.5
2.9
0.2
1.4
1.1

0.3

1.8

Sep.99
0.9
0.4
1.9
0.4
2.2
1.6
0.6
1.9
0.4
2.4
1.1
0.9
1.6
2.6
0.3
1.4
1.1

0.4

1.9

Oct.99
0.9
0.5
2.0
0.4
2.2
1.6
0.7
2.0
0.4
2.3
1.1
1.0
1.8
2.4
0.4
1.4
1.1

0.4

1.9

Nov.99
1.0
0.5
2.1
0.5
2.3
1.6
0.9
2.0
0.4
2.3
1.2
1.0
1.9
2.3
0.5
1.4
1.1

0.5

2.0

Dec.99
1.1
0.6
2.2
0.6
2.5
1.7
1.0
2.0
0.5
2.2
1.3
1.1
2.1
2.1
0.6
1.3
1.2

0.6

2.1

Jan.00
1.2
0.8
2.4
0.7
2.7
1.7
1.4
2.0
0.6
2.1
1.5
1.2
2.2
2.1
0.6
1.3
1.3

0.6

2.1

Feb.00 Mar.00

1.3
0.9
2.4
0.8
2.9
1.8
1.6
2.0
0.8
2.0
1.6
1.3
2.3
2.0
0.7
1.2
1.3

0.8

2.3

1.4
1.1
2.5
0.9
3.1
1.9
1.8
1.9
0.9
1.9
1.8
1.4
2.4
2.0
0.8
1.2
1.4

0.9

2.4

a) Measured by the percentage change in the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices of the previous period.
b) Unweighted arithmetic avergae of the three best performing Member States ( underlined) in terms of price stability ; ordering determined using unrounded data.
c) Average of the three best performers plus 1.5 percentage points ; same method as used in the 1998 convergence report.
Source: Eurostat , Commission services.

55

shows

how average
Table B.2
inflation rates have evolved in the
Member States since the beginning
of 1999, and the derivation of the
reference value, calculated using the
the
as
same method
1998
in
Convergence
Table B.3
Report.
shows for the period since the HICP
became available (first comparison
possible December 1996) the three
best performers (in the EU) in terms
average
of
inflation rate in these three best
performers and the corresponding
reference value.

stability,

price

the

B.3.

Recent
developments in HICP

methodological

for

the

assessment

comparable
provide
The HICPs
measures of consumer price inflation
in the Member States. The HICPs are
of
used
convergence in inflation across the
EU and they form the main measure
of price stability in the euro area.
Since the Commission undertook its
previous convergence assessment in
March 1998,
the
statistical offices of
the Member
States have continued to refine the
measurement of inflation provided
by the HICPs.

Eurostat

and

Table B.3

Evolution of the inflation a) reference value
and the three best performers

Three best
performers

Average
of 3 best

Reference
value b)

Dec. 96 - Feb. 97
Mar. - Apr.97
May 97
Jun. 97
Jul. 97
Aug 97
Sep. 97
Oct. - Nov. 97
Dec. 97
Jan .98
Feb. - Apr. 98
May - Jul. 98
Aug. 98
Sep. 98
Oct. - Nov. 98
Dec. 98
Jan . 99
Feb . - Mar. 99
Apr. - May 99
99
Jun.
Jul.
- Aug 99
Sep. 99
Oct. 99
Nov. 99
Dec. 99
Jan. 2000
Feb. 2000
Mar. 2000

L, FIN,S
L, FIN,S
L, FIN,S
L, FIN,S
L, FIN,S
L, FIN,S
L, FIN,S
F, A, FIN
IRL,A,FIN
F,IRL,A
F, IRL, A
D, F, A
D, F, A
D, F, A
D, F, A
D, F, A
D, F, L
D, F, S
D, A, S
F, A, S
F, A, S
F, A, S
F, A, S
F, A, S
F, A, S
F, A, S
F, A, S
F, A, S

1.0
1.1
1.0
1.1
1.1
1.2
1.3
1.3
1.2
1.2
1.1
1.1
1.0
0.9
0.8
0.7
0.6
0.6
0.5
0.4
0.3
0.4
0.4
0.5
0.6
0.6
0.8
0.9

2.5
2.6
2.5
2.6
2.6
2.7
2.8
2.8
2.7
2.7
2.6
2.6
2.5
2.4
2.3
2.2
2.1
2.1
2.0
1.9
1.8
1.9
1.9
2.0
2.1
2.1
2.3
2.4

a) Measured by the percentage change in the arithmetic

b) Unweighted arithmetic average of the three best

average of the latest 12 monthly indices relative to the
arithmetic average of the 12 monthly indices of the
previous period.

HICPs are intended to cover all
expenditure
forms of household
(“household
monetary
final
the
consumption expenditure”). At
launch of the HICP in 1997, certain
technically
areas were
difficult
excluded because Member States did
comparable
not
methodologies. The initial product
coverage
approximately
95% of all household final monetary consumption expenditure (this concept does not
include owner-occupied housing). The product coverage of the HICPs has now been
extended to include additional goods and services, and there have been changes to
the population and geographic coverage.30 This brings the coverage to virtually

performers in terms of inflation plus 1.5
percentage points ; same method as used in the 1998
convergence report.

Source: Commission services.

included

agree

yet

on

30

The extension takes place under the legal umbrella of Council Regulations (EC) Nos 1687/98 and
1688/98.

56

100% of household final monetary consumption spending (still not including owner-
occupied housing). The extension occurs in a two-stage approach: most are reflected
from the January 2000 index but a few items will be included only from the index for
January 2001.

The extension of product coverage from January 2000 covers health, education, and
social protection items, certain insurance and financial services, and certain tax-like
charges in connection with housing. The extension was possible due to an agreed
methodology on tax-like charges and subsidies.31 The consumer prices of subsidised
goods and services, e.g. pharmaceutical products and medical and dental services, are
measured net of reimbursements and subsidies. Since the prices that consumers pay
in the health, education and social protection areas are linked to the social welfare
and tax policies in the different countries, the weights and price changes for these
sub-indices may vary markedly between Member States. The insurance and financial
services have been extended with e.g. health insurance and fees for investment
counsellors. The few additional services which will be covered only from
January 2001 are hospital services, social protection services provided within the
home (e.g. cleaning, meals), retirement homes, and residences for the disabled. There
has also been a harmonization of the treatment of tariff prices.

The geographic and population coverage was harmonized in all Member States with
the January 2000 index. Spending by tourists and cross-border shoppers, which
previously was not covered by all Member States, are now always covered in the
Member State in which the purchase is made. The HICP now has complete
population and geographic coverage without omissions or overlaps.

The implication of the methodological improvements for headline inflation is likely
to be very small in the early months of 2000. This is because of the way the data are
linked: the annual rate of change for the all-items HICP index in, for example,
March 2000 is based on the change from March 1999 to December 1999 (using the
old coverage) combined with the change from December 1999 to March 2000 (using
new coverage). Thus, in this example, the extension of the coverage only affects 3
out of 12 months. The impact may become progressively larger during the year but
not enough information is available to provide a reliable estimate of the full-year
impact of the methodological improvements.

Given that the data used for the price convergence criterion is the average rate of
implications of this change in
inflation observed over one year,
methodology for the assessment of inflation convergence in this examination is
small.32

the practical

31

32

As laid down in Council Regulation (EC) No 2166/1999.
However, in connection with the proper chaining of initial coverage items between December 1999 and
2000, the National Statistical Service of Greece replaced expenditure weights referring to the year 1994
with a new set of expenditure weights referring to the year 1998. The new weights are used in the HICP
for January 1999 onwards. This is in compliance with Commission Regulation (EC) No 2454/97
concerning the quality of HICP weights and gives an HICP comparable to those of other Member
States.

57

B.4.

Additional tables on other price and cost indicators

Table B.4

Price deflator of private final
consumption expenditure in EU Member States
(national currency, annual percentage change)

1995

1996

1997

1998

1999

2000*

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15

EUR-11
EU-15

1.7
1.9
4.7
2.0
2.8
6.0
2.1
1.4
1.5
4.5
0.4
2.9
0.6
8.9
2.9
2.9
2.9

1.7
2.3

2.1
1.9
3.4
1.9
2.5
4.4
1.7
1.9
2.3
3.2
1.4
2.5
1.4
8.2
1.4
3.1
2.6

1.5
1.7
2.5
1.4
2.4
2.2
1.7
2.1
1.8
2.7
1.3
1.9
1.9
5.5
2.2
2.5
2.0

Standard deviation

0.9
1.7

0.5
1.0

0.8
0.9
2.0
0.9
3.7
2.1
1.7
1.8
0.7
1.8
2.1
1.3
1.8
4.7
1.0
2.5
1.6

0.9
1.1

1.1
0.8
2.8
0.8
3.3
2.2
1.0
2.0
0.6
2.3
1.8
1.4
2.1
2.5
0.7
2.2
1.6

0.9
0.9

1.5
1.5
2.5
1.2
4.0
2.3
2.0
2.4
1.2
2.2
2.3
1.8
2.4
2.5
1.4
2.1
1.9

0.8
0.7

* Spring 2000 economic forecasts.

Source: Commission services.

58

Table B.5

1992
-95 a)
4.0
5.5
5.7
2.9
4.4
4.4
4.1
3.2
4.2
8.7
2.5
4.5
2.9
11.3
4.0
3.9
4.5

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15

Labour costs in EU Member States
(percentage change, total economy)

2000*

1999

Nominal compensation
per employee
1996
-99 a)
2.0
1.7
3.0
2.3
5.2
2.6
2.0
2.4
1.8
4.4
2.9
2.3
3.7
7.9
3.6
4.6
2.8

2.1
1.9
2.4
1.9
7.0
1.9
2.5
3.7
2.8
5.1
2.4
2.2
4.1
4.8
1.4
4.9
2.7

2.2
2.0
2.9
2.1
6.8
2.4
2.5
4.0
1.6
4.8
4.0
2.5
3.8
4.7
4.1
5.0
3.0

Labour productivity

Nominal unit labour costs

1992
-95 a)
1.6
2.2
1.9
1.7
2.8
2.4
2.9
1.6
1.4
3.0
4.2
2.1
2.3
-0.5
3.4
2.4
2.1

1996
-99 a)
1.5
1.7
0.7
1.7
4.1
0.8
1.2
0.8
1.6
1.4
2.1
1.4
1.3
2.2
1.9
1.2
1.3

1999

2000*

1.2
1.2
0.3
1.3
3.9
0.5
0.2
1.0
1.3
1.1
0.1
1.0
0.6
2.2
1.5
0.8
1.0

2.2
2.5
1.0
1.9
4.2
1.7
1.6
1.5
2.4
2.4
2.5
2.0
1.8
2.5
2.5
2.3
2.1

1992
-95 a)
2.3
3.2
3.7
1.2
1.5
1.9
1.2
1.6
2.7
5.5
-1.7
2.4
0.6
11.9
0.6
1.5
2.3

1996
-99 a)
0.5
0.0
2.3
0.7
1.0
1.7
0.8
1.6
0.2
2.9
0.7
0.9
2.4
5.5
1.7
3.4
1.4

1999

2000*

0.9
0.7
2.0
0.6
2.9
1.4
2.3
2.7
1.5
4.0
2.3
1.2
3.5
2.5
-0.1
4.1
1.7

0.0
-0.4
1.9
0.2
2.5
0.8
1.0
2.4
-0.7
2.4
1.4
0.5
1.9
2.1
1.5
2.6
0.9

a) Average annual percentage change.
* Spring 2000 economic forecasts.

Source: Commission services.

59

Table B.6

Import prices in EU Member States
(percentage change in the deflator of imports of goods and services,
in national currency)

1995

1996

1997

1998

1999

2000*

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15

2.3
0.7
4.7
0.4
3.8
11.1
0.8
0.4
1.0
3.5
0.1
3.0
-0.2
6.8
5.7
6.1
3.5

2.9
0.7
0.7
2.3
-0.6
-2.9
0.7
1.2
2.0
-1.3
0.4
0.6
-0.8
5.0
-4.2
0.2
0.4

5.2
2.7
3.7
2.4
0.7
1.4
2.0
2.6
1.9
2.1
0.5
2.6
3.8
2.2
1.4
-6.7
1.1

-1.6
-2.0
-0.6
-0.6
2.4
-1.3
-0.5
-1.5
-0.1
-1.9
-3.0
-1.2
-1.0
5.0
-0.3
-6.3
-1.9

0.7
-1.2
0.7
0.0
2.0
1.3
0.8
0.1
-0.4
-0.6
-1.0
0.0
-1.4
0.6
1.3
-2.6
-0.3

* Spring 2000 economic forecasts.

Source : Commission services.

2.9
3.5
4.0
2.5
4.7
4.9
2.1
3.3
2.7
4.0
3.0
3.5
2.4
6.1
1.1
-1.1
2.8

60

ANNEX C: GOVERNMENT BUDGETARY DATA

C.1.

Shift to ESA 95 and revision to Regulation (EC) No 3605/93

The government budgetary data used in the excessive deficit procedure, and hence
for the assessment of convergence, are on a national accounts basis. From the
year 2000 a new system of accounts, ESA 95, has been brought into use for these
purposes. This section describes main features of the new system and key differences
from the earlier system of accounts, ESA 79, which was used in the excessive deficit
procedure until the end of 1999 and in the 1998 convergence report.

obligatory in

From April 1999, the new system of national and regional accounts ESA 9533 has
become
to
Regulation (EC) No 3605/9334
of
- which specifies
government deficit and debt, and of GDP, and governs the twice-yearly transmission
of government data by the Member State to the Commission - the former accounting
system (ESA-2nd edition, or simply ESA 79) remained the applicable standard for
the purpose of the excessive deficit procedure until the end of 1999.

the EU Member States. However,
relevant

according
definitions

the

This lag in the application of the new accounting system to the excessive deficit
procedure had been planned since long, notably in the regulation that adopted the
ESA 95 methodology.35 It allowed the two reporting exercises of 1999 (in March and
September) to be made on the same methodological basis. As a result, the Council
Decision of 17 December 1999 to abrogate the Decision on the existence of an
excessive deficit in Greece was taken on the same accounting basis as all previous
Council decisions on the existence of, or correction of, excessive deficits.

Regulation (EC) No 3605/93 was amended36 to take into account the new accounting
environment in February 2000, and Member States reported government data, in the
context of the excessive deficit procedure according to the new methodology, for the
first
the beginning of March 2000. Therefore, unless otherwise stated,
government data in this report comply with ESA 95.

time at

The implementation of ESA 95 is the result of a long-term exercise conducted within
the EU (Eurostat and the national statistical offices) but also at international level
(UN, IMF, OECD, World Bank). The new accounting system ensures consistency
with the international System of National Accounts (SNA 93) and the 5th edition of
the IMF Balance of Payments Manual. It culminates in the modernisation of concepts
increasing harmonized
to reflect new economic and financial phenomena,

33

34

35

36

The ESA 95 accounting methodology and the transmission programme of national accounts data are
specified by Council Regulation (EC) No 2223/93 of 25 June 1996 on the European system of national
and regional accounts in the Community, OJ L 310, 30.11.1996, p.1.
Council Regulation (EC) No 3605/93 of 22 November 1993 on the application of the Protocol on the
excessive deficit procedure annexed to the Treaty establishing the European Community, OJ L 332,
31.12.1993, p.7.
Article 8(3) of Regulation (EC) No 2223/96.
Council Regulation (EC) No 475/2000 of 28 February 2000 amending Regulation (EC) No 3605/93 on
the application of the Protocol on the excessive deficit procedure annexed to the Treaty establishing the
European Community, OJ L 58, 3.3.2000, p.1.

61

methodologies, greater precision in accounting rules and definitions and a wider
coverage of the whole range of economic activities. In addition, the implementation
of ESA 95 has been the opportunity for each Member State to improve its sources
and its methods of compiling the accounts.

in particular

Government accounts,
the government deficit/surplus, have been
affected by the changeover to the new system. However, for most Member States,
the changes in the balance ratios are relatively small, especially if the magnitude of
total government expenditure and revenue (in some cases above 50% of GDP) is
taken into account. The methodological differences between ESA95 and the former
system that have a larger impact on the government balance ratios are the following:

delimitation of general government. Some entities that were previously recorded
outside the government sector are now treated as part of general government.
Similarly, some units formerly included in government are now accounted as
financial or non-financial corporations.

Transactions are, in principle, recorded at the time of the events that generate them
(accruals principle), rather than when a payment is made. For example, interest is
recorded as accruing continuously to the creditor and no longer when it is paid. The
time of recording of taxes and social contributions has also been adjusted.

Changes in GDP (generally upwards) have also led to marginal revisions in the
deficit and debt ratios.

The government debt (general government consolidated gross debt at nominal value)
is not strictly-speaking an ESA 95 concept, just as it was not an ESA 79 concept. It is
defined in Regulation (EC) No 3605/93 specifically for the purpose of the excessive
deficit procedure. This is because the accounting system that existed in 1994, when
the excessive deficit procedure entered into force, did not contain any definition of
debt.37 Moreover, the definition of financial liabilities at market prices that exists
now in ESA 95 is not appropriate for the excessive deficit procedure. Nonetheless,
the debt definition was also revised in February 2000 to take into account the new
accounting environment. Among other changes, the new delimitation of government
sector has been taken into account, the components of the debt have been further
amplified (for example,
leasing is now included in the liabilities
constituting government debt) and the valuation of debt issued in foreign currency
(including liabilities swapped to, or among, foreign currencies) has been clarified.

financial

37

ESA 79 was a purely flow-based system that, as said above, contained neither balance sheets nor any
other stock accounts.

62

C.2.

Additional tables on the public finances

Table C.1

Government surplus / deficit
in EU Member States
(General government net lending (+) / net borrowing (-) ,
as % of GDP)

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15

1995
-4.2
-3.3
-6.9
-5.5
-2.5
-7.6
2.2
-4.2
-5.1
-4.2
-3.7
-4.9
-2.3
-10.2
-7.9
-5.8
-5.1

1996
-3.7
-3.4
-5.0
-4.2
-0.6
-7.1
2.7
-1.8
-3.8
-3.8
-3.2
-4.2
-1.0
-7.8
-3.4
-4.4
-4.2

1997
-2.0
-2.6
-3.2
-3.0
0.8
-2.7
3.6
-1.2
-1.9
-2.6
-1.5
-2.6
0.5
-4.6
-2.0
-2.0
-2.4

* Spring 2000 economic forecasts.

Source: Commission services.

1998
-1.0
-1.7
-2.6
-2.7
2.1
-2.8
3.2
-0.8
-2.5
-2.1
1.3
-2.0
1.2
-3.1
1.9
0.3
-1.5

1999
-0.9
-1.1
-1.1
-1.8
2.0
-1.9
2.4
0.5
-2.0
-2.0
2.3
-1.2
3.0
-1.6
1.9
1.2
-0.6

2000*
-0.5
-1.0
-0.7
-1.5
1.7
-1.5
2.6
1.0
-1.7
-1.5
4.1
-0.9
2.4
-1.3
2.4
0.9
-0.4

63

Table C.2

Government debt in EU Member States
(General government consolidated gross debt , as % of GDP)

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK
EU-15

1995
129.8
57.0
63.2
51.9
80.8
123.2
5.6
75.5
68.0
64.7
56.6
71.4
69.3
108.7
76.6
52.0
69.5

1996
128.3
59.8
68.0
57.1
74.1
122.1
6.2
75.3
68.3
63.6
57.1
74.7
65.0
111.3
76.0
52.6
72.1

1997
123.0
60.9
66.7
59.0
65.3
119.8
6.0
70.3
63.9
60.3
54.1
74.5
61.3
108.5
75.0
50.8
71.0

1998
117.4
60.7
64.9
59.3
55.6
116.3
6.4
67.0
63.5
56.5
49.0
73.0
55.6
105.4
72.4
48.4
69.0

1999
114.4
61.1
63.5
58.6
52.4
114.9
6.2
63.8
64.9
56.8
47.1
72.2
52.6
104.4
65.5
46.0
67.6

2000*
110.1
60.7
62.3
58.2
45.2
110.8
5.8
58.8
62.6
57.0
42.6
70.3
49.3
103.7
61.3
42.4
65.1

* Spring 2000 economic forecasts.

Source: Commission services.

64

Table C.3

Updated stability/convergence programme projections
for government surplus/deficit in EU Member States
(General government net lending (+) / net borrowing (-) , as % of GDP)

Date
submitted
Dec.'99
Dec.'99
Jan.2000
Jan.2000
Dec.'99
Jan.2000
Feb.2000
Nov.'99
Mar.2000
Feb.2000
Sep.'99

Dec.'99
Dec.'99
Nov.'99
Dec.'99

1998

1999

2000

2001

2002

2003

-1.0
-1.7
-2.3
-2.7
2.5 (b)
-2.7
2.6
-0.8
-2.5
-2.1
0.9 (b)
-2.0
0.9
-2.5
2.3
0.5
-1.4

-1.1
-1.2
-1.3
-2.1
1.4 (c)
-2.0
2.3
-0.6
-2.0
-2.0
3.1 (b)
-1.4
2.9
-1.5
1.7
0.3
-1.0

-1.0
-1
-0.8
-1.7
1.2 (c)
-1.5
2.5
-0.6
-1.7
-1.5
4.7 (b)
-1.1
2.1
-1.2
2.1
0.2
-0.7

-0.5
-1½
-0.4
-1.2 (a)
2.5 (c)
-1.0
2.6
-1.3 (d)
-1.5
-1.1
4.2 (b)
-1.0
2.2
-0.2
2.0
0.2
-0.6

0.0
-1
0.1
-0.7 (a)
2.6 (c)
-0.6
2.9
-1.1 (d)
-1.4
-0.7
4.6 (b)
-0.6
2.3
0.2
2.0
-0.1
-0.3

0.2
-½
0.2
-0.3 (a)

-0.1
3.1

-1.3
-0.3
4.7
-0.2
2.5

-0.4
-0.2

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11
DK
EL
S
UK (e)
EU-15

(a) Government deficit of 1.3% of GDP in 2001,a deficit of 0.9% in 2002 ,

a deficit of 0.5% of GDP in 2003 is projected if the international environment
will be less favourable(annual GDP growth rate of 2.5%).
In ESA 79.

(b)
(c) After adjustment for special factors.
(d) Government deficit of 1.1% of GDP in 2002 is that projected in the cautious scenario;

the middle scenario projects a deficit of ¾% of GDP in 2001 and a deficit
of ¼% of GDP in 2002 ; the favourable scenario projects a deficit of ½% of GDP
in 2001 and a balanced government deficit ( 0% of GDP ) in 2002.
In financial years .

(e)

Source: Updated stability/convergence programmes.

65

ANNEX D: EXCHANGE RATE CRITERION

D.1.

Treaty provisions and ERM II

The relevant period for assessing exchange rate stability in this report is from
April 1998 to March 2000, extending over the last nine months of Stage 2 of EMU
and the first 15 months of Stage 3. Equality of treatment considerations require that
application of the exchange rate criterion must reflect both the situation that existed
in Stage 2 and the changes implied by the move to Stage 3 - notably the introduction
of the euro and the establishment of the ERM II. Accordingly, the assessment of
exchange rate stability in this examination will be based on the Treaty provisions, as
elaborated by the relevant protocol, and by the Council Resolution establishing the
ERM II with effect from 1 January 1999.

The relevant Treaty provisions are:

• The third indent of Article 121(1) (ex Article 109j(1)), which refers to the

exchange rate criterion as:

"the observance of the normal fluctuation margins provided for by the exchange-rate
two years, without
mechanism of the European Monetary System, for at
devaluing against the currency of any other Member State”;

least

• Article 3 of Protocol No 6 which states that:

“The criterion on participation in the exchange-rate mechanism of the European
monetary system referred to in the third indent of Article 121(1) of this Treaty shall
mean that a Member State has respected the normal fluctuation margins provided for
by the exchange-rate mechanism of the European Monetary System without severe
tensions for at least the last two years before the examination. In particular, the
Member State shall not have devalued its currency’s bilateral central rate against any
other Member State’s currency on its own initiative for the same period”.

• The Council Resolution on the establishment of the ERM II (97/C 236/03 of

16 June 1997)38 which states that:

"With the start of the third stage of economic and monetary union, the European
Monetary System will be replaced by the exchange rate mechanism as defined in this
Resolution….The exchange-rate mechanism will link currencies of Member States
outside the euro area to the euro".

38

OJ C 236, 2.8.1997, p. 5.

66

D.2.

Application of exchange rate criterion in Stage 2 of EMU

In the convergence examination of March 1998, application of the exchange rate
criterion was based on the median-currency approach.39 This was a new analytical
framework, necessitated by the changes that were made to the ERM following the
exchange rate turbulence of 1992/1993. These changes had complicated the
application of the criterion by creating uncertainty about how to define exchange rate
stability in the context of ERM participation.

The main difficulty in applying the exchange rate criterion related to the decision to
widen the ERM fluctuation margins to 15% in August 1993. At the time of the
convergence examination some five years later,
it was unclear whether these
widened margins or the former margins of 2.25% corresponded to the term "normal
fluctuation margins" in the criterion. On the one hand, assessment of exchange rate
stability on the basis of movements within the 15% margins was considered
inappropriate, because (i) the Treaty had been drafted when the 2.25% margins were
considered to be normal; (ii) the wider margins provided a very accommodative
benchmark against which to measure exchange rate stability; (iii) the widening of the
margins had been introduced as a temporary measure with the expectation of
returning to the narrow margins; and (iv) the intention in widening the margins had
not been to facilitate greater exchange rate variability but to counter speculation
against ERM currencies. On the other hand, the absence of a formal commitment to
observe the original 2.25% margins and the presumption that the wider margins
could be exploited had to be taken into account. This meant that assessment of
exchange rate stability on the basis of the original 2.25% margins was also
considered to be inappropriate. The median currency approach was devised as a
balanced solution to this difficulty in applying the criterion.

In the median currency approach, the exchange rate stability of ERM currencies was
assessed in the context of fluctuation margins of ±2.25% against the currency at the
centre of the mechanism on each day. While these margins may seem to correspond
to the original narrow margins, the median currency approach was, in fact, less
restrictive. Using the median currency as a basis meant that the stability of a currency
was assessed against the currency at the middle of the mechanism rather than against
the strongest currency. In consequence, the use of the fluctuation margins of ±2.25%
implied that a 4.5% appreciation/depreciation against another currency would be
tolerated, rather than the 2.25% appreciation/depreciation implied by the original
normal margins. However, the attractive feature of the median currency approach
was that it assessed favourably those currencies that were clustered at the centre of
the ERM.

A breach of the ±2.25% fluctuation margins against the median currency was not
automatically classified as indicative of severe tensions. In assessing whether a
breach of the margins corresponded to severe tensions, a range of elements was taken
into account. These included: (i) the duration and amplitude of the deviation; (ii) the
nature and extent of any policy response with particular reference to foreign

39

The median currency within the ERM is defined as the currency closest to its central rate against the
ECU at the exchange rate fixing on any given day.

67

exchange intervention and/or changes in short term interest rates40 and (iii) whether
the pressure has been towards appreciation or depreciation of the currency. Indeed, a
distinction was drawn between tensions in respecting the upper and lower margins,
which was seen as corresponding, respectively, to relative strength and weakness of a
currency. Given the implied linkage between severe tensions and devaluation in the
wording of the Treaty, it was considered reasonable to exclude movements above the
2.25% margin against the median currency as a possible cause for non-fulfilment of
the criterion. This interpretation was relevant in the case of the Irish pound, which
had been far above the 2.25% range for most of the two-year assessment period.

D.3.

Application of the exchange rate criterion in Stage 3 of EMU

Unlike the original ERM, the ERM II is not based on multilateral exchange rate
commitments between all participant currencies but on a bilateral exchange rate
commitment between the euro and the other participant currencies. A "standard"
fluctuation band of ±15% has been established and this, in principle, corresponds to
the "normal fluctuation margins" referred to in the Treaty. The standard fluctuation
band of ±15% implies the possibility of a 30% appreciation/depreciation of a
currency against
the euro while remaining within the band, making it a very
accommodative benchmark for assessing exchange rate stability. There exists the
possibility of establishing narrower fluctuation bands within the ERM II to reflect
progress in economic convergence, but there is no requirement to do so41. The main
features of the ERM and the ERM II are compared in the box.

Despite the differences between the ERM II and the original ERM, equality of
treatment can be reasonably assured by a modification of the framework for applying
the exchange rate criterion in Stage 2. While the median currency approach no longer
applies in the ERM II, a similar assessment of exchange rate stability can be made in
the context of a fluctuation band of ±2.25% around a currency's central parity against
the euro. Continuity between the two approaches is enhanced by the fact that the
median currency in the original ERM on the final day of Stage 2 was fixed
irrevocably against the euro from the first day of Stage 3. The "euro-based approach"
would also imply that an appreciation/depreciation of 4.5% would be tolerated,
although, once again, a breach of the band would not necessarily correspond to
severe tensions but would be assessed by reference to the same range of elements as
in the examination of 1998. As with the median-currency approach, a distinction
would be drawn between movements above the 2.25% upper margin and movements
below the 2.25% lower margin, with only the latter potentially indicating severe
tensions within the ERM II.

40

41

It should be recalled that the 1987 Basle-Nyborg 1987 agreement called for “…a more active, flexible
and concerted use of the instruments available, namely exchange-rate movements within the fluctuation
band, interest rates and intervention” (Press communiqué of the Committee of Governors of EC central
banks). For completeness, any episodes of intervention within the ±2.25% limits were also examined.
Indeed, Greece has applied to adopt the euro while maintaining the standard fluctuation band for the
GRD.

68

BOX: Similarities and differences between the ERM and the ERM II

The common elements of the ERM and the ERM II are:

• central rates and fluctuation bands set by common procedure (involving Finance

Ministers, ECB and NCB Governors and the Commission);

• standard fluctuation band is ±15%, while not excluding possibility of closer links;
• intervention support with appropriate financing will be automatic at the margin;
• realignments will be made by common procedure;

The main differences between the ERM and the ERM II are:

• bilateral links between the euro and the "pre-in" currencies (i.e. the so-called "hub
and spokes" model) replace the multilateral
links in the ERM; accordingly,
intervention obligations will be bilateral between the ECB and each "pre-in"
NCB. The ERM was characterised by multilateral intervention obligations;

• the euro is the formal anchor of the ERM II; while the DEM acted as de facto
anchor in the ERM, this was not a formal role. With the euro as anchor, the
operation of the ERM II will be clearly focused on the need to foster convergence
among the "pre-ins" toward the standards of macroeconomic stability in the euro
area;

• the ECB or any non-euro NCB will have a formal right to suspend intervention if
its price stability objective is jeopardised; this "safeguard clause" did not formally
exist in the ERM, although the events of 1992/1993 indicated that there were
limits to the commitment to "unlimited intervention";

• realignments will take place in a timely manner. The experience of the ERM in
1992/93 revealed the dangers of a failure to adjust central parities before the
emergence of speculative pressures. In the ERM II, all parties to the agreement,
including the ECB, will have the right to initiate a procedure which may result in
a realignment. In the ERM, a procedure for realignment of a currency's central
rate could be initiated only by the Member State concerned.

69

D.4.

Fulfilling the exchange rate criterion in the current examination

The principle of equal treatment requires that the exchange rate criterion should be
applied as consistently as possible over time. For the purposes of this examination
the criterion will be applied (i) using the median currency approach in respect of the
months from April to December 1998 (Stage 2 of EMU); and (ii) using the euro-
based approach in respect of the remainder of the examination period (Stage 3 of
EMU). In summary,
the conditions to be respected in fulfilling the
exchange rate criterion would be as follows:

therefore,

• Participation in the ERM II at the time of the assessment is mandatory.

• Participation in the ERM/ERM II for at least two years is expected, although
exchange rate stability during a period of non-participation before entering
ERM/ERM II can be taken into account.

• No downward realignment of the central parity either in the ERM or in the

ERM II within the two-year examination period.

• Exchange rate to have been maintained within a fluctuation band of ±2.25%
around the currency's central parity against the median currency in the context of
the ERM and against the euro in the context of the ERM2. However, the extent to
which a breach of the ±2.25% fluctuation band would correspond to severe
tensions would take account of a range of relevant considerations. A distinction is
to be made between exchange rate movements above the 2.25% upper margin and
movements below the 2.25% lower margin.

70

ANNEX E: LONG-TERM INTEREST RATE CRITERION

The application of the interest
rate criterion in this report is
on the same basis as in the
1998 convergence report.

Table E.1

Long-term interest rates
in EU Member States
(12-month averages)

of

1999

1996

1995

1998

1997

the

the

best

periods

box. The

has
about

details
rates used for

5.8
5.6
6.4
5.6
6.3
6.9
5.6
5.6
5.7
6.4
6.0
6.0
6.3
9.9
6.6
7.1
6.3

4.8
4.6
4.8
4.6
4.8
4.9
4.7
4.6
4.7
4.9
4.8
4.7
4.9
8.5
5.0
5.6
4.9

4.7
4.5
4.7
4.6
4.7
4.7
4.7
4.6
4.7
4.8
4.7
4.6
4.9
6.3
5.0
5.0
4.7

6.5
6.2
8.7
6.3
7.3
9.4
6.3
6.2
6.3
8.6
7.1
7.2
7.2
14.5
8.0
7.9
7.5

7.5
6.9
11.3
7.5
8.3
12.2
7.2
6.9
7.1
11.5
8.8
8.7
8.3
17.0
10.2
8.3
8.8

B
D
E
F
IRL
I
L
NL
A
P
FIN
EUR-11 b)
DK
EL c)
S
UK
EU-15 b)
Reference
value c)
Average of 3
best
price
performers
Dispersion
rate d)

For
operational
assessment of the criterion on
the convergence of interest
rates the yield on benchmark
been
ten-year
bonds
the
used;
interest
the
Member States are given in
the
long-term
rates are averaged
interest
over
twelve
of
months. The reference value
is calculated from the simple
average
average
long-term interest rates of the
three
performing
Member States in terms of
stability42
price
plus
As
2 percentage
the
explained in Annex B,
three
performing
best
Member States in terms of
price stability are selected
using the harmonized indices
of consumer prices (HICPs);
average inflation rates based
on the HICPs can only be
from
calculated
December 1996 and are not
beyond
available
implies
March 2000. This
that the reference value for
long-term interest rates can
only be derived on a consistent basis for this same period, and that the March 2000
data are the relevant ones for the purpose of the assessment in this report.

a) Average of April 1999-March 2000.
b) Weighted average based on GDP.
c) Average of interest rates of the three best performing

Member States (underlined) in terms of price stability plus
2 percentage points.

d) Measured by the standard deviation.

Source: ECB , Commission services.

points.

6.6

1.0

9.1

8.0

6.8

7.1

6.0

4.6

4.8

1.3

1.8

0.5

March
2000 a)
5.2
4.9
5.1
5.0
5.1
5.1
5.1
5.0
5.1
5.2
5.1
5.0
5.3
6.4
5.4
5.3
5.1

7.2

5.2

0.2

42

It should be noted that the best performing Member States in terms of price stability do not necessarily
have the lowest interest rates.

71

BOX: Data for the interest rate convergence criterion

The fourth indent of Article 121(l) of the Treaty requires that the durability of
nominal convergence and exchange rate stability in Member States should be
assessed by reference to long-term interest rates. Article 4 of Protocol No 21 on the
convergence criteria adds that these "Interest rates shall be measured on the basis of
long-term government bonds or comparable securities,
taking into account
differences in national definitions".

Article 5 of Protocol No 21 requires that
the Commission should provide the
statistical data used for the application of the convergence criteria. However, in the
context of the interest rate criterion, the European Monetary Institute developed the
criteria for harmonising the series of yields on benchmark 10-year bonds on behalf of
Eurostat and started collecting the data from the central banks, a task which has then
been transferred to the European Central Bank. The selection of bonds for inclusion
in this series has the following characteristics:

• a residual maturity close to 10 years;

• issued by central government;

• adequate liquidity, which is the main selection criterion; the choice between a
single benchmark or the simple average of a sample is based on this requirement;

• yield gross of tax;

• fixed coupon.

For all the Member States, the representative interest rates used in this examination
incorporate all of the above characteristics. This ensures cross-country comparability.
Since December 1997, 11 Member States have been using a single benchmark bond
and four a sample of bonds (Germany, Spain, Portugal, Sweden). The harmonized
series for Greece starts in mid-1997, as a 10-year benchmark bond has been available
only since June 1997. Before this date, the representative interest rate was based on
available best proxies: the yield on a seven-year bond with fixed coupon from March
to June 1997, rates at issue of seven-year bonds from February 1996 to January 1997,
and rates at issue of five-year bonds from September 1992 to January 1996.

the annual averages

Table E.1 reports
in the
years 1995-1999 and in March 2000, the latest date for which monthly data are
available. Average long-term interest rates for the 12-month period from April 1999
to March 2000 are shown in the final column of the table. The reference value has
tended to decline since December 1996, when it was 9.1%.

long-term interest

rates

for

In March 2000, the reference value, derived from the average interest rates in France,
Austria and Sweden, the three best performing Member States in terms of price
stability, was 7.2%.

72