Report from the Commission - Convergence Report 2004 (prepared in accordance with Article 122(2) of the Treaty) [SEC(2004) 1268]
Date: 2004-10-20
Institutions: European Commission
Subjects: Economic and Monetary Union, European System of Central Banks, European integration, Sweden, convergence criteria, economic convergence, non-participating country (euro area)

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 20.10.2004 
COM(2004) 690 final 

REPORT FROM THE COMMISSION 

CONVERGENCE REPORT 2004 

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

[SEC(2004) 1268] 

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1. 

PURPOSE OF THE REPORT 

In accordance with Article 122(2) of the Treaty, the Commission and the European 
Central  Bank (ECB)  are  required to report  to  the  Council  on  the  progress  made  by 
the  “Member  States  with  a  derogation”  with  respect  to  the  compliance  of  their 
national legislation with the Treaty, as well as the achievement of a high degree of 
sustainable  convergence.  “Member  States  with  a  derogation”  have  not  yet  adopted 
the euro with the exception of Denmark and the United Kingdom which are Member 
States with a special status1. Such convergence reports must be prepared at least once 
every  two  years,  or  at  the  request  of  a  Member  State  with  a  derogation.  Sweden, 
being one such Member State, is now due for a convergence report as two years have 
elapsed  since  the  last  one.  This  provides  an  opportunity  to  also  assess,  for  the  first 
time, the ten countries that joined the European Union (EU) on 1 May 2004, which 
are  automatically  “Member  States  with  a  derogation”  by  virtue  of  Article  4  of  the 
Treaty  of  Accession.  It  will  contribute  to  the  preparation  in  these  countries  of  the 
requirements  for  euro  adoption.  This  report  therefore  covers  the  following  eleven 
Member  States  with  a  derogation:  the  Czech  Republic,  Estonia,  Cyprus,  Latvia, 
Lithuania, Hungary, Malta, Poland, Slovenia, Slovakia and Sweden.  

The content of the reports2 prepared by the Commission and the ECB is governed by 
Article 121(1) of the Treaty, which requires that the reports include an examination 
of  (i)  the  compatibility  of  national  legislation  with  the  Treaty  as  well  as  with  the 
Statute  of  the  European  System  of  Central  Banks  (ESCB)  and  of  the  European 
Central  Bank.  The  reports  must  also  examine  whether  a  high  degree  of  sustainable 
convergence has been achieved, by reference to the four convergence criteria relating 
to  (ii)  price  stability,  (iii)  the  government  budgetary  position,  (iv)  exchange  rate 
stability and (v) the long-term interest rate as well as a number of additional factors3. 
The four convergence criteria and the periods over which they are to be respected are 
further developed in a Protocol annexed to the Treaty (“Protocol on the convergence 
criteria referred to in Article 121”).  

2. 

OVERVIEW:  COMPATIBILITY  OF  LEGISLATION  AND  ACHIEVEMENT  OF  ECONOMIC 
CONVERGENCE 

(i) Compatibility of national legislation, including the statutes of the national central 
banks,  with  Articles  108  and  109  of  the  Treaty  and  the  Statute  of  the  ESCB/ECB 
must be ensured. As far as the new Member States are concerned, the independence 
of  their  respective  national  central  banks  and  the  latter’s  compliance  with  the 

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2 

3 

Denmark and the United Kingdom have a special status since they have opt-out arrangements. They are 
not examined because they have not indicated that they wish to adopt the euro (Article 4 on the Protocol 
on certain provisions related to Denmark and Article 10(a) of the Protocol on certain provisions related 
to the UK). 
Convergence Report 2002 on Sweden, COM(2002) 243 final, 22 May 2002; Convergence Report 2000 
on Sweden and Greece, COM(2000) 277 final, 3 May 2000; Convergence Report 1998 (on all the 15 
Member  States  at  that  time),  COM(1998)  1999  final,  25  March  1998;  Convergence  Report  1996, 
COM(1996) 560 final, 6 November 1996. 
These  additional  factors  are  not  necessary  conditions  for  adopting  the  euro  and  are  therefore  not 
examined here. For a technical analysis of all factors affecting convergence, see SEC(2004) 1268. 

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ESCB’s objectives have been taken care of as part of the pre-accession requirements. 
However, in order to ensure the full integration of the different national central banks 
into  the  ESCB  before  the  countries  concerned  join  the  euro  area,  incompatibilities 
need to be resolved in the legislation of all countries. 

(ii) The assessment of the price stability criterion is based on the observance of an 
average inflation rate over a period of one year before the examination, that does not 
exceed by more than 1.5 percentage points that of, at most, the three best-performing 
Member States in terms of price stability. The reference value was calculated to be 
2.4%  in  August  2004,  with  Finland,  Denmark  and  Sweden  as  the  three  best-
performing Member States. Of the eleven Member States analysed in this report, five 
fulfil  this  criterion,  namely  the  Czech  Republic,  Estonia,  Cyprus,  Lithuania  and 
Sweden.  

(iii)  The  criterion  on  the  government  budgetary  position  is  linked  to  the  decisions 
made in accordance with the excessive deficit procedure in Article 104 of the Treaty. 
At  present,  five  of  the  eleven  Member  States  examined  are  not  the  subject  of  a 
Council  decision  under  Article  104(6)  on  the  existence  of  an  excessive  deficit, 
namely  Estonia,  Latvia,  Lithuania,  Slovenia  and  Sweden,  which  therefore  fulfil  the 
criterion. 

(iv)  The  exchange  rate  criterion  requires  the  observance  of  the  normal  fluctuation 
margins  of  the  exchange  rate  mechanism  (ERM  II)  for  at  least  two  years  without 
severe tensions. On 28 June 2004, the Estonian kroon, Lithuanian litas and Slovenian 
tolar  joined  ERM  II.  The  Czech  koruna,  Hungarian  forint,  Cyprus  pound,  Latvian 
lats, Maltese lira, Polish zloty, Slovak koruna and Swedish krona have not yet joined 
ERM II. While the three currencies participating in ERM II since 28 June 2004 have 
been stable vis-à-vis the euro, no country examined has participated in ERM II for 
the required period. None of the eleven countries fulfils the exchange rate criterion. 

(v) The long-term interest rate criterion is based on the observance, over a period of 
one  year  before  the  examination,  of  an  average  nominal  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. The reference value was calculated to be 
6.4% in August 2004. Long-term interest rates were below the reference value in the 
Czech  Republic,  Cyprus,  Latvia,  Lithuania,  Malta,  Slovenia,  Slovakia  and  Sweden. 
These  eight  countries  were  found  to  meet  the  interest  rate  criterion.  For  Estonia, 
where no long-term government bonds or comparable securities are available, there 
are no reasons to conclude that Estonia would not fulfil the interest rate criterion.  

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Compatibility of legislation and fulfilment of convergence criteria 

Legal 
compatibility 

Price 
stability 

Government 
budgetary 
position 

Exchange 
rates  

Long-term 
interest rate 
convergence 

Czech Republic 

Estonia 

Cyprus 

Latvia 

Lithuania 

Hungary 

Malta 

Poland 

Slovenia 

Slovakia 

Sweden 

Source: Commission services 

no 

no 

no 

no 

no 

no 

no 

no 

no 

no 

no 

yes 

yes 

yes 

no 

yes 

no 

no 

no 

no 

no 

yes 

No 

Yes 

No 

Yes 

Yes 

No 

No 

No 

Yes 

No 

Yes 

no 

no 

no 

no 

no 

no 

no 

no 

no 

no 

no 

yes 

-- 

yes 

yes 

yes 

no 

yes 

no 

yes 

yes 

yes 

3. 

ASSESSMENT BY MEMBER STATE 

3.1. 

The Czech Republic 

As regards the central bank integration into the ESCB at the time of euro adoption, 
legislation in the Czech Republic, in particular the Czech National Bank Act, is not 
fully compatible with Article 109 of the Treaty and the ESCB/ECB Statute . 

The  average  inflation  rate  in  the  Czech  Republic  during  the  12  months  to  August 
2004 was 1.8%. The Czech Republic fulfils the criterion on price stability.  

The  Czech  Republic  is  at  present  the  subject  of  a  decision  on  the  existence  of  an 
excessive deficit (Council decision of 5 July 2004). The general government deficit 
was 12.6% of GDP in 2003, while government debt was 37.8 % of GDP. The Czech 
Republic does not fulfil the criterion on the government budgetary position. 

The Czech koruna is not participating in ERM II and is subject to a managed floating 
regime with occasional interventions by the central bank. The Czech Republic does 
not fulfil the exchange rate criterion. 

The average long-term interest rate in the Czech Republic in the year to August 2004 
was  4.7%  and  the  Czech  Republic  fulfils  the  criterion  on  the  convergence  of  long-
term  interest  rates.  Against  a  background  of  low  inflationary  pressures,  long-term 
interest  rates  in  the  Czech  Republic  dropped  temporarily  below  euro  area  levels 
between  mid-2002  and  mid-2003,  but  long-term  interest  rate  spreads  have  since 
become positive.  

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

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3.2. 

Estonia 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Estonia,  in  particular  the  Eesti  Pank  Act,  the  Constitution  of  the 
Republic  of  Estonia  as  well  as  the  currency  law  and  the  law  on  the  security  for 
Estonian  kroon,  is  not  fully  compatible  with  Article  109  of  the  Treaty  and  the 
ESCB/ECB Statute  

The average inflation rate in Estonia during the 12 months to August 2004 was 2.0%. 
Estonia fulfils the criterion on price stability.  

Estonia is not the subject of a decision on the existence of an excessive deficit. The 
general  government  surplus  was  3.1%  of  GDP  in  2003  and  government  debt  was 
5.3% of GDP. Estonia fulfils the criterion on the government budgetary position. 

Since 28 June 2004, Estonia has participated in ERM II and the Estonian authorities 
have committed to unilaterally maintaining their currency board arrangement within 
ERM II. The Estonian kroon has not deviated from its central parity. At the time of 
this  examination,  ERM  II  participation  was  less  than  two  years.  Estonia  does  not 
fulfil the exchange rate criterion. 

Due  to  the  absence,  partially  linked  to  the  low  level  of  government  debt,  of  a 
harmonised  benchmark  long-term  government  bond  or  comparable  security,  an 
interest rate indicator has been identified, based on bank lending rates. This interest 
rate  indicator  in  the  year  to  August  2004  was  on  average  4.6%.  On  the  basis  of 
developments in the interest rate indicator and taking into account, inter alia, the low 
government debt level, there are no reasons to conclude that Estonia would not fulfil 
the long-term interest criterion.  

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

3.3. 

Cyprus 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Cyprus,  in  particular  the  Central  Bank  of  Cyprus  Law,  is  not  fully 
compatible with Article 109 of the Treaty and the ESCB/ECB Statute .  

The average inflation rate in Cyprus during the 12 months to August 2004 was 2.1%. 
Cyprus fulfils the criterion on price stability.  

Cyprus is at present the subject of a decision on the existence of an excessive deficit 
(Council decision of 5 July 2004). The general government deficit was 6.4% of GDP 
in 2003 and government debt was 70.9% of GDP. Cyprus does not fulfil the criterion 
on the government budgetary position. 

The Cyprus pound is not participating in ERM II and is pegged to the euro with a ± 
15% fluctuation margin. Cyprus does not fulfil the exchange rate criterion. 

The average long-term interest rate in Cyprus in the year to August 2004 was 5.2% 
and Cyprus fulfils the criterion on the convergence of long-term interest rates. Long-

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term interest rates converged considerably towards euro area levels in early 2002 and 
the spread remained within 1 percentage point for most of 2003. Recently, long-term 
interest rates have increased to well above euro area levels.  

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

3.4. 

Latvia 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Latvia,  in  particular  the  Law  on  the  Bank  of  Latvia,  is  not  fully 
compatible with Article 109 of the Treaty and the ESCB/ECB Statute . 

The average inflation rate in Latvia during the 12 months to August 2004 was 4.9%. 
Latvia does not fulfil the criterion on price stability.  

Latvia is not the subject of a decision on the existence of an excessive deficit. The 
general  government  deficit  was  1.5%  of  GDP  in  2003  and  government  debt  was 
14.4% of GDP. Latvia fulfils the criterion on the government budgetary position. 

The Latvian lats is not participating in ERM II and is pegged to the SDR basket of 
currencies  with  a  normal  fluctuation  margin  of  ±  1%.  Latvia  does  not  fulfil  the 
exchange rate criterion. 

The average long-term interest rate in Latvia in the year to August 2004 was 5.0% 
and Latvia fulfils the criterion on the convergence of long-term interest rates. Long-
term  interest  rate  differentials  with  the  euro  area  have  increased  slightly  in  Latvia 
since mid-2002 to ½-1 percentage points.  

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

3.5. 

Lithuania 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Lithuania,  in  particular  the  Law  on  the  Bank  of  Lithuania,  the 
Constitution  of  Lithuania  as  well  as  the  law  on  currency  and  the  law  on  the 
credibility of the litas, is not fully compatible with Articles 109 of the Treaty and the 
ESCB/ECB Statute  

The average inflation rate in Lithuania during the 12 months to August 2004 was -
0.2%. Lithuania fulfils the criterion on price stability.  

Lithuania is not the subject of a decision on the existence of an excessive deficit. The 
general  government  deficit  was  1.9%  of  GDP  in  2003  and  government  debt  was 
21.4% of GDP. Lithuania fulfils the criterion on the government budgetary position. 

Since  28  June  2004,  Lithuania  has  participated  in  ERM  II  and  the  Lithuanian 
authorities  have  committed  to  unilaterally  maintaining  their  currency  board 
arrangement within ERM II. The litas has not deviated from its central parity. At the 
time  of  this  examination,  ERM  II  participation  was  less  than  two  years.  Lithuania 
does not fulfil the exchange rate criterion. 

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The average long-term interest rate in Lithuania in the year to August 2004 was 4.7% 
and  Lithuania  fulfils  the  criterion  on  the  convergence  of  long-term  interest  rates. 
Long-term  interest  rates  in  Lithuania,  still  at  10%  at  the  beginning  of  2001,  have 
declined considerably and the interest rate differential with the euro area narrowed to 
0.4 percentage points in the period January-August 2004.  

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

3.6. 

Hungary 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Hungary,  in  particular  the  Magyar  Nemzety  Bank  Act  and  the 
Constitution  Act,  is  not  fully  compatible  with  Article  109  of  the  Treaty  and  the 
ESCB/ECB Statute  

The  average  inflation  rate  in  Hungary  during  the  12  months  to  August  2004  was 
6.5%. Hungary does not fulfil the criterion on price stability.  

Hungary  is  at  present  the  subject  of  a  decision  on  the  existence  of  an  excessive 
deficit (Council decision of 5 July 2004). The general government deficit was 6.2% 
of GDP in 2003, while government debt was 59.1% of GDP. Hungary does not fulfil 
the criterion on the government budgetary position. 

The Hungarian forint, which is pegged to the euro with a ± 15% fluctuation margin, 
is not participating in ERM II. Hungary does not fulfil the exchange rate criterion. 

The average long-term interest rate in Hungary in the year to August 2004 was 8.1% 
and  Hungary  does  not  fulfil  the  criterion  on  the  convergence  of  long-term  interest 
rates.  Long-term  interest  rates  in  Hungary  diverged  from  developments  in  the  euro 
area which can be associated with an increased foreign exchange risk premium and 
higher inflation expectations.  

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

3.7.  Malta 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Malta,  in  particular  the  Central  Bank  of  Malta  Act,  is  not  fully 
compatible with Article 109 of the Treaty and the ESCB/ECB Statute  

The average inflation rate in Malta during the 12 months to August 2004 was 2.6%. 
Malta does not fulfil the criterion on price stability.  

Malta is at present the subject of a decision on the existence of an excessive deficit 
(Council decision of 5 July 2004). The general government deficit was 9.7% of GDP 
in 2003 and government debt was 71.1% of GDP. Malta does not fulfil the criterion 
on the government budgetary position. 

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The Maltese lira, which is pegged to a basket of currencies in which the euro has a 
weight of 70%, is not participating in ERM II. Malta does not fulfil the exchange rate 
criterion. 

The  average  long-term  interest  rate  in  Malta  in  the  year  to  August  2004  was  4.7% 
and Malta fulfils the criterion on the convergence of long-term interest rates. Long-
term interest rate differentials with the euro area were around 0.4 percentage points 
in the period January-August 2004.  

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

3.8. 

Poland 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Poland,  in  particular  the  Act  on  the  National  Bank  of  Poland  and  the 
Constitution of Poland, is not fully compatible with Article 109 of the Treaty and the 
ESCB/ECB Statute.  

The average inflation rate in Poland during the 12 months to August 2004 was 2.5%. 
Poland does not fulfil the criterion on price stability.  

Poland is at present the subject of a decision on the existence of an excessive deficit 
(Council decision of 5 July 2004). The general government deficit was 3.9% of GDP 
in  2003,  while  government  debt  was  45.4%  of  GDP.  Poland  does  not  fulfil  the 
criterion on the government budgetary position. 

The  Polish  zloty  is  not  participating  in  ERM  II  and  is  left  floating  with  the  central 
bank abstaining from currency interventions. Poland does not fulfil the exchange rate 
criterion. 

The average long-term interest rate in Poland in the year to August 2004 was 6.9% 
and  Poland  does  not  fulfil  the  criterion  on  the  convergence  of  long-term  interest 
rates. Long-term interest rates in Poland diverged from developments in the euro area 
which may be associated with concerns about fiscal policy and inflation.  

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

3.9. 

Slovenia 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation in Slovenia, in particular the Bank of Slovenia Act, is not fully compatible 
with Article 109 of the Treaty and the ESCB/ECB Statute. 

The  average  inflation  rate  in  Slovenia  during  the  12  months  to  August  2004  was 
4.1%. Slovenia does not fulfil the criterion on price stability.  

Slovenia is not the subject of a decision on the existence of an excessive deficit. The 
general  government  deficit  was  2.0%  of  GDP  in  2003  and  government  debt  was 
29.4% of GDP. Slovenia fulfils the criterion on the government budgetary position. 

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Since  28  June  2004,  the  Slovenian  tolar  has  participated  in  ERM  II  and  has  been 
trading  close  to  its  central  parity  since  that  date.  At  the  time  of  this  examination, 
ERM II participation was less than two years. Slovenia does not fulfil the exchange 
rate criterion. 

The average long-term interest rate in Slovenia in the year to August 2004 was 5.2% 
and  Slovenia  fulfils  the  criterion  on  the  convergence  of  long-term  interest  rates. 
Since  mid-2002,  long-term  interest  rates  in  Slovenia  have  declined  sharply  toward 
the euro area level with differentials narrowing to 0.6 percentage points in the period 
January-August 2004.  

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

3.10. 

Slovakia 

As  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation in Slovakia, in particular the Act on the National Bank of Slovakia, is not 
fully compatible with Articles 108 and 109 of the Treaty and the ESCB/ECB Statute.  

The  average  inflation  rate  in  Slovakia  during  the  12  months  to  August  2004  was 
8.4%. Slovakia does not fulfil the criterion on price stability.  

Slovakia  is  at  present  the  subject  of  a  decision  on  the  existence  of  an  excessive 
deficit (Council decision of 5 July 2004). The general government deficit was 3.7% 
of GDP in 2003, while government debt was 42.6 % of GDP. Slovakia does not fulfil 
the criterion on the government budgetary position. 

The  Slovak  koruna  is  not  participating  in  ERM  II  and  is  subject  to  a  managed 
floating regime with occasional interventions by the central bank. Slovakia does not 
fulfil the exchange rate criterion. 

The average long-term interest rate in Slovakia in the year to August 2004 was 5.1% 
and  Slovakia  fulfils  the  criterion  on  the  convergence  of  long-term  interest  rates. 
Since  mid-2002,  long-term  interest  rates  in  Slovakia  have  declined  sharply  toward 
the  euro-area  level,  with  differentials  narrowing  to  0.9  percentage  points  in  the 
period January-August 2004.  

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

3.11. 

Sweden 

In  the  2002  convergence  report,  the  Commission  assessment  was  that  Sweden 
already fulfilled three of the convergence criteria (on price stability, the government 
budgetary position and the convergence of interest rates), but that it did not fulfil the 
exchange  rate  criterion.  It  also  concluded  that  legislation  in  Sweden  was  not 
compatible with the Treaty and the ESCB/ECB Statute. 

As  regards  central  bank  financial  independence  as  well  as  central  bank  integration 
into the ESCB at the time of euro adoption, legislation in Sweden, in particular the 
the  Instrument  of  Government  (the  country’s 
Sveriges  Riksbank  Act  and 

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Constitution), continues not to be fully compatible with Articles 108 and 109 of the 
Treaty and the ESCB/ECB Statute.  

The  average  inflation  rate  in  Sweden  during  the  12  months  to  August  2004  was 
1.3%. Sweden continues to fulfil the criterion on price stability.  

Sweden is not the subject of a decision on the existence of an excessive deficit. The 
general  government  surplus  was  0.3%  of  GDP  in  2003  and  government  debt  was 
52.0% of GDP. Sweden continues to fulfil the criterion on the government budgetary 
position. 

The Swedish krona is not participating in ERM II and is floating. Sweden continues 
not to fulfil the exchange rate criterion. 

The average long-term interest rate in Sweden in the year to August 2004 was 4.7% 
and Sweden continues to fulfil the criterion on the convergence of long-term interest 
rates.  Swedish  long-term  interest  rates  have  been  close  to  euro-area  levels  and 
occasionally below them.  

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”. 

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