Report from the Commission convergence report 2008 (prepared in accordance with Article 122(2) of the Treaty) {SEC(2008) 567}
Date: 2008-05-07
Institutions: European Commission
Subjects: EU Member State, Economic and Monetary Union, European integration, accession to the European Union, convergence criteria, economic convergence, non-participating country (euro area)

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 7.5.2008 
COM(2008) 248 final 

REPORT FROM THE COMMISSION 

CONVERGENCE REPORT 2008  

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

{SEC(2008) 567} 

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1. 

PURPOSE OF THE REPORT 

Article 122(2)  of the Treaty requires the Commission and the ECB to report to the 
Council,  at  least  once  every  two  years,  or  at  the  request  of  a  Member  State  with  a 
derogation, on the progress made by the Member States in fulfilling their obligations 
regarding the achievement of economic and monetary union. 

The  latest  Commission  and  ECB  regular  Convergence  Reports  were  adopted  in 
December 20061. Denmark and the United Kingdom have not expressed their wish to 
adopt  the  single  currency.  Therefore,  this  convergence  assessment  covers  the 
following  ten  Member  States  with  a  derogation:  Bulgaria,  the  Czech  Republic, 
Estonia,  Latvia,  Lithuania,  Hungary,  Poland,  Romania,  Slovakia  and  Sweden. 
Having  joined  the  EU  on  1  January  2007,  Bulgaria  and  Romania  are  examined  for 
the  first  time.  A  more  detailed  assessment  of  the  state  of  convergence  in  the  ten 
countries  is  provided  in  a  Technical  Annex  to  this  report  (SEC(2008)  567).  In 
parallel,  on  4  April  2008  Slovakia  submitted  a  request  for  an  assessment  of  the 
fulfilment of the necessary conditions to adopt the euro on 1 January 2009. 

The content of the reports prepared by the Commission and the ECB is governed by 
Article  121(1)  of  the  Treaty.  This  Article  requires  the  reports  to  include  an 
examination of the compatibility of national legislation, including the statutes of its 
national central bank, with Articles 108 and 109 of the Treaty and the Statute of the 
ESCB  and  of  the  ECB  (henceforth  ESCB/ECB  Statute).  The  reports  must  also 
examine whether a high degree of sustainable convergence has been achieved in the 
Member  State  concerned  by  reference  to  the  fulfilment  of  the  convergence  criteria 
(price  stability,  government  budgetary  position,  exchange  rate  stability,  long-term 
interest rates), and by taking account of several other factors mentioned in the final 
sub-paragraph of Article 121(1). The four convergence criteria are developed further 
in a Protocol annexed to the Treaty (Protocol No 21 on the convergence criteria). 

The examination of the compatibility of national legislation, including the statutes of 
the  national  central  banks,  with  Articles  108  and  109  of  the  Treaty  and  the 
ESCB/ECB  Statute  requires  an  assessment  of  compliance  with  the  prohibition  of 
monetary financing (Article 101 EC) and the prohibition of privileged access (Article 
102 EC); consistency with the ESCB's objectives (Article 105(1) EC); central bank 
independence  (Article  108  EC);  and  integration  of  national  central  banks  into  the 
ESCB (several EC Treaty and ESCB/ECB Statute articles). 

The  price  stability  criterion  is  defined  in  the  first  indent  of  Article  121(1)  of  the 
Treaty:  “the  achievement  of  a  high  degree  of  price  stability  […]  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”. 

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In 2007, the Commission and the ECB prepared Convergence Reports on Cyprus and Malta, following 
the request of the national authorities. Cyprus and Malta adopted the euro on 1 January 2008. 

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Article  1  of  the  Protocol  on  the  convergence  criteria  further  stipulates  that  “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 
1.5 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”2. The requirement of sustainability implies that the satisfactory inflation 
performance must essentially be attributable to the behaviour of input costs and other 
factors  influencing  price  developments  in  a  structural  manner,  rather  than  the 
influence of temporary factors. Therefore, the convergence examination includes an 
assessment of the factors underlying inflation and of medium-term prospects. It also 
assesses  whether  the  country  is  likely  to  meet  the  reference  value  in  the  months 
ahead3. 
The inflation reference value was calculated to be 3.2% in March 20084, with Malta, 
the Netherlands and Denmark as the three best-performing Member States. 

The  convergence  criterion  dealing  with  the  government  budgetary  position  is 
defined in the second indent of Article 121(1) of the Treaty as “the sustainability of 
the  government  financial  position:  this  will  be  apparent  from  having  achieved  a 
government  budgetary  position  without  a  deficit  that  is  excessive  as  determined  in 
accordance  with  Article  104(6)”.  Furthermore,  Article  2  of  the  Protocol  on  the 
convergence  criteria  states  that  this  criterion  means  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”. 

The Treaty refers to the exchange rate criterion in the third indent of Article 121 as 
“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”. 

Article  3  of  the  Protocol  on  the  convergence  criteria  stipulates:  “The  criterion  on 
participation in the exchange rate mechanism of the European Monetary System (…) 
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 

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For  the  purpose  of  the  criterion  on  price  stability,  inflation  is  measured  by  the  Harmonised  Index  of 
Consumer Prices (HICP) defined in Council Regulation (EC) No 2494/95, amended by Regulation (EC) 
No 1882/2003 of the European Parliament and the Council.  
All  the  forecasts  for  inflation  and  other  variables  in  the  current  report  are  from  the  Commission 
services'  Spring  2008  Forecast.  The  Commission  services'  forecasts  are  based  on  a  set  of  common 
assumptions  for  external  variables  and  on  a  no-policy  change  assumption  while  taking  into 
consideration measures that are known in sufficient detail. The forecast of the reference value is subject 
to significant uncertainties given that it is calculated on the basis of the inflation forecasts for the three 
Member  States  projected  to  have  the  lowest  inflation  in  the  forecast  period,  thereby  increasing  the 
possible margin of error. 
The cut-off date for the data used in this report is 18 April 2008. 

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rate  against  any  other  Member  State’s  currency  on  its  own  initiative  for  the  same 
period”5. 

The  relevant  two-year  period  for  assessing  exchange  rate  stability  in  this  report  is 
19 April 2006 to 18 April 2008. 

The  fourth  indent  of  Article  121(1)  of  the  Treaty  requires  “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”.  Article  4  of  the  Protocol  on  the  convergence  criteria  further 
stipulates  that  “the  criterion  on  the  convergence  of  interest  rates  (…)  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”. 

The interest rate reference value was calculated to be 6.5% in March 2008. 

Article 121  of  the  Treaty  also  requires  an  examination  of  other  factors  relevant  to 
economic integration and convergence. These additional factors include financial and 
product  market integration, the  development of the balance of payments on current 
account6 and the development of unit labour costs and other price indices. The latter 
are covered within the assessment of price stability. 

2. 

BULGARIA 

Bulgaria  joined  the  European  Union  on  1  January  2007.  In  this  report,  the 
compatibility  of  its  legislation  with  Article  108  and  109  of  the  EC  Treaty  and  the 
ESCB/ECB  Statute  and  its  progress  towards  the  achievement  of  sustainable 
economic convergence are therefore assessed for the first time.  

The  legal  basis  for  the  Bulgarian  National  Bank  (BNB)  is  the  Law  on  the  BNB  of 
5 June  1997.  The  latest  amendments  were  made  in  June  and  July  2007.  As  regards 
central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption,  legislation  in 
Bulgaria, in particular the Law on the BNB, is not fully compatible with Article 108 
and  109 of  the Treaty  and the  ESCB/ECB Statute.  Imperfections subsist as regards 
banknotes  and  coins  issues,  the  promotion  of  the  smooth  operation  of  payment 
systems,  the  ECB's  approval  before  participation  in  international  monetary 
institutions,  the  statistical  role  of  the  ECB  and  the  EU,  auditing  by  independent 
external auditors, institutional and personal independence as well as the prohibition 
of monetary financing. 

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In  assessing  compliance  with  the  exchange  rate  criterion,  the  Commission  examines  whether  the 
exchange rate has remained close to the ERM II central rate, while reasons for an appreciation may be 
taken into account, in accordance with the Common Statement on Acceding Countries and ERM2 by the 
Informal ECOFIN Council, Athens, 5 April 2003. 
The focus of the assessment is on the "external balance", defined as the combined current and capital 
account  (net  lending/borrowing  vis-à-vis  the  rest  of  the  world).  This  concept  permits  in  particular  to 
take full account of external transfers (including EU transfers), which are partly recorded in the capital 
account. 

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In Bulgaria, 12-month average inflation has been above the reference value since EU 
accession.  The  average  inflation  rate  in  Bulgaria  during  the  12  months  to  March 
2008  was  9.4%,  well  above  the  reference  value  of  3.2%,  and  it  is  likely  to  remain 
well above the reference value in the months ahead.  

HICP  inflation  in  Bulgaria  picked  up  significantly  in  recent  years,  with  annual 
average  inflation  rising  from  2.3%  in  2003  to  some  7½%  in  2006  and  2007  and 
monthly  year-on-year  inflation  reaching  double  digits  in  late  2007.  Drivers  of 
increasing inflation included higher energy and food prices and hikes in administered 
prices and excise duties, although underlying inflationary pressures also strengthened 
amid buoyant domestic demand and wage growth. Against this background, inflation 
is  forecast  to  remain  at  elevated  levels  in  the  coming  months,  with  annual  average 
inflation rising to around 10% in 2008. Looking further ahead, a gradual decrease of 
inflation to some 6% is forecast in 2009 in line with an easing of demand pressures 
in the economy and the fading-out of the commodity price shock. The low price level 
in  Bulgaria  (45%  of  the  EU  average  in  2006)  suggests  potential  for  price  level 
convergence in the long term.  

Bulgaria does not fulfil the criterion on price stability.  

Graph 1a: Bulgaria - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

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Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

B ulgaria

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Bulgaria  is  not  the  subject  of  a  Council  Decision  on  the  existence  of  an  excessive 
deficit. Bulgaria's general government balance has improved markedly over the past 
several years, moving from a balanced position in 2003 to a surplus of 3.4% of GDP 
in 2007. While the total revenue-to-GDP ratio has been rising, expenditure as a share 
of GDP has been kept under restraint for most of the period. The general government 
gross debt ratio has followed a downward trend, from over 50% of GDP in 2002 to 
18%  of  GDP  in  2007.  Based  on  a  no-policy-change  assumption,  the  Commission 
services' Spring 2008 Forecast expects the surplus to remain at around 3% of GDP in 
2008  and  2009,  while  the  debt  ratio  should  remain  on  a  decreasing  path,  reaching 
11% of GDP in 2009. 

Bulgaria fulfils the criterion on the government budgetary position. 

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Graph 1b: Bulgaria - Government budget balance and debt
Inverted scale
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(in percent of GDP)

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2

3

4

50

40

30

20

10

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2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The Bulgarian lev is not participating in ERM II. Since 1997, Bulgaria has pursued a 
currency  board  regime  anchored  to  the  D-Mark,  and  later  the  euro.  The  currency 
board  arrangement  has  been  instrumental  to  macroeconomic  stabilisation  and  has 
been functioning smoothly since its introduction. Additional indicators do not point 
to pressures on the exchange rate during the assessment period, though investor risk 
perceptions  seem  to  have  heightened  somewhat  in  the  context  of  the  recent  global 
financial  market  turbulences,  as  indicated  by  a  widening  of  short-term  interest  rate 
spreads  vis-à-vis  the  euro  area  since  late  2007.  The  currency  board  remains  well-
supported by official reserves, which increased robustly in recent years.  

Bulgaria does not fulfil the exchange rate criterion. 

The average long-term interest rate in Bulgaria in the year to March 2008 was 4.7%, 
below the reference value of 6.5%. Average long-term interest rates in Bulgaria have 
been  below  the  reference  value  since  EU  accession.  Long-term  interest  rates 
decreased  significantly  between  2003  and  2005,  reflecting  both  a  decline  in  global 
yields and a narrowing of spreads vis-à-vis the euro area. The latter virtually closed 
by  end-2005,  reflecting  high  investor  confidence  in  Bulgaria's  macroeconomic 
performance and prospects. Since mid-2006 spreads have opened up again, reaching 
some  80  basis  points  in  March  2008,  amidst  increasing  investor  concern  about  the 
risks stemming from considerable macroeconomic imbalances.  

Bulgaria fulfils the criterion on the convergence of long-term interest rates. 

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  Bulgaria's  external 
deficit widened significantly in recent years, from 6% of GDP in 2004 to about 20% 
of GDP in 2007. The large external imbalance mainly reflects both consumption and 
investment  expanding  rapidly  in  the  context  of  catching-up.  Its  size  has  clearly 
surpassed  a  level  that  can  be  considered  sustainable  in  the  medium  term,  implying 
that a considerable adjustment will be required over time. The external shortfall has 
been  fully  financed  by  foreign  direct  investment  (FDI)  inflows,  amid  positive 
investor sentiment. Given the high level of external debt, Bulgaria's external position 
implies  significant  financing  needs  in  the  medium-term.  The  Bulgarian  economy  is 
highly  integrated  with  the  EU.  In  particular,  trade  and  FDI  relations  with  other 
Member States are extensive and integration of the domestic financial sector into the 
broader  EU  sector  has  progressed  substantially,  mainly  through  a  high  degree  of 
foreign ownership of financial intermediaries.  

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In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Bulgaria does not fulfil the conditions for the adoption of the euro. 

3. 

THE CZECH REPUBLIC 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that legislation in the Czech Republic – notably the Act on the Czech National Bank 
(CNB)  and  the  Act  on  the  Financial  Arbitrator  –  was  not  fully  compatible  with 
Article 108 and 109 of the Treaty and the ESCB/ECB Statute. The Act on the CNB 
was  amended  in  2007.  However,  the  incompatibilities  highlighted  in  the  2006 
Convergence  Report  have  not  been  addressed.  As  regards  central  bank  integration 
into the ESCB at the time of euro adoption, the central bank's independence as well 
as  the  prohibition  of  monetary  financing,  the  legislation  in  the  Czech  Republic,  in 
particular  the  Act  on  the  CNB  and  the  Act on  the  Financial  Arbitrator,  is  not  fully 
compatible with Article 108 and 109 of the Treaty and the ESCB/ECB Statute. The 
Act on the CNB contains imperfections related to the role of the ECB in the field of 
international  cooperation,  the  role  of  the  ECB  and  the  EU  in  the  collection  of 
statistics  and  the  appointment  of  external  auditors,  the  promotion  of  the  smooth 
operation  of  payment  systems,  the  institutional  and  personal  independence  and  the 
prohibition of monetary financing.  

In  the  Czech  Republic,  12-month  average  inflation  has  been  above  the  reference 
value since December 2007. The average inflation rate in the Czech Republic during 
the 12 months to March 2008 was 4.4%, above the reference value of 3.2%, and it is 
likely to move further away from the reference value in the months ahead.  

Inflation  in  the  Czech  Republic,  after  having  fluctuated  around  2%  since  2004, 
increased  significantly  in  the  second  half  of  2007  against  the  backdrop  of  rising 
energy  and  food  prices.  The  rise  in  headline  inflation  occurred  despite  a  further 
significant strengthening of the koruna, which has been on a sustained appreciation 
trend since 2004. During the first quarter of 2008, pushed up further by indirect tax 
changes  and  administered  price  increases,  annual  HICP  inflation  jumped  to  a  nine-
year high of almost 8%. The simultaneous rise in core inflation indices suggests that 
underlying domestic inflationary pressures have also increased. Inflation is likely to 
remain  elevated  for  much  of  2008,  according  to  the  Commission  services'  Spring 
2008  Forecast,  mainly  due  to  the  impact  of  higher  commodity  prices  and  one-off 
administrative measures, but it is forecast to decline sharply thereafter to below 3% 
on average in 2009 as these increases drop out of the calculation of annual rates. The 
relatively  low  price  level  in  the  Czech  Republic  (62%  of  the  EU  average  in  2006) 
suggests potential for price level convergence in the long term. 

The Czech Republic does not fulfil the criterion on price stability.  

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Graph 2a: Czech Republic - Inflation criterion since 2004
 (percent, 12-month mov ing av erage)

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6

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4

3

2

1

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Czech Republic

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

The Czech Republic is at present the subject of a Council Decision on the existence 
of  an  excessive  deficit  (Council  Decision  of  5  July  2004).7  The  Council 
recommended that Czech Republic take action in a medium-term framework in order 
to bring the deficit below 3% of GDP by 2008 in a credible and sustainable manner. 
The  Czech  Republic's  general  government  deficit  has  been  reduced  substantially 
since 2004. The general government deficit improved to 2.7% of GDP in 2006 and 
1.6%  of  GDP  in  2007.  This  is  a  result  of  better-than-expected  revenues  as  well  as 
some  expenditure  restraint.  According  to  the  Commission  services'  Spring  2008 
Forecast, which is based on a no-policy-change assumption, the deficit-to-GDP ratio 
will amount to 1.4% of GDP in 2008 and decrease slightly to 1.1% of GDP in 2009, 
while  the  general  government  debt  is  expected  to  decline  from  28.1%  of  GDP  in 
2008 to 27.2% in 2009. 

In view of these developments and the Commission services' Spring 2008 Forecast, 
the  Commission  considers  that  the  excessive  deficit  has  been  corrected  with  a 
credible  and  sustainable  reduction  of  the  budget  deficit  below  3%  of  GDP.  The 
Commission is therefore recommending that the Council abrogate the decision on the 
existence of an excessive deficit for the Czech Republic (SEC(2008) 571).  

If  the  Council  decides  to  abrogate  the  excessive  deficit  procedure  for  the  Czech 
Republic,  the  Czech  Republic  will  fulfil  the  criterion  on  the  government  budgetary 
position. 

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2005/185/EC, (OJ L 62, 9.3.2005, p. 20). 

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(in percent of GDP)

Graph 2b: Czech Rep - Government budget balance and debt
Inverted scale
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-6
-5
-4
-3
-2
-1
0

26

27

28

29

30

31

25

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The  Czech  koruna  is  not  participating  in  ERM  II.  The  Czech  Republic  operates  a 
floating  exchange  rate  regime.  During  the  two–year  assessment  period,  the  koruna 
appreciated against the euro by nearly 13%. The short-term volatility of the koruna 
appears  to  have  reflected  changes  in  global  financial  market  conditions,  though 
domestic factors have also been at play (e.g. developments in interest rate differential 
vis-à-vis major world currencies).  

The Czech Republic does not fulfil the exchange rate criterion. 

The average long-term interest rate in the Czech Republic in the year to March 2008 
was 4.5%, below the reference value of 6.5%. Average long-term interest rates in the 
Czech  Republic  have  been  below  the  reference  value  since  EU  accession.  Inflation 
expectations  have  been  anchored  at  a  low  level  and  the  appreciation  of  the  koruna 
has  contributed  to  keeping  yields  down.  Long-term  interest  rates  in  the  Czech 
Republic  have  moved  close  to  or  below  the  euro-area  level  since  2005,  though  the 
spread  has  turned  slightly  positive  since  the  second  half  of  2007,  mainly  reflecting 
the diverging outlook for policy rates in the Czech Republic vis-à-vis the euro area 
and a decline in global risk appetite.  

The  Czech  Republic  fulfils  the  criterion  on  the  convergence  of  long-term  interest 
rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  The  external  deficit  in 
the Czech Republic narrowed significantly from around 6% of GDP in 2002-2004 to 
1.6% of GDP in 2005, before widening to an average of around 2.6% in 2006-2007. 
The solid performance of the external balance was chiefly on account of a surge in 
merchandise  exports,  notably  driven  by  foreign  investment  in  manufacturing.  The 
external deficit has been fully financed by net FDI inflows since EU accession. The 
Czech  economy  is  highly  integrated  with  the  EU.  In  particular,  trade  and  FDI 
relations  with  other  Member  States  are  extensive  and  integration  of  the  domestic 
financial  sector  into  the  broader  EU  sector  has  progressed  substantially,  mainly 
through a high degree of foreign ownership of financial intermediaries.  

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that the Czech  Republic does not fulfil the conditions for the adoption of 
the euro.  

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4. 

ESTONIA 

As  stated  in  the  2006  Convergence  Report,  all  legal  incompatibilities  raised  in  the 
2004  Convergence  Report  have  been  removed.  As  regards  central  bank  integration 
into the ESCB at the time of euro adoption, Article 111 of Estonia's Constitution is 
not formally compatible with the requirements of the EC Treaty and the ESCB/ECB 
Statute. However, the ruling of 11 May 2006 of the Constitutional Review Chamber 
of Estonia's Supreme Court provides legal clarity, in particular on the inapplicability 
of  Article  111  after  the  introduction  of  the  euro  in  Estonia.  National  legislation  in 
Estonia  can  be  considered  compatible  with  the  requirements  of  the  Treaty  and  the 
ESCB/ECB  Statute,  subject  to  the  repeal  of  the  Currency  Law  and  the  Law  on  the 
Security  of  the  Estonian  Kroon  with  effect  from  the  date  of  the  introduction  of  the 
euro. The Eesti Pank Act contains, however, still some imperfections related to the 
Eesti Pank's integration into the ESCB for some banknote issues and the collection of 
statistics.  

In  Estonia,  12-month  average  inflation  has  been  above  the  reference  value  since 
September  2004.  The  average  inflation  rate  in  Estonia  during  the  12  months  to 
March  2008  was  8.3%,  well  above  the  reference  value  of  3.2%,  and  it  is  likely  to 
move further away from the reference value in the months ahead.  

HICP  inflation  in  Estonia  accelerated  sharply  in  recent  years,  with  annual  average 
inflation rising to 6¾% in 2007 and monthly year-on-year inflation reaching double-
digits  in  early  2008.  Rising  inflation  reflected  strong  domestic  demand  growth  and 
rising  wage  costs,  compounded  by  significant  food  and  energy  price  pressures. 
Inflation performance in the coming months will reflect continued upward pressures 
stemming from labour cost developments, higher energy and food prices as well as 
the  impact  of  excise  increases.  Looking  further  ahead,  a  decline  in  inflation  from  
9½%  in  2008  to  5%  in  2009  is  forecast,  in  line  with  a  cooling  economy  and  the 
fading  out  of  one-off  effects.  The  relatively  low  price  level  in  Estonia  (67%  of  the 
EU average in 2006) suggests potential for price level convergence in the long term.  

Estonia does not fulfil the criterion on price stability. 

Graph 3a: Estonia - Inflation criterion since 2004
 (percent, 12-month mov ing av erage)

10

8

6

4

2

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Esto nia

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

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Estonia  is  not  the  subject  of  a  Council  Decision  on  the  existence  of  an  excessive 
deficit.  Between  2002  and  2007,  Estonia  recorded  an  average  general  government 
surplus of some 2% of GDP. In 2007, Estonia recorded a general government surplus 
of 2.8%, compared to a peak of 3.4% one year earlier. The general government gross 
debt ratio  stood at  3.4% of  GDP  in  2007,  the  lowest  of  all  the  EU  Member  States. 
The  authorities  have  used  the  period  of  strong  growth  to  build  up  considerable 
government reserves. According to the Commission services' Spring 2008 Forecast, 
which is based on a no-policy-change assumption, the surplus will drop significantly 
to  0.4%  of  GDP  in  2008  and  a  deficit  of  0.7%  of  GDP  will  emerge  in  2009  on 
account of a sharply slowing economy. The debt ratio is forecast to stabilise around 
current levels in 2008 and 2009. 

Estonia fulfils the criterion on the government budgetary position. 

Graph 3b: Estonia - Government budget balance and debt
Inverted scale
-1

(in percent of GDP)

0

1

2

3

4

6

5

4

3

2

1

0

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The Estonian kroon has participated in ERM II since 28 June 2004, i.e. for more than 
two  years  at  the  time  of  adoption  of  this  report.  Before  ERM  II  entry,  Estonia  had 
pursued a currency board regime anchored to the D-Mark, and later the euro, since 
1992.  Upon  ERM  II  entry,  Estonia  unilaterally  committed  to  maintain  its  currency 
board  in  the  mechanism.  Additional  indicators  do  not  point  to  pressures  on  the 
exchange  rate,  though  a  rise  in  short-term  interest  rates  in  late  2007  has  pointed  to 
increased  risk  perceptions  by  markets.  The  currency  board  remains  well-supported 
by  official  reserves.  During  the  two-year  assessment  period,  the  kroon  did  not 
deviate from the central rate, and it did not experience severe tensions.  

Estonia fulfils the exchange rate criterion. 

As a result of Estonia's low level of government indebtedness, no benchmark long-
term government bond or comparable security is available to assess the durability of 
convergence as reflected in long-term interest rates. On the basis of developments in 
an interest rate indicator based on kroon-denominated bank loans to households and 
non-financial  businesses  and  taking  into  account,  inter  alia,  the  low  level  of 
government  debt,  there  is  no  reason  to  conclude  that  Estonia  would  not  fulfil  the 
criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments and product and financial market integration. Estonia's external deficit 
has  widened  in  recent  years,  increasing  from  around  10%  of  GDP  on  average 
between 2002 and 2005 to some 16% of GDP in 2007. While the emergence of the 
high  external  deficit  can  largely  be  attributed  to  transitional  effects  in  a  rapidly 

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catching  up  economy,  its  size  has  clearly  surpassed  levels  that  can  be  considered 
sustainable  in  the  medium  term,  implying  that  a  considerable  adjustment  will  be 
required over time. The external shortfall has to a significant extent been financed by 
intra-group  bank  lending.  FDI  inflows  are  sizeable  but  have  more  recently  been 
partly outweighed by increased outward FDI. Given the high level of external debt, 
Estonia's  external  position  implies  significant  financing  needs  in  the  medium  term. 
The  Estonian  economy  is  highly  integrated  within  the  EU.  In  particular,  trade  and 
FDI relations with other Member States are extensive and integration of the domestic 
financial  sector  into  the  broader  EU  sector  has  progressed  substantially,  mainly 
through a high degree of foreign ownership of financial intermediaries.  

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Estonia does not fulfil the conditions for the adoption of the euro.  

5. 

LATVIA 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that  legislation  in  Latvia  was  not  fully  compatible  with  Article  108  and  109  of  the 
Treaty and the ESCB/ECB Statute. The Law on the Bank of Latvia was amended in 
June  2006.  No  further  amendments  have  been  made  since  then.  As  regards  central 
bank integration into the ESCB at the time of euro adoption, the independence of the 
central bank and the prohibition of monetary financing, the legislation in Latvia, in 
particular  the  Law  on  the  Bank  of  Latvia,  is  not  fully  compatible  with  Article  108 
and  109  of  the  EC  Treaty  and  the  ESCB/ECB  Statute.  Imperfections  subsist  as 
regards  the  objectives  of  the  ESCB,  the  promotion  of  the  smooth  operation  of 
payment  systems,  the  statistical  role  of  the  ECB  and  the  EU  Council,  the 
appointment  of  external  auditors,  the  role  of  the  ECB  in  the  field  of  international 
cooperation,  the  institutional  independence  of  the  bank  as  well  as  the  personal 
independence of the members of the Bank of Latvia’s decision-making bodies. 

In Latvia, 12-month average inflation has been above the reference value since EU 
accession. The average inflation rate in Latvia during the 12 months to March 2008 
was 12.3%, well above the reference value of 3.2%, and it is likely to move further 
away from the reference value in the months ahead. 

In recent years, Latvia has experienced high and, since early 2007, rapidly increasing 
HICP inflation, reflecting sustained wage and demand pressures as well as the impact 
of  external  factors.  Between  EU  accession  in  May  2004  and  early  2007,  HICP 
inflation moved in a range from 6 to 8%. However, in the course of 2007 headline 
HICP inflation accelerated sharply and reached more than 16% in the first quarter of 
2008. Higher inflation partly reflected increases in administered prices and excises as 
well  as  global  increases  in  energy  and  food  prices.  However,  pressures  from 
domestic sources, as evidenced by rising inflation for all main components of HICP 
except  non-energy  industrial  goods,  contributed  importantly  to  the  upsurge  in 
inflation. Inflation is  forecast to remain around the present elevated levels in 2008, 
averaging  nearly  16%  for  the  year,  and  to  decelerate  in  2009,  albeit  to  a  still 
relatively  high  level  of  around  8½%,  in  response  to  the  expected  economic 
slowdown  and  a  fading-out  of  the  impact  of  commodity  price  increases.  The 
relatively  low  price  level  in  Latvia  (61%  of  the  EU  average  in  2006)  suggests 
potential for price level convergence in the long term.  

Latvia does not fulfil the criterion on price stability. 

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12 

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Graph 4a: Latvia - Inflation criterion since 2004
 (percent, 12-month mov ing av erage)

16

14

12

10

8

6

4

2

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Latvia

Reference value

Note: The dots show the projected reference value and 12-month average inflation 
in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Latvia  is  not  the  subject  of  a  Council  Decision  on  the  existence  of  an  excessive 
deficit.  Since  2002  the  general  government  position  has  gradually  improved  to  a 
balanced budget in 2007. The Commission services' Spring 2008 Forecast, which is 
based  on  a  no-policy-change  assumption,  projects  a  deterioration  of  the  general 
government position in 2008 and 2009 as the economy slows down sharply, with a 
deficit  of  slightly  above  2%  of  GDP  expected  for  2009.  General  government  debt 
remained  below  15%  of  GDP  since  the  beginning  of  the  decade,  reached  9.7%  of 
GDP in 2007, and is expected to increase only slightly in 2008 and 2009.  

Latvia fulfils the criterion on the government budgetary position. 

Graph 4b: Latvia - Government budget balance and debt

Inverted scale
-3

(in percent of GDP)

-2

-1

0

20

15

10

5

0

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The  Latvian  lats  has  participated  in  ERM  II  since  2  May  2005,  i.e.  for  more  than 
2 years at the time of adoption of this report. Before ERM II entry, Latvia operated 
an exchange rate peg, initially to the SDR basket (Special Drawing Rights), and from 
1  January  2005  to  the  euro.  Upon  ERM  II  entry,  Latvia  unilaterally  committed  to 
keep the exchange rate of the lats within a ± 1% fluctuation band around the central 
rate. During the assessment period, the lats remained close to the central rate, and it 
did  not  experience  severe  tensions,  although  it  incurred  temporary  episodes  of 
financial market volatility. Until mid-February 2007 the lats traded close to the upper 
limit of the unilateral band with very limited fluctuations. In mid-February 2007, the 
exchange  rate  weakened  suddenly  against  the  euro  in  an  episode  of  high  market 
uncertainty and by end-March  2007 the lats was trading close to the lower limit of 

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13 

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the  unilateral  ±  1%  fluctuation  band.  However,  subsequently  the  exchange  rate 
strengthened  again  and  mostly  remained  within  the  upper  half  of  the  fluctuation 
band,  albeit  with  some  short-term  fluctuations.  Additional  indicators,  such  as 
developments  in  foreign  exchange  reserves  and  short-term  interest  rates,  do  not 
reveal sustained pressures on the exchange rate, though a rise in the level of short-
term interest rates relative to the euro area since early 2007 (reaching a peak at the 
end of 2007) has pointed to increased risk perceptions by markets.  

Latvia fulfils the exchange rate criterion. 

The average long-term interest rate in Latvia in the year to March 2008 was 5.4%, 
below the reference value of 6.5%. Average long-term interest rates in Latvia have 
been  below  the  reference  value  since  EU  accession.  The  spread  vis-à-vis  euro  area 
long-term  benchmark  bonds  closed  in  the  spring  of  2006.  Subsequently,  however, 
long-term  interest  spreads  to  the  euro  area  increased  to  around  120  basis  points  in 
March  2008  amidst  increasing  investor  concern  about  the  risks  stemming  from 
considerable macroeconomic imbalances. 

Latvia fulfils the criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments and product and financial market integration. Latvia's external deficit 
has  soared  in  recent  years,  exceeding  10%  of  GDP  since  2004  and  widening  to 
20.9% of GDP in 2007. This has mainly reflected a shortfall in merchandise trade as 
imports were buoyed by strong domestic demand. While the emergence of the high 
external deficit can largely be attributed to transitional effects in a rapidly catching 
up economy, its size has clearly surpassed levels that can be considered sustainable 
in  the  medium  term,  implying  that  a  considerable  adjustment  will  be  required  over 
time.  The  deficit  on  the  external  balance  has  been  mainly  financed  by  inflows  of 
other investment, largely linked to intra-group bank funding. Given the high level of 
external debt, the external position implies substantial financing needs in the medium 
term.  The  Latvian  economy  has  become  increasingly  integrated  with  the  EU.  In 
particular,  trade  and  FDI  relations  with  other  Member  States  are  extensive  and 
integration of the domestic financial sector into the broader EU sector has progressed 
substantially,  mainly  through a  significant  degree  of  foreign  ownership  of  financial 
intermediaries. 

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Latvia does not fulfil the conditions for the adoption of the euro.  

6. 

LITHUANIA 

As  already  concluded  in  the  2006  Convergence  Report,  legislation  in  Lithuania,  in 
particular the Law on the Bank of Lithuania, is fully compatible with Article 108 and 
109 of the Treaty and the ESCB/ECB Statute.  

In  Lithuania,  12-month  average  inflation  has  been  above  the  reference  value  since 
April 2005, with the exception of April 2006 when it was at the reference value. The 
average  inflation  rate  in  Lithuania  during  the  12  months  to  March  2008  was  7.4%, 
well above the reference value of 3.2%, and it is likely to move further away from 
the reference value in the months ahead.  

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HICP  inflation  in  Lithuania  has  been  on  an  increasing  trend  since  mid-2005,  with 
inflation rising to 5.8% in 2007 and monthly year-on-year inflation reaching double 
digits  in  early  2008.  The  increase  in  inflation  reflected  a  combination  of  factors 
including  higher  energy  prices  on  world  markets;  increases  in  administered  prices; 
and rising prices of unprocessed and processed food products, the latter most notably 
in 2007. Against the background of increasing pressure from the labour market and 
rising  wage  costs,  the  acceleration  in  inflation  was  also  increasingly  driven  by 
demand factors, leading to a rapid increase in services prices.  

A  further  significant  increase  in  inflation  is  forecast  in  2008,  reflecting  upward 
pressures  from  oil  and  agricultural  prices,  the  feed-through  of  the  large  increase  in 
prices of imported gas and excises taxes for tobacco, fuel and alcohol as well as rapid 
wage growth. Inflation is forecast to ease only gradually, from an annual average of 
about 10% in 2008 to about 7% in 2009, reflecting the lagged response of prices to 
the growth slowdown and moderation in oil and food prices. The relatively low price 
level in Lithuania (57% of the EU average in 2006) suggests potential for price level 
convergence in the long term.  

Lithuania does not fulfil the criterion on price stability.  

Graph 5a: Lithuania - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

10

8

6

4

2

0

-2
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Lithuania

Reference value

Note: The dots show the projected reference value and 12-month average inflation 
in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Lithuania  is not  the subject of a Council Decision on the existence of an excessive 
deficit. Fiscal consolidation efforts led to a decline of the deficit from around 2% of 
GDP  in  2002  to  0.5%  of  GDP  in  2005.  Thereafter  the  budgetary  deficit  increased 
again and was 1.2% in 2007. The revenue ratio to GDP increased after 2004, mainly 
reflecting  increasing  inflows  of  EU  funds,  while  the  current  primary  expenditure 
ratio to GDP stayed relatively stable. According to the Commission services' Spring 
2008 Forecast, which is based on a no-policy-change assumption, the deficit-to-GDP 
ratio will widen further to 1.7% in 2008 and diminish only slightly to 1.5% in 2009. 
Lithuania's  general  government  debt  ratio  declined  steadily  from  22.4%  of  GDP  at 
the end of 2002 to 17.3% of GDP at the end of 2007, and it is expected to stabilise 
around this level in 2008 and 2009.  

Lithuania fulfils the criterion on the government budgetary position. 

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Graph 5b: Lithuania - Government budget balance and debt

Inverted scale
-3

(in percent of GDP)

-2

-1

0

25

20

15

10

5

0

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

Lithuania has participated in ERM II since 28 June 2004, i.e. for more than 2 years at 
the  time  of  adoption  of  this  report.  Before  ERM  II  entry,  the  Bank  of  Lithuania 
operated a currency board as of April 1994, with the litas initially pegged to the US 
dollar  and  then  re-pegged  to  the  euro  in  February  2002.  When  entering  ERM  II, 
Lithuania  unilaterally  committed  to  maintain  its  currency  board  in  the  mechanism. 
During  the  assessment  period,  the  litas  did  not  deviate  from  the  central  rate,  and  it 
did  not  experience  severe  tensions.  Additional  indicators,  such  as  developments  in 
foreign exchange reserves and short-term interest rates, do not point to pressures on 
the  exchange  rate,  although  increased  risk  perceptions  by  market  participants  have 
been reflected in a marked widening of short-term interest rates spreads vis-à-vis the 
euro area in the course of 2007, which largely reversed in early 2008.  

Lithuania fulfils the exchange rate criterion. 

The average long-term interest rate in Lithuania in the year to March 2008 was 4.6% 
percent,  below  the  reference  value  of  6.5%.  Average  long-term  interest  rates  in 
Lithuania have been below the reference value since EU accession. The spread vis-à-
vis euro area long-term benchmark bonds, which had declined markedly in the run-
up to ERM II entry in June 2004 and reached a low of about 20 basis points in mid-
2007,  started  to  increase  thereafter  to  about  60  basis  points  at  end-2007.  This 
widening  of  spreads  partly  reflects  a  higher  country  risk  premium  amid  increasing 
investor  concern  about  the  risks  stemming  from  considerable  macroeconomic 
imbalances.  

Lithuania fulfils the criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  Lithuania's  external 
deficit  widened  from  4.7%  of  GDP  in  2001  to  12%  of  GDP  in  2007,  largely  as  a 
consequence  of  buoyant  domestic  demand.  The  main  driver  was  a  growing  trade 
deficit in goods. While the pattern of an increasing external deficit is consistent with 
the rapid catching-up path of the economy, its size has clearly surpassed levels that 
can  be  considered  sustainable  in  the  medium  term,  implying  that  a  considerable 
adjustment will be required over time. The deteriorating external balance was mainly 
financed  by  intra-group  bank  lending  and  to  a  lower  extent  by  foreign  direct 
investment.  Given  the  sizeable  external  debt,  Lithuania's  external  position  implies 
significant financing needs in  the medium-term. The Lithuanian economy  is  highly 
integrated  with  the  EU.  In  particular,  trade  and  FDI  relations  with  other  Member 

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States  are  extensive  and  the  Lithuanian  financial  sector  is  substantially  integrated 
into  the  broader  EU  financial  sector,  mainly  through  a  high  degree  of  foreign 
ownership of financial intermediaries. 

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Lithuania does not fulfil the conditions for the adoption of the euro. 

7. 

HUNGARY 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that legislation in Hungary was not fully compatible with Article 108 and 109 of the 
EC  Treaty  and  the  ESCB/ECB  Statute.  The  Act  on  the  Magyar  Nemzeti  Bank 
(MNB)  was  amended  in  July  2007.  Although  some  incompatibilities  raised  by  the 
Convergence Report in 2006 have been removed, there are still many remaining. As 
regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
independence  as  well  as  the  prohibition  of  monetary  financing,  existing  Hungarian 
legislations,  in  particular  the  Act  on  the  MNB,  the  Statutes  of  the  MNB,  the 
Constitution of Hungary and the Credit Institutions Act, are not fully compatible with 
Article 108 and 109 of the Treaty and the ESCB/ECB Statute. Imperfections subsist 
as regards the objectives of the ESCB, banknotes and coins issues, the promotion of 
the smooth operations of payment systems, the statistical role of the ECB and the EU 
Council, the role of the ECB in the field of international cooperation, the absence of 
an  obligation  to  comply  with  Eurosystem's  financial  reporting  regime,  the  personal 
independence of the Governor and the prohibition of monetary financing. 

In Hungary, 12-month average inflation has been above the reference value since EU 
accession.  The  average  inflation  rate  in  Hungary  during  the  12  months  to  March 
2008  was  7.5%,  well  above  the  reference  value  of  3.2%,  and  it  is  likely  to  remain 
well above the reference value in the months ahead.  

Inflation has been very volatile in Hungary in recent years, mainly reflecting of the 
evolution of oil and food prices. Changes in administered prices and taxations have 
further amplified inflation volatility. These factors, compounded by the depreciation 
of  the  forint,  led  to  a  rapid  increase  in  inflation  from  the  second  quarter  of  2006. 
Inflation  peaked  at  9%  in  March  2007  and  followed  a  downward  trend  until 
September  2007  reflecting  lower  inflation  in  unprocessed  food  and  energy  and  an 
appreciating  forint.  Higher  food  price  inflation  led  to  a  renewed  increase  in  HICP 
inflation from the last quarter of 2007. Inflation averaged 7.9 % in 2007.  

Reflecting high prices of food, oil, electricity and gas as well as the delayed impact 
of the depreciation of the forint in the second half of 2007 and in the beginning of 
2008,  inflation  is  forecast  to  remain  elevated  in  2008  at  above  6%.  Negative  base 
effects for food and energy are forecast to lower inflation in 2009 to below 4%. The 
relatively  low  price  level  in  Hungary  (60%  of  the  EU  average  in  2006)  suggests 
potential for price level convergence in the long term.  

Hungary does not fulfil the criterion on price stability.  

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Graph 6a: Hungary - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

8

6

4

2

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Hungary

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Hungary  is  at  present  the  subject  of  a  Council  Decision  on  the  existence  of  an 
excessive deficit (Council Decision of 5 July 2004)8. The Council recommended that 
Hungary take action in a medium-term framework in order to correct the excessive 
deficit  by  2009  in  a  credible  and  sustainable  manner.  Thanks  to  the  fiscal 
consolidation programme started in mid-2006, the budget deficit fell to 5.5% of GDP 
in 2007 from 9.2% in 2006. The expenditure ratio  was somewhat reduced in 2007, 
while the revenue ratio benefited from measures addressing tax evasion. According 
to  the  Commission  services'  Spring  2008  Forecast,  which  is  based  on  a  no-policy-
change  assumption,  the  deficit-to-GDP  ratio  will  amount  to  4%  of  GDP  in  2008, 
followed  by  a  slight  improvement  to  3.6%  of  GDP  in  2009.  Due  to  the  continued 
fiscal  loosening  until  mid-2006,  the  debt-to-GDP  ratio  significantly  increased  and 
reached  around  66%  in  2007.  The  Commission  services'  Spring  2008  Forecast 
projects general government debt to remain around present levels in 2008 and 2009. 

Hungary does not fulfil the criterion on the government budgetary position. 

(in percent of GDP)

Graph 6b: Hungary - Government budget balance and debt
Inverted scale
-10
-9
-8
-7
-6
-5
-4
-3
-2
-1
0

70

65

60

55

50

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The  Hungarian  forint  is  not  participating  in  ERM  II.  The  forint  was  unilaterally 
pegged  to  the  euro  with  a  ±  15 %  fluctuation  margin  between  2001  and  February 
2008, when the exchange rate bands were abolished and a free-floating exchange rate 

8 

2004/918/EC, (OJ L 389, 30.12.2004, p. 27). 

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18 

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regime was adopted. Between August 2005 and August 2006, the forint depreciated 
substantially  vis-à-vis  the  euro  in  response  to  growing  concerns  about  the  fiscal 
situation.  The  forint  reached  a  low  point  in  June  2006,  after  which  it  gradually 
strengthened.  The  strengthening  path  reversed  in  mid-2007,  mainly  reflecting 
increased risk aversion vis-à-vis emerging markets and increased concerns about the 
Hungarian  economic  situation,  but  the  exchange  rate  started  to  appreciate  again  in 
March  2008.  During  the  two-year  assessment  period,  the  forint  appreciated  against 
the euro by about 4.5%. 

Hungary does not fulfil the exchange rate criterion. 

The average long-term interest rate in Hungary in the year to March 2008 was 6.9%, 
above the reference value of 6.5%. Average long-term interest rates in Hungary have 
been above the reference value since EU accession. Bond yield spreads with the euro 
area widened to approximately 400 basis points in October 2006 reflecting mounting 
investors'  worries  about  fiscal  slippages,  and  gradually  decreased  thereafter.  They 
started to widen again in November 2007 and reached about 400 basis points in early 
2008,  in  a  context  of  lower  global  risk  appetite  and  concerns  about  the  domestic 
economic situation.  

Hungary does not fulfil the criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments and product and financial market integration. The Hungarian external 
deficit  reached  a  peak  of  8.1%  of  GDP  in  2004  and  gradually  decreased  thereafter 
reflecting buoyant export growth. In 2007, it further decreased to 4% of GDP due to 
weaker  domestic  demand.  The  substantial  external  deficits  in  recent  years  were 
mainly  financed  by  FDI  and  portfolio  inflows,  although  in  2007  banks'  external 
borrowing was the main source of financing, as one-off factors led to a sharp fall in 
FDI  and  portfolio  inflows.  Given  the  high  level  of  external  debt,  a  return  to  larger 
external  deficits  would  imply  substantial  financing  needs  in  the  medium  term.  The 
Hungarian economy is highly integrated within the EU. In particular, trade and FDI 
relations  with  other  Member  States  are  extensive  and  integration  of  the  domestic 
financial  sector  into  the  broader  EU  financial  sector  has  progressed  substantially, 
mainly through a high degree of foreign ownership of financial intermediaries.  

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Hungary does not fulfil the conditions for the adoption of the euro. 

EN 

19 

   EN 

 
8. 

POLAND 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that  legislation  in  Poland  –  notably  the  Constitution  of  Poland,  the  Act  on  the 
National Bank of Poland (NBP) and the law on the Bank Guarantee Fund – was not 
fully compatible with Article 108 and 109 of the Treaty and the ESCB/ECB Statute. 
In January 2007, an amendment was made to the Act on the NBP. However, it did 
not address any of the incompatibilities highlighted in the 2006 Convergence Report. 
As regards central bank integration into the ESCB at the time of euro adoption, the 
independence  of  the  central  bank  and  the  prohibition  of  monetary  financing,  the 
objectives  of  the  monetary  policy,  the  legislation  in  Poland  is  not  fully  compatible 
with  Article  108  and  109  of  the  EC  Treaty  and  the  ESCB/ECB  Statute.  Several 
imperfections  subsist  as  regards  the  reference  to  the  objectives  of  the  ESCB,  the 
statistical  role  of  the  ECB  and  EU  Council,  the  role  of  the  ECB  in  the  field  of 
international cooperation, the role of the ECB and the EU in appointing the external 
auditor, the role of the ECB in the functioning of payment systems, the obligation to 
consult  the  ECB  for  certain  acts  and  the  personal  independence  of  the  NBP's 
decision-making bodies. 

In  Poland,  12-month  average  inflation  was  below  or  at  the  reference  value  from 
November 2005 until February 2008. The average inflation rate in Poland during the 
12 months to March 2008 was 3.2%, at the reference value, and it is likely to move 
slightly above the reference value in the months ahead.  

Following  high  and  volatile  inflation  in  the  1990s,  HICP  inflation  in  Poland 
decreased  sharply  to  a  very  low  level,  averaging  around  2%  over  the  period  2002-
2006.  The  sustained  strengthening  trend  of  the  zloty  since  2004  has  exerted  a 
significant moderating effect on inflation over recent years. However, HICP inflation 
picked up strongly in the course of the second half of 2007 on the back of rising food 
and  energy  prices,  though  buoyant  domestic  demand  contributed  to  price  pressures 
across a wide range of categories. Annual headline HICP inflation reached 4.5% in 
the first quarter 2008, which was the highest level since end-2004. 

HICP inflation is likely to remain at elevated levels for much of 2008, according to 
the  Commission  services'  Spring  2008  Forecast.  This  reflects  mainly  the  impact  of 
higher commodity prices, some of them being passed through with a lag (for instance 
to  consumer  gas  and  electricity  prices),  and  demand  pressures  stemming  from 
buoyant  wage  and  credit  growth.  Annual  inflation  is  forecast  to  decline  slightly 
thereafter from 4.3% in 2008 to 3.4% in 2009, as the one-off price hikes drop out of 
the  calculation  of  annual  rates.  This  profile  for  inflation  also  hinges  on  the 
assumption  that  that  second-round  effects  from  temporary  factors  affecting  current 
headline inflation will remain broadly contained in a context of increasing capacity 
utilisation  and  a  tightening  labour  market.  The  relatively  low  price  level  in  Poland 
(62%  of  the  EU  average  in  2006)  suggests  potential  for  price  level  convergence  in 
the long term. 

Sustainable  convergence  implies  that  respect  of  the  reference  value  reflects 
underlying  fundamentals  rather  than  temporary  factors.  In  the  case  of  Poland,  the 
moderating  influence  of  the  appreciating  exchange  rate  on  inflation  represents  an 
important  temporary  factor,  and  average  annual  inflation  is  expected  to  soon  rise 
above the reference value.  

Poland does not fulfil the criterion on price stability.  

EN 

20 

   EN 

 
Graph 7a: Poland - Inflation criterion since 2004
 (percent, 12-month mov ing av erage)

5

4

3

2

1

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

P o land

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Poland  is  at  present  the  subject  of  a  Council  Decision  on  the  existence  of  an 
excessive deficit (Council Decision of 5 July 2004)9. The Council recommended that 
Poland take action in a medium-term framework in order to bring the deficit below 
3%  of  GDP  by  2007  in  a  credible  and  sustainable  manner.  Poland's  general 
government  deficit  has  been  reduced  substantially  since  2004.  The  deficit-to-GDP 
ratio  was  2.0%  in  2007  and  according  to  the  Commission  services'  Spring  2008 
Forecast  will  amount  to  around  2½%  of  GDP  in  both  2008  and  2009  under  a  no-
policy-change assumption. General government debt reached 45.2 of GDP in 2007. 
The  Commission  services'  Spring  2008  Forecast  projects  a  slight  reduction  of  the 
general government debt ratio in 2008 and 2009.  

At the end of 2007 the Commission and the Council invited the Polish authorities to 
submit  a  new  convergence  programme  update  describing  their  medium-term 
budgetary  strategy  for  the  whole  legislature  geared  towards  confirming  a  durable 
correction of the excessive deficit in 2007 and making progress towards the medium-
term  objective  thereafter.  The  Polish  authorities  submitted  a  new  convergence 
programme update at the end of March 2008. At the time of preparing this report, the 
Commission  is  assessing  this  programme.  In  the  light  of  this  assessment  and  the 
Commission services' Spring 2008 Forecast, the Commission could recommend the 
abrogation of the excessive deficit procedure. 

Poland does not fulfil the criterion on the government budgetary position.  

9 

2005/183/EC, (OJ L 62, 9.3.2005, p. 18). 

EN 

21 

   EN 

 
 
 
                                                 
(in percent of GDP)

Graph 7b: Poland - Government budget balance and debt
Inverted scale
-7
-6
-5
-4
-3
-2
-1
0

50

48

46

44

42

40

38

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The Polish zloty is not participating in ERM II. Poland operates a floating exchange 
rate regime. During the two-year assessment period, the zloty appreciated by nearly 
13% against the euro. The short-term volatility of the zloty appears to have reflected 
predominantly changes in global financial market conditions such as reversals in risk 
appetite,  though  domestic  factors  have  also  been  at  play  (e.g.  recent  widening  of 
short-term spread vis-à-vis the euro).  

Poland does not fulfil the exchange rate criterion. 

The average long-term interest rate in Poland in the year to March 2008 was 5.7%, 
below the reference value of 6.5%. Average long-term interest rates in Poland have 
been  below  the  reference  value  since  January  2006.  A  decreasing  country-risk 
premium,  the  appreciation  of  the  zloty  and  a  positive  perception  among  investors 
about the prospects for the Polish economy helped keep yields down. With the fall in 
inflation  and  monetary  policy  rates  in  2005,  the  positive  long-term  interest  spreads 
vis-à-vis the euro area fell and then hovered at just above 100 basis points, although 
the spread has widened since mid-2007, reflecting notably the diverging outlook for 
policy rates in Poland relative to the euro area and a decline in global risk appetite.  

Poland fulfils the criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments and product and financial market integration. Poland's external deficit 
slightly deteriorated, to around 2.6% of GDP in 2007, after bottoming out at 0.9% of 
GDP in 2005, largely due to a worsening in the trade balance as imports were buoyed 
by strong domestic demand. Net FDI inflows have increased substantially since EU 
accession, though from a lower level compared to other new Member States, and are 
providing  sufficient  financing  for  external  deficits.  The  Polish  economy  is 
increasingly  integrated  within  the  EU.  In  particular,  trade  and  FDI  relations  with 
other  Member  States  are  growing,  and  integration  of  the  domestic  financial  sector 
into  the  broader  EU  sector  has  progressed  substantially,  mainly  through  a  high 
degree of foreign ownership of financial intermediaries.  

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Poland does not fulfil the conditions for the adoption of the euro.  

EN 

22 

   EN 

 
 
9. 

ROMANIA 

Romania  joined  the  European  Union  on  1  January  2007.  In  this  report,  the 
compatibility  of  its  legislation  with  Article  108  and  109  of  the  EC  Treaty  and  the 
ESCB/ECB  Statute  and  its  progress  towards  the  achievement  of  sustainable 
economic convergence are therefore assessed for the first time.  

The legal basis for the Banca Naţională a României (BNR) is set out in the Law No 
312 of 28 June 2004 on the Statute of the BNR. This Law entered into force on 30 
July 2004 and has not been amended since then. As regards central bank integration 
into  the  ESCB  at  the  time  of  euro  adoption,  its  independence  as  well  as  the 
prohibition of monetary financing, the legislation in Romania, in particular the Law 
on the Statute of the BNR, is not fully compatible with Article 108 and 109 of the EC 
Treaty and the ESCB/ECB Statute. Imperfections subsist as regards the reference to 
the objectives of the ESCB, institutional and personal independence, the ECB's right 
to be consulted in its fields of competence, the promotion of the smooth operation of 
payment systems, the statistical role of the ECB and of the EU Council and their role 
in the appointment of an external auditor. 

In Romania, 12-month average inflation has been above the reference value since EU 
accession.  The  average  inflation  rate  in  Romania  during  the  12  months  to  March 
2008  was  5.9%,  well  above  the  reference  value  of  3.2%,  and  it  is  likely  to  move 
further away from the reference value in the months ahead. 

Inflation  in  Romania  recorded  a  sustained  downward  trend  for  a  number  of  years 
until  2006,  supported  inter  alia  by  an  appreciation  of  the  leu  since  2004.  Headline 
HICP inflation reached a minimum of slightly below 4% in early 2007 but increased 
markedly  afterwards  partly  driven  by  a  sharp  upward  movement  in  agricultural 
prices, which reflected both the severe drought in the summer of 2007 and trends in 
world market prices. Persistent wage and demand pressures, increases in fuel prices 
and the significant weakening of the leu from the second half of 2007 added to the 
pick-up  in  inflation.  HICP  inflation  averaged  4.9%  in  2007  and  is  projected  to 
increase markedly in 2008, to slightly below 8% on average, before decelerating in 
2009 to close to 5% as the inflationary impact of commodity price increases fades. 
The relatively low price level in Romania (57% of the EU average in 2006) suggests 
potential for price level convergence in the long term.  

Romania does not fulfil the criterion on price stability.  

Graph 8a: Romania - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

16

14

12

10

8

6

4

2

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Ro mania

Reference value

Note: The dots show the projected reference value and 12-month average inflation 
in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

EN 

23 

   EN 

 
 
Romania  is  not  the  subject  of  a  Council  Decision  on  the  existence  of  an  excessive 
deficit.  The  general  government  balance  has  deteriorated  significantly  over  the  last 
two  years,  with  the  deficit  rising  from  1.2%  of  GDP  in  2005  to  2.5%  of  GDP  in 
2007. Both the revenue- and expenditure-to-GDP ratios have gradually increased in 
the  past  few  years.  According  to  the  Commission  services'  Spring  2008  Forecast, 
which  is  based  on  a  no-policy-change  assumption,  the  general  government  balance 
will deteriorate slightly to a deficit of just below 3% of GDP in 2008, followed by a 
further  increase  to  3.7%  in  2009.  General  government  debt  declined  from  25%  of 
GDP in 2002 to 13% of GDP in 2007, with modest increases foreseen for 2008 and 
2009.  

Romania fulfils the criterion on the government budgetary position. 

Graph 8b: Romania - Government budget balance and debt
Inverted scale
-4

(in percent of GDP)

30

-3

-2

-1

0

25

20

15

10

5

0

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The  Romanian  leu  is  not  participating  in  ERM  II.  Romania  operates  a  floating 
exchange  rate  regime.  From  late  2004  to  the  beginning  of  July  2007,  the  exchange 
rate  of  the  leu  experienced  a  strong  appreciation  against  the  euro  and  other  major 
currencies, supported by inflows of foreign capital and a positive investor sentiment. 
The start of turbulences on world financial markets in the summer of 2007 marked 
the  beginning  of  a  substantial  weakening  of  the  leu  exchange  rate.  In  recent  years 
official  reserves  have  shown  a  trend  increase,  and  until  mid-2007  exchange  rate 
appreciation  went  hand  in  hand  with  narrowing  money  market  interest  rate 
differentials  vis-à-vis  the  euro  area.  The  reversal  in  the  exchange  rate  in  summer 
2007 was accompanied by a marked widening of the 3-month interest rate spread.  

Romania does not fulfil the exchange rate criterion. 

Average  long-term  interest  rates  in  Romania  have  been  above  the  reference  value 
since  EU  accession.  The  average  long-term  interest  rate  in  Romania  in  the  year  to 
March 2008 was 7.1%, above the reference value of 6.5%. After EU accession, long-
tem bond yield spreads against the euro area initially declined, but widened again in 
the  second  half  of  2007  in  the  wake  of  global  financial  turmoil  which  prompted  a 
decrease in risk appetite. 

Romania does not fulfil the criterion on the convergence of long-term interest rates.  

EN 

24 

   EN 

 
 
Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  Romania's  external 
deficit has risen sharply in recent years, mainly reflecting a shortfall in merchandise 
trade  as  imports  were  buoyed  by  strong  domestic  demand.  The  external  deficit 
widened from 7.5% of GDP in 2004 to slightly above 13% of GDP in 2007. While 
the pattern of an increasing external deficit is consistent with the rapid catching-up 
path  of  the  economy,  its  size  has  clearly  surpassed  levels  that  can  be  considered 
sustainable  in  the  medium  term,  implying  that  a  considerable  adjustment  will  be 
required  over  time.  The  sharp  widening  in  the  external  deficit  has  led  to  a  marked 
increase  in  foreign  liabilities,  implying  higher  financing  costs  in  the  medium  term. 
Whereas until 2006 the external deficit was largely covered by FDI, sizeable inflows 
of other investment (largely linked to intra-group bank funding) gained in importance 
in  2007.  The  process  of  trade  integration  with  the  EU  is  well  under  way,  but 
Romanian  exports  are  concentrated  in  rather  low-technology  segments.  The 
Romanian  financial  sector  is  substantially  integrated  into  the  broader  EU  financial 
through  a  high  degree  of  foreign  ownership  of  financial 
sector,  mainly 
intermediaries. 

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Romania does not fulfil the conditions for the adoption of the euro.  

10. 

SLOVAKIA 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that  legislation  in  Slovakia,  in  particular  the  Act  on  the  National  Bank  of  Slovakia 
(NBS) and the Law on the protection of bank deposits and on amendments to certain 
laws,  was  not  fully  compatible  with  Article  108  and  109  of  the  Treaty  and  the 
ESCB/ECB Statute. Incompatibilities existed regarding the legal integration into the 
ESCB and the prohibition of monetary financing. In order to address these issues and 
to ensure full compatibility with the Treaty and the ESCB/ECB Statute, the Act on 
the NBS was amended. The revised Act on the NBS was adopted by the Parliament 
on  28  November  2007  and  signed  by  the  President  of  the  Slovak  Republic  on 
14 December 2007. All incompatibilities raised in the Convergence Report of 2006 
have  been  removed.  Legislation  in  Slovakia,  in  particular  the  Act  on  the  National 
Bank of Slovakia and the Law on the protection of bank deposits and on amendments 
to certain laws, is now fully compatible with Article 108 and 109 of the Treaty and 
the ESCB/ECB Statute. 

In  Slovakia,  12-month  average  inflation  has  been  at  or  below  the  reference  value 
since  August  2007.  The  average  inflation  rate  in  Slovakia  during  the  12  months  to 
March  2008  was  2.2%,  well  below  the  reference  value  of  3.2%,  and  it  is  likely  to 
remain  below  the  reference  value  in  the  months  ahead,  albeit  with  a  narrowing 
margin.  

In recent years, Slovakia has experienced volatile, and at times high, HICP inflation, 
reflecting the impact of external factors and adjustments in administered prices and 
indirect taxes. Adjusted for the impact of administered price increases, developments 
in  underlying  inflation  have  on  the  whole  been  favourable.  The  koruna's  trend 
exchange rate appreciation since 2002 has exerted a moderating effect on inflation, in 
particular  in  2007  and  early  2008,  following  the  large  appreciation  between  mid-
2006 and spring 2007 (14% in effective terms). 

EN 

25 

   EN 

 
The stronger exchange rate of the koruna combined with low increases in regulated 
energy prices and fuel prices contributed to a decrease in annual HICP inflation to a 
historical low of 1.2% in summer 2007. Inflation subsequently increased to 3.4% in 
the first quarter of 2008, mostly as a result of the global shocks affecting food and 
fuel  prices,  but  also  due  to  some  acceleration  in  prices  of  non-regulated  services. 
These factors are expected to raise inflation further in the coming months, leading to 
an annual average rate around 3¾% in 2008. Average inflation is forecast to decline 
to  some  3¼%  in  2009.  Favourable  base  effects  at  the  end  of  2008,  related  to  the 
assumed  lower  increases  in  commodity  prices,  and  the  further  exchange  rate 
appreciation in the first quarter of 2008 should more than offset the delayed impact 
of higher excise duties on tobacco and the fading away of the disinflationary impact 
of  the  exchange  rate  appreciation  in  2006-2007,  thus  supporting  a  return  to  lower 
inflation rates towards the end of the year. The tightening labour market and strong 
cyclical  position  (with  the  possibility  of  an  acceleration  in  household  demand  and 
wages) as well as possible higher increases in administered prices represent risks to 
the medium-term inflation outlook. The relatively low price level in Slovakia (58% 
of the EU average in 2006) suggests potential for price level convergence in the long 
term. 

Sustainable  convergence  implies  that  respect  of  the  reference  value  reflects 
underlying fundamentals rather than temporary factors. In the  case of Slovakia, the 
moderating  influence  of  the  appreciating  exchange  rate  on  inflation  represents  an 
important  temporary  factor.  However,  the  analysis  of  underlying  fundamentals  and 
the  fact  that  the  reference  value  is  met  by  a  wide  margin  support  a  positive 
assessment on the fulfilment of the price stability criterion. 

Slovakia  needs  to  be  vigilant  to  protect  the  low  inflationary  environment  and  a 
favourable  competitiveness  position.  In  particular,  wage  discipline  will  have  to 
continue  after  the  productivity  upswing  related  to  FDI  inflows  has  subsided,  and 
advancing  structural  reforms  to  improve  the  functioning  of  product  markets  is 
warranted  with  a  view  to  strengthening  the  competitive  environment.  A  more 
ambitious fiscal policy stance would also help to mitigate risks to inflation. With a 
view to keep inflation in check after possible euro adoption , the Slovak government 
and  social  partners  signed  in  early  2008  the  Declaration  of  Social  Agreement  to 
Adopt and Use the Euro in Slovakia, which commits employers and trade unions to 
keep  wage  growth  in  line  with  productivity  growth.  Furthermore,  the  government 
adopted other policy commitments, such as reaching a balanced general government 
budget  by  2011  and  tightening  the  fiscal  stance  further  in  case  of  unexpected 
inflationary pressures, as well as a set of structural measures. However, these policy 
commitments need to be translated into action. 

Slovakia fulfils the criterion on price stability. 

EN 

26 

   EN 

 
Graph 9a: Slovakia - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

10

8

6

4

2

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Slo vakia

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Slovakia  is  at  present  the  subject  of  a  Council  Decision  on  the  existence  of  an 
excessive  deficit  (Council  Decision  of  5  July  2004).10
  The  Council  recommended 
Slovakia  to  take  action  in  a  medium-term  framework  in  order  to  bring  the  deficit 
below 3% of GDP by 2007 in a credible and sustainable manner. Slovakia's general 
government deficit has been reduced substantially since 2002. Both the revenue- and 
expenditure-to-GDP ratios have decreased, the latter at a higher rate. The deficit-to-
GDP ratio was 2.2% in 2007 and according to the Commission services' Spring 2008 
Forecast, which is based on a no-policy-change assumption, it will amount to 2.0% 
of  GDP  in  2008,  followed  by  a  moderate  widening  to  2.3%  in  2009.  General 
government  debt  declined  significantly  since  the  beginning  of  the  decade  to  reach 
29.4% of GDP in 2007. The Commission services' Spring 2008 Forecast projects a 
general government debt ratio of 29.2% of GDP for 2008 and 29.7% in 2009.  

In view of these developments and the Commission services' Spring 2008 Forecast, 
the  Commission  considers  that  the  excessive  deficit  has  been  corrected  with  a 
credible  and  sustainable  reduction  of  the  budget  deficit  below  3%  of  GDP.  The 
Commission is therefore recommending that the Council abrogate the decision on the 
existence of an excessive deficit for Slovakia (SEC(2008) 572).  

If  the  Council  decides  to  abrogate  the  excessive  deficit  procedure  for  Slovakia, 
Slovakia will fulfil the criterion on the government budgetary position. 

10 

2005/182/EC, (OJ L 62, 9.3.2005, pp. 16-17). 

EN 

27 

   EN 

 
 
                                                 
(in percent of GDP)

Graph 9b : Slovakia - Government budget balance and debt
Inverted scale
-9
-8
-7
-6
-5
-4
-3
-2
-1
0

0

50

40

30

20

10

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The Slovak koruna has participated in ERM II since 28 November 2005, i.e. for more 
than  2  years  at  the  time  of  adoption  of  this  report.  Before  ERM  II  entry,  Slovakia 
operated a managed floating exchange rate regime. After ERM II entry, the koruna 
continued its pre-ERM II appreciation trend. The steady appreciation was interrupted 
in  the  second  quarter  of  2006  when  the  koruna  temporarily  weakened  due  to  post-
election  uncertainties  about  prospects  for  fiscal  policy,  combined  with  broader 
pressures on the central European currencies. Strong appreciation between July 2006 
and March 2007 led to a revaluation of the central parity of the koruna by 8.5% with 
effect  from  19  March  2007.  Following  the  revaluation,  the  koruna  exchange  rate 
moved between 3% and 7.3% above the new central parity until January 2008 when 
renewed  appreciation  pressures  pushed  the  koruna  up  to  8-9%  above  the  ERM  II 
central  parity  in  March-April.  During  the  two-year  assessment  period,  the  koruna 
traded  almost  always  in  the  stronger  part  of  the  fluctuation  band,  with  an  average 
deviation of 5.4% from the central parity. The appreciation within ERM II over the 
assessment period can be considered as consistent with underlying fundamentals and 
the koruna did not experience severe tensions. 

Slovakia fulfils the exchange rate criterion. 

The  average  long-term  interest  rate  in  Slovakia  in  the  year  to  March  2008  was 
4.5 percent,  below  the  reference  value  of  6.5  percent.  Average  long-term  interest 
rates  in  Slovakia  have  been  below  the  reference  value  since  EU  accession.  The 
spread vis-à-vis euro-area long-term benchmark bonds had been declining markedly 
since 2002 to practically disappear in April 2007. The factors behind this trend were 
decreasing  country-risk  premia  linked  to  fiscal  consolidation  and  far-reaching 
structural reforms in 2002-2005, and more recently the benign inflation outlook and 
associated  reduction  in  short-term  policy  rates.  Since  mid-2007,  a  slight  positive 
spread of around 30 basis points opened again reflecting the significant drop in long-
term interest rates in the euro area.  

Slovakia fulfils the criterion on the convergence of long-term interest rates.  

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  Slovakia's  external 
balance  has  been  highly  volatile  in  recent  years  reflecting  swings  in  export 
performance  driven  by  new  FDI-related  production  capacities,  in  particular  in  the 
automotive  and  electronic  equipment  sector.  Following  a  substantial  deterioration 
from  0.8%  of  GDP  in  2003  to  above  8%  of  GDP  in  2005-2006  on  account  of 

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dynamic  private  consumption  and  an  increase  in  FDI-related  imports,  the  external 
deficit narrowed back to 5.3% of GDP in 2007 as export performance was boosted 
by the launch of production in new FDI-financed capacities. The external deficit has 
been  mainly  financed  by  large  net  FDI  inflows.  The  Slovak  economy  is  highly 
integrated  with  the  EU.  In  particular,  trade  and  FDI  relations  with  other  Member 
States are extensive and integration of the domestic financial sector into the broader 
EU  sector  has  progressed  substantially,  mainly  through  a  significant  degree  of 
foreign ownership of financial intermediaries. 

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, taking into account the additional factors, and assuming that the 
Council  will  follow  the  Commission's  recommendation  for  the  abrogation  of  the 
excessive  deficit,  the  Commission  considers  that  Slovakia  fulfils  the conditions  for 
the adoption of the euro.  

11. 

SWEDEN 

In  the  2006  Convergence  Report,  the  assessment  on  legal  convergence  concluded 
that legislation in Sweden was not fully compatible with Article 108 and 109 of the 
Treaty and the ESCB/ECB Statute. The Sveriges Riksbank Act was amended in 2006 
and  2007,  without  addressing  the  incompatibilities  highlighted  in  the  2006 
Convergence Report. As regards the independence of the central bank as well as its 
integration into the ESCB at the time of euro adoption, the legislation in Sweden, in 
particular  the  Sveriges  Riksbank  Act,  the  Instrument  of  Government  (part  of  the 
Swedish  Constitution)  and  the  Law  on  the  Exchange  Rate  Policy,  is  not  fully 
compatible with Articles 108 and 109 of the EC Treaty and the ESCB/ECB Statute. 
Several imperfections subsist as regards the objectives of the Sveriges Riksbank, the 
promotion of the smooth operation of payment systems, the prohibition of monetary 
financing, the role of the ECB in the functioning of the payment systems and in the 
field of international cooperation, the statistical role of the ECB and of the EU and 
their role in the appointment of external auditors. 

In Sweden, 12-month average inflation has been below the reference value since the 
start of monitoring in December 1996. The average inflation rate in Sweden during 
the 12 months to March 2008 was 2.0%, well below the reference value of 3.2%, and 
it is likely to remain well below the reference value in the months ahead. 

HICP inflation in Sweden recorded a downward trend until late 2005 but has picked 
up  since  then.  Falling  HICP  inflation  until  late  2005  was  mainly  related  to  high 
productivity growth, underpinned by a cyclical component as well as by the impact 
of extensive investment in information technology. A second contributing factor was 
lower  import  prices,  due  to  the  gradual  pass-through  of  the  strengthening  of  the 
krona between 2002 and 2004 and increased international competition. The upward 
dynamics  since  late  2005  has  mainly  reflected  higher  oil  and  electricity  prices.  In 
addition, food prices have contributed to higher inflation during the last part of 2007, 
in line with overall global developments. Inflation is forecast to decline from 2.4% in 
2008 to around 1.9% in 2009.  

Sweden fulfils the criterion on price stability. 

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Graph 10a:   Sweden - Inflation criterion since 2004

 (percent, 12-month mov ing av erage)

5

4

3

2

1

0
Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Sweden

Reference value

Note: The dots show the projected reference value and 12-month average 
inflation in the country in December 2008.
Sources: Eurostat, Commission services' Spring 2008 Forecast.

Sweden  is  not  the  subject  of  a  Council  decision  on  the  existence  of  an  excessive 
deficit.  Over  the  period  2002-2007,  the  budgetary  position  of  Sweden  improved 
steadily, with the general government balance moving from a deficit of about 1% of 
GDP in 2002 to a surplus of 3.5% in 2007, partly due to the cyclical recovery of the 
economy. The revenue ratio remained stable at around 55% of GDP, while the share 
of  expenditure  to  GDP  has  gradually  decreased  (from  56.5%  in  2002  to  52.5%  in 
2007). In line with the favourable fiscal development, the government gross debt has 
fallen from 52.6% of GDP in 2002 to 40.6% in 2007. Based on a no-policy-change 
assumption,  the  Commission  services'  Spring  2008  Forecast  projects  a  decrease  of 
the  general  government  surplus  to  above  2%  of  GDP  in  2008  and  2009,  while  the 
debt ratio will remain on a declining path, reaching 32% of GDP in 2009.  

Sweden fulfils the criterion on the government budgetary position. 

Graph 10b: Sweden - Government budget balance and debt
Inverted scale
-2

(in percent of GDP)

60

-1

0

1

2

3

4

50

40

30

20

10

0

2002

2003

2004

2005

2006

2007

2008(*) 2009(*)

Go vernment balance (lhs)

Cyclically-adjusted balance (lhs)

Gro ss debt (rhs)

(*) Co mmissio n services' Spring 2008 Fo recast.

So urce: Euro stat, Co mmissio n services.

The  Swedish  krona  is  not  participating  in  ERM  II.  Sweden  has  pursued  a  floating 
exchange  rate  regime  and  inflation  targeting  since  the  early  1990s.  After  a  sharp 
depreciation following the abandonment of the pegged system in 1992, the krona has 
moved in a relatively narrow range vis-à-vis the Deutsche mark and subsequently the 
euro. During the two-year assessment period, the krona has been between 9 and 9.50 
SEK/EUR, averaging above 9.2 SEK/EUR.  

Sweden does not fulfil the exchange rate criterion.  

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In  March  2008,  the  twelve-month  moving  average  of  the  Swedish  ten-year 
benchmark  bond  was  4.2%,  below  the  reference  value  of  6.5%.  Average  long-term 
interest rates have been consistently below the reference value in recent years. The 
spread  vis-à-vis  euro-area  long  term  interest  rates  declined  gradually  from  around 
50 basis points in 2003 to -25 basis points in mid-2007. Subsequently, in line with a 
closing  short-term  interest  rate  gap,  the  negative  spread  between  the  Swedish  and 
euro-area  long  term  interest  rate  narrowed  gradually  to  its  present  level  of  around 
zero.  

Sweden fulfils the criterion on the convergence of long-term interest rates. 

Additional  factors  have  also  been  examined,  including  balance  of  payments 
developments  and  product  and  financial  market  integration.  The  Swedish  external 
account has been in surplus since the mid-1990s, driven by high net exports in goods 
and  to  a  lesser  extent  in  services.  The  external  account  surplus  has  increased  from 
4.9% of GDP in 2002 to a level of around 6-7% of GDP during the last years. The 
Swedish economy is open and well integrated within the EU, with a share of intra-
EU trade in goods around two thirds on both the export and import side. The relative 
importance of intra-EU trade in services has slightly increased over the period and is 
above  the  average  for  the  EU-27.  The  integration  of  Sweden's  financial  sector  into 
the broader EU sector relates mainly to links with other Nordic States and the Baltic 
States.  Sweden’s  financial  sector  is  overall  very  well  developed,  both  in  size  and 
sophistication, and corresponds to its advanced stage of economic development.  

In  the  light  of  its  assessment  on  legal  compatibility  and  on  the  fulfilment  of  the 
convergence criteria, and taking into account the additional factors, the Commission 
considers that Sweden does not fulfil the conditions for the adoption of the euro.  

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