COMMISSION STAFF WORKING DOCUMENT CONVERGENCE REPORT 2012 - TECHNICAL ANNEX Accompanying the document REPORT FROM THE COMMISSION CONVERGENCE REPORT 2012 (Prepared in accordance with Article 140(1) of the the Treaty on the functioning of the European Union)
Date: 2012-05-30
Institutions: European Commission
Subjects: Bulgaria, Czechia, Hungary, Latvia, Lithuania, Poland, Romania, Sweden, convergence criteria

EUROPEAN COMMISSION 

Brussels, 30.5.2012  
SWD(2012) 144 final 

COMMISSION STAFF WORKING DOCUMENT 

CONVERGENCE REPORT 2012 - TECHNICAL ANNEX 

Accompanying the document 

REPORT FROM THE COMMISSION 

CONVERGENCE REPORT 2012 
(Prepared in accordance with Article 140(1) of the the Treaty on the functioning of the 
European Union) 

{COM(2012) 257 final} 

EN 

   EN 

 
 
 
 
  
 
 
 
European Commission 

Directorate-General for Economic and Financial Affairs 

Convergence Report 2012 

EUROPEAN ECONOMY 

xxx/2012 

 
 
 
 
 
 
ABBREVIATIONS 

Member States 

Bulgaria 
Czech Republic 
Latvia 
Lithuania 
Hungary 
Poland 
Romania 
Sweden 
Euro area 

BG 
CZ 
LV 
LT 
HU 
PL 
RO 
SE 
EA 
EU-27  European Union, 27 Member States 
EU-25  European Union, 25 Member States before 2007 (i.e. EU-27 excl. BG and RO) 
EU-15  European Union, 15 Member States before 2004 

Currencies 

EUR   Euro 
ECU   European currency unit 
BGN  Bulgarian lev 
Czech koruna 
CZK 
Latvian lats 
LVL 
LTL 
Lithuanian litas 
HUF  Hungarian forint 
PLN 
RON  Romanian leu (ROL until 30 June 2005) 
Slovak koruna 
SKK 
SEK 
Swedish krona 
DEM  Deutsche Mark  
USD   US dollar 
SDR 

Special Drawing Rights 

Polish zloty 

Central Banks 

BNB  Bulgarska narodna banka (Bulgarian National Bank – central bank of Bulgaria) 
ČNB  Česká národní banka (Czech National Bank – central bank of the Czech Republic) 
MNB  Magyar Nemzeti Bank (Hungarian National Bank – central bank of Hungary) 
NBP  Narodowy Bank Polski (National Bank of Poland – central bank of Poland) 
BNR  Banca Naţională a României (National Bank of Romania – central bank of Romania) 

Other abbreviations 

Balance of Payments 
Business process outsourcing 

AMR  Alert Mechanism Report 
BoP 
BPO 
CAR  Capital adequacy ratio 
CBA  Currency board arrangement 
Credit Default Swaps 
CDS 
Central and Eastern Europe 
CEE 
Commonwealth of Independent States 
CIS 
Corporate Income Tax 
CIT 

ii 

 
 
 
 
European Union 

Foreign direct investment 
Financial Supervisory Authority 

Consumer price index 
CPI 
Concentration ratio (aggregated market share of five banks with the largest market share) 
CR5 
European Community 
EC 
European Central Bank 
ECB 
EDP 
Excessive Deficit Procedure 
EERP  European Economic Recovery Plan 
European Monetary Institute 
EMI 
EMS 
European Monetary System 
EMU  Economic and monetary union 
ERM II  Exchange rate mechanism II 
ESA 95  European System of Accounts 
ESCB  European System of Central Banks 
EU 
Eurostat Statistical Office of the European Union 
FESE  Federation of European Securities Exchanges 
FDI 
FSA 
FSAP  Financial Sector Action Plan 
GDP  Gross domestic product 
HICP  Harmonised index of consumer prices 
KNF  Komisja Nadzoru Finansowego (Polish Financial Supervision Authority) 
MFI  Monetary Financial Institution  
MIP  Macroeconomic Imbalance Procedure 
MTO  Medium-term objective 
NCBs  National central banks 
NEER  Nominal effective exchange rate 
NIK 
NPL 
OJ 
OJL 
PIT 
PPS 
PPP 
R&D  Research and development 
REER  Real effective exchange rate 
SITC 
SKOK  Spółdzielcze Kasy Oszczędnościowo-Kredytowe (Credit Union) 
TEC 
TFEU  Treaty on the Functioning of the European Union 
ULC   Unit labour costs 
VAT  Value added tax 
VSE 
Vilnius Stock Exchange 
WSE  Warsaw Stock Exchange 

Najwyzsza Izba Kontroli (Poland's Supreme Chamber of Control) 
Non-performing loans 
Official Journal 
Official Journal Lex 
Personal Income Tax 
Purchasing Power Standard 
Purchasing Power Percentage 

Treaty establishing the European Community 

Standard International Trade Classification 

iii 

 
 
ACKNOWLEDGEMENTS 

The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic 
and  Financial  Affairs.  The  main  contributors  were  Zdeněk  Čech,  Balazs  Forgo,  Anton  Jevcak,  Sara 
Tägtström and Ewa Klima.  

Other contributors were Benjamin Angel, Piotr Bogumil, Carlos Cuerpo Caballero, Jonas Fischer, Olivia 
Galgau,  Nikolay  Gertchev,  Gabriele  Giudice,  Oskar  Grevesmuhl,  Isabel  Grilo,  Zoltan  Gyenes,  Renata 
Hruzova, Laszlo Jankovics, Barbara Kauffmann, Filip Keereman, Julda Kielyte, Daniel Kosicki, Bozhil 
Kostov,  Joost  Kuhlmann,  Sven  Langedijk,  Martin  Larch,  Karolina  Leib,  Milan  Lisický,  Lucia  Piana, 
Bartoz Przywara, Elena Reitano, Stéphanie Riso, Dominique Simonis, Michal Strojwas, Ingrid Toming, 
Ruediger Voss, Corina Weidinger Sosdean, Markus Wintersteller and Pavlína Žáková.  

Statistical assistance was provided by Gerda Symens and André Verbanck, administrative assistance by 
Maya Philippé.  

The  report  was  coordinated  by  Zdeněk  Čech  under  the  supervision  of  Paul  Kutos,  Head  of  Unit  and 
approved  by  Sean  Berrigan,  Director,  Maarten  Verwey,  Deputy  Director  General,  and  Marco  Buti, 
Director General. 

Questions and comments may be referred to Zdeněk Čech (zdenek.cech@ec.europa.eu). 

iv 

 
 
CONTENTS 

Convergence Report 2012 

Convergence Report 2012 - Technical annex 

1.1.  ROLE OF THE REPORT 

1.2.  APPLICATION OF THE CRITERIA 

1.2.1.  Compatibility of legislation 

1.2.2.  Price stability 

1.2.3.  Public finances 

1.2.4.  Exchange rate stability 

1.2.5. 

 Long-term interest rates 

1.2.6.  15 

1.2.7.  Additional factors 

2. 

Bulgaria 

2.1. 

LEGAL COMPATIBILITY 

2.1.1. 

Introduction 

2.1.2.  Central Bank independence 

2.1.3.  Prohibition of monetary financing and privileged access 

2.1.4. 

Integration in the ESCB 

2.1.5.  Assessment of compatibility 

2.2.  PRICE STABILITY 

2.2.1.  Respect of the reference value 

2.2.2.  Recent inflation developments 

2.2.3.  Underlying factors and sustainability of inflation 

2.3.  PUBLIC FINANCES 

2.3.1.  The excessive deficit procedure for Bulgaria 

2.3.2.  Recent fiscal developments 

2.3.3.  Medium-term prospects 

2.4.  EXCHANGE RATE STABILITY 

2.5. 

LONG-TERM INTEREST RATES 

2.6.  ADDITIONAL FACTORS 

2.6.1.  Developments of the balance of payments 

2.6.2.  Product market integration 

2.6.3.  Financial market integration 

3.  Czech Republic 

3.1. 

LEGAL COMPATIBILITY 

3.1.1. 

Introduction 

3.1.2. 

Independence 

3.1.3.  Prohibition of monetary financing 

3.1.4. 

Integration in the ESCB 

3.1.5.  Assessment of compatibility 

3.2.  PRICE STABILITY 

3.2.1.  Respect of the reference value 

3.2.2.  Recent inflation developments 

3.2.3.  Underlying factors and sustainability of inflation 

3.3.  PUBLIC FINANCES 

3.3.1.  The excessive deficit procedure for the Czech Republic 

3.3.2.  Recent fiscal developments 

3.3.3.  Medium-term prospects 

3.4.  EXCHANGE RATE STABILITY 

v 

1 

3 

5 

6 

7 

7 

12 

12 

14 

16 

17 

17 

17 

17 

17 

18 

18 

18 

18 

19 

19 

22 

22 

23 

23 

24 

25 

26 

26 

27 

29 

31 

31 

31 

31 

32 

32 

32 

32 

32 

33 

33 

36 

36 

36 

37 

38 

 
3.5. 

LONG-TERM INTEREST RATES 

3.6.  ADDITIONAL FACTORS 

3.6.1.  Developments of the balance of payments 

3.6.2.  Product market integration 

3.6.3.  Financial market integration 

4. 

Latvia 

4.1. 

LEGAL COMPATIBILITY 

4.1.1. 

Introduction 

4.1.2.  Central bank independence 

4.1.3.  Prohibition of monetary financing and privileged access 

4.1.4. 

Integration in the ESCB 

4.1.5.  Assessment of compatibility 

4.2.  PRICE STABILITY 

4.2.1.  Respect of the reference value 

4.2.2.  Recent inflation developments 

4.2.3.  Underlying factors and sustainability of inflation 

4.3.  PUBLIC FINANCES 

4.3.1.  The excessive deficit procedure for Latvia 

4.3.2.  Recent fiscal developments 

4.3.3.  Medium-term prospects 

4.4.  EXCHANGE RATE STABILITY 

4.5. 

LONG-TERM INTEREST RATES 

4.6.  ADDITIONAL FACTORS 

4.6.1.  Developments of the balance of payments 

4.6.2.  Product market integration 

4.6.3.  Financial market integration 

5. 

Lithuania 

5.1. 

LEGAL COMPATIBILITY 

5.1.1. 

Introduction 

5.1.2.  Central bank independence 

5.1.3.  Prohibition of monetary financing and privileged access 

5.1.4. 

Integration in the ESCB 

5.1.5.  Assessment of compatibility 

5.2.  PRICE STABILITY 

5.2.1.  Respect of the reference value 

5.2.2.  Recent inflation developments 

5.2.3.  Underlying factors and sustainability of inflation 

5.3.  PUBLIC FINANCES 

5.3.1.  The excessive deficit procedure for Lithuania 

5.3.2.  Recent fiscal developments 

5.3.3.  Medium-term prospects 

5.4.  EXCHANGE RATE STABILITY 

5.5. 

LONG-TERM INTEREST RATES 

5.6.  ADDITIONAL FACTORS 

5.6.1.  Developments of the balance of payments 

5.6.2.  Product market integration 

5.6.3.  Financial market integration 

6.  Hungary 

6.1. 

LEGAL COMPATIBILITY 

6.1.1. 

Introduction 

6.1.2.  Central bank independence 

39 

40 

40 

41 

43 

45 

45 

45 

45 

46 

46 

46 

46 

46 

47 

48 

51 

51 

51 

52 

53 

54 

55 

56 

57 

59 

61 

61 

61 

61 

61 

61 

61 

61 

61 

61 

62 

64 

64 

65 

65 

67 

68 

68 

69 

70 

71 

75 

75 

75 

75 

vi 

 
 
6.1.3.  Prohibition of monetary financing and privileged access 

6.1.4. 

Integration in the ESCB 

6.1.5.  Assessment of compatibility 

6.2.  PRICE STABILITY 

6.2.1.  Respect of the reference value 

6.2.2.  Recent inflation developments 

6.2.3.  Underlying factors and sustainability of inflation 

6.3.  PUBLIC FINANCES 

6.3.1.  The excessive deficit procedure for Hungary 

6.3.2.  Recent fiscal developments 

6.3.3.  Medium-term prospects 

6.4.  EXCHANGE RATE STABILITY 

6.5. 

LONG-TERM INTEREST RATES 

6.6.  ADDITIONAL FACTORS 

6.6.1.  Developments of the balance of payments 

6.6.2.  Product market integration 

6.6.3.  Financial market integration 

7. 

Poland 

7.1. 

LEGAL COMPATIBILITY 

7.1.1. 

Introduction 

7.1.2.  Central bank independence 

7.1.3.  Prohibition of monetary financing and privileged access 

7.1.4. 

Integration in the ESCB 

7.1.5.  Assessment of compatibility 

7.2.  PRICE STABILITY 

7.2.1.  Respect of the reference value 

7.2.2.  Recent inflation developments 

7.2.3.  Underlying factors and sustainability of inflation 

7.3.  PUBLIC FINANCES 

7.3.1.  The excessive deficit procedure for Poland 

7.3.2.  Recent fiscal developments 

7.3.3.  Medium-term prospects 

7.4.  EXCHANGE RATE STABILITY 

7.5. 

LONG-TERM INTEREST RATES 

7.6.  ADDITIONAL FACTORS 

7.6.1.  Developments of the balance of payments 

7.6.2.  Product market integration 

7.6.3.  Financial market integration 

8. 

Romania 

8.1. 

LEGAL COMPATIBILITY 

8.1.1. 

Introduction 

8.1.2.  Central Bank independence 

8.1.3.  Prohibition of monetary financing and privileged access 

8.1.4. 

Integration in the ESCB 

8.1.5.  Assessment of compatibility 

8.2.  PRICE STABILITY 

8.2.1.  Respect of the reference value 

8.2.2.  Recent inflation developments 

8.2.3.  Underlying factors and sustainability of inflations 

8.3.  PUBLIC FINANCES 

8.3.1.  The excessive deficit procedure for Romania 

8.3.2.  Recent fiscal developments 

vii 

76 

76 

76 

77 

77 

77 

77 

80 

80 

81 

82 

83 

84 

84 

85 

86 

88 

89 

89 

89 

89 

89 

90 

90 

90 

90 

90 

91 

93 

93 

94 

94 

96 

96 

97 

97 

99 

100 

103 

103 

103 

103 

104 

105 

106 

106 

106 

106 

107 

110 

110 

110 

 
 
8.3.3.  Medium-term prospects 

8.4.  EXCHANGE RATE STABILITY 

8.5. 

LONG-TERM INTEREST RATES 

8.6.  ADITIONAL FACTORS 

8.6.1.  Developments of the balance of payments 

8.6.2.  Product market integration 

8.6.3.  Financial market integration 

9. 

Sweden 

9.1. 

LEGAL COMPATITABILITY 

9.1.1. 

Introduction 

9.1.1.  Central Bank Independence 

9.1.2.  Prohibition of monetary financing and privileged access 

9.1.3. 

Integration in the ESCB 

9.1.4.  Assessment of compatibility 

9.2.  PRICE STABILITY 

9.2.1.  Respect of the reference value 

9.2.1.  Recent inflation developments 

9.2.1.  Underlying factors and sustainability of inflation 

9.3.  PUBLIC FINANCES 

9.3.1.  Recent fiscal developments 

9.3.1.  Medium-term prospects 

9.4.  EXCHANGE RATE STABILITY 

9.5. 

LONG-TERM INTEREST RATES 

9.6.  ADDITIONAL FACTORS 

9.6.1.  Developments of the balance of payments 

9.6.1.  Product market integration 

9.6.1.  Financial market integration 

LIST OF TABLES 

2.1.  Bulgaria - Components of inflation 

2.2.  Bulgaria - Other inflation and cost indicators 

2.3.  Bulgaria - Budgetary developments and projections 

2.4.  Bulgaria - Balance of payments 

2.5.  Bulgaria - Product market integration 

3.1.  Czech Republic - Components of inflation 

3.2.  Czech Republic - Other inflation and cost indicators 

3.3.  Czech Republic - Budgetary developments and projections 

3.4.  Czech Republic - Balance of payments 

3.5.  Czech Republic - Product market integration 

4.1. 

4.2. 

4.3. 

4.4. 

4.5. 

5.1. 

5.2. 

5.3. 

5.4. 

5.5. 

Latvia - Components of inflation 

Latvia - Other inflation and cost indicators 

Latvia - Budgetary developments and projections 

Latvia - Balance of payments 

Latvia - Product market integration 

Lithuania - Components of inflation 

Lithuania - Other inflation and cost indicators 

Lithuania - Budgetary developments and projections 

Lithuania - Balance of payments 

Lithuania - Product market integration 

6.1.  Hungary - Components of inflation 

6.2.  Hungary - Other inflation and cost indicators 

6.3.  Hungary - Budgetary developments and projections 

111 

112 

113 

114 

114 

116 

118 

121 

121 

121 

121 

121 

122 

122 

123 

123 

123 

123 

126 

126 

127 

128 

129 

130 

130 

131 

133 

20 

21 

23 

27 

28 

34 

35 

37 

41 

42 

47 

49 

52 

57 

58 

62 

63 

66 

69 

71 

78 

79 

81 

viii 

 
 
 
6.4.  Hungary - Balance of payments 

6.5.  Hungary - Product market integration 

7.1.  Poland - Components of inflation 

7.2.  Poland - Other inflation and cost indicators 

7.3.  Poland - Budgetary developments and projections 

7.4.  Poland - Balance of payments 

7.5.  Poland - Product market integration 

8.1.  Romania - Components of inflation 

8.2.  Romania - Other inflation and cost indicators 

8.3.  Romania - Budgetary developments and projections 

8.4.  Romania - Balance of payments 

8.5.  Romania - Product market integration 

9.1. 

9.2. 

9.3. 

9.4. 

9.5. 

Sweden - Components of inflation 

Sweden - Other inflation and cost indicators 

Sweden - Budgetary developments and projections 

Sweden - Balance of payments 

Sweden - Product market integration 

LIST OF GRAPHS 

2.1.  Bulgaria - Inflation criterion since 2006 

2.2.  Bulgaria - HICP inflation 

2.3.  Bulgaria - Inflation, productivity and wage trends 

2.4.  Exchange rates - BGN/EUR 

2.5.  Bulgaria - 3-M Sofibor spread to 3-M Euribor 

2.6.  Bulgaria - Long-term interest rate criterion 

2.7.  Bulgaria - Long-term interest rates 

2.8.  Bulgaria - Saving and investment 

2.9.  Bulgaria - Effective exchange rates 

2.10.  Bulgaria - Foreign ownership and concentration in the banking sector 

2.11.  Bulgaria - selected banking sector soundness indicators relatively to the euro area 

2.12.  Bulgaria - Recent development of the financial system relatively to the euro area 

3.1.  Czech Republic - Inflation criterion since 2006 

3.2.  Czech Republic - HICP inflation 

3.3.  Czech Rep. - Inflation, productivity and wage trends 

3.4.  Exchange rates - CZK/EUR 

3.5.  Czech Republic - 3-M Pribor spread to 3-M Euribor 

3.6.  Czech Republic - Long-term interest rate criterion 

3.7.  Czech Republic - Long-term interest rates 

3.8.  Czech Republic - Saving and investment 

3.9.  Czech Republic - Effective exchange rates 

3.10.  Czech Republic - Foreign ownership and concentration in the banking sector 

3.11.  Czech Republic - selected banking sector soundness indicators relatively to the euro area 

3.12.  Czech Republic - Recent development of the financial system relatively to the euro area 

4.1. 

4.2. 

4.3. 

4.4. 

Latvia - Inflation criterion since 2006 

Latvia - HICP inflation 

Latvia - Inflation, productivity and wage trends 

LVL - Spread vs central rate 

4.5.  Exchange rates - LVL/EUR 

4.6. 

4.7. 

4.8. 

4.9. 

Latvia - 3-M Rigibor spread to 3-M Euribor 

Latvia - Long-term interest rate criterion 

Latvia - Long-term interest rates 

Latvia - Saving and investment 

4.10.  Latvia - Effective exchange rates 

ix 

85 

87 

91 

92 

95 

98 

100 

107 

108 

111 

116 

117 

124 

125 

127 

130 

132 

19 

19 

20 

24 

25 

25 

26 

26 

27 

29 

30 

30 

33 

33 

34 

39 

39 

39 

40 

40 

41 

43 

44 

44 

47 

47 

49 

53 

54 

54 

55 

55 

56 

56 

 
 
 
4.11.  Latvia - Foreign ownership and concentration in the banking sector 

4.12.  Latvia - selected banking sector soundness indicators relatively to the euro area 

4.13.  Latvia - Recent development of the financial system relatively to the euro area 

5.1. 

5.2. 

5.3. 

5.4. 

Lithuania - Inflation criterion since 2006 

Lithuania - HICP inflation 

Lithuania - Inflation, productivity and wage trends 

LTL - Spread vs central rate 

5.5.  Exchange rates - LTL/EUR 

5.6. 

5.7. 

5.8. 

5.9. 

Lithuania - 3-M Vilibor spread to 3-M Euribor 

Lithuania - Long-term interest rate criterion 

Lithuania - Long-term interest rates 

Lithuania - Saving and investment 

5.10.  Lithuania - Effective exchange rates 

5.11.  Lithuania - Foreign ownership and concentration in the banking sector 

5.12.  Lithuania - selected banking sector soundness indicators relatively to the euro area 

5.13.  Lithuania - Recent development of the financial system relatively to the euro area 

6.1.  Hungary - Inflation criterion since 2006 

6.2.  Hungary - HICP inflation 

6.3.  Hungary - Inflation, productivity and wage trends 

6.4.  Exchange rates - HUF/EUR 

6.5.  Hungary - 3-M Bubor spread to 3-M Euribor 

6.6.  Hungary - Long-term interest rate criterion 

6.7.  Hungary - Long-term interest rates 

6.8.  Hungary - Saving and investment 

6.9.  Hungary - Effective exchange rates 

6.10.  Hungary - Foreign ownership and concentration in the banking sector 

6.11.  Hungary - selected banking sector soundness indicators relatively to the euro area 

6.12.  Hungary - Recent development of the financial system relatively to the euro area 

7.1.  Poland - Inflation criterion since 2006 

7.2.  Poland - HICP inflation 

7.3.  Poland - Inflation, productivity and wage trends 

7.4.  Exchange rates - PLN/EUR 

7.5.  Poland - 3-M Wibor spread to 3-M Euribor 

7.6.  Poland - Long-term interest rate criterion 

7.7.  Poland - Long-term interest rates 

7.8.  Poland - Saving and investment 

7.9.  Poland - Effective exchange rates 

7.10.  Poland - Foreign ownership and concentration in the banking sector 

7.11.  Poland - selected banking sector soundness indicators relatively to the euro area 

7.12.  Poland - Recent development of the financial system relatively to the euro area 

8.1.  Romania - Inflation criterion since 2006 

8.2.  Romania - HICP inflation 

8.3.  Romania - Inflation, productivity and wage trends 

8.4.  Exchange rates - RON/EUR 

8.5.  Romania - 3-M Robor spread to 3-M Euribor 

8.6.  Romania - Long-term interest rate criterion 

8.7.  Romania - Long-term interest rates 

8.8.  Romania - Saving and investment 

8.9.  Romania - Effective exchange rates 

8.10.  Romania - Foreign ownership and concentration in the banking sector 

8.11.  Romania - selected banking sector soundness indicators relatively to the euro area 

8.12.  Romania - Recent development of the financial system relatively to the euro area 

9.1. 

9.2. 

9.3. 

Sweden - Inflation criterion since 2006 

Sweden - HICP inflation 

Sweden - Inflation, productivity and wage trends 

59 

60 

60 

61 

62 

63 

67 

67 

68 

68 

68 

69 

70 

72 

72 

73 

77 

77 

79 

83 

84 

84 

84 

86 

86 

88 

88 

88 

90 

91 

92 

96 

96 

97 

97 

98 

98 

101 

101 

101 

106 

106 

108 

113 

113 

114 

114 

115 

115 

118 

118 

119 

123 

123 

125 

x 

 
 
9.4.  Exchange rates - SEK/EUR 

9.5. 

9.6. 

9.7. 

9.8. 

9.9. 

Sweden - 3-M Stibor spread to 3-M Euribor 

Sweden - Long-term interest rate criterion 

Sweden - Long-term interest rates 

Sweden - Saving and investment 

Sweden - Effective exchange rates 

9.10.  Sweden - Foreign ownership and concentration in the banking sector 

9.11.  Sweden - selected banking sector soundness indicators relatively to the euro area 

9.12.  Sweden - Recent development of the financial system relatively to the euro area 

LIST OF BOXES 

1.1.  Article 140 of the Treaty 

1.2.  Assessment of price stability and the reference value 

1.3.  Excessive deficit procedure 

1.4.  Data for the interest rate convergence 

1.5. 

The Macroeconomic Imbalance Procedure (MIP) 

128 

129 

129 

129 

131 

131 

133 

134 

134 

6 

8 

10 

13 

15 

xi 

 
 
 
 
 
Convergence Report 2012 

(prepared in accordance with Article 140(1) of the Treaty) 

 
 
Report 

 
 
Convergence Report 2012 

Technical annex 

 
 
1. 

INTRODUCTION 

1.1. 

ROLE OF THE REPORT 

The  euro  was  introduced  on  1  January  1999  by 
eleven  Member  States.  The  decision  (1)  by  the 
Council (meeting in the composition of the Heads 
of  State  or  Government)  on  3  May  1998  in 
Brussels  on  the  eleven  Member  States  deemed 
ready  to  participate  in  the  single  currency  had,  in 
accordance  with 
(Article  121(4) 
the  Treaty 
TEC) (2), been prepared by the Ecofin Council on 
a  recommendation  from  the  Commission.  The 
decision  was  based  on  the  two  Convergence 
Reports  made  by  the  Commission (3)  and  the 
(EMI), 
European 
Monetary 
respectively (4).  These 
in 
accordance with Article 121(1) TEC (5), examined 
the 
whether 
convergence 
legal 
requirements. 

the  Member  States 

reports,  prepared 

satisfied 
the 

and  met 

Institute 

criteria 

Since 
then,  Greece  (2001),  Slovenia  (2007), 
Cyprus  and  Malta  (2008),  Slovakia  (2009)  and 
Estonia (2011) have joined the euro. 

Those  Member  States  which  are  assessed  as  not 
fulfilling the necessary conditions for the adoption 
of the euro are referred to as "Member States with 
a derogation". Article 140 of the Treaty lays down 
provisions  and  procedures  for  examining  the 
situation of Member States with a derogation (Box 
1.1).  At  least  once  every  two  years,  or  at  the 
request  of  a  Member  State  with  a  derogation,  the 
Commission  and  the  European  Central  Bank 
(ECB)  prepare  Convergence  Reports  on  such 
Member States. Denmark and the United Kingdom 
the 
negotiated  opt-out  arrangements  before 
adoption  of  the  Maastricht  Treaty (6)  and  do  not 

(1)  OJ L 139, 11.5.1998, pp. 30-35. 
(2)  The  numbering  of  Treaty  articles  cited  in  this  report 
corresponds to the one of the Treaty on the Functioning of 
the  European  Union  (TFEU)  except  when  explicitly 
mentioned. Article 121(4) TEC does no longer exist in the 
TFEU,  as  it  refers  to  the  first  countries  deemed  ready  to 
adopt the euro on 1 January 1999. 

participate  in  the  third  stage  of  EMU.  Until  these 
Member  States 
to 
participate in the third stage and join the euro, they 
are not the subject of an assessment as to whether 
they fulfil the necessary conditions.  

they  wish 

indicate 

that 

latest 

In  2010,  the  Commission  and  the  ECB  adopted 
regular  Convergence  Reports (7). 
their 
Following  the  Convergence  Reports  and  on  the 
basis of a proposal by the Commission, the Ecofin 
Council decided in July 2010 that Estonia fulfilled 
the  necessary  conditions  for  adopting  the  euro  as 
of  1  January  2011 (8).  None  of  the  other  Member 
States assessed was deemed to meet the necessary 
conditions for adopting the euro. 

In 2012, two years will have elapsed since the last 
regular  reports  were  made.  Denmark  and  the 
United  Kingdom  have  not  expressed  a  wish  to 
enter  the  third  stage  of  EMU.  Therefore,  this 
convergence  assessment  covers  Bulgaria, 
the 
Czech  Republic,  Latvia,  Lithuania,  Hungary, 
Poland,  Romania  and  Sweden.  This  Commission 
Staff Working Document is a Technical Annex to 
the  Convergence  Report  2012  and  includes  a 
detailed 
the  progress  with 
convergence. 

assessment  of 

The  financial  and  economic  crisis,  along  with  the 
recent  euro-area  debt  crisis,  has  exposed  gaps  in 
the  current  economic  governance  system  of  EMU 
and showed that its existing instruments need to be 
used  more  fully.  With  the  aim  of  ensuring  a 
sustainable functioning of economic and monetary 
union,  an  overall  strengthening  of  economic 
governance in the Union was undertaken over past 
two  years.  Accordingly,  this  Commission  Staff 
Working  Document  makes 
references  where 
appropriate  to  procedures  that  help  to  strengthen 
the 
each  Member  States' 
convergence  process  and  its  sustainability.  In 
incorporates 
particular, 
the 
it 
strengthened 
surveillance  of  macroeconomic 
imbalances (see section 1.2.6.). 

assessment 

references 

of 

to 

(3)  Report 

on 

progress 

and 
recommendation  with  a  view  to  the  transition  to  the  third 
stage  of  economic  and  monetary  union,  COM(1998)1999 
final, 25 March 1998. 

convergence 

towards 

(4)  European  Monetary  Institute,  Convergence  Report,  March 

1998. 

(5)  The content of this article is now included in Article 140(1) 

TFEU. 

(6)  Protocol  (No  16)  on  certain  provisions  relating 

to 
Denmark,  Protocol  (No  15)  on  certain  provisions  relating 

to  the  United  Kingdom  of  Great  Britain  and  Northern 
Ireland. 

(7)  European  Commission,  Convergence  Report  2010, 
COM(2010)  238  final,  12  May  2010;  European  Central 
Bank, Convergence Report 2010, May 2010. 

(8)  Council Decision of 13 July 2010 (OJ L 196, 28.7.2010, p. 

24–26). 

5 

 
                                                           
                                                                                   
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box 1.1: Article 140 of the Treaty

"1. At least once every two years, or at the request of a Member  State with a derogation, the Commission 
and the European Central Bank shall report to the Council on the progress made by the Member States with 
a  derogation  in  fulfilling  their  obligations  regarding  the  achievement  of  economic  and  monetary  union. 
These reports shall include an examination of the compatibility between the national legislation of each of 
these Member States, including the statutes of its national central bank, and  Articles 130 and 131 and the 
Statute of the  ESCB and of the ECB. The  reports shall also examine the achievement of a high degree of 
sustainable convergence by reference to the fulfilment by each Member State of the following criteria: 

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

—  the  sustainability  of  the  government  financial  position;  this  will  be  apparent  from  having  achieved  a 
government budgetary position without a deficit that is excessive as determined in accordance with Article 
126(6), 

—  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 euro, 

— the durability of convergence achieved by the Member State with a derogation and of its participation in 
the exchange-rate mechanism being reflected in the long-term interest-rate levels. 

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

2. After consulting the European Parliament and after discussion in the European Council, the Council shall, 
on  a  proposal  from  the  Commission,  decide  which  Member  States  with  a  derogation  fulfil  the  necessary 
conditions on  the basis of the criteria set out in  paragraph 1, and abrogate the derogations of  the Member 
States concerned. 

The Council shall act having received a recommendation of a qualified majority of those among its members 
representing Member States whose currency is the euro. These members shall act within six months of the 
Council receiving the Commission's proposal. 

The qualified  majority of the said members, as referred to in the second subparagraph, shall be defined in 
accordance with Article 238(3)(a). 

3.  If  it  is  decided,  in  accordance  with  the  procedure  set  out  in  paragraph  2,  to  abrogate  a  derogation,  the 
Council shall, acting with the unanimity of the Member States whose currency is the euro and the Member 
State  concerned,  on  a  proposal  from  the  Commission  and  after  consulting  the  European  Central  Bank, 
irrevocably  fix  the  rate  at  which  the  euro  shall  be  substituted  for  the  currency  of  the  Member  State 
concerned, and take the other measures necessary for the introduction of the euro as the single currency in 
the Member State concerned." 

The  remainder  of  the  first  chapter  presents  the 
methodology  used  for  the  application  of  the 
assessment criteria. Chapters 2 to 10 examine, on a 
country-by-country  basis, 
the 
convergence criteria and other requirements in the 
order  as  they  appear  in  Article  140(1)  (see  Box 
1.1).  The  cut-off  date  for  the  statistical  data 
included in this Convergence Report was 30 April 
2012. 

fulfilment  of 

1.2.  APPLICATION OF THE CRITERIA 

In  accordance  with  Article  140(1)  of  the  Treaty, 
the 
the  Convergence  Reports  shall  examine 
compatibility  of  national  legislation  with  Articles 
130  and  131  of  the  Treaty  and  the  Statute  of  the 
European System of Central Banks (ESCB) and of 
the European Central Bank. The reports shall also 
examine  the  achievement  of  a  high  degree  of 
sustainable  convergence  by  reference 
the 
fulfilment of the four convergence criteria dealing 

to 

6 

 
 
 
 
 
 
with price stability, public finances, exchange rate 
stability  and  long  term  interest  rates  as  well  as 
some  additional  factors.  The  four  convergence 
criteria  are  developed  further 
in  a  Protocol 
annexed  to  the  Treaty  (Protocol  No  13  on  the 
convergence criteria).  

1.2.1.  Compatibility of legislation 

In  accordance  with  Article  140(1)  of  the  Treaty, 
the  legal  examination  includes  an  assessment  of 
compatibility 
a  Member  State’s 
legislation,  including  the  statute  of  its  national 
central  bank,  and  Article  131  of  the  Treaty.  This 
assessment mainly covers three areas.  

between 

•  First,  the  independence  of  the  national  central 
bank  and  of  the  members  of  its  decision-
making  bodies,  as  laid  down  in  Article  130, 
must  be  assessed.  This  assessment  covers  all 
issues  linked  to  a  national  central  bank's 
institutional  financial  independence  and  to  the 
personal  independence  of  the  members  of  its 
decision-making bodies.  

financing 

•  Second,  in  accordance  with  Articles  123  and 
124  of  the  Treaty,  the  compliance  of  the 
national  legislation  is  verified  against  the 
prohibition  of  monetary 
and 
privileged access. The prohibition of monetary 
financing is laid down in Article 123(1) of the 
Treaty,  which  prohibits  overdraft  facilities  or 
any  other  type  of  credit  facility  with  the  ECB 
or the central banks of Member States in favour 
of  Union 
institutions,  bodies,  offices  or 
agencies,  central  governments,  regional,  local 
or  other  public  authorities,  other  bodies 
governed by public law, or public undertakings 
of  Member  States;  and  the  purchase  directly 
from these public sector entities by the ECB or 
central  banks  of  debt  instruments.  As  regards 
the prohibition on privileged access, the central 
banks,  as  public  authorities,  may  not  take 
measures  granting  privileged  access  by  the 
public  sector  to  financial  institutions  if  such 
measures  are  not  based  on  prudential 
considerations.  

•  Third,  the  integration  of  the  national  central 
bank  into  the  ESCB  has  to  be  examined,  in 
order to ensure that at the latest by the moment 
of euro adoption, the objectives of the national 
central bank are compatible with the objectives 
of the ESCB as formulated in Article 127 of the 
Treaty.  What  is  more,  the  provisions  on  tasks 

Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

in  national  central  banks  laws  are  assessed 
against  the  relevant  provisions  of  the  Treaty 
and the ESCB/ECB Statute.  

1.2.2.  Price stability 

The  price  stability  criterion  is  defined  in  the  first 
indent  of  Article  140(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” (see Box 
1.2). 

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”.  

legal  basis  for 

they  do  not  constitute 

Since  national  consumer  price  indices  (CPIs) 
diverge substantially in terms of concepts, methods 
and  practices, 
the 
appropriate means to meet the Treaty requirement 
that  inflation  must  be  measured  on  a  comparable 
basis.  To  this  end,  the  Council  adopted  on  23 
October  1995  a  framework  regulation (9)  setting 
the 
the  establishment  of  a 
harmonised  methodology  for  compiling  consumer 
price  indices  in  the  Member  States.  This  process 
resulted  in  the  production  of  the  Harmonised 
Indices  of  Consumer  Prices  (HICPs),  which  are 
used  for  assessing  the  fulfilment  of  the  price 
stability  criterion.  Until  December  2005,  HICP 
series  had  been  based  on  1996  as  the  reference 
period.  A  Commission  Regulation  (EC)  No 
1708/2005 (10)  provided  the  basis  for  a  change  of 
the  HICP  index  base  reference  period  from 
1996=100 to 2005=100. 

(9)  Council  Regulation  (EC)  No  2494/95  of  23  October  1995 
concerning  harmonised  indices  of  consumer  prices  (OJ  L 
257,  27.10.1995,  pp.  1-4),  amended  Regulations  (EC)  No 
1882/2003 and No 596/2009 of the European Parliament of 
the Council. 

(10)  Commission Regulation (EC) No 1708/2005 of 19 October 
2005 laying down detailed rules for the implementation of 
Council  Regulation  (EC)  No  2494/95  as  regards  the 
common  index  reference  period  for  the  harmonised  index 
of  consumer  prices,  and  amending  Regulation  (EC)  No 
2214/96. 

7 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box 1.2: Assessment of price stability and the reference value

The numerical part of the price stability criterion implies a comparison between a Member State's average 
price performance and a reference value.  

A  Member  State’s  average  rate  of  inflation  is  measured  by  the  percentage  change  in  the  unweighted 
average of the last 12 monthly indices relative to the unweighted average of the 12 monthly indices of the 
previous period, rounded to one decimal. This measure captures inflation trends over a period of one year as 
requested  by  the  provisions  of  the  Treaty.  Using  the  commonly  used  inflation  rate  –  calculated  as  the 
percentage change in the consumer price index of the latest month over the index for the equivalent month 
of  the  previous  year  –  would  not  meet  the  one  year  requirement.  The  latter  measure  may  also  vary 
importantly from month to month because of exceptional factors.  

The reference value is calculated as the unweighted average of the average rates of inflation of, at most, the 
three best-performing Member States in terms of price stability plus 1.5 percentage points. The outcome is 
rounded to one decimal. While in principle the reference value could also be calculated on the basis of the 
price performance of only one or two best performing Member States in terms of price stability, it has been 
existing  practice  to  select  the  three  best  performers.  Defining  the  reference  value  in  a  relative  way  (as 
opposed to a fixed reference value) allows to take into account the effects of a common shock that affects 
inflation rates across all Member States.  

As Article 140(1) of the Treaty refers to 'Member States' and does not make a distinction between euro area 
and other Member States, the Convergence Reports select the three best performers from all Member States 
– EU-15 for the Convergence Reports before 2004, EU-25 for the reports between 2004 and 2006 and EU-
27 for reports as of 2007.  

The notion of 'best performer' is not defined explicitly in the Treaty. It is appropriate to interpret this notion 
in a dynamic way, taking into account the state of the economic environment at the time of the assessment. 
In previous Convergence Reports, when all Member States had a positive rate of inflation, the group of best 
performers  in  terms  of  price  stability  naturally  consisted  of  those  Member  States  which  had  the  lowest 
positive average rate of inflation. In the 2004 report,  Lithuania was not taken into account in the calculation 
of  the  reference  value  because  its  negative  rate  of  inflation,  which  was  due  to  country-specific  economic 
circumstances,  was  significantly  diverging  from  that  of  the  other  Member  States,  making  Lithuania  a  de 
facto outlier that could not be considered as 'best performer' in terms of price stability (Lithuania's average 
12-month inflation was at that time 2.3 percentage points below the euro area average 12-month inflation). 
In 2010, in an environment characterised by exceptionally large common shocks (the global economic and 
financial crisis and the associated sharp fall in commodity prices), a significant number of countries faced 
episodes  of  negative  inflation  rates  (the  euro  area  average  inflation  rate  in  March  2010  was  only  slightly 
positive, at 0.3%). In this context, Ireland was excluded from the best performers, i.e. the only Member State 
whose average inflation rate deviated by a wide margin from that of the euro area and other Member States, 
mainly  due  to  the  severe  economic  downturn  in  that  country.  Table  1.1  lists  the  reference  value  in  the 
Convergence Reports issued since 1998.  

(Continued on the next page) 

8 

 
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

Table 1:

Inflation reference value in previous and current Convergence Reports

Convergence Report

Cut-off month

adoption date

1998

2000

2002

2004

2006 May 

2006 December

2007

2008

2010

2012

January 1998

March 2000

April 2002

August 2004

March 2006

October 2006

March 2007

March 2008

March 2010

March 2012

Three best
performers 1) 2)

Austria, France, Ireland

Sweden, France, Austria

United Kingdom, Germany, France

Finland, Denmark, Sweden

Sweden, Finland, Poland

Poland, Finland, Sweden

Finland, Poland, Sweden

Malta, Netherlands, Denmark

Portugal, Estonia, Belgium 

 Sweden, Ireland, Slovenia

Reference
value 3)

Euro area average
inflation rate 4)

2.7

2.4

3.3

2.4

2.6

2.8

3.0

3.2

1.0

3.1

1.5

1.4

2.4

2.1

2.3

2.2

2.1

2.5

0.3

2.8

1) EU15 until April 2004; EU25 between May 2004 and December 2006; EU27 from January 2007 onwards.

2) In case of equal rounded average inflation for several potential best performers, the ranking is determined on the basis of unrounded da

3) Reference values are only computed at the time of Convergence Reports. All calculations of the reference value

    between the Convergence Reports are purely illustrative.

4) Measured by the percentage change in the arthmetic average of the latest 12 monthly indices relative to the 

    arithmetic average of the 12 monthly indices of the previous period.

Sources: Eurostat and Commission services.

in 

inflation 

the  percentage  change 

As has been the case in past convergence reports, a 
Member  State’s  average  rate  of 
is 
the 
measured  by 
arithmetic  average  of  the  last  12  monthly  indices 
relative to the arithmetic average of the 12 monthly 
indices of the previous period. The reference value 
is  calculated  as  the  arithmetic  average  of  the 
average  rate  of 
three  best-
inflation  of 
performing  Member  States  in  terms  of  price 
stability plus 1.5 percentage points. 

the 

Over  the  12-month  period  covering  April  2011-
March  2012,  the  three  best-performing  Member 
States  in  terms  of  price  stability  were  Sweden 
(1.3%),  Ireland  (1.4%)  and  Slovenia  (2.1%), 
yielding a reference value of 3.1%.  

The Protocol on the convergence criteria not only 
requires  Member  States  to  have  achieved  a  high 
degree  of  price  stability  but  also  calls  for  a  price 
performance  that  is  sustainable.  The  requirement 
of sustainability aims at ensuring that the degree of 
price  stability  and  inflation  convergence  achieved 
in previous years will be maintained after adoption 
of  the  euro.  This  deserves  particular  attention  in 
the  current  juncture  as  the  financial  turmoil 
exposed unsustainable price developments in many 
EU Member States, including euro area countries, 
in the pre-crisis period. 

than  reflecting 

Inflation sustainability implies that the satisfactory 
inflation  performance  must  essentially  be  due  to 
the  adequate  behaviour  of  input  costs  and  other 
in  a 
factors 
influencing  price  developments 
structural  manner,  rather 
the 
influence  of  temporary  factors.  Therefore,  this 
Technical  Annex  examines  also  the  role  of  the 
macroeconomic  situation  and  cyclical  stance  in 
inflation performance, developments in unit labour 
costs  as  a  result  of  trends  in  labour  productivity 
and nominal compensation per head, developments 
in  import  prices  to  assess  how  external  price 
developments  have 
impacted  on  domestic 
inflation.  Similarly,  the  impact  of  administered 
prices  and  indirect  taxes  on  headline  inflation  is 
also considered.  

9 

 
 
 
 
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box 1.3: Excessive deficit procedure

The  excessive  deficit  procedure  is  specified  in  Article  126  of  the  Treaty,  the  associated  Protocol  on  the 
excessive  deficit  procedure  and  Council  Regulation  (EC)  No  1467/97  on  speeding  up  and  clarifying  the 
implementation  of  the  excessive  deficit  procedure (1),  which  is  the  “corrective  arm”  of  the  Stability  and 
Growth Pact. Together, they determine the steps to be followed to reach a Council decision on the existence 
of  an  excessive  deficit,  which  forms  the  basis  for  the  assessment  of  compliance  with  the  convergence 
criterion on the government budgetary position. As part of an overall strengthening of economic governance 
in  the  Union,  Council  Regulation  (EC)  No  1467/97  was  amended  in  2011.  In  particular,  a  numerical 
benchmark was introduced for operationalising the debt criterion in Article 126(2) of the Treaty.  

Article  126(1)  states  that  Member  States  are  to  avoid  excessive  government  deficits.  The  Commission  is 
required to monitor the development of the budgetary situation and of the stock of government debt in the 
Member  States  with  a  view  to  identifying  gross  errors  (Article  126(2)).  In  particular,  compliance  with 
budgetary discipline is to be examined by the Commission on the basis of the following two criteria: 

“(a)  whether  the  ratio  of  the  planned  or  actual  government  deficit  to  gross  domestic  product  exceeds  a 
reference value [specified in the Protocol as 3 percent], unless: 
•  either the ratio has declined substantially and continuously and reached a level that comes close to the 

reference value; 

•  or,  alternatively,  the  excess  over  the  reference  value  is  only  exceptional  and  temporary  and  the  ratio 

remains close to the reference value; 

(b) whether the ratio of government debt to gross domestic product exceeds a reference value [specified in 
the Protocol as 60 percent], unless the ratio is sufficiently diminishing and approaching the reference value 
at a satisfactory pace”. 

According to the Protocol on the excessive deficit procedure, the Commission provides the statistical data 
for the implementation of the procedure. As part of the application of this Protocol, Member States have to 
notify data on government deficits, government debt, nominal GDP and other associated variables twice a 
year, before 1 April and before 1 October (2). After each reporting date, Eurostat examines whether the data 
are in conformity with ESA95 (3) rules and related Eurostat decisions and, if they are, validates them. 

The Commission is required to prepare a report if a Member State does not fulfil the requirements under one 
or  both  of  the  criteria  given  above  (Article  126(3)).  The  report  also  has  to  take  into  account  whether  the 
government deficit exceeds government investment expenditure and all other relevant factors. These include 
developments  in  the  medium-term  economic  position (4)  the  medium-term  budgetary  position  of  the 
Member State (5), in the medium-term government debt position (6), as well as any other factors which, in 
the opinion of the Member State concerned, are relevant and which the Member State has put forward to the 
Council  and  the  Commission.  In  that  context,  particular  consideration  shall  be  given  to  financial 
contributions  to  fostering  international  solidarity  and  achieving  the  policy  goals  of  the  Union,  the  debt 
incurred  in  the  form  of  bilateral  and  multilateral  support  between  Member  States  in  the  context  of 
safeguarding  financial  stability,  and  the  debt  related  to  financial  stabilisation  operations  during  major 
financial disturbances.  

(1)  OJ L 209, 2.8.1997, p. 6. Regulation as amended by Regulation (EC) No 1056/2005 (OJ L 174, 7.7.2005, p. 5). 
(2)  Council Regulation  (EC)  No  479/2009  on the application  of  the  Protocol  on  the  excessive  deficit  procedure  (OJ  L 

145, 10.06.2009, p1). 

(3)  European System of National and Regional Accounts, adopted by Council Regulation (EC) No 2223/96 (OJ L 310, 
30.11.1996, p. 1). Regulation as last amended by Regulation (EC) No 400/2009 of the European Parliament and of 
the Council (OJ L 126, 21.5.2009, p. 11). 

(4)  In particular, potential growth, including the various contributions, cyclical developments, and the private sector net 

savings position. 

(5)  In particular, the record of adjustment towards the medium-term budgetary objective, the level of the primary balance 
and  developments  in  primary  expenditure,  the  implementation  of  policies  in  the  context  of  the  prevention  and 
correction of excessive macroeconomic imbalances and in the context of the common growth strategy of the Union, 
as well as the overall quality of public finances, in particular the effectiveness of national budgetary frameworks. 
(6)  In  particular,  its  dynamics  and  sustainability,  including,  risk  factors  including  the  maturity  structure  and  currency 
denomination of the debt, stock-flow adjustment and its composition, accumulated reserves and other financial assets, 
guarantees, in particular those linked to the financial sector, and any implicit liabilities related to ageing and private 
debt, to the extent that it may represent a contingent implicit liability for the government.

(Continued on the next page) 

10 

 
 
 
 
                                                           
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

The Council and the Commission shall make a balanced overall assessment of all the relevant factors. Those 
factors shall be taken into account in the steps leading to the decision on the existence of an excessive deficit 
when assessing compliance on the basis of the debt criterion. When assessing compliance on the basis of the 
deficit criterion in a country with a debt ratio exceeding the reference value, those factors shall be taken into 
account  in  the  steps  leading  to  the  decision  on  the  existence  of  an  excessive  deficit  subject  to  the  double 
condition that the deficit is close to the reference value and its excess over it is temporary. Due consideration 
is foreseen for pension reforms introducing a multi-pillar system including a mandatory, fully-funded pillar 
and the net cost of the publicly managed pillar. (1) 

The next step in the procedure is the formulation by the Economic and Financial Committee of an opinion 
on this report, which according to the Stability and Growth Pact must occur within two weeks of its adoption 
by  the  Commission  (Article  126(4)).  If  it  considers  that  an  excessive  deficit  exists  or  may  occur,  the 
Commission  addresses  an  opinion  to  the  Council  (Article  126(5)).  Then,  on  the  basis  of  a  Commission 
proposal,  the  Council  decides,  after  an  overall  assessment,  including  any  observation  that  the  concerned 
Member State may have, whether an excessive deficit exists (Article 126(6)). The Stability and Growth Pact 
prescribes that any  such decision has to be adopted as a rule  within four months of the reporting dates (1 
April, 1 October). 

At  the  same  time  as  deciding  on  the  existence  of  an  excessive  deficit,  the  Council  has  to  issue  a 
recommendation to the Member  State concerned with a  view to  bringing that situation to an end within a 
given period, on the basis of a Commission recommendation (Article 126(7)). According to the Stability and 
Growth Pact, the Council recommendation has to specify when the correction of the excessive deficit should 
be  completed,  the  annual  budgetary  targets  that  the  Member  State  concerned  has  to  achieve,  and  has  to 
include  a  maximum  deadline  of  six  months  at  most  for  effective  action  to  be  taken  by  the  Member  State 
concerned.  Within this deadline, the Member State concerned shall report to the Council on action taken. 
The report shall include targets for government expenditure and revenue and for the discretionary measures 
consistent with the Council's recommendation, as well as information on the measures taken and the nature 
of those envisaged to achieve the targets.  

If effective action has been taken in compliance with a recommendation under Article 126(7) and, compared 
with  the  economic  forecasts  in  this  recommendation,  unexpected  adverse  economic  events  with  major 
unfavourable  consequences  for  government  finances  occur  subsequent  to  its  adoption,  the  Council  may 
decide,  on  a  recommendation  from  the  Commission,  to  adopt  a  revised  recommendation  under  the  same 
article, which may notably extend the deadline for the correction of the excessive deficit by one year. In the 
case of severe economic downturn for the euro area or the EU as a whole, the Council may also decide, on 
recommendation by the Commission, to adopt a revised recommendation under Article 126(7), provided that 
this does not endanger fiscal sustainability in the medium term. 

Where it establishes that there has been no effective action in response to its recommendations, the Council 
adopts a decision under Article 126(8) on the basis of a Commission recommendation immediately after the 
expiry of the deadline for taking action (or at any time thereafter when monitoring of the action taken by the 
Member State indicates that action is not being implemented or is proving to be inadequate). The provisions 
of  Article  126(9  and  11),  on  enhanced  Council  surveillance  and  ultimately  sanctions  in  case  of  non-
compliance, as well as the new enforcement mechanisms introduced in 2011, are not applicable to Member 
States with a derogation (that is, those that have not yet adopted the euro), which is the case of the Member 
States  considered  in  this  report.  Following  a  Council  decision  establishing,  under  Article  126(8),  that  the 
Member State did not take effective action in response to a Council recommendation under Article 126(7), 
the Council, on recommendation by the Commission, addresses to Member States with a derogation a new 
recommendation under Article 126(7).  

When, in the view of the Council, the excessive deficit in the Member State concerned has been corrected, 
the  Council  abrogates  its  decision  on  the  existence  of  an  excessive  deficit,  again  on  the  basis  of  a 
Commission recommendation (Article 126(12)). 

(1)  Where the excess of the deficit over the reference value reflects the implementation of a pension reform introducing a 
multi-pillar system that includes a mandatory, fully funded pillar, the Council and the Commission shall also consider 
the  cost  of  the  reform  when  deciding  on  the  existence  of  an  excessive  deficit,  as  long  as  the  deficit  does  not 
significantly exceed a level that can be considered close to the reference value, and the debt ratio does not exceed the 
reference value, provided that overall fiscal sustainability is maintained.

11 

 
 
                                                           
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

From  a  forward-looking  inflation  perspective,  the 
report  includes  an  assessment  of  medium-term 
prospects  for  price  developments.  The  analysis  of 
factors that have an impact on the inflation outlook 
– cyclical conditions, labour market developments 
and  credit  growth  –  is  complemented  by  a 
reference to the most recent Commission services' 
can 
forecast 
inflation.  That 
of 
subsequently  be  used 
the 
Member State is likely to meet the reference value 
the  months  ahead (11).  Medium-term 
also 
inflation  prospects  are  also  assessed  by  reference 
to  the  economies'  key  structural  characteristics, 
including the functioning of the labour and product 
markets. 

to  assess  whether 

forecast 

in 

to 

fulfil 

Failure  by  a  Member  State 
the 
requirements under either of these criteria can lead 
to a decision by the Council on the existence of an 
excessive deficit, in which case the Member State 
concerned  does  not  comply  with  the  budgetary 
convergence criterion (12).  

The  issue  of  sustainability  deserves  particular 
attention  at  a  time  when  the  financial  crisis  has 
significantly  impacted  on  the  fiscal  positions  in 
many  Member  States.  Related  to  this,  economic 
governance 
the  EMU  was  substantially 
strengthened in 2011. This included, inter alia, the 
operationalisation  of  the  debt  criterion  in  the 
Excessive Deficit Procedure (13). 

in 

1.2.3.  Public finances 

1.2.4.  Exchange rate stability 

The  convergence  criterion  dealing  with 
the 
government  budgetary  position  is  defined  in  the 
second  indent  of  Article  140(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  126(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 
126(6) of the said Treaty that an excessive deficit 
exists”. 

The convergence assessment in the budgetary area 
is  thus  directly  linked  to  the  excessive  deficit 
procedure which is specified in Article 126 of the 
Treaty  and  further  clarified  in  the  Stability  and 
Growth  Pact  (see  Box  1.3  for  further  information 
on the excessive deficit procedure as strengthened 
by  the  2011  reform  of  the  Stability  and  Growth 
Pact).  The  existence  of  an  excessive  deficit  is 
determined  in  relation  to  the  two  criteria  for 
budgetary  discipline  set  in  Article  126(2),  namely 
the  government  deficit  and  the  government  debt. 

(11)  According  to  the  Commission  services'  Spring  2012 
Forecast, the inflation reference value is forecast to stand at 
3.1%  in  December  2012,  with  Sweden,  Ireland  and  Spain 
as  best  performers  in  terms  of  price  stability.  Greece  has 
been excluded from the best performers in December 2012 
as  its  average  inflation  rate  is  forecasted  to  become 
negative  and,  at  the  same  time,  to  deviate  from  the  euro 
area  average  by  a  wide  margin,  being  at  2.9  percentage 
points  below  the  euro  area  average  inflation.  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  be  the 
best  performers  in  terms  of  price  stability  in  the  forecast 
period, thereby increasing the possible margin of error.  

12 

third 

The Treaty refers to the exchange rate criterion in 
indent  of  Article  140(1)  as  “the 
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 euro”.  

(12)  The  definition  of  the  general  government  deficit  used  in 
this  report  is  in  accordance  with  the  excessive  deficit 
procedure, as was the case in previous convergence reports. 
In particular, interest expenditure, total expenditure and the 
overall balance include net streams of interest expenditure 
resulting  from  swaps  arrangements  and  forward  rate 
agreements.  Government  debt  is  general  government 
consolidated  gross  debt  at  nominal  value  (Council 
Regulation 479/2009). Information regarding the excessive 
deficit  procedure  and  its  application  to  different  Member 
States 
at: 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm. 

found 

since 

2002 

can 

be 

and 

two 

new 

regulations 

surveillance 

frameworks, 

the  Stability 

three 
and  Growth  Pact 

(13)  A  directive  on  minimum  requirements  for  national 
on 
budgetary 
regulations 
macroeconomic 
and 
amending 
complementing  it  with  new  enforcement  mechanisms  for 
euro  area  Member  States  entered  into  force  on  13 
December 2011. Besides the operationalisation of the debt 
criterion  in  the  Excessive  Deficit  Procedure  mentioned  in 
introduced  a  number  of 
Box  1.3, 
important  novelties  in  the  Stability  and  Growth  Pact,  in 
particular  an  expenditure  benchmark  to  complement  the 
assessment  of  progress 
the  country-specific 
medium-term budgetary objective. 

the  amendments 

towards 

 
                                                           
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box 1.4: Data for the interest rate convergence

The  fourth  indent  of  Article  140(l)  of  the  Treaty  requires  that  the  durability  of  nominal  convergence  and 
exchange rate stability in Member States should be assessed by reference to long-term interest rates. Article 
4 of the Protocol on the convergence criteria adds that these “Interest rates shall be measured on the basis of 
long-term  government  bonds  or  comparable  securities,  taking  into  account  differences  in  national 
definitions”. 

Article  5  of  the  Protocol  requires  that  the  Commission  should  provide  the  statistical  data  used  for  the 
application of the convergence criteria.  However, in the context of the interest rate criterion,  the ECB has 
developed the criteria for harmonising the series of yields on benchmark 10 year bonds on behalf of Eurostat 
and collects the data from the central banks. The selection of bonds for inclusion in this series is based on 
the following criteria: 

• 

issued by central government; 

•  a residual maturity close to 10 years; 

•  adequate liquidity, which is the main selection criterion; the choice between a single benchmark or the 

simple average of a sample is based on this requirement; 

• 

fixed coupon; 

•  yield gross of tax. 

For sixteen Member States, the representative interest rates used in this report incorporate all of the above 
characteristics. For ten Member States, the residual maturity of the benchmark bond is below 9.5 years, in 
particular  for  Lithuania  with  a  residual  maturity  below  8  years.  All  yields  are  calculated  on  the  basis  of 
secondary  market  rates.  For  the  Czech  Republic,  Germany  and  Spain  a  basket  of  bonds  is  used,  while  a 
single  benchmark  bond  is  used  in  twenty-three  Member  States.  For  Estonia,  no  appropriate  harmonised 
series or proxy could be identified, primarily reflecting the very low level of Estonian government debt.  

Data  used  in  this  Report  can  be  found  on  Eurostat  ("Maastricht  criterion  bond  yields  (mcby):  EMU 
convergence  criterion  bond  yields",  code:  tec00097).  The  same  series  is  also  published  by  the  ECB's 
Statistical Data Warehouse (code IRS.M.Country Code.U2.L.L40.CI.0000.EUR.N.Z). 

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 
rate  against  the  euro  on  its  own  initiative  for  the 
same period” (14). Based on the Council Resolution 
on  the  establishment  of  the  ERM  II (15),  the 
European  Monetary  System  has  been  replaced  by 
the 
the  Exchange  Rate  Mechanism  II  upon 

(14)  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. 

(15)  97/C 236/03 of 16 June 1997, OJ C 236, 2.8.1997, p.5. 

introduction of the euro, and the euro has become 
the centre of the mechanism.  

in  auxiliary 

In  its  assessment  of  the  exchange  rate  stability 
criterion,  the  Commission  takes  into  account 
developments 
indicators  such  as 
foreign  reserve  developments  and  short-term 
interest  rates,  as  well  as  the  role  of  policy 
exchange 
measures, 
interventions, 
rate 
stability.  

in  maintaining  exchange 

including 

foreign 

In  order 

international 

Some  Member  States,  as  was  already  the  case  at 
the  time  of  the  2010  Convergence  Report,  have 
balance-of-payments 
received 
assistance  during  the  assessment  period  for  this 
report. 
this 
constitutes  evidence  that  a  country  has  faced 
the 
severe 
Commission  examines  several  factors,  including 
the  situation  that  led  to  the  need  for  official 
external  financing,  the  magnitude  and  financing 

to  determine  whether 

its  exchange 

tensions 

rate, 

in 

13 

 
                                                           
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

profile  of  the  assistance  programme,  the  residual 
financing gap, the policy conditionality attached to 
it as well as developments in foreign exchange and 
financial markets.  

As  in  previous  reports,  the  assessment  of  this 
criterion  verifies  the  participation  in  ERM  II  and 
examines  exchange  rate  behaviour  within  the 
mechanism.  The  relevant  period  for  assessing 
exchange rate stability in this Technical Annex is 1 
May 2010 to 30 April 2012. 

1.2.5.   Long-term interest rates 

the  Protocol  on 

The  fourth  indent  of  Article  140(1)  of  the  Treaty 
requires  “the  durability  of  convergence  achieved 
by  the  Member  State  with  a  derogation  and  of  its 
participation  in  the  exchange  rate  mechanism 
being  reflected  in  the  long-term  interest  rate 
the 
levels”.  Article  4  of 
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  two  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, 
into 
account  differences  in  national  definitions”  (see 
Box 1.4).    

taking 

their 

At the current juncture, sovereign bond markets in 
some  Member  States  are  subject 
to  severe 
distortions. In particular, some Member States face 
episodes  of  unusually  high  nominal  long-term 
interest rates and/or closure of market access. This 
interest  rates  not  an 
makes 
long-term 
the 
economically  meaningful  benchmark 
assessment  of  convergence  and  including  them 
would severely affect the reference value and thus 
the 
this 
background, the calculation of the reference value 
excludes  Ireland,  i.e.  one  of  the  three  best-
performing  Member  States  in  terms  of  price 
stability (16). 

the  criterion.  Against 

fairness  of 

for 

the  criterion  on 

the  assessment  of 

the 
For 
convergence of interest rates, yields on benchmark 
10-year  bonds  have  been  taken,  using  an  average 
rate over the latest 12 months. Taking into account 
the current exceptional economic circumstances, in 
line with Article 4 of the Protocol (referring to 'at 
most  the  three  best  performing  Member  States'), 
the reference value for March 2012 is calculated as 
the  simple  average  of  the  average  long-term 
interest  rates  in  Sweden  (2.2%)  and  Slovenia 
(5.4%)  plus  2  percentage  points,  yielding  a 
reference value of 5.8%.  

(16)  In  March  2012,  the  12-month  average  long-term  interest 
rate  in  Ireland  was  9.1%.  Ireland  has  been  the beneficiary 
of  an  EU/IMF  financial  assistance  programme  since 
December 2010. 

14 

 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

Box 1.5: The Macroeconomic Imbalance Procedure (MIP)

The Macroeconomic Imbalance Procedure (MIP): key elements  

A  key  lesson  from  the  economic  and  financial  crisis  has  been  that  the  economic  governance  framework 
underpinning EMU needed to be further strengthened to address the issue of unsustainable macroeconomic 
trends.  The  new  procedure  on  prevention  and  correction  of  macroeconomic  imbalances  –  the 
Macroeconomic Imbalance Procedure (MIP) – responds to this need and was one of the key elements of the 
legislative package (the "6-pack") to enhance the governance structures in EMU.  

A two-step approach with a preventive and a corrective arm  

The overall design of the MIP includes a "preventive" arm and a stronger "corrective" arm for more serious 
cases. For euro area countries, the corrective arm is supplemented by an enforcement mechanism including 
the  possibility  of  financial  sanctions.  The  procedure  relies  on  a  two-step  approach  where  the  first  step 
consists  of  an  alert  mechanism  that  aims  to  identify  Member  States  with  potentially  emerging 
macroeconomic  imbalances  and  which  require  more  in-depth  investigation.  If,  on the  basis of  such  an  in-
depth  analysis,  the  situation  is  considered  unproblematic  no  further  steps  are  taken.  If  the  Commission 
however  considers  that  macroeconomic  imbalances  exist,  it  may  come  forward  with  proposals  for  policy 
recommendations  for  the  Member  State  concerned  (which  will  be  –  in  the  preventive  arm  –  part  of  the 
integrated package of recommendations under the European semester). In case the in-depth review points to 
severe imbalances in a Member  State, the Council would declare the existence of an excessive imbalance 
and  adopt  a  recommendation  asking  the  Member  State  to  present  a  Corrective  Action  Plan  (CAP).  After 
submission of the CAP by the Member State, the Council would assess the CAP which either can be deemed 
sufficient or insufficient; if found insufficient, the Member State should present a new CAP. If the new CAP 
is again found insufficient, a fine can be imposed (0.1% of GDP), though just for euro area Member States 
(1). When a sufficient CAP is in place, the Council will assess whether or not the Member State concerned 
has  taken  the  recommended  actions  according  to  the  set  deadlines.    For  euro  area  Member  States  a  first 
assessment of non-compliance would lead to an interesting-bearing deposit (0.1% of GDP). After a second 
decision by the Council declaring non-compliance, the Council can take the decision to convert the deposit 
into an annual fine. If the Council considers that the Member State has taken the recommended corrective 
action,  but  imbalances  are  not  yet  corrected,  the  procedure  will  be  placed  in  abeyance.  If  the  Council 
considers  that  the  Member  State  concerned  has  taken  the  appropriate  action  and  the  Member  State  is  no 
longer experiencing excessive imbalances, the procedure will be closed.  

The alert mechanism scoreboard: design and rationale 

The scoreboard is an element of the alert mechanism and is intended to facilitate the identification of trends 
of imbalances that are under the scope of the MIP and require closer examination. In line with the different 
challenges  facing the Member States, it comprises indicators of the external position (current account and 
net  international  investment  position),  competitiveness  developments  (real  effective  exchange  rates,  unit 
labour  cost,  export  market  shares)  and  indicators  of  internal  imbalances  (private  sector  and  general 
government debt, private sector credit flow, house prices and the unemployment rate). The scoreboard thus 
encompasses variables where both the economic literature and recent experiences suggest associations with 
economic crises, while indicative alert thresholds were identified for each indicator.  

The 2012 Alert Mechanism Report (AMR)  

As a first step in implementing the MIP, the Commission published its first Alert Mechanism Report on 14 
February 2012. The AMR made an economic reading of the scoreboard as foreseen by the legislation and on 
this basis 12 Member States were identified for which in-depth reviews on different possible imbalances are 
warranted. Three of them are Member States covered in this report (Bulgaria, Hungary and Sweden). The in-
depth reviews were conducted in the course of spring 2012 in the context of the European Semester. 

(1)  These decisions are taken with so called "reversed qualified majority voting" (RQMV), which implies that there needs
to be a majority against taking the step (as opposed to the normal approach where a decision needs the backing of a
qualified majority).

15 

 
 
 
                                                           
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 1 - Introduction 

in 

fiscal 

ensuring 

For  the  first  time,  the  Convergence  Report  is 
aligned  with  the  broader  "European  semester" 
approach  which  takes  an  integrated  and  upstream 
look  at  the  economic  policy  challenges  facing  the 
EMU 
sustainability, 
competitiveness,  financial  market  stability  and 
economic  growth.  The  section  on  additional 
factors  makes  reference  to  the  surveillance  of 
macroeconomic 
the  Macro-
economic  imbalance  procedure  (MIP  –  see  Box 
1.5), that was adopted in December 2011 as one of 
the key elements of the legislative package (the "6-
pack")  to  enhance  the  governance  structures  in 
EMU, and integrates its results into the assessment 
(18).  

imbalances  under 

1.2.6.  Additional factors 

The  Treaty  in  Article  140  also  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence.  These  additional 
factors 
include  financial  and  product  market 
integration and the development of the balance of 
payments. The examination of the development of 
unit labour costs and other price indices, which is 
also  prescribed  by  Article  140  of  the  Treaty,  is 
covered in the chapter on price stability. 

of 

the 

The  assessment  of  additional  factors  is  equally 
important indication of whether the integration of a 
Member  State  into  the  euro  area  would  proceed 
without  difficulties.  As  regards  the  balance  of 
payments,  the  focus  is  on  the  situation  and 
balance (17). 
development 
Integration of product markets is assessed through 
trade,  foreign  direct  investment  and  a  smooth 
functioning  of 
internal  market.  Finally, 
progress  in  financial  integration  is  examined, 
together with the impact of the financial crisis, the 
main  characteristics,  structures  and  trends  of  the 
financial sector and compliance with the acquis of 
the Union in this area.  

external 

the 

(17)  The  external  balance  is  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.  It  is  the 
concept closest to the current account as defined when the 
Maastricht Treaty was drafted. 

(18)  To  avoid  the  duplication  of  surveillance  procedures, 
Member  States  under  EU-IMF 
financial  assistance 
programmes    are  not  examined  under  the  macroeconomic 
imbalances  procedure  and  were  therefore  not  covered  in 
the Alert Mechanism Report and in-depth reviews. Among 
the  Member  States  examined  in  this  report,  this  concerns 
Romania. 

16 

 
                                                           
 
                                                           
2. 

BULGARIA 

2.1. 

LEGAL COMPATIBILITY 

2.1.1.  Introduction 

The  Law  on  the  Bulgarian  National  Bank  (BNB 
Law),  adopted  in  1997,  constitutes  the  legal  basis 
for  the  Bulgarska  narodna  banka  (BNB  –  central 
bank  of  Bulgaria)  and  deals  with  the  BNB’s 
structure  and  functions.  Some  amendments  were 
made  to  it  after  the  2010  convergence  report  was 
published:  (1)  )  In  relation  to  the  conflict  of 
interests, the BNB Law now refers to the Conflict 
of  Interest  Prevention  and  Ascertainment  Act;  (2) 
the  BNB  Law  now  provides  for  competences  of 
the BNB in the area of licensing and supervision of 
payment 
systems  and 
electronic money institutions. 

institutions,  payment 

2.1.2.  Central Bank independence 

Article 14(1) and (2) of the BNB Law Bank do not 
accurately  mirror  the  grounds  for  dismissal  of  the 
Governor  as  laid  down  in  Article  14.2  of  the 
ESCB/ECB Statute. Article 14(1) of the BNB Law 
provides  that  a  member  of  the  BNB  Governing 
Council  amongst  others  can  be  relieved  from 
office  if  "he  no  longer  fulfils  the  conditions 
required  for  the  performance  of  his  duties  under 
Article  11(4),  if  "he  is  in  practical  inability  to 
perform his duties for more than six months" or if 
"he  has  been  guilty  of  serious  professional 
second  dismissal  ground 
misconduct".  The 
mentioned  in  Article  14(1)  is  not  provided  in 
Article  14.2  of  the  Statute,  whereas  the  third 
criterion  narrows  down  the  concept  of  "serious 
misconduct"  of  Article  14.2  of  the  Statute  to 
"serious  professional  misconduct".  In  order  to 
remove  this  imperfection  and  limit  interpretation 
problems  a  clear  definition  of  these  grounds,  in 
line  with  Article  14.2  of  the  Statute,  would  be 
required.  

In  order  to  be  in  line  with  the  term  duration 
requirements of Article 14.2 of the Statute, Article 
14(2)  of  the  BNB  Law  should  explicitly  foresee 
that  a  person  replacing  the  Governor  whose 
mandate  has  ceased  as  member  of  the  Governing 
Council  should  also  be  elected  or  appointed  for  a 
term of office of at least five years. 

Pursuant  to  Article  33(1)  in  conjunction  with 
Article 3(13) of the Conflict of Interest Prevention 
and  Ascertainment  Act,  the  breach  of  conflict  of 
interest prevention and ascertainment duties by the 
Governor shall be a ground for his dismissal. The 
Act should remove this incompatibility and specify 
that the dismissal is only possible if, as per Article 
14.2 of the Statute, the breach of the duty is a lack 
of  fulfilment  of  the  conditions  required  for  the 
performance  of  the  Governor's  duty  or  a  serious 
misconduct of which the Governor has been guilty. 

Article 12(1) and (2) of the BNB Law provides for 
the  National  Assembly’s  powers  to  elect  the 
Governor  and  the  Deputy  Governors  of  the  BNB. 
The National Assembly has claimed that it has the 
power  to  annul  or  amend  its  previous  decisions, 
including  decisions  concerning  the  election  of  the 
Governor and Deputy Governors of the BNB taken 
under  Article  12(1)  and  (2)  of  the  Law.  The 
National  Assembly  has  justified  its  claim  on  the 
basis  of  a  Constitutional  Court  decision  of 
February  26,  1993  stating  that  the  Constitution 
does  not  contain  an  express  provision  prohibiting 
the  National  Assembly 
from  annulling  or 
amending  its  acts.  The  Law  should  remove  this 
incompatibility  and  ensure  that  the  Governor, 
when  elected or  appointed, shall  not be dismissed 
under  conditions  other  than  those  mentioned  in 
Article 14.2 of the ESCB/ECB Statute, even if he 
has not yet taken up his duties.  

in 

the  Governing  Council, 

Article  44  of  the  BNB  law  provides  that  the 
members  of 
the 
performance  of  their  tasks,  shall  be  independent 
and shall not seek or take any instructions from the 
Council  of  Ministers  or  from  any  other  body  or 
institution.  Neither  the  Council  of  Ministers  nor 
any other body or institution shall give instructions 
to  the  members  of  the  Governing  Council.  This 
provision constitutes an imperfection and does not 
correspond to the wording of the Article 130 of the  
TFEU and the Article 7 of the ESCB/ECB Statute 
(e.g.  Union  institutions  are  not  included)  and 
should therefore be brought into line with it. 

2.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Article  45(1)  provides  that  the  BNB  shall  not 
extend  credits  and  guarantees,  including  through 
purchase  of  debt  instruments,  to  the  Council  of 

17 

 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

There are also numerous imperfections regarding: 

•  non-recognition of the role of the ECB for the 
functioning  of  the  payment  systems  (Articles 
2(4) and 40(1));  

•  non-recognition of the role of the ECB and the 
EU for the collection of statistics (Article 4(1) 
and 42); 

•  non-recognition  of  the  role  of  the  ECB  and  of 
the Council for the appointment of the external 
auditor (Articles 49 (4)); 

•  absence  of  an  obligation  to  comply  with  the 
Eurosystem's regime for the financial reporting 
of NCB operations (Article 16(11), 46 and 49). 

2.1.5.  Assessment of compatibility 

the 

time  of  euro  adoption, 
the  central  bank  and 

As  regards  the  central  bank  integration  into  the 
the 
ESCB  at 
independence  of 
the 
prohibition  on  monetary  financing,  the  legislation 
in  Bulgaria  -  in  particular,  the  BNB  Law  and  the 
Conflict  of  Interest  Prevention  and  Ascertainment 
Act - are not fully compatible with the compliance 
duty under Article 131 of the TFEU. 

2.2. 

PRICE STABILITY 

2.2.1.  Respect of the reference value 

The  12-month  average  inflation  rate  for  Bulgaria, 
which is used for the convergence assessment, was 
above  the  reference  value  at  each  convergence 
assessment since Bulgaria became an EU Member 
State  in  2007. Average  annual  inflation rose  from 
1.6% in April 2010 to 3.8% by June 2010, before 
declining to 3.4% by end-2011. In March 2012, the 
reference  value  was  3.1%,  calculated  as  the 
average of the 12-month average inflation rates in 
Sweden,  Ireland  and Slovenia  plus  1.5 percentage 
points.  The  average  inflation  rate  in  Bulgaria 
during the 12 months to March 2012 was 2.7%, i.e. 
below the reference value. It is projected to remain 
below the reference value in the months ahead. 

Ministers,  municipalities,  as  well  as  to  other 
governmental 
institutions, 
and  municipal 
organizations  and  enterprises.  Pursuant  to  Article 
45(2)  of  the  Law  on  BNB,  this  does  not  apply  to 
the  extension  of  credits 
to  state-owned  and 
municipal  banks  in  emergency  cases  of  liquidity 
risk  that  may  affect  the  stability  of  the  banking 
system.  Article  45(1)  should  include  all  entities 
which  are  mentioned  in  Article  123(1)  of  the 
TFEU  and  Article  21.1  ESCB/ECB  Statute.  The 
provisions  of  Article  45(1)  and  (2)  provide  for 
incompatibility with the wording of Article 123 of 
the  TFEU  and  Article  21.1  of  the  ESCB/ECB 
Statute  and  thus,  should  be  amended.  What  is 
more, 
the  prohibition  of  monetary  financing 
prohibits the direct purchase of public sector debt, 
but  such  purchases  in  the  secondary  market  are 
allowed  as 
long  as  such  secondary  market 
purchases are not used to circumvent the objective 
of  Article  123  of  the  TFEU.  For  this  reason  the 
word ‘direct’ should be inserted in Article 45(1) of 
the  Law  to  remove  this  imperfection  and  be  fully 
in line with Article 123 of the TFEU.  

2.1.4.  Integration in the ESCB 

Objectives 

The objectives of the BNB are compatible with the 
TFEU.  

Tasks 

The  incompatibilities  in  the  Law  on  the  BNB  are 
linked to the following ESCB/ECB tasks: 

•  definition  of  monetary  policy  and  monetary 
functions,  operations  and  instruments  of  the 
ESCB (Articles 2(1), 3, 16(4-5),28, 30, 31, 32, 
33, 35, 38, 41 and 61); 

•  conduct of foreign exchange operations and the 
definition  of  foreign  exchange  rate  policy 
(Articles 20(1), 28, 28, 31, 32); 

• 

right to authorise the issue of banknotes and the 
volume  of  coins  (Articles  2(5),  16(9),  24  to 
27); 

•  non-recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Articles  5, 
16(12) and 37(4)); 

•  ECB's  right  to  impose  sanctions  (Article  61, 

62). 

18 

 
Graph 2.1:Bulgaria - Inflation criterion since 2006

(percent, 12-month moving average)

14

12

10

8

6

4

2

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Bulgaria
Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

Reference value

2.2.2.  Recent inflation developments 

to  zero  by 

The  inflation  rate  in  Bulgaria  has  fluctuated  over 
the past two years, reflecting the impact of volatile 
international commodity prices on energy and food 
prices.  With  the  turn  in  the  commodity  cycle  and 
the strong recession, headline inflation declined to 
close 
late  2009.  Strengthening 
commodity  prices,  indirect  tax  increases  and  still 
significant  wage  growth  put  inflation  back  on  an 
upward  trend  in  2010  and  it  reached  a  peak  of 
4.6%  in  early  2011  before  decreasing  again  with 
the fading of the impact of the former two factors 
to  2%  by  end-2011,  well  below  the  euro  area 
average.  By  March  2012,  annual  inflation  fell 
further 
taxes  contributed 
Indirect 
positively to inflation in 2010, but their impact was 
minor  from  2011,  when  fiscal  consolidation 
became even more expenditure-based. 

to  1.7%. 

Graph 2.2:Bulgaria - HICP inflation

(y-o-y percentage change)

16

12

8

4

0

-4

2006

2007

2008

2009

2010

2011

2012

Bulgaria

Euro area

Source: Eurostat.

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  was  by 
construction  more  resilient  to  the  import  price 
shocks  than  headline  inflation.  The  gap  between 
the  two  measures  of  inflation  varied  mainly 
depending on global commodity price fluctuations, 
with  headline  rising  above  core  inflation  in  early 
2010 and reverting to it at end-2011. Core inflation 

Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

picked  up  slightly  in  late  2010  amid  rising 
processed food inflation, but this short-lived trend 
reversed  by  mid-2011  as  the  commodity  price 
pressure  on  processed  food  abated.  Core  inflation 
fell  to  1%  by  March  2012.  Prices  of  non-energy 
industrial  goods  continued  to  fall,  partly  due  to 
weak domestic demand. Decreasing producer price 
inflation confirmed the easing of cost pressures in 
2011, but its year-on-year level remained elevated 
in early 2012. 

2.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy-mix  and  cyclical 
stance 

imbalances  started  somewhat 

Following  a  long  period  of  dynamic  growth,  real 
GDP  contracted  by  more  than  5%  in  2009,  as 
foreign  capital  flows  dried  up  and  export  markets 
were  hit  by  the  effects  of  the  financial  crisis. 
Exports rebounded in 2010 and 2011, but domestic 
demand  remained  very  sluggish.  Output  was 
overall  broadly  stable  in  2010  and  increased  by 
around  2%  in  2011.  The  correction  of  large  pre-
crisis 
in 
Bulgaria  than  in  other  countries  of  the  region. 
Available  indicators  for  the  first  quarter  of  2012 
suggest  that  domestic  demand  remains  weak. 
According  to  the  Commission  services'  Spring 
2012  Forecast,  Bulgaria's  GDP  will  increase  by 
0.5% in 2012 and by 1.9% in 2013. The Bulgarian 
economy is estimated to have operated well below 
its  potential  since  2009  and  a  sizeable  negative 
output gap is projected to remain even in 2013. 

later 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural balance, has been restrictive since 2010, 
allowing  for  a  frontloaded  correction  of  the 
structural  deficit  that  emerged  in  2009.  The 
correction  of  the  headline  deficit  was  achieved 
mainly  by  structural  measures,  in  particular  in 
2010, and fiscal consolidation was concentrated on 
the  expenditure  side.  In  view  of  the  good  starting 
budgetary  position  and  the  ambitious  tackling  of 
the  fiscal  slippage  in  2009,  the  drag  on  the 
economy  from  fiscal  consolidation  is  expected  to 
be rather moderate, with the fiscal stance projected 
to  be  slightly  restrictive  in  2012  and  broadly 
neutral in 2013.  

In the context of its currency board arrangement to 
in 
the  euro,  monetary  conditions 
Bulgaria with the international financial crisis. The 

tightened 

19 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

Table 2.1:

Bulgaria - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

7.4

2.6

5.2

5.4

7.6

4.4

5.1

6.3

18.5

13.4

6.5

8.1

5.4

5.8

7.8

8.2

7.2

5.8

12.0

6.0

12.5

10.9

17.2

12.7

12.0

11.3

10.6

2.5

2.9

-5.7

1.3

2.4

5.8

4.1

1.9

7.2

3.0

0.3

9.2

-1.6

7.5

1.5

2.5

2.1

3.6

3.4

-0.4

8.9

1.6

7.7

1.9

2.6

3.2

2.5

2.7

-0.5

7.2

1.7

5.1

2.0

2.1

3.0

2.5

2012

1000

234

137

84

221

324

779

1000

162

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices 

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

the 

impact  of 

partial  relaxation  in  the  local  financial  regulatory 
environment,  which  included  the  lowering  of  the 
reserve requirement by early 2010, could not fully 
counterbalance 
increased  risk 
aversion  and  reduced  funding  by  foreign  parent 
banks.  The  uncertain  economic  outlook, 
in 
particular  the  heightened  risk  of  unemployment 
and  falling  real  estate  prices,  lowered  credit 
demand as well. The flow of new credit recovered 
somewhat  during  2011,  as  the  banking  sector's 
reliance on foreign funding declined. 

Wages and labour costs 

Bulgaria  entered  the  recession  with  a  tight  labour 
market.  The  initial  labour  market  reaction  was  a 
drop in employment of almost 3% in 2009, but the 
situation  turned  even  more  severe  in  2010,  when 
the employment loss reached almost 5%, before a 
further  4%  decline  in  2011.  The  unemployment 
rate rose from below 6% in 2008 to slightly above 
11% by 2011, as jobs were lost mainly in the non-
tradable  sector,  but  the  manufacturing  sector  also 
suffered  heavily.  Despite  these  factors  and  wage 
restraint  in  the  public  sector  from  2010,  nominal 
wage  growth  remained  high  in  the  private  sector. 
This  suggests  that  skills  mismatches  impeded 
labour  market  flexibility,  despite  a  relatively 
decentralized wage setting process.  

Labour  productivity  turned  negative  in  2009,  as 
output fell faster than employment, but it increased 
strongly in 2010 and 2011 with continuing labour 
force reductions amid rising exports. Accordingly, 
the  growth  in  nominal  unit  labour  cost  (ULC) 
remained  high  in  2009,  before  moderating  to  

20 

around  5%  in  2010  and  1%  in  2011 (19).  Looking 
ahead,  ULC  growth  is  expected  to  rise,  as  the 
growth  in  nominal  compensation  per  employee  is 
to remain high and productivity growth is likely to 
decrease  with  the  stabilization  of  the  labour 
market.  

Graph 2.3:Bulgaria - Inflation, productivity and wage trends
20

(y-o-y % change)

16

12

8

4

0

-4

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

External factors 

the  high  openness  of 

the  Bulgarian 
Given 
economy,  developments  in  import  prices  play  an 
important role in domestic price formation. Import 
prices,  as  measured  by  the  imports  of  goods 
deflator  in  the  national  accounts,  dropped  at  a 
double-digit  rate  in  2009,  but  increased  markedly 
in 2010 and 2011. Annual growth in import prices 
is expected to remain significant in 2012 mainly on 
account of rising oil prices. 

The  development  of  Bulgaria's  import  prices  is 
closely  linked  to  the  fluctuations  in  international 
commodity  prices.  Accordingly,  energy  and  food 

(19)  Significant revisions to data on nominal compensation per 
interpret  ULC 
it  more  difficult 

to 

employee  make 
developments.  

 
 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

Table 2.2:

Bulgaria - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Bulgaria

Euro area

Private consumption deflator

Bulgaria

Euro area

7.4

2.2

2.2

2.2

Nominal compensation per employee

Bulgaria

Euro area

Labour productivity

Bulgaria

Euro area

Nominal unit labour costs

Bulgaria

Euro area

Imports of goods deflator

Bulgaria

Euro area

6.3

2.5

3.1

1.9

3.1

0.8

11.4

3.9

7.6

2.1

9.0

2.2

12.7

2.6

3.2

1.3

9.3

1.4

7.3

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

12.0

3.3

7.2

2.7

16.3

3.4

3.5

-0.3

12.5

3.8

10.8

4.2

2.5

0.3

1.5

-0.4

9.4

1.8

-2.9

-2.4

12.7

4.2

-13.7

-7.7

3.0

1.6

2.4

1.7

11.2

1.7

5.3

2.5

5.6

-0.8

8.5

5.7

3.4

2.7

3.8

2.5

7.3

2.2

6.1

1.2

1.1

0.8

9.5

6.9

2.6

2.4

3.0

2.2

5.2

1.9

2.4

0.1

2.7

1.6

5.8

3.6

2.7

1.8

3.2

1.7

5.1

1.9

2.1

1.0

3.0

0.8

2.0

1.3

products  were  the  most  relevant  channels  of 
imported  inflation,  in  particular  when  taking  into 
account their relatively large share in the consumer 
basket. Energy and processed food inflation rose to 
high  levels  in  early  2010,  but  moderated  by  late 
2011,  reflecting  commodity  price  changes  with  a 
time lag. The good local harvest in 2011 helped to 
keep unprocessed food inflation moderate and non-
energy  industrial  goods  prices,  another  typical 
channel  of  import  price  transmission,  declined 
marginally in the past two years.  

The  nominal  effective  exchange  rate  of  the  lev 
(measured  against  a  group  of  35  trading  partners) 
was  relatively  strong  from  early  2009,  after  the 
currencies of some trading partners depreciated to 
the  euro  in  reaction  to  the  financial  crisis.  This 
strength  was  lost  by  mid-2010  and  then  gradually 
regained by the summer of 2011. From late-2011, 
the  nominal  effective  exchange  rate  of  the  lev 
depreciated somewhat. Overall, fluctuations in the 
nominal  effective  exchange  rate  do  not  appear  to 
inflation 
have  had  a  significant 
developments. 

impact  on 

Administered prices and taxes 

Administered  prices (20)  and  indirect  tax  changes 
played  a  significant  role  in determining  Bulgarian 
inflation  over  the  past  few  years.  The  share  of 
administered  prices  in  the  HICP  basket  is  around 
16%.  The  annual  increase  of  administered  prices 
fell  from  3.6%  in  2010  to  2.6%  in  2011,  as 
pressure  to  correct  the  budget  deficit  abated,  but 
energy  prices  were  increasingly  pushing  up  costs. 
lifted  headline 
Overall,  administered  prices 
inflation  in  2010,  but  lowered  it  in  2011.  The 
excise tax increase on tobacco in 2010 had a major 
impact  on  the  price  level,  but  other  indirect  tax 
changes were not significant. 

The  pressing  need  for  fiscal  consolidation  led  to 
significant  increases  in  administered  prices  in 
2010,  mostly  in  the  categories  of  water  supply, 
sewage 
collection,  pharmaceutical  products, 
education and other services. In 2011, the price of 
hospital  services  went  up  markedly.  On  the  other 
hand, the price increase of electricity was low over 

(20)  According to the Eurostat definition, administered prices in 
Bulgaria  include  inter  alia  electricity  and  other  regulated 
utility  prices,  pharmaceutical  products,  hospital  services, 
part  of  public  transport  and  education.  For  details,  see 
http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/met
hodology/administered_prices 

21 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

the  past  two  years,  while  the  price  of  heat  energy 
fluctuated with global energy prices.  

gas,  gas  oil  and  kerosene  is  expected  to  add  to 
inflation over the medium-term. 

In line with tax harmonisation requirements within 
the  EU  and  the  need  to  increase  budget  revenues, 
the excise tax on tobacco was raised sharply in the 
beginning of 2010. Accordingly, tobacco products 
contributed by an estimated 1.3 and 0.5 percentage 
points  to  average  annual  inflation  in  2010  and 
2011, respectively.  

Medium-term prospects 

increases 

After  the  decline  until  March  2012,  inflation  is 
expected  to  pick  up  slightly  during  the  course  of 
the 
2012,  as  commodity  price 
beginning  of  the  year  will  feed  through  and  high 
nominal wage growth is set to lift services prices, 
despite  weak  domestic  demand.  Accordingly,  the 
Commission  services'  2012  Spring  Forecast 
projects  annual  average  inflation  at  2.6%  in  2012 
and 2.7% in 2013.  

in 

Risks to the inflation outlook appear to be broadly 
balanced.  A  stronger  economic  recovery  with  an 
even faster private sector wage growth, potentially 
spreading  to  the  public  sector,  a  recovery  in  bank 
lending  or  a  further  rise  in  global  commodity 
prices  would 
pressures. 
Conversely,  a  moderation  of  wage  growth  due  to 
high  unemployment  or  a  reversal  of  international 
commodity  prices  would  have  disinflationary 
effects.  

inflationary 

raise 

The  level  of  consumer  prices  in  Bulgaria  was  at 
49%  of  the  euro  area  average  in  2010.  Over  the 
long  run,  there  is  significant  potential  for  further 
price  level  convergence,  in  line  with  the  expected 
catching-up  of  the  Bulgarian  economy  (Bulgaria's 
income  level  was  at  about  41%  of  the  euro  area 
average in PPS terms in 2010).  

Medium-term  inflation  prospects  will  depend  on 
the  gap  between  wage  and  productivity  growth, 
which  could  widen  again,  as  the  allocation  of 
labour  market  resources  does  not  appear  to  be 
efficient  and  unemployment  created  during  the 
downturn  could  become  structural.  Bulgaria  is 
particularly  exposed  to  rising  global  commodity 
prices,  due  to  the  high  share  of  commodity-type 
products  in  the  consumer  basket. A  prudent  fiscal 
stance  is  expected  to  help  contain  inflationary 
pressures,  but  the  need  to  harmonize  excise  taxes 
with  EU  legal  requirements  on  tobacco,  natural 

22 

2.3. 

PUBLIC FINANCES 

2.3.1.  The  excessive  deficit  procedure 

for 

Bulgaria 

In 

by 

for 

deficit 

excessive 

authorities 

On 13 July 2010, the European Council adopted a 
decision on the existence of an excessive deficit in 
Bulgaria  in  accordance  with  Article  126(6)  of 
TFEU. The decision was based on data notified by 
the  Bulgarian 
the  general 
government  deficit  in  2009,  showing  that  the 
deficit  exceeded  the  3%  of  GDP  reference  value. 
The  Council  issued  a  set  of  recommendations  to 
Bulgaria  in  accordance  with Article  126(7)  TFEU 
with  a  view  to  bringing  an  end  to  the  situation  of 
its 
2011. 
an 
recommendations, 
the  Council  established  a 
deadline of 13 January 2011 for effective action to 
be  taken  and  invited  the  Bulgarian  authorities  to 
take  necessary  measures  to  avoid  deterioration  of 
the 2010 deficit beyond the planned 3.8% of GDP; 
ensure  a  fiscal  effort  of  at  least  ¾%  of  GDP  in 
2011; and specify and implement the measures that 
were  necessary  to  achieve  the  correction  of  the 
excessive  deficit  by  2011.  To  limit  risks  to  the 
adjustment,  Bulgaria  was 
to 
strengthen  its  fiscal  governance  and  transparency 
by  reinforcing  the  Ministry  of  Finance's  spending 
controls,  strengthening  the  binding  nature  of  its 
medium-term  budgetary  framework  as  well  as 
improving the monitoring of the budget execution 
throughout  the  year.  The  Bulgarian  authorities 
were  also 
that  budgetary 
consolidation  towards  the  medium-term  objective 
for  the  budgetary  position  was  sustained  after  the 
excessive  deficit  has  been  corrected.  Finally,  the 
Bulgarian authorities were encouraged to improve 
the  efficiency  of  public  spending  by 
fully 
implementing the planned structural reforms in the 
area 
healthcare, 
education, and pensions. On 15 February 2011, the 
Council  concluded 
taken 
effective  action  representing  adequate  progress 
towards correcting its deficit within the time limit 
set  in  the  recommendations  and  that  no  further 
steps  under  the  excessive  deficit  procedure  were 
required (21).   

that  Bulgaria  had 

administration, 

recommended 

to  ensure 

invited 

public 

of 

(21)  An overview of all on-going and previous excessive deficit 
at:  http://ec.europa.eu/ 
found 

procedures 

can  be 

 
                                                           
Table 2.3:

Bulgaria - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

2008

Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

(as % of GDP unless indicated otherwise)

2009

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme 
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP growth (%)

1.9

36.2

34.4

1.3

30.7

3.2

0.8

-0.1
0.9

21.6

6.5

3.1

1.2

40.9

39.8

1.2

33.5

2.3

-0.3

-3.1
2.8

17.2

6.4

4.0

1.7

40.0

38.3

0.9

31.9

2.5

-0.2

0.0
-0.2

13.7

6.2

5.1

-4.3

36.3

40.7

0.8

28.7

-3.6

-3.1

0.0
-3.1

14.6

-5.5

-3.4

-3.1

34.3

37.4

0.6

27.3

-2.5

-1.6

-0.1
-1.5

16.3

0.4

-4.1

-2.1

33.1

35.2

0.6

27.0

-1.5

-1.0

0.0
-1.0

16.3

1.7

-3.1

-1.9

33.3

35.2

0.8

27.0

-1.1

-0.7

0.0
-0.7

17.6

0.5

-3.3

2012
-1.6

-0.6

19.8

1.4

-1.7

33.6

35.3

1.0

27.2

-0.7

-0.8

0.0
-0.8

18.5

1.9

-2.5

2013
-1.3

-0.5

18.4

2.5

2014
-0.5

-0.1

18.0

3.5

2015
0.0

-0.2

16.4

4.0

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme.

There are no one-off and other temporary measures in the programme.

Sources: Commission services, the 2012 Convergence Programme of Bulgaria

2.3.2.  Recent fiscal developments 

Bulgaria  has  maintained  a 
relatively  strong 
budgetary  position  prior  to  the  crisis  and  in  the 
context  of  a  very  tax-rich  growth  structure.  The 
general  government  budget  posted  surpluses  of 
above 1.5% of GDP on average in 2006-08 which 
contributed  to  the  accumulation  of  sizeable  fiscal 
reserves  (above  12%  of  GDP  in  2008).  In  2009, 
however,  the  crisis  impacted  severely  on  public 
finances  and  the  budget  balance  turned  from  a 
surplus  of  1.7%  of  GDP  in  2008  to  a  deficit  of 
4.3% of GDP in 2009. In response, the government 
undertook strict consolidation measures which led 
to  a  gradual 
the  budgetary 
improvement  of 
position over the period of 2010-11. The measures 
aimed  at 
revenue  collection  while 
maintaining a tight control on the expenditure side, 
including  through  freezing  the  public  sector  wage 
bill  and  pensions.  Thus,  the  general  government 
deficit  narrowed  to  3.1%  of  GDP  in  2010  and 
improved further to 2.1% of GDP in 2011, against 
an initially set target of 2.5% of GDP in the 2011 
Convergence Programme.  

raising 

in 

to  a  further  drop 

The  better-than-expected  budget  outcome  in  2011 
was  mainly  due 
the 
expenditure-to-GDP  ratio,  largely  on  account  of 
lower-than-projected  capital  spending.  Thanks  to 
frontloading  of  the  consolidation  measures  the 
structural  deficit  improved  by  1.6  percentage 
points in 2010 and dropped further by another 0.5 
percentage  points  to  -1.0%  of  GDP  in  2011.  The 
fiscal  consolidation  was  facilitated  by  a  gradual 
the  growth  structure 
recovery  of  GDP  with 
becoming more broad based.  

Bulgaria's  public  debt  is one  of  the  lowest among 
the  EU  Member  States.  The  debt-to-GDP  ratio 
increased  moderately  from  14.6%  in  2009  to 
16.3%  in  2010.  The  ratio  stayed  unchanged  in 
2011, thus remaining well below the 60% of GDP 
reference  value.  The  debt  dynamics  reflect  the 
negative  impact  from  the  development  in  the 
is 
headline 
partly 
stock-flow 
compensated 
the 
adjustments 
accumulated fiscal reserves.  

balance  which 
debt-reducing 
to  drawing  down 

by 
related 

fiscal 

economy_finance/economic_governance/sgp/deficit/index_
en.htm 

2.3.3.  Medium-term prospects  

The 2012 Budget Law was adopted by parliament 
on  16  December  2011.  The  budget  targets  a 
general government deficit of 1.5% of GDP (1.3% 

23 

 
                                                                                   
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

of  GDP  in  cash  terms).  There  are  no  major  tax 
policy  or  rate  changes  except  for  increasing  the 
the 
taxes  on  some  energy  goods 
excise 
minimum  EU  levels  in  accordance  with  agreed 
transition  periods  and  the  introduction  of  natural 
gas  excise  tax  as  of  1  June,  2012.  Budget  sector 
wage  bill  and  pensions  will  be  frozen  for  a  third 
year in row.  

to 

policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

In the Commission services' 2012 Spring Forecast 
the  general  government  balance  is  projected  to 
improve  further  to  -1.9%  and  -1.7%  of  GDP  in 
2012 and 2013, respectively.  The structural deficit 
is  forecast  to  decline  to  -0.8%  of  GDP  in  2013, 
implying a cumulative structural fiscal effort of 0.2 
pp.  over  2012-13.  The  general  government  gross 
debt  is  set  to  increase  moderately  from  16⅓%  of 
GDP in 2011 to 18½% of GDP in 2013. The debt 
forecast  does  not  include  possible  external  debt 
issuance  in  2012  to  pre-fund  the  repayment  of 
Eurobonds of around 2% of GDP in January 2013. 

The 2012 Convergence Programme was submitted 
on 12 April 2012. After the expected correction of 
the excessive deficit in 2011, as recommended by 
the  Council,  the  programme  aims  at  achieving  a 
close to balanced budget position by the end of the 
programme  period  (2015).  The  official  targets  for 
the general government budget balance have been 
marginally revised to -1.6% of GDP in 2012 and -
1.3%  of  GDP  in  2013,  while  the  targets  for  2014 
and  2015  have  been  kept  unchanged.  The  small 
deviation  of  the  targets  for  2012-2013  compared 
with 
the  Commission  services'  2012  Spring 
Forecast  is  mainly  due  to  a  more  favourable 
the 
scenario 
macroeconomic 
programme. 

underlying 

in 

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  Bulgaria  can  be 
the  forthcoming  Commission  Staff 
found 
Working  Document,  which  accompanies 
the 
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme  of  Bulgaria  and  delivering  a  Council 
Opinion  on  the  2012  Convergence  Programme  of 
Bulgaria (22). 

In  March  2012,  Bulgaria  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 

(22)  Available 

at: 

http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/convergence/programmes/2012_en.htm 

24 

2.4. 

EXCHANGE RATE STABILITY 

The Bulgarian lev does not participate in ERM II. 
The  BNB  pursues  its  primary  objective  of  price 
stability  through  an  exchange  rate  anchor  in  the 
context  of  a  currency  board  arrangement  (CBA). 
Bulgaria  introduced  its  CBA  on  1  July  1997, 
pegging the Bulgarian lev to the German mark and 
subsequently  to  the  euro  (at  an  exchange  rate  of 
1.95583  BGN/EUR).  Under  the  CBA,  the  BNB’s 
monetary liabilities have to be fully covered by its 
foreign reserves. The BNB is obliged to exchange 
monetary 
the  official 
exchange  rate  without  any  limit.  The  CBA  was 
instrumental 
achieving  macroeconomic 
stabilisation and serves as a key policy anchor.  

liabilities  and  euro  at 

in 

Since the onset of the financial crisis, the CBA has 
operated  in  a  difficult  and  uncertain  environment, 
as  capital  inflows  turned  down  and  the  banking 
sector  was  challenged  by  deteriorating  asset 
quality  and  linkages  to  Greece.  However,  the 
export-driven  economic  recovery,  a  relatively 
strong  public  finance  position  and  sizable  reserve 
buffers  have  underpinned  the  resilience  of  the 
CBA. 

Graph 2.4:Exchange rates - BGN/EUR
(monthly averages)

2.1

2.0

1.9

1.8

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

Bulgaria's  international  reserves  covered  around 
176%  of  the  monetary  base  and  close  to  half  of 
broad money (M3) as of end-March 2012. A high 
reserve  coverage  was  deliberately  built  into  the 
framework  for  Bulgaria's  CBA,  to  cater  for 

 
                                                           
 
potential financial sector stress following the 1996-
97  crisis.  The  government  keeps  the  bulk  of  its 
fiscal  reserve  deposited  in  the  BNB.  International 
reserves  remained  fairly  stable  over  the  past  two 
years, as the reduction in government deposits was 
counterbalanced  by  other 
items,  namely  by 
increases in cash in circulation, banks' deposits and 
accumulated  profit  of  the  BNB.  At  end-2011, 
international  reserves  covered  some  133%  of 
Bulgaria's  short-term  debt  (at  original  maturity, 
excluding liabilities related to direct investments). 

The  BNB  does  not  set  monetary  policy  interest 
rates.  The  domestic  interest  rate  environment  is 
directly  affected  by  the  monetary  policy  of  the 
euro area through the operation of Bulgaria's CBA. 
Short-term  interest  rate  differentials  vis-à-vis  the 
euro area spiked in late-2008 with tighter liquidity 
and  heightened  risk  perception 
towards  new 
Member  States.  The  3-month  spread  declined 
gradually  until  July  2011  from  its  peak  of  around 
490  basis  points  of  March  2009  and  stabilized 
somewhat  above  200  basis  points  since  then. 
Bulgarian overnight interbank rates were however 
typically below those of the euro area in 2011 and 
early 2012.  

Graph 2.5:Bulgaria - 3-M Sofibor spread to 3-M Euribor

(basis points, monthly values)

500

400

300

200

100

0

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

2.5. 

LONG-TERM INTEREST RATES 

the  development  of 

long-term 
For  Bulgaria, 
interest  rates  over  the  current  reference  period  is 
assessed  on  the  basis  of  secondary  market  yields 
on  a  single  benchmark  government  bond  with  a 
residual maturity of close to, but below 10 years. 

The  Bulgarian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  above  the  reference  value  at 
the  2010  convergence  assessment.  It  gradually 
to 
declined  from  above  7% 

in  early  2010 

Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

somewhat above 5% by end-2011. In March 2012, 
the  latest  month  for  which  data  are  available,  the 
reference value, given by the average of long-term 
interest  rates  in  Sweden  and  Slovenia  plus  2 
percentage  points,  stood  at  5.8%.  In  that  month, 
the  twelve-month  moving  average  of  the  yield  on 
the  Bulgarian  benchmark  bond  stood  at  5.3%,  i.e. 
about  0.5  percentage  points  below  the  reference 
value. 

Graph 2.6:Bulgaria - Long-term interest rate criterion

(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Source: Commission services.

Bulgaria

Reference value

The  long-term  interest  rate  spread  vis-à-vis  the 
euro area rose sharply in 2008, during the turmoil 
of  the  international  financial  crisis.  The  spread 
started to decline from autumn 2009, as Bulgarian 
bond  yields  fell  with  the  calming  of  global 
financial  tensions.  There was  a  temporary  bout  of 
pressure in mid-2010 linked to the sovereign debt 
crisis and concerns about the quality of Bulgarian 
public  finance  statistics,  but  the  improving  trend 
resumed  relatively  soon.  Long-term  government 
yields  of  Bulgaria  were  broadly  resilient 
to 
international financial tensions in late 2011, as the 
liquidity  position  of  the  local  banking  system 
improved  by  year-end.  Spreads  to  the  Bund 
remained  elevated,  reaching  around  320  basis 
points  in  March  2012,  as  yields  of  the  latter  were 
influenced by safe haven inflows (23) . 

(23)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

25 

 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

Graph 2.7:Bulgaria - Long-term interest rates

2.6.1.  Developments  of 

the  balance  of 

(percent, monthly values)

payments 

10

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Bulgaria

Germany

Source: Eurostat.

2.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance 
in  EMU. 
the  governance  structures 
Related  to  this,  following  the  adoption  of  the 
legislation  establishing  the  new  procedure  for 
surveillance  and  correction  of  macroeconomic 
imbalances  (MIP) (24),  the  Commission  published 
its  Alert  Mechanism  Report  (AMR) in  February 
2012  (25).  The  scoreboard  shows  that  Bulgaria 
exceeds the indicative threshold in four out of ten 
indicators, three in the area of external imbalances 
(namely  on  the  current  account  balance,  net 
international  investment  position  and  nominal 
ULC  growth)  and  one  in  the  area  of  internal 
imbalances  (on  private  sector  debt).  In  line  with 
the  conclusion  of  the  AMR  which  was  based  on 
economic  analysis  and  the  scoreboard  for  2010, 
Bulgaria  was  subject  to  an  in-depth  review  in  the 
context of the MIP. 

(24)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898  

(25)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

26 

Bulgaria's  external  balance  (i.e.  the  combined 
current  and  capital  account)  adjusted  from  very 
large deficits until 2008 to around balance in 2010 
and  to  a  surplus  of  around  2%  of  GDP  in  2011. 
The  improvement  was  mostly  on  account  of 
merchandise  trade,  as  imports  fell  with  lower 
domestic  demand,  but  exports  also  grew 
dynamically  in  2010  and  2011.  The  surpluses  on 
services  and  current  transfers  increased,  the  latter 
favourably 
of 
Bulgarians  working  abroad.  The  income  account 
improved  temporarily  in  2009,  reflecting  lower 
profits on FDI, but it returned close to 2008 levels 
in  2011.  The  current  transfers  and  capital  account 
surpluses also reflect sizeable net inflows from EU 
funds,  although  EU  funds  absorption  could  be 
improved further.  

remittances 

influenced 

by 

The  large  savings-investment  gaps  of  2006-2008 
closed  by  2010,  as  capital  flows  moderated 
following  the  international  financial  crisis.  Gross 
national  savings  hovered  at  a  historically  high 
level  of  around  25%  of  GDP 
in  2011,  as 
companies  underwent  balance  sheet  adjustment 
after  several  years  of  high  credit  growth  and 
households  were  cautious  in  the  context  of  rising 
unemployment.  Gross  fixed  capital  formation 
declined  both 
in  2010  and  2011,  as  firms 
postponed  investment  in  the  uncertain  economic 
environment. 

Graph 2.8:Bulgaria - Saving and investment

(in percent of GDP at market prices)

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

Competitiveness 
indicators  showed  a  mixed 
picture in the past years. After some correction in 
2009  and  early  2010,  the  ULC-deflated  real-
effective  exchange 
its  sharp 
appreciation  trend,  partly  due  to  the  rising  NEER 
and  ULC  of  Bulgaria,  while  the  HICP-  and 
manufacturing  sector  ULC-based  REER  remained 
considerably more stable. Bulgaria’s export market 
share  increased  significantly  in  2010  and  2011, 

rate  continued 

 
 
                                                           
 
Table 2.4:

Bulgaria - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

2006

-17.6

-21.0

3.5

-2.6

2.5

0.7

-16.9

20.0

23.0

1.1

1.6

-5.7

25.7

-3.1

32.1

14.5

78.1

-58.0

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, Bulgarian National Bank.

although the pace of improvement moderated with 
the slow-down in export growth towards the end of 
2011. 

Graph 2.9:Bulgaria - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

150

140

130

120

110

100

90

80

2006

2007

NEER

2008
REER, HICP deflated

2009

2010

2011

REER, ULC deflated

Source: Commission services.

Mirroring the improvement in the external balance, 
the financial account turned into a deficit by 2010. 
The  net  FDI  balance  remained  positive,  but 
diminished,  as  new  investments  were  mainly 
related  to  companies  already  present  in  Bulgaria.  
The  long-term  trend  of  net  outflows  of  portfolio 
investment  continued,  as  the  government  did  not 
issue on the international market and interest in the 
Bulgarian  stock  market  remained  weak.  The 
reduction  in  net  external  funding  of  the  banking 

Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

2007

-25.2

-23.5

3.8

-7.7

2.2

-1.9

2008

-23.1

-24.3

3.7

-5.0

2.4

0.8

-27.1

-22.3

34.2

28.7

-1.7

16.6

-9.5

43.6

-7.0

34.1

8.8

94.3

-81.1

30.5

17.5

-2.1

16.9

-1.9

32.4

-8.1

37.5

14.4

105.1

-98.4

2009

-8.9

-11.9

3.7

-3.4

2.7

1.4

-7.6

5.2

7.2

-1.8

-2.1

1.9

3.3

2.4

29.4

20.4

108.3

-101.8

(percentage of GDP)

2010

2011

-1.0

-7.7

5.6

-3.1

4.2

0.8

-0.2

-0.9

2.9

-1.8

-3.0

1.1

-1.9

1.1

22.9

22.5

102.8

-94.7

0.9

-5.1

5.9

-4.3

4.4

1.3

2.2

-3.5

3.1

-0.9

-5.3

-0.4

-3.1

1.3

23.1

24.8

91.9

-85.3

sector resulted in a significant deficit on net other 
inflows, especially in 2011. Gross external debt to 
GDP  declined  significantly  from  around  108%  at 
end-2009 to about 92% by end-2011, supported by 
strong  nominal  GDP  growth  and  repayment  of 
foreign  debt  by 
sector.  The 
improvement  was  similar  in  the  net  international 
investment  position,  but  its  negative  balance 
remained substantial. 

the  banking 

According  to  the  Commission  services’  Spring 
2012 Forecast, the external surplus is projected to 
remain unchanged in 2012, as domestic demand is 
expected to stagnate while export growth is to slow 
somewhat. 

2.6.2.  Product market integration 

through 

trade  and 

The Bulgarian economy is well integrated into the 
EU  economy 
investment 
linkages.  As  a  small  open  economy,  Bulgaria  is 
characterised  by  a  high  ratio  of  trade  openness 
reaching 70% of GDP in the recent years. In 2009, 
the  global  crisis 
temporary 
resulted 
contraction of trade openness, as external demand 
faltered and both imports and exports contracted in 
real  terms.  The  rebound  of  global  trade  in  2010 
resulted  in  an  increase  in  openness,  both  on  the 

in  a 

27 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

Table 2.5:

Bulgaria - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

48.1

28.7

9.3

18.0

2.9

-3.6

13.6

10.1

5.5

:

:

32.0

100.0

3.1

100.0

70.0

31.3

9.9

20.0

3.3

-3.4

23.5

19.6

9.9

:

:

32.0

112.2

5.7

162.0

69.3

34.1

9.2

23.4

3.5

-3.2

29.4

25.0

12.6

0.8

49.4

32.0

132.7

5.3

195.0

68.5

32.9

9.0

23.9

3.6

-2.9

18.9

16.1

8.6

0.4

42.0

49.0

154.9

6.1

150.0

51.9

25.4

8.5

15.5

4.6

-2.0

9.4

8.0

3.7

0.3

63.3

18.0

121.5

5.3

61.0

58.4

28.8

7.7

19.4

n.a.

n.a.

4.9

4.4

2.3

0.4

34.8

18.0

107.9

4.3

39.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

export and import side. This trend was maintained 
in 2011.  

and 

fuels 

shows  a  pattern  of 

Bulgaria 
intermediate 
technology  exports.  Trade  in  goods  reveals  a 
comparative  advantage  mainly  in  the  export  of 
tobacco, 
textiles,  basic  metals, 
registering a combined 60% export share in 2010. 
A  breakdown  of  exported  goods  by  product 
category  demonstrates  a  predominance  of  labour- 
and  raw-material-intensive,  low-  and  medium-
quality  goods  over  high  technology  goods.  The 
share  of  high  value-added  goods  in  exports  has 
increased slightly recently (reaching 4.6% of GDP 
in 2009), reflecting a gradual, albeit slow, upward 
shift in the economy's specialisation pattern in the 
productivity  scale  while  the  technological  trade 
deficit  almost  halved  in  2009  (-2%)  compared  to 
2005  (-3.6%).  In  the  medium-to-long  term,  the 
economy  should  move  further  away  from  labour-
intensive  sectors  towards  a  larger  reliance  on 
higher value-added sectors and services.  

FDI  inflows  were  more  than  three  times  higher 
than  the  EU  27  average  in  the  period  2005-2010. 
Bulgaria particularly benefited from lower costs of 
inputs,  especially  labour,  and  a  fairly  well-trained 
work force. FDI inflows peaked at around 29% of 
GDP in 2007 and dried up considerably during the 
global  economic  crisis  down  to  3.4%  of  GDP  in 
2010. The FDI stock was 101% of GDP at the end 
2009,  substantially  higher  than  that  in  Romania 
(42%) and the EU 27 average (70%). The EU 27 is 
the  main  contributor  to  FDI  inflows,  accounting 
for well over 85% of total FDI stock at the end of 
2009  (the  most  important  source  countries  were 
the  Netherlands,  Austria  and  Greece).  The 
dominant part of the FDI inflows went however to 
industries  serving  local  needs,  including  housing 
construction  and  trade  and  did  not  significantly 
improve the export capacity of the country. Almost 
70% of the total FDI stock at the end of 2009 was 
in  the  service  sector  (real  estate  and  business 
activities,  and  financial  intermediation),  while  the 

28 

 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

Graph 2.10:Bulgaria - Foreign ownership and concentration 
in the banking sector
(in percent, weighted averages)

90
80
70
60
50
40
30
20
10
0

BG, 2007

BG, 2010

EA, 2007

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

Financial  intermediation  in  Bulgaria  is  mainly 
indirect,  with  domestic  bank  credit  above  70%  of 
GDP  at  the  end  of  2011.  Rapid  credit  expansion 
ended  by  2009  as  changes  in  the  international 
financial  environment  constrained  access 
to 
foreign  funding  and  the  economy  started  to 
deleverage. The attractiveness of domestic deposit 
collection increased and competition among banks 
led  to  high  deposit  rates  in  some  periods.  By  the 
end  of  2011,  the  banking  sector  managed  to 
substantially  reduce 
its  reliance  on  external 
funding from the 2009 levels and most banks had 
only  small  net  external  positions.  Credit  to  non-
financial  corporations  by  the  domestic  banking 
sector increased modestly since 2009, partly due to 
accounting  reasons  (cross-border  transfers  of  debt 
owed  previously  to  non-residents).  The  share  of 
foreign  currency  loans  (predominantly  in  euro) 
increased somewhat during the past two years and 
stood  around  77%  for  non-financial  corporations 
and 40% for households at the end of 2011.  

The  Bulgarian 
financial  system  has  proved 
resilient to the international financial crisis and its 
consequences. No banking system rescue measure 
had to be taken by the government. Confidence in 
the  currency  board  arrangement  is  strong  and 
level, 
international 
supported  by  government  deposits,  which  were 
prudently  accumulated  earlier.  Contagion  from 
Greece  has  remained  limited,  despite  significant 
Greek ownership in the Bulgarian banking sector.   

remain  at  high 

reserves 

share of FDI in manufacturing (food, textile, metal 
and chemical products) was around 16%.  

House  prices  and  residential  construction  boomed 
prior to the crisis. The cumulative real house price 
growth from trough (in the second quarter of 2002) 
to  peak  (in  the  third  quarter  of  2008)  stood  at 
around 230%, with average quarterly year-on-year 
price  growth  reaching  23%.  Real  house  prices 
dropped substantially during the crisis, by close to 
40% since the end of 2008. From 2004 until 2008 
the share of residential construction in GDP tripled 
(as it went from about 2% to 6%), and readjusted 
to  about  4%  in  2010.  The  correction  in  building 
permits  started  already  in  2008,  is  still  on-going, 
and  has  been  much  sharper  than  the  correction  in 
investment. 

indicators, 

Concerning  the  business  environment,  Bulgaria 
scores  below  the  average  of  euro  area  Member 
States  in  international  rankings  (26).  Based  on  the 
World  Bank  Doing  Business 
the 
performance  of  Bulgaria  deteriorated  in  2011  in 
the  area  of  starting  a  business,  dealing  with 
construction  permits  and  registering  property,  and 
protecting  investors  and  resolving  insolvency.  In 
terms  of  income  and  corporate  tax  rates,  Bulgaria 
is  still  very  competitive  in  the  EU.  Finally, 
according  to  the  November  2011  Internal  Market 
Scoreboard,  Bulgaria  had  a  transposition  deficit 
below  the  EU  average  (0.9%  compared  to  1.2%) 
while  the  share  of  public  procurement  tenders 
announced  in  the  EU  Official  Journal  has  been 
higher  than  the  EU  average  (average  of  47.4% 
between 2007 and 2010 compared to 17.7% for the 
EU 27) (27) . 

2.6.3.  Financial market integration 

Bulgaria's  financial  sector  is  well  integrated  into 
the  EU  financial  system,  in  particular  through  a 
high  level  of  foreign  ownership  in  its  banking 
sector.  The  share  of  foreign-owned  institutions  in 
total  credit  institution  assets  remained  broadly 
stable  at  over  80%.  Bank  concentration,  as 
measured  by  the  market  share  of  the  largest  five 
credit 
total  assets,  decreased 
somewhat since EU accession, but was still above 
the euro area average in 2010.   

institutions 

in 

(26)  For  instance,  Bulgaria  ranks  on  74th  and  59th  place 
according to the 2011-2012 Global Competitiveness index 
and the 2012 World Bank Doing Business respectively. 
(27)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may  serves  as  a  proxy  of  the  extent  to  which  national 
public procurement are open to foreign bidders. 

29 

 
                                                           
 
Graph 2.11:Bulgaria - selected banking sector soundness 
indicators relatively to the euro area

30

%

25

20

15

10

5

0

BG, 2007

BG, 2011

EA, 2007

EA, H1-11

Return on equity

Capital adequacy

Non performing loans

Note: For 2007 and 2011, EU-27 non performing loans are a proxy for EA.

For 2007, EA RoE and CAR averages are unweighted.

Source: ECB, Bulgarian National Bank, EC calculations.

Slow  mortgage  lending  and  unsold  real  estate 
projects  contributed  to  declining  house  prices  in 
2011,  but  profitability  of  the  domestic  banking 
sector remained positive ever since EU accession. 
The  banking  system  is  fairly  liquid  and  well 
capitalized, with a capital adequacy ratio of 17.5% 
at  the  end  of  2011.  The  quality  of  the  loan 
portfolio  is,  however,  still  deteriorating,  with  the 
share  of  non-performing  loans  reaching  14.9%  at 
end  2011,  as  domestic  demand  recovery  has  been 
weak. 

Graph 2.12:Bulgaria - Recent development of the  
financial system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

BG, 2007

BG, 2011

EA, 2007

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.

Source: Eurostat, ECB, Bulgarian National Bank, FESE, Reuters EcoWin.

Convergence Report 2012 - Technical annex 

Chapter 2 - Bulgaria 

sector 

non-bank 

The 
remains 
financial 
underdeveloped  relative  to  the  euro  area.  Total 
assets  managed  by  insurance  companies,  though 
growing, are still very low at 4.1% of GDP at the 
end of 2010. Health insurance, in particular, is still 
characterised  by  a  very  low  penetration  rate  in 
Bulgaria.  Pension  funds  have  shown  a  somewhat 
more  dynamic  development  since  the  start  of  the 
financial  crisis,  with  total  assets  increasing  from 
3.3% of GDP in 2008 to 5.7% of GDP in 2010.  

The  deepening  of  capital  markets,  which 
progressed  considerably  during 
the  economic 
boom, came to a halt with the financial crisis. The 
capitalization  of 
the  stock  market  declined 
markedly  since  its  highs  of  2007,  but  it  regained 
more than 15% in 2011. The debt securities market 
remains  small  in  comparison  with  the  euro  area 
average and is mainly used for financing a part of 
Bulgaria's relatively low public debt. Private sector 
debt of 169% of GDP in 2010 is slightly above the 
euro area average (164.6% of GDP) (28).  

the  monetary 
Regulation  and  supervision  of 
financial  institutions  is  conducted  by  the  BNB. 
Since 1 March 2003, all players in the non-banking 
financial  sector  and  the  capital  markets  are  under 
the supervision of a single regulator, the Financial 
Supervision  Commission 
(FSC).  The  FSC 
cooperates  closely  with  the  BNB,  as  well  as  with 
international  partners, 
the 
neighbouring countries. While all FSAP directives 
have  been  transposed,  no  notification  has  been 
received  yet  by  the  European  Commission  on  the 
transposition of two of the post-FSAP directives. 

especially 

from 

(28)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

30 

 
 
 
                                                           
3.  CZECH REPUBLIC 

3.1. 

LEGAL COMPATIBILITY 

3.1.1.  Introduction 

Česká  národní  banka  (ČNB  –  central  bank  of  the 
Czech  Republic)  was  established  on  January  1, 
1993,  following  the  division  of  the  State  Bank  of 
Czechoslovakia.  Its  creation  was  based  on  the 
Czech  National  Council  Act  No.  6/1993,  adopted 
on December 17, 1992.  

The  Act  on  ČNB  was  last  amended  in  2010  and 
2011.  The  recent  amendments  did  not  introduce 
significant  changes  which  would  remove  the 
incompatibilities  or  imperfections  covered  by  the 
last Convergence Report.  

3.1.2.  Independence 

its  Board 

Article  9(1)  of  the  ČNB  Act  in  conjunction  with 
Article  II(1)(c)  of  the  Law  No  442/2000  Coll 
prohibit  ČNB  and 
taking 
instructions  from  the  President  of  the  Czech 
Republic, 
Government, 
administrative 
authorities,  European  Union 
institutions, any government of a Member State of 
the European Union or any other body. 

Parliament, 

from 

the 

According to Article 3 of the Act on the ČNB, the 
ČNB  shall  submit  a  report  on  the  monetary 
development  to  the  Chamber  of  Deputies  of  the 
Parliament  for  review.  The  Chamber  of  Deputies 
may  ask  for  a  revised  report  and  in  this  case,  the 
ČNB  will  have  to  submit  a  revised  version 
the  Chamber  of  Deputies' 
complying  with 
the 
requirements.  This 
Parliament  to  ask  for  amendments  and,  thus,  to 
influence  the  content  of  the  ČNB's  report  on  the 
monetary  development  can  affect 
the  ČNB's 
institutional independence. For this reason, Article 
3  contradicts  Article  9(1)  and  is  considered  as 
incompatible  with  Article  130  of  the  TFEU  and 
Article 7 of the ESCB/ECB Statute. 

legal  possibility 

for 

Further, Article 9(1) of the Act and Article II(1)(c) 
of  the  Law  442/2000  need  to  be  adapted  to  fully 
reflect  the  provisions  of  Article  130  of  the Treaty 
and  Article  7  of  the  Statute  and  consequently  to 
expressly  prohibit 
third  parties  from  giving 
instructions  to  the  ČNB  and  its  Board  members 
who are involved in ESCB-related tasks. 

Articles  7  and  8  of  the  Law  provide  for  the 
replacement  of  the  Governor  by  a  Vice-Governor 
nominated  by  him  in  case  of  absence.  To  ensure 
smooth and continuous functioning of the ČNB in 
case  of  expiry  of  the  term  of  office,  resignation, 
dismissal  or  other  cause  of  termination  of  office, 
the  Act  needs  to  remove  this  imperfection  and 
provide  for  procedures  and  rules  regarding  the 
successor  of  the  Governor  in  cases  of  termination 
of office. 

to 

request  modifications 

The possibility for the Chamber of Deputies of the 
Parliament 
(Article 
47(5)),  to  the  submitted  earlier  annual  financial 
report,  could  also  hamper  the  ČNB’s  institutional 
independence.  Thus, 
(and  possibly  financial) 
Article  47(5)  constitutes  a  further  incompatibility 
which should be removed from the Act. 

As  regards  the  personal  independence  of  the 
ČNB's  decision  making  bodies,  Article  6(11)-(13) 
provides  for  grounds  of  dismissal,  which  are  not 
exactly  corresponding  to  those  of  Article  14.2  of 
the  ESCB/ECB  Statute.  In  order  to  remove  this 
incompatibility  and  limit  interpretation  problems 
those  provisions  should  be  brought  in  line  with 
Article 14.2 of the ESCB/ECB Statute.  

Pursuant  to  Article  11(1)  of  the  ČNB  Act  the 
Minister of Finance or another nominated member 
of the Government may attend the meetings of the 
Bank  Board  in  an  advisory  capacity  and  may 
submit  motions  for  discussion.  Paragraph  (2)  of 
this  Article  provides  for  a  possibility  for  the 
Governor  of 
the  ČNB,  or  a  Vice-Governor 
nominated  by  him,  to  attend  the  meetings  of  the 
Government  in  an  advisory  capacity.  With  regard 
to  Article  11(1),  although  a  dialogue  between  a 
central  bank  and  third  parties  is  not  prohibited  as 
such,  it  should  be  ensured  that  this  dialogue  is 
constructed  in  such  a  way  that  the  Government 
should not be in a position to influence the central 
bank  when  the  latter  is  adopting  decisions  for 
which its independence is protected by the TFEU. 
The  active  participation  of  the  Minister,  even 
without  voting 
to  discussions  where 
monetary  policy  is  set  would  structurally  offer  to 
the  Government  the  possibility  to  influence  the 
its  key  decisions. 
taking 
central  bank  when 
Therefore,  Article  11(1)  is  incompatible  with 
Article  130  of  the  TFEU,  as  Member  States  have 
to  take  undertake  not  to  seek  to  influence  the 

right, 

31 

 
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

members  of  the  decision-making  bodies  of  the 
national central bank  

•  non-recognition of the competences of the ECB 
and of the Council on the banknotes and coins 
(Article 2(2)(b), Articles 12 to 22); 

3.1.3.  Prohibition of monetary financing 

According to Article 30(2) of the Act on the ČNB, 
the ČNB is not allowed to provide returnable funds 
or  any  other  financial  support  to  the  Czech 
Republic or its bodies or to any other authority and 
body  governed  by  public  law,  with  the  exception 
of  public  banks.  The  wording  of  this  provision 
constitutes  an  imperfection.  It  is  rather  extensive 
and does not take fully into account Article 123(2) 
of  the  TFEU.  It  provides  de  facto  a  wider 
exemption than the one foreseen in Article 123(2) 
of the TFEU, which exempts publicly owned credit 
institutions  only  'in  the  context  of  the  supply  of 
reserves by central banks'.  

In  addition,  point  1(d)  of  Section  II  of  Law  No 
442/2000 Coll. does not cover the prohibition on a 
direct  purchase  by  the  ČNB  of  debt  instruments 
from public sector entities and thus, it constitutes a  
further  incompatibility  with  Article  123(1)  of  the 
TFEU.  For  legal  certainty  reasons,  Article  30(2) 
and  point  1(d)  of  Section  II  of  Law  No  442/2000 
Coll  should  be  amended  to  ensure  the  correct 
the  field  of 
in 
application  of 
prohibition of monetary financing. 

the  EU 

law 

3.1.4.  Integration in the ESCB 

Objectives 

No  incompatibilities  with  the  TFEU  exist  in  this 
area. 

Tasks 

The  incompatibilities  in  this  area,  following  the 
TFEU provisions and ESCB/ECB Statute, include: 

•  definition  of  monetary  policy  and    monetary 
functions,  operations  and  instruments  of  the 
ECB/ESCB  (Articles  2(2)(a),  5(1)  and  23  to 
26a, 28, 29, 32, 33); 

•  conduct  of  exchange  rate  operations  and  the 
definition  of  exchange  rate  policy  (Articles  35 
and 36); 

•  holding  and  management  of  foreign  reserves 

(Article 1(4) and Articles 35(d) and 36); 

32 

•  ECB's right to impose sanctions (Article 46b). 

There are also some imperfections regarding: 

• 

the absence of reference of the role of the ECB 
and  of  the  EU  for  the  collection  of  statistics 
(Article 41); 

•  non-recognition of the role of the ECB for the 
functioning  of  the  payment  systems  (Article 
38); 

•  non-recognition  of  the  role  of  the  ECB  and  of 
the Council for the appointment of the external 
audit of the ČNB (Article 48(2)); 

•  absence  of  an  obligation  to  comply  with  the 
Eurosystem's regime for the financial reporting 
of NCB operations (Article 48); 

•  non-recognition  of  the  role  of  the  ECB  in  the 
field of international cooperation (Article 40). 

3.1.5.  Assessment of compatibility 

As  regards  the  independence  of  the  central  bank, 
the  prohibition  on  monetary  financing  and  the 
central bank integration into the ESCB at the time 
of  euro  adoption, 
in  Czech 
Republic, in particular the Act on the ČNB, is not 
fully  compatible  with  the  compliance  duty  under 
Article 131 of the TFEU. 

legislation 

the 

3.2. 

PRICE STABILITY 

3.2.1.  Respect of the reference value 

The 12-month average inflation rate for the Czech 
Republic,  which  is  used  for  the  convergence 
evaluation,  was  below  the  reference  value  at  the 
time  of  the  last  convergence  assessment  in  2010. 
Average  annual  inflation bottomed  out  at  0.3%  in 
the  second  quarter  2010,  before 
increasing 
gradually  until  early  2012.  In  March  2012,  the 
reference  value  was  3.1%,  calculated  as  the 
average of the 12-month average inflation rates in 
Sweden,  Ireland  and Slovenia  plus  1.5 percentage 
points.  The  corresponding  inflation  rate  in  the 
Czech  Republic  was  2.7%,  i.e.  0.4  percentage 
points  below  the  reference  value.  The  12-month 

 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

average  inflation  rate  is  projected  to  increase 
above the reference value in the months ahead. 

Graph 3.1:Czech Republic - Inflation criterion since 2006

(percent, 12-month moving average)

7

6

5

4

3

2

1

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Czech Republic

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

underlying price and cost pressures stemming from 
the  real  economy  were  moderate.  Since  2010, 
headline  inflation  has  been  running  well  above 
core  inflation  largely  due  to  sizeable  energy  price 
increases.  Core  inflation  was  partly  pushed  down 
by  negative  non-energy  industrial  goods  inflation 
due  to  the  volatile  but  on  the  whole  appreciating 
koruna  exchange  rate  since  2009.  Conversely, 
relatively  sharp  price  increases  in  processed  food 
since  around  mid-2010,  amid  rising  commodity 
prices  and  indirect  taxes,  drove  core  inflation 
higher. Annual average producer price inflation for 
total industry increased to 5.5% in 2011, indicating 
elevated cost price pressures related to commodity 
price increases.  

3.2.3.  Underlying  factors  and  sustainability  of 

3.2.2.  Recent inflation developments 

inflation 

Annual  HICP  inflation  in  the  Czech  Republic 
moved broadly in sync with euro area levels in the 
period  between  2004  and  late  2007.  Inflation 
spiked temporarily, but very sharply, in 2008 amid 
rising  commodity  prices  and  increases  in  indirect 
taxes  and  administered  prices.  In  2009,  when  the 
effects of large negative cost-push factors receded 
and  the  Czech  economy  entered  recession,  annual 
inflation fell sharply and briefly became negative. 
Inflation  remained  subdued  in  2010  and  for  most 
of  2011  amid  muted  domestic  demand,  while 
developments in  global  commodity  prices  and  the 
koruna's  exchange  rate  were  the  main  factors 
affecting  domestic  prices.  Headline 
inflation 
picked  up  towards  end-2011,  and  remained  at  a 
higher  level  in  early  2012,  largely  reflecting  an 
increase  in  the  VAT  preferential  rate  with  effect 
from January 2012.  

Graph 3.2:Czech Republic - HICP inflation
(y-o-y percentage change)

8

6

4

2

0

-2

2006

2007

2008

2009

2010

2011

2012

Czech Republic

Euro area

Source: Eurostat.

inflation 

(measured  as  HICP 
Subdued  core 
inflation excluding energy and unprocessed food), 
that 
averaging  1.0% 

in  2010-2011,  suggests 

Macroeconomic  policy-mix  and  cyclical 
stance 

The  Czech  economy  is  estimated  to  have  been 
operating well below its potential during the global 
economic crisis. Economic growth turned negative 
in  2009,  dragged  down  by  a  collapse  of  external 
demand. Strong exports lifted annual GDP growth 
to  positive  territory  in  2010  and  2011  (to  an 
average  of  2.2%),  but  muted  domestic  demand 
amid  the  ongoing  fiscal  consolidation  and  weak 
confidence indicators did not allow for a sustained 
recovery.  GDP  growth  is  projected  to  remain  flat 
in  2012,  affected  by  economic  weakness  in  the 
euro  area,  and  to  increase  to  1.5%  in  2013  as 
external  conditions  gradually  improve,  according 
to the Commission services' Spring 2012 Forecast. 
The  Commission  services'  estimates  suggest  a 
sizeable  negative  output  gap  to  remain  over  the 
medium term. 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural balance, has been restrictive since 2009. 
The  decline  in  the  headline  deficit  in  2010  and 
2011 reflected an improvement in both the cyclical 
and structural component, with the latter mirroring 
the  impact  of  fiscal  consolidation  measures.  The 
fiscal stance is expected to be tightened further in 
2012 and to remain stable in 2013. 

Monetary  policy,  conducted  within  an  inflation 
targeting  framework (29),  was  loosened  in  2009 
and  early  2010  in  view  of  an  improved  inflation 

(29)  As  from  January  2010,  the  inflation  target  of  the  ČNB  is 
defined  as  annual  consumer  price  index  growth  of  2% 
(with a tolerance band of ± 1 percentage point). 

33 

 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

Table 3.1:

Czech Republic - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

2.1

-2.0

9.7

0.3

1.0

3.1

0.9

1.4

4.0

3.0

-0.4

2.2

3.1

7.6

3.2

3.1

2.4

4.7

6.3

-0.2

11.0

2.1

11.0

7.6

5.8

4.3

13.6

0.6

-2.4

2.7

-1.8

0.7

2.5

0.5

0.6

6.9

1.2

-2.4

4.3

3.5

2.1

1.9

0.5

-0.1

5.0

2.1

-1.8

7.2

0.7

5.9

1.1

1.4

2.1

2.9

2.7

-1.3

7.8

0.5

6.7

1.6

2.0

2.3

4.2

2012

1000

254

142

67

195

341

790

1000

112

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices 

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

outlook  amid  the  sharp  economic  downturn.  The 
ČNB lowered the key policy rate by a cumulative 
150 basis points to 0.75% between early 2009 and 
May 2010. In 2011, ex post real interbank interest 
rates were negative due to an increase in headline 
inflation.  The  depreciation  of 
the  koruna's 
exchange rate in the second half 2011 contributed 
further to an easing of monetary conditions. Credit 
growth 
the  private  sector  slowed  down 
markedly  during  the  crisis  amid  unfavourable 
cyclical conditions, though the economy saw some 
signs of a revival in lending activity in 2011. 

to 

Wages and labour costs 

The  labour  market  was  considerably  impacted  by 
the  economic  downturn.  The  unemployment  rate 
increased  from  a  low  of  4.4%  in  2008  to  around 
7%  on  average  in  2010-2011.  Employment  fell 
markedly  in  2009-2010,  on  account  of  labour 
shedding  in  the  private  sector  and  cuts  in  the 
public  sector  workforce,  and  staged  only  a  very 
modest  recovery  in  2011.  Growth  in  nominal 
compensation per employee declined from 3.7% in 
2010 to 1.6% in 2011 amid a weakening economy, 
and an increase of around 2% is expected in 2012 
and  2013.  Labour  productivity  growth  should 
remain  broadly  flat  in  2012,  but  it  is  projected  to 
regain  some  momentum  in  line  with  a  gradual 
recovery of economic activity in 2013. As a result, 
growth  in  nominal  unit  labour  costs  (ULC)  is 
projected to remain muted in 2012-2013. 

Graph 3.3: Czech Rep. - Inflation, productivity and wage trends

12

(y-o-y % change)

9

6

3

0

-3

-6

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation

Source: Eurostat, Commission services' Spring 2012 Forecast.

The  wage-setting  process  in  the  private  sector  is 
decentralised, with wage agreements largely at the 
enterprise level. Wage developments, in particular 
in  the  private  sector,  reacted  swiftly  to  the 
economic  downturn.  Public  sector  wage  restraint 
also  contributed  to  a  moderate  growth  of  wage 
costs for the whole economy in 2010-2011. In line 
with  fiscal  consolidation  efforts  of  the  Czech 
government, 
for  2012  assumes 
continuation  of  a  freeze  in  the  public  sector wage 
bill.  In  January  2012,  the  Czech  Republic  revised 
the Employment Act and the Labour Code, which 
is expected to contribute to flexibility on the labour 
market.  

the  budget 

External factors 

Given  the  high  degree  of  openness  of  the  Czech 
Republic,  developments  in  import  prices  play  an 
important role in domestic price formation. Import 
prices,  as  measured  by  the  imports  of  goods 
deflator  in  the  national  accounts,  contributed  to 
disinflation  during  the  economic  downturn  in 
2009.  The  annual  increase  in  import  prices  is 
projected  to  pick  up  gradually  in  the  period  of 

34 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

Table 3.2:

Czech Republic - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Czech Republic

Euro area

Private consumption deflator

Czech Republic

Euro area

2.1

2.2

1.5

2.2

Nominal compensation per employee

Czech Republic

Euro area

Labour productivity

Czech Republic

Euro area

Nominal unit labour costs

Czech Republic

Euro area

Imports of goods deflator

Czech Republic

Euro area

6.0

2.5

5.6

1.9

0.4

0.8

1.1

3.9

3.0

2.1

2.9

2.2

6.3

2.6

3.5

1.3

2.6

1.4

-1.0

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

6.3

3.3

4.8

2.7

4.2

3.4

0.8

-0.3

3.4

3.8

-3.0

4.2

0.6

0.3

0.2

-0.4

-1.2

1.8

-3.5

-2.4

2.4

4.2

-2.6

-7.7

1.2

1.6

0.4

1.7

3.7

1.7

4.5

2.5

-0.7

-0.8

1.7

5.7

2.1

2.7

1.8

2.5

1.6

2.2

1.4

1.2

0.2

0.8

3.3

6.9

3.3

2.4

3.2

2.2

2.0

1.9

0.1

0.1

1.9

1.6

4.5

3.6

2.2

1.8

2.0

1.7

2.1

1.9

1.3

1.0

0.8

0.8

1.0

1.3

2010-2012. The inflationary effect of import prices 
is  expected  to  diminish  in  2013  in  line  with  the 
assumed path for commodity prices. 

Import  prices  were  driven  up  in  2010-2011  by 
volatile  –  but  on  the  whole  rising  –  global 
commodity  prices.  The  contribution  of  energy 
prices to HICP inflation increased from around 0.4 
percentage points in 2009 to around 0.8 percentage 
points on average in 2010-2011. Unprocessed food 
in  2010, 
inflation,  after 
became  negative  in  the  second  half  of  2011;  this 
reflected  easing  global  food  prices,  but  also  the 
price-dampening  effect  of  favourable  domestic 
harvest. 

increasing  markedly 

Import  price  dynamics  have  been  significantly 
influenced  by  fluctuations  of  the  koruna.  Most 
available estimates suggest that the pass-through of 
the  exchange  rate  to  inflation  in  the  Czech 
Republic  is  substantial  and  fast.  The  koruna's 
nominal effective exchange rate (measured against 
a  group  of  35  trading  partners)  strengthened  by 
about 9% between 2009 and mid-2011; this helped 
to  moderate  the  inflationary  impulses  emanating 
from  global  commodity  markets.  A  weakening 
impetus set in during the second half of 2011 amid 
a  rise  in  global  risk  aversion,  when  the  koruna's 
nominal effective exchange rate lost about 5%.  

Administered prices and taxes 

important  driver  of 

Changes  in  administered  prices  and  indirect  taxes 
have  been  an 
inflation 
dynamics  in  the  Czech  Republic  in  recent  years. 
The  contribution  of  indirect  taxes  to  headline 
inflation was particularly strong in 2008 and 2010, 
notably mirroring fiscal consolidation efforts of the 
government. The inflationary impact of changes in 
administered  prices  has  however  been  on  a 
declining trend. Administered prices had a weight 
in  the  HICP  basket  of  around  11%  in  2011,  i.e. 
down  by  about  8  percentage  points  compared  to 
2004 (30). 

Administered  price  inflation  declined  from  5%  in 
2010  to  2.9%  in  2011,  while  the  narrowing  gap 
vis-à-vis  headline  average 
inflation  remained 
positive. The administered price increases in 2011 
occurred 
a 
comparatively  low  weight  in  the  headline  index 
toll 
(rail  fares,  postal  services  and  highway 

items  with 

particularly 

for 

(30)  According to the Eurostat definition, administered prices in 
the  Czech  Republic  include  inter  alia  regulated  utility 
prices,  heat  energy,  public  transport,  pharmaceuticals, 
medical  and  social  services.  Eurostat  considers  gas  and 
electricity as a non-administered item, as the Czech Energy 
Regulatory Office sets price for these items only for part of 
the  sub-index  (transmission,  distribution  and  related 
services).  For  details,  see  http://epp.eurostat.ec.europa.eu 
/portal/page/portal/hicp/methodology/administered_prices 

35 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

outlook, further measures to increase labour supply 
and  facilitate  the  effective  allocation  of  labour 
resources  will  play  a  key  role  in  alleviating 
possible wage pressures.  

3.3. 

PUBLIC FINANCES 

3.3.1.  The  excessive  deficit  procedure  for  the 

Czech Republic 

On 2 December 2009, the Council decided that an 
excessive deficit existed in the Czech Republic in 
accordance  with  Article  126(6)  of  the  Treaty  on 
the  Functioning  of  the  European  Union  (TFEU) 
and  addressed  recommendations  to  the  Czech 
Republic in accordance with Article 126(7) with a 
view  to  bringing  an  end  to  the  situation  of  an 
excessive  government  deficit  by  2013.  In  its 
recommendations,  the  Council  invited  the  Czech 
Republic to ensure an average annual fiscal effort 
of  1%  of  GDP  over  the  period  2010-2013.  The 
Council established the deadline of 2 June 2010 for 
the  Czech  government  to  take  effective  action  to 
implement  the  deficit  reducing  measures  in  2010 
as planned in the draft budget law for 2010 and to 
outline  in  some  detail  the  consolidation  strategy 
that  will  be  necessary  to  progress  towards  the 
correction  of  the  excessive  deficit.  On  13  July 
2010  the  Council  concluded  that  the  Czech 
authorities had taken effective action to correct the 
excessive deficit and that no additional steps in the 
excessive  deficit  procedure were necessary  at  that 
stage (31).  

3.3.2.  Recent fiscal developments 

the  crisis 

progress  with 

Fiscal  policy  before 
(2006-2008) 
provided  some  pro-cyclical  stimulus  to  economic 
activity  as  the  structural  deficit  averaged  3.8%  of 
GDP  in  a  relatively  high-growth  environment. 
Good  economic  times  were  thus  not  exploited  to 
make 
consolidation. 
Worsening  economic  conditions  during  the  crisis 
put a serious strain on public finances. The general 
government deficit increased from 2.2% of GDP in 
2008  to  5.8% of GDP  in  2009,  mainly  as  a  result 
of 
the  economic  downturn  and  discretionary 
measures taken to counter the impact of the crisis. 
Faced  with  a  severe  deterioration  of  the  deficit  in 
2009,  the  Czech  authorities  decided  to  withdraw 

fiscal 

(31)  An  overview  of  all  ongoing  excessive  deficit  procedures 
at: 

can 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm 

found 

be 

indirect 

tax  changes 

stickers).  The 
in  2010 
included  a  1  percentage  point  increase  in  both 
standard  and  preferential  VAT  rates  and  rising 
excise  duties  (on  tobacco,  alcohols  and  motor 
fuels). In January 2012, the preferential VAT rate 
was  increased  by  4  percentage  points  to  14%  and 
there was a relatively modest excise duty increase 
for  cigarettes  (in  line  with  tax  harmonisation 
requirements within the EU); the first-round effect 
of  these  indirect  tax  changes  is  estimated  to  have 
contributed by around 1 percentage point to annual 
headline 
the  Czech 
government  plans  another  1  percentage  point 
increase  in  both  standard  and  preferential  VAT 
rates.  

inflation.  For  2013, 

Medium-term prospects 

Inflation  is  projected  to  remain  higher  in  2012 
compared  to  recent  years,  in  response  to  the 
preferential  VAT  rate  increase.  Domestic  price 
pressures are, however, expected to remain muted 
amid a difficult external environment and sluggish 
domestic  demand  going  forward.  Second-round 
effects 
inflation 
expectations and wage growth seem unlikely given 
the weak economy. On this basis, the Commission 
services'  Spring  2012  Forecast  projects  annual 
HICP inflation to average 3.3% in 2012 and 2.2% 
in 2013.  

increases  on 

from  price 

to 

this 

inflation  outlook  are  broadly 
Risks 
balanced.  There  are  still  some  downside  risks  to 
economic  activity,  particularly  as  the  weakness  in 
the euro area may affect the highly open economy 
through the trade channel. Conversely, upside risks 
are  mainly  related  to  a  possible  further  rise  in 
commodity prices. There is also an important two-
sided risk to inflation stemming from the koruna's 
exchange rate. 

The  level  of  consumer  prices  in  the  Czech 
Republic  was  at  some  72%  of  the  euro  area 
average in 2010, with the relative price gap widest 
for  services.  This  suggests  potential  for  further 
price  level  convergence  in  the  long  term,  as 
income levels (about 74% of the euro area average 
in  PPS  in  2010)  increase  gradually  towards  the 
euro area average. 

Medium-term  inflation  prospects  will  continue  to 
hinge upon productivity and wage developments as 
well as on the functioning of product markets (e.g. 
energy  and  telecommunication  prices).  Over  the 
longer  term,  in  view  of  the  negative  demographic 

36 

 
                                                           
 
Table 3.3:

Czech Republic - Budgetary developments and projections
Outturn and forecast 1)

2007

2008

2006

2009

Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

(as % of GDP unless indicated otherwise)

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-2.4

39.6

42.0

1.1

35.4

-1.3

-4.1

-0.1
-3.9

28.3

7.0

4.7

-0.7

40.3

41.0

1.1

35.9

0.4

-3.1

0.0
-3.1

27.9

5.7

6.5

-2.2

38.9

41.1

1.1

34.5

-1.2

-4.4

0.0
-4.4

28.7

3.1

5.8

-5.8

39.1

44.9

1.3

33.6

-4.6

-5.2

0.3
-5.6

34.4

-4.7

-1.7

-4.8

39.3

44.1

1.4

33.8

-3.4

-4.5

0.1
-4.6

38.1

2.7

-0.9

-3.1

40.3

43.4

1.4

35.0

-1.7

-2.8

-0.2
-2.6

41.2

1.7

-0.8

-2.9

40.4

43.3

1.4

35.4

-1.4

-2.1

-0.3
-1.8

43.9

0.0

-2.1

2012
-3.0

-2.0

44.0

0.2

-2.6

40.5

43.1

1.5

35.7

-1.1

-1.8

0.0
-1.8

44.9

1.5

-2.2

2013
-2.9

-2.1

45.1

1.3

2014
-1.9

-1.3

44.8

2.2

2015
-0.9

-0.6

43.4

2.8

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme. One-off and other temporary

measures in the convergence programme of April 2012 are 0.3% of GDP in 2012 and 0.1% of GDP in 2013; deficit-decreasing.

Sources: Commission services, the 2012 Convergence Programme of Czech Republic.

to 

temporary  stimulus  measures  and  start  fiscal 
consolidation  already 
in  2010.  Consolidation 
measures  included  increases  in  indirect  and  real 
estate  taxes  and  cuts  in  social  benefits.  Revenue 
shortfalls  and  expenditure  slippages  prompted  the 
government 
in 
government  consumption  in  the  course  of  2010 
amounting  to  around  0.5%  of  GDP.  Overall,  the 
ratio  declined  by  0.8 
expenditure-to-GDP 
percentage  points  to  44.1%  while  the  revenue-to-
GDP  ratio  increased  by  0.2  percentage  points  to 
39.3%,  resulting  in  a  reduction  of  the  general 
government deficit to 4.8% of GDP in 2010.  

implement  additional  cuts 

government  consumption.  The  structural  deficit 
improved  from  4.6%  of  GDP  in  2010  to  2.6%  of 
GDP in 2011. Fiscal consolidation took place in a 
period  of  a  relatively  low  growth  whereby  the 
output  gap  remained  negative  in  both  2010  and 
2011.  

While remaining still well below the 60% of GDP 
threshold,  the  debt-to-GDP  ratio  increased  from 
34.4% of GDP in 2009 to 41.2% of GDP in 2011 
mainly on account of the high government deficit.  

3.3.3.  Medium-term prospects 

than 
in 

With consolidation efforts continuing also in 2011, 
the  general  government  deficit  dropped  further  to 
3.1%  of  GDP.  This  is  a  significantly  lower 
the 
outcome 
target  of  4.2%  of  GDP 
announced 
the  Czech  Republic's  2011 
Convergence  Programme.  Higher-than-expected 
savings were  achieved  on  the  expenditure  side,  in 
particular  in  government  consumption  and  debt 
servicing. By far the largest cuts occurred in public 
investment,  which  declined  more  than  15%  year-
on-year or by 0.7% of GDP. On the revenue side, 
some  slippages  occurred,  mainly  in  VAT  and 
direct taxes but these were more than compensated 
by  the  retrenchment  in  public  investment  and 

The  budget  for  2012  was  adopted  by 
the 
Parliament  on  14  December  2011.  An  increase  in 
the  preferential  VAT  rate  is  expected  to  bring 
additional revenue of approximately 0.7% of GDP. 
A new lottery tax could boost the corporate income 
tax revenue by around 0.1% of GDP. On the other 
hand,  revenue  from  personal  income  tax  will  be 
negatively  affected  by 
tax 
allowances  for  families  with  children  (0.1%  of 
GDP).  Faced  with  worsening  macroeconomic 
conditions,  in  March  2012  the  Czech  authorities 
approved additional expenditure cuts amounting to 
0.6% of GDP. These are expected to further reduce 
the operational costs of ministries and other central 

increase 

the 

in 

37 

 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

i.e.  a  structural  deficit  of  1%  of  GDP.  The  MTO 
should  be  achieved  in  2015  according  to  the 
programme. The general government deficit is set 
to decline gradually from 3% in 2012 to 2.9% and 
1.9% of GDP in 2013 and 2014 respectively. The 
deficit  reduction  will  accelerate  in  2015  when  the 
headline deficit is set to decrease to 0.9% of GDP. 

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  the  Czech  Republic 
can be found in the forthcoming Commission Staff 
Working  Document  (32),  which  accompanies  the 
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme of the Czech Republic and delivering a 
the  2012  Convergence 
Council  Opinion  on 
Programme of the Czech Republic. 

The  Czech  Republic  has not  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU by the time of this assessment.  

3.4. 

EXCHANGE RATE STABILITY 

The Czech koruna does not participate in ERM II. 
Since  the  late  1990's,  the  ČNB  has  been  applying 
targeting  combined  with  a  floating 
inflation 
exchange  rate  regime.  The  central  bank  abstains 
from currency interventions, though the instrument 
remains available in principle.  

suffered  a 

The  exchange  rate  of  the  koruna  against  the  euro 
experienced  a  prolonged  nominal  appreciation  in 
the  period  following  EU  accession  in  2004,  amid 
significant capital inflows that helped to support a 
sustainable  economic  catching-up.  After  reaching 
an all-time-high against the euro in mid-2008, the 
koruna's  exchange 
strong 
rate 
weakening  impetus  amid  the  unfolding  global 
financial  crisis  and  the  deterioration  in  sentiment 
vis-à-vis emerging markets. The koruna recovered 
partly  in  2009  and  followed  a  broad  appreciation 
trend until mid-2011, reflecting an improvement in 
the  external  balance  and  a  rebound  in  global 
market  sentiment.  The  koruna  depreciated  in  the 
midst of renewed global capital market tensions in 
the second half of 2011, but it recovered part of the 
losses  in  early  2012.  During  the  two  years  before 
this assessment, the koruna appreciated against the 
euro by 2.8%.  

(32)  Available 

at: 

http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/convergence/programmes/2012_en.htm 

government  bodies  (expenditure  on  goods  and 
services and the wage bill). A moderate rebound in 
public investment is expected in 2012. Overall, the 
general government deficit is projected to decrease 
to  2.9%  of  GDP  in  2012  while  the  structural 
balance  will  improve  by  0.8  percentage  points 
according  to  the  Commission  services'  Spring 
2012 Forecast.  

the 

than 

Several factors are expected to affect the budgetary 
outcome in 2013. The planned introduction of the 
private  pension  pillar  is  projected  to  reduce 
revenue  from  the  social  security  contributions  by 
approximately 0.2% of GDP but this effect will be 
more 
sizeable 
compensated  by 
consolidation package (1.2% of GDP) approved by 
the  Czech  government  in  April  2012.  Main 
measures of the package which will form the basis 
for  the  2013  budget  proposal  include  a  further 
increase in both VAT rates by 1 percentage point, 
lower  indexation  of  pensions,  stricter  conditions 
for  tax  deductibility  for  the  self-employed  and  an 
increase 
tax.  The 
in 
together  with  a  modest 
consolidation  effort 
improvement  in  the  macroeconomic  conditions 
will result in a reduction of the general government 
deficit  to  2.6%  of  GDP.  In  2013,  the  structural 
balance  is  projected  to  remain  unchanged.  The 
debt-to-GDP  ratio  is  projected  to  increase  further 
over  the  forecast  horizon  reaching  around  45%  in 
2013.  

the  property 

transfer 

The budgetary projections are subject to two main 
risks.  The  first  risk  is  related  to  co-financing  of 
projects  from  the  European  Funds.  As  payments 
from  the  Funds  have  been  temporarily  suspended 
due  to  irregularities,  it  cannot  be  excluded  that 
some  projects  will  have  to  be  financed  entirely 
from  national  sources  which  could  lead  to  an 
increase  in  the  general  government  deficit.  The 
second  risk  concerns  a  law  on  church  restitutions 
currently discussed by the Parliament. Its approval 
would  lead  to  a  one-off  increase  in  the  general 
government deficit by approximately 1.5% of GDP 
in the year when the law enters into force.  

The  2012  Convergence  Programme,  covering  the 
period  2012-2015,  was  submitted  by  the  Czech 
authorities on 25 April 2012. The main goal of the 
budgetary strategy in the short term is to bring the 
government  deficit  below  the  3%  reference  value 
by  2013.  In 
the  Czech 
authorities are committed to reaching the objective 
of  a  balanced  budget  in  2016  and  to  complying 
with the medium-term budgetary objective (MTO), 

the  medium 

term, 

38 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

secondary market yields of a basket of benchmark 
government  bonds  with  an  average  residual 
maturity of around 10 years.  

The  Czech  12-month  moving  average  long-term 
interest  rate  relevant  for  the  assessment  of  the 
Treaty  criterion  stayed  below  the  reference  value 
at  each  convergence  assessment  since  EU 
accession  in  2004.  It  peaked  in  the  fourth  quarter 
of 2009 at 4.9%, but gradually declined hereafter. 
In March 2012, the latest month for which data are 
available, the reference value, given by the average 
of long-term interest rates in Sweden and Slovenia 
plus  2  percentage  points,  stood  at  5.8%.  In  that 
month, the 12-month moving average of the yield 
on the Czech benchmark bonds stood at 3.5%, i.e. 
2.3 percentage points below the reference value.  

Graph 3.6: Czech Republic - Long-term interest rate criterion

(percent, 12-month moving average)

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Czech Republic

Reference value

Source: Commission services.

Yields  on  Czech  government  bonds  broadly 
mirrored those of the euro area in the period before 
2008. The favourable inflation outlook, amidst the 
trend  appreciation  of  the  nominal  exchange  rate, 
contributed to a narrowing of the long-term spread 
vis-à-vis  the  euro  area.  In  late  2008,  long-term 
interest rate spreads widened abruptly in the midst 
the  global  crisis.  The  yields  on  Czech 
of 
government  bonds,  nonetheless, 
less 
affected than those of regional peers and declined 
markedly  in  the  period  between  2009  and  early 
2012.  This  decline  was  notably  driven  by 
downward  adjustment  in  the  expected  path  of 
interbank  rates  as  well  as  by  solid  demand  for 
the 
Czech 
comparatively 
the 
the  German 
economy.  The 
benchmark  bond  was  around  170  basis  points  in 
March 2012 (33) . 

reflecting 
fundamentals  of 

spread  against 

sovereign 

bonds, 

stayed 

strong 

Graph 3.4: Exchange rates - CZK/EUR
(monthly averages)

35

30

25

20

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

Short-term  interest  rate  spreads  vis-à-vis  the  euro 
area  were  negative  between  2006  and  late  2008, 
reflecting  the  muted  outlook  for  inflation  and 
prolonged  appreciation  pressures  on  the  Czech 
currency.  The  3-month  interest  rate  differential 
against the euro area narrowed rapidly and turned 
positive  in  late  2008  amid  the  intensifying  global 
financial  crisis  and  substantial  cuts  in  the  ECB 
policy rates.  The 3-month interest rate differential 
against  the  euro  decreased  gradually  in  late  2009 
and 2010, partly reflecting the cuts in policy rates 
of  the  ČNB.  In  May  2010,  the  ČNB  lowered  the 
main  policy  rate  to  an  all-time  low  of  0.75%,  i.e. 
25  basis  points  below  the  ECB's  key  rate.  Short-
term  interest  rate  spreads  vis-à-vis  the  euro  area 
turned negative in 2011 amid tensions in euro area 
financial  markets.    In  early  2012,  as  the  stress  in 
the  euro  area  eased,  the  3-month  interest  rate 
differential  became  positive.  Foreign  exchange 
reserves hovered at an equivalent of around 3 to 4 
months of imports in recent years. 

Graph 3.5: Czech Republic - 3-M Pribor spread to 3-M Euribor

 (basis points, monthly values)

150

100

50

0

-50

-100

-150

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

3.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  the  Czech  Republic 
used  for  the  convergence  examination  reflect 

(33)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

39 

 
  
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

Graph 3.7: Czech Republic - Long-term interest rates

3.6.1.  Developments  of 

the  balance  of 

 (percent, monthly values)

payments 

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Czech Republic

Germany

Source: Eurostat.

3.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

its 

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance  the  governance  structures  in  EMU (34). 
Related to this, in February 2012, the Commission 
published 
first  Alert  Mechanism  Report 
(AMR) (35). The AMR scoreboard showed that the 
Czech  Republic  exceeded  the  indicative  threshold 
for  two  out  of  ten  indicators,  both  in  the  area  of 
external  imbalances  and  competitiveness  (namely 
the  international  investment  position  and  the  real 
effective  exchange  rate  with  HICP  deflators).  In 
line  with  the  conclusion  of  the  AMR,  the  Czech 
Republic was not subject to an in-depth review in 
the 
Imbalance 
Procedure. 

context  of  Macroeconomic 

integration  with 

The external deficit (i.e. the combined current and 
capital  account)  declined  from  a  peak  of  3.7%  of 
GDP in 2007 to an average of around 2% in 2008-
2011. The narrowing of the external shortfall over 
the  past  years  notably  reflected  a  significant 
increase in the merchandise trade surplus, due to a 
solid  export  performance  (benefiting  from  deep 
economic 
the  euro  area, 
particularly  with  Germany),  while  imports  were 
dampened by persistently weak domestic demand. 
The  services  balance  continued  to  record  a  solid 
surplus,  notably  due  to  a  positive  contribution  of 
favourable 
balance. 
travel 
developments 
trade  balance  were, 
the 
nonetheless, 
largely  offset  by  significant  net 
income  outflows  amid  solid  FDI-related  profits 
paid  to  non-residents.  The  balance  on  current 
transfers  and  capital  account  benefited  markedly 
from inflows of EU funds over past years.  

services 

The 

in 

In  terms  of  the  saving-investment  balance,  the 
increase  in  the  external  deficit  in  the  pre-crisis 
period was mainly accounted for by an increase in 
domestic  investment.  In  2009,  both  saving  and 
investment  ratios  to  GDP  decreased  sharply;  the 
private  saving-investment  gap  fell  due  to  the 
economic  downturn  and  balance  sheet  adjustment 
in the private sector, though the rising government 
deficit partly acted as an offset. In 2010-2011, the 
saving-investment gap remained broadly stable, as 
the improvement in the fiscal balance was largely 
counterbalanced  –  amidst  the  signs  of  economic 
stabilisation  –  by  the  deterioration  in  the  private 
saving-investment balance. 

Graph 3.8: Czech Republic - Saving and investment
(in percent of GDP at market prices)

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving

Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

(34)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(35)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

External competitiveness appears to have remained 
solid, with  the  Czech  Republic  continuing  to  gain 
significant export market shares in recent years. A 
large fraction of real exchange rate fluctuations has 
been  due  to  swings  in  the  nominal  effective 

40 

 
 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

Table 3.4:

Czech Republic - Balance of payments

(percentage of GDP)

2006

2007

2008

2009

2010

2011

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

1) The combined current and capital account.

2) Including financial derivatives.

-2.0

1.8

1.5

-4.9

-0.3

0.3

-1.7

2.9

2.7

-0.8

1.1

-0.1

3.0

-1.2

27.7

25.1

36.8

-33.3

-4.3

1.3

1.6

-7.0

-0.2

0.6

-3.7

3.0

4.9

-1.5

0.1

-0.4

3.4

0.7

29.8

24.7

39.2

-40.4

-2.1

0.7

1.9

-4.6

-0.2

0.7

-1.4

1.4

1.0

-0.2

1.7

-1.0

2.5

0.0

28.9

26.0

39.2

-37.2

-2.4

2.3

2.0

-6.7

0.0

1.4

-1.1

2.3

1.0

4.3

-1.4

-1.6

3.9

-1.2

24.0

20.7

43.8

-46.2

-3.9

1.4

2.0

-7.6

0.2

0.9

-3.1

3.6

2.5

4.0

-1.8

-1.1

4.7

-0.5

25.1

20.7

47.2

-48.9

-2.9

2.5

1.7

-7.2

0.1

0.4

-2.5

2.8

2.0

0.1

0.2

0.5

2.3

-0.3

24.5

20.9

46.9

-47.4

Note: Loans for direct investment that are included in the gross external debt are currently reported in net terms by the CNB. 
Sources: Eurostat, Commission services, Czech National Bank.

exchange  rate  of  the  koruna,  while  domestic 
inflation rates remained close to those of the main 
trade  partners.  The  sharp  nominal  depreciation  in 
the second half of 2008 led to a strong weakening 
the  koruna's  real  effective  exchange  rate 
of 
deflated both by HICP and unit labour costs. These 
gains  in  price  competitiveness  were  partly  offset 
by  the  nominal  appreciation  of  the  koruna  since 
2009. 

Graph 3.9: Czech Republic - Effective exchange rates

 (vs. 35 trading partners;  monthly averages;
  index numbers, 2006 = 100)

150

140

130

120

110

100

90

80

2006

2007

2008

2009

2010

2011

NEER

REER, HICP deflated

REER, ULC deflated

Source: Commission services.

The  financial  account  surplus  picked  up  from  an 
average  of  1.8%  of  GDP  in  2008-2009  to  an 
average  of  3.2%  of  GDP  recorded  in  2010-2011. 
The  upturn  was  driven  by  higher  foreign  direct 

investment  inflows  (FDI),  linked  largely  to  an 
increase  in  reinvested  earnings.  Net  portfolio 
inflows  recovered  in  2009-2010,  but  sharply 
declined  in  2011  partly  due  to  the  absence  of 
sovereign  debt  issuance  on  foreign  markets.  In 
2011, total gross external debt broadly stabilised at 
just above 47% of GDP, broadly the same level as 
the negative net international investment position.  

According  to  the  Commission  services'  Spring 
2012  Forecast,  the  external  deficit  is  expected  to 
remain at a low level in 2012-2013, with domestic 
demand projected to recover only gradually going 
forward.  

3.6.2.  Product market integration 

through 
trade  and 
trade  openness  of 

The  Czech  economy  is  highly  integrated  into  the 
investment 
EU  economy 
linkages.  The 
the  Czech 
Republic  remains  very  high;  it  declined  sharply 
during  the  global  crisis,  but  quickly  rebounded  in 
2010  and  exceeded  70%  of  GDP  in  2011.  The 
dominant  part  of  the  trade  is  conducted  with  the 
neighbouring euro area Member States, also due to 
the  significant  foreign  direct  investment  presence. 
The  share  of  trade  with  the  EU  as  a  whole  is 
comparatively  very high (about 85% and 75% for 

41 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

Table 3.5:

Czech Republic - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

63.1

49.6

5.9

9.8

11.7

-1.2

9.0

8.5

4.2

2.5

13.2

40.0

100.0

3.4

100.0

65.5

52.6

6.1

10.7

12.7

-1.0

3.7

3.3

2.2

1.6

20.3

24.0

105.3

3.5

109.0

66.9

55.1

6.3

11.5

14.1

-0.5

5.8

4.5

2.6

3.4

17.0

17.0

121.9

4.1

111.0

63.3

51.5

6.7

12.1

14.1

-0.3

2.9

2.6

2.2

1.4

20.9

20.0

132.5

4.3

111.0

57.7

45.0

6.9

10.2

15.2

-0.5

1.4

0.8

0.6

1.2

19.6

20.0

126.3

3.7

92.0

66.3

52.2

7.2

13.4

n.a.

n.a.

3.4

3.3

2.0

1.2

21.5

20.0

123.1

4.4

71.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

exports  and  imports  respectively),  but  it  has  been 
on  a  downward  path  since  mid-2000s.  This 
tendency  seems  somewhat  more  marked  on  the 
import side, though this was line with development 
seen  for  the  EU  as  a  whole  (i.e.  due  to  a  rise  in 
imports from emerging economies). 

The gains in market shares of the Czech Republic 
were  driven  by  a  few  sectors  over  past  years, 
namely  transport,  optical  and  electrical  equipment 
–  while  a  decrease  was  recorded  inter  alia  for 
metal and textile products. A rising share of high-
tech  exports  in  total  exports  combined  with  a 
that  closes  only 
technological 
gradually,  points  to  the  significance  of  outward 
processing  trade.  High-tech  exports  have  gained 
market share over past years (e.g. computers), but 
the technologically more advanced components are 
lesser  extent 
produced  abroad  (though 
recently).  The  consolidation  of  a  good  export 
from  a  greater 
performance  would  benefit 

trade  deficit 

to  a 

technological  content  of  exports  to  build  up  non-
price  competitiveness  and  become  less  dependent 
on labour cost advantages. 

The  massive  export-oriented  FDIs  during  the  past 
to  generate  significant 
decade  have  helped 
merchandise  trade  surpluses.  The  Czech  Republic 
attracted  more  FDIs  in  the  tradable  sector  than 
most  other  Member  States  with  derogation thanks 
to  its  geographical  proximity  to  EU  core markets, 
relatively  good  infrastructure  and  highly  educated 
labour  force.  FDI  inflows  mainly  originate  in  the 
EU,  with  the  Netherlands,  Germany,  and  Austria 
accounting for more than half of the FDI stock in 
2009.  From  a  sectoral  perspective,  FDI  were 
directed  mainly  to  manufacturing,  finance  and 
insurance  (accounting  for  more  than  50%  of  the 
total  stock).  The  motor  vehicle  industry  accounts 
for 28% of the total FDI stock in manufacturing. 

42 

 
 
 
 
 
to 

though 

the  crisis, 

House prices and residential construction increased 
significantly  prior 
the 
dynamics  were  less  pronounced  than  in  other 
catching-up  Member  States.  Between  2004  and 
2008, cumulative real house price growth reached 
32%. From the peak in 2008 until the third quarter 
of  2011,  real  house  prices  declined  by  10%. 
Investment  in  residential  construction  increased 
from  3.6  %  of  GDP  in  2000  to  4.6%  of  GDP  in 
2011. The number of dwellings increased by 9.2% 
in  the  period  2001-2011,  though  the  number  of 
building  permits  has  been  on  a  downward  path 
since  2008.  The  rental  market  began  a  process  of 
gradual  deregulation  in 2006,  which  is  planned  to 
be finished by end-2012. This may contribute to a 
larger availability of apartments for rent. 

Concerning  the  business  environment,  the  Czech 
Republic  scores  below  the  average  of  euro  area 
Member  States  in  international  rankings  (36).  The 
Czech  Republic  exhibits  a  persistently  higher 
deficit  in  the  transposition  of  EU  directives  than 
the EU average. In addition, some practices in the 
area  of  public  procurement  lack  transparency  and 
suffer from  procedural  inefficiencies  –  though  the 
value  share  of  public  procurement 
(openly 
advertised in the EU Official Journal) is above the 
EU  average (37).  In  particular,  there  is  some 
tendency  to  use  simplified  procedures  for  smaller 
tenders,  which  are  just  below  the  limit  set  by  the 
EU Regulation. The authorities adopted in 2011 an 
anti-corruption  strategy  and  amendments  to  the 
public  procurement  law  (entering  into  force  in 
April  2012)  are  expected 
to 
improving competition and transparency of public 
to 
procurement.  Some 
improve 
include 
measures in the area of reduction of administrative 
burden, support for innovative start-ups and further 
development of e-Government services (38). 

to  contribute 

the  business 

environment 

initiatives 

important 

3.6.3.  Financial market integration 

The  Czech  Republic’s  financial  sector  is  highly 
integrated  into  the  EU  financial  sector.  The  main 
channel of integration is through a high degree of 

(36)  For  instance,  the  Czech  Republic  scores  on  38th  and  64th 
place  according  to  the  2011-2012  Global  Competitiveness 
index  and 
the  2012  World  Bank  Doing  Business 
respectively. 

(37)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may serve as a proxy of the extent to which national public 
procurement are open to foreign bidders. 

(38)  The Czech authorities have set a target of reduction of the 
administrative  burden  for  businesses  by  25%  over  the 
period  2005–2012  (a  reduction of  15.6%  was  achieved  by 
end-2010) 

Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

foreign ownership of financial intermediaries. The 
Czech  banks,  of  which  around  95%  belonged  to 
foreign  groups,  are  dedicated  to  a  conservative 
retail-orientated 
Bank 
business 
concentration, as measured by the market share of 
the  largest  five  credit  institutions  in  total  assets, 
remained  above  the  euro  area  average  over  past 
years. 

model. 

Graph 3.10: Czech Republic - Foreign ownership and 
concentration in the banking sector

(in percent, weighted averages)

120

100

80

60

40

20

0

CZ, 2004

CZ, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

Financial  intermediation  in  the  Czech  Republic 
remains heavily bank-based, similar to that in other 
new  Member  States.  Annual  credit  growth  to  the 
private  sector  fell  from  an  average  of  22.5%  in 
2007-2008  to  around  5%  in  2011.  In  contrast  to 
some  other  new  Member  States,  the  pre-crisis 
credit  boom  in  the  Czech  Republic  was  more 
muted  and  the  impact  of  the  global  financial 
turmoil on domestic banks remained limited. As a 
result,  domestic  bank  credit  to  the  private  sector 
relative  to  GDP  expanded  from  around  45%  in 
2008 to 50% in 2011. Banks finance their lending 
activities  primarily  through  abundant  domestic 
deposits  and  displayed  a  sound  loan-to-deposit-
ratio hovering at just below 80% in 2011. The low 
level of domestic interest rates as well as abundant 
domestic  liquidity  made  lending  in  currencies 
other  than  the  koruna  very  limited.  The  share  of 
credit  was 
foreign 
negligible for households and stood at around 17% 
of  total  loans  for  companies  in 2011.  This  feature 
makes  the  Czech  banking  system  less  exposed  to 
currency 
vulnerabilities 
mismatches. 

exchange-denominated 

stemming 

from 

The  Czech  financial  sector  has  weathered  the 
financial  crisis  well  thus  far.  Average  return  on 
equity  in  the  banking  sector  remained  high  at 
above 15% in 2011 and the capital adequacy ratio 
(CAR) increased from about 11% in 2007 to above 
15%  in  2011. The NPL  ratio  increased  during  the 
crisis, but it remains one of the lowest among the 
new  Member  States  (though  above  the  euro  area 
average). The property market declined moderately 

43 

 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 3 - Czech Republic 

during the crisis and there seems to be no evidence 
of  large-scale  mortgage  foreclosures  in  the  Czech 
Republic.  

Graph 3.11: Czech Republic - selected banking sector 
soundness indicators relatively to the euro area

%

30

25

20

15

10

5

0

Graph 3.12:Czech Republic - Recent development of the  
financial system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

CZ, 2004

CZ, 2011

EA, 2004

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.

Source: Eurostat, ECB, Czech National Bank, FESE, Reuters EcoWin.

is 

currently 

to  partially  notify 

transposition  of 
by 
examined 

While  all  Financial  Sector  Action  Plan  (FSAP) 
directives  have  been  completely  transposed,  no 
notification has been received yet by the European 
Commission  on  the  transposition  of  one  post-
three 
FSAP  directive.  The 
directives 
the 
Commission services; the Czech Republic was the 
first  Member  State 
the 
transposition  of  Solvency  II  in  the  insurance 
sector.  The  ČNB  supervises  banks,  insurance 
companies,  pension  funds  and  capital  markets. 
the 
Legal  amendments  aimed  at  broadening 
mandate  of  the  ČNB  and  regulating  the  activities 
of  credit  unions  are  under  preparation.  The  ČNB 
recently  improved  bank  reporting  requirements 
and  supervises  transactions  between  parents  and 
subsidiaries, as Czech banks remain as a whole net 
creditors to their parents. 

CZ, 2004
Return on equity

CZ, H1-11

EA, 2004

Capital adequacy

EA, H1-11
Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.
Source: ECB, IMF, EC calculations.

low. 

Market  penetration  rates  for  non-bank  services 
remain  comparatively 
In  2011,  credit 
institutions  managed  a  large  part  of  the  Czech 
financial  system's  assets  (about  77%  of  the  total), 
while  the  share  of  the  insurance  sector,  pension 
funds and other financial auxiliaries accounted for 
about  23%  of  the  total (39).  The  insurance  sector 
remains  underdeveloped  compared  to  the  euro 
area,  although  total  assets  and  the  premiums 
written  are  increasing  steadily,  largely  due  to 
comparatively low penetration in the life insurance 
segment. The financial system as a whole remains 
significantly interlinked through mutual exposures. 

Czech equity and debt markets are less developed 
compared  to  the  euro  area.  During  the  crisis,  the 
stock  market  capitalisation  gap  vis-à-vis  the  euro 
area  remained  broadly  unchanged  amid  high 
market  volatility,  as  the  Czech  market  largely 
moved  in  sync  with  global  markets.  The  total 
amount  of  outstanding  debt  securities  increased 
markedly  since  the  EU  accession,  amounting  to 
about 57% of GDP in 2011. However, both ratios 
remain well below euro area levels. Private sector 
debt,  at  around  77%  of  GDP  in  2010,  stood  well 
below the euro area average (40). 

(39)  The  depth  of  financial  intermediation  in  the  Czech 
Republic  reached  about  156%  of  GDP  in  2010,  i.e.  well 
below the euro area average. 

(40)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

44 

 
 
                                                           
 
4. 

LATVIA 

4.1. 

LEGAL COMPATIBILITY 

4.1.1.  Introduction 

The Latvijas Banka (Bank of Latvia – central bank 
of Latvia) was founded in 1922 and re-instated in 
1991,  under  the  Law  on  the  Bank  of  Latvia.  This 
Law was last amended in October 2009.  

4.1.2.  Central bank independence 

Pursuant to Article 17 of the Law on the Bank of 
Latvia,  the  Parliament  can  liquidate  the  Bank  of 
Latvia  by  means  of  a  resolution.  Any  liquidation 
pre-supposes  a  bankruptcy.  Latvia  would  have 
failed  to  guarantee  that  the  central  bank  has 
enough  financial  resources  to  ensure  the  tasks 
entrusted to it by the TFEU and thereby breach the 
principle of financial independence. Liquidation by 
means of a parliamentary resolution would breach 
the  institutional  independence  of  the  Bank  of 
Latvia. The Parliament could decide on the Bank's 
winding-up,  while  not  being  legally  obliged  to 
provide for a succeeding institution.  

As  to  the  personal  independence,  Article  22(3) 
contains an imperfection. In line with Article 14.2 
of  the  ESCB/ESB  Statute,  the  Article  should 
clearly state that if the Governor resigns before the 
term  of  office,  the  successor's  term  should  be  at 
least 5 years.  

The  grounds  for  dismissal  of 
the  Governor 
pursuant to Article 22(4) do not exactly correspond 
to  those  stated  in  Article  14.2  of  the  ESCB/ECB 
Statute.  Consequently,  Article  22  needs  to  be 
adapted to be fully compliant with Article 14.2 of 
the ESCB/ECB Statute. 

Article  28(5)  of  the  Law  provides  that  if  the 
Governor  of  the  Bank  of  Latvia  is  absent,  his  or 
her  rights  and  obligations  are  exercised  by  the 
Deputy Governor or by the person appointed by an 
express  order.  This  provision,  to  the  extent  that  a 
person who is not a member of the Bank of Latvia 
the 
Council  can  be  appointed 
Governor’s  duties, 
the 
requirement of central bank independence. Article 
28  of  the  Law  needs  to  be  adapted  to  be  fully 
compliant with Article 14.2 of the Statute.  

to  exercise 
incompatible  with 

is 

In  addition,  to  ensure  smooth  and  continuous 
functioning of the Bank of Latvia in case of expiry 
of  the  term  of  office,  resignation,  dismissal  or 
other  cause  of  termination  of  office,  the  Law  on 
the Bank of Latvia needs to provide for procedures 
and rules regarding the successor of the Governor 
in  cases  of  termination  of  office.  The  absence  of 
such provisions in the Law on the Bank of Latvia 
is an imperfection. 

According  to  Article  13,  the  Bank  of  Latvia  shall 
be independent in the adoption of its decisions and 
their  implementation  in  practice.  It  shall  neither 
seek nor take instructions from the Government or 
any  other  institution, nor  shall  it  be  subject  to  the 
decisions and regulations adopted by these bodies. 
Article  13  is  imperfect  as  it  does  not  mention 
Union  institutions,  bodies,  offices  or  agencies  as 
referred to in Article 130 of the TFEU and Article 
7  of  the  ESCB/EC  Statute.  Further,  Article  13 
needs to be adapted to fully reflect Article 130 of 
the  TFEU  and  Article  7  of  the  ESCB/EC  Statute, 
in  order  to  expressly  prohibit  third  parties  to  give 
instructions to the Bank of Latvia and the members 
of its decision making bodies.  

With  regard  to  financial  independence,  according 
to  Article  181  of  the  Law,  the  Bank  of  Latvia 
transfers  to  the  state  budget,  within  15  days 
following the approval of the annual report by the 
Council,  part  of  its  profit  calculated  by  applying 
the  tax  rate  for  residents  under  the  Law  on 
corporate income tax and a payment for the use of 
state  capital  in  the  amount  of  50%  of  the  profit. 
What  is  more,  Article  19  provides  that  the  profits 
are transferred to the reserve capital of the Bank of 
Latvia  after  the  part  of  its  profits  specified  in 
Article  181  of  the  Law  is  transferred  to  the  State 
budget.  This  provision,  as  it stands now, provides 
for  an  incompatibility  as  it  reduces  significantly 
the capacity of the Bank of Latvia to decide on the 
level  of  its  reserves,  which  limits  its  financial 
independence.  The  sequence  of  the  operations  in 
Articles 181  and 19 indicates that the contribution 
to  the  State  budget  is  very  significant  and  is 
deducted  before  any  transfer  of  profit  to  the 
reserve  capital  of  the  Bank  of  Latvia.  The  law 
should  be  amended  with  a  view  to  increasing  the 
financial independence of the Bank of Latvia. 

45 

 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

•  non-recognition of the role of the ECB and the 
EU  for  the  collection  of  statistics  (Article  39 
and 40); 

•  non-recognition of the role of the ECB for the 
functioning of the payment systems (Article 9); 

• 

rules  for  publishing  balance  sheets  and  the 
absence  of  an  obligation  to  comply  with  the 
Eurosystem's regime for the financial reporting 
of NCB operations (Article 15); 

•  non-recognition of the role of the ECB and the 
Council  for 
the  appointment  of  external 
auditors  and  lack  of  a  clear  definition  of  the 
scope  of  control  performed  by  the  audit 
commission,  whose  members  are  approved  by 
the State Audit Office (Article 43). 

4.1.5.  Assessment of compatibility 

the 

time  of  euro  adoption, 
the  central  bank  and 

As  regards  the  central  bank  integration  into  the 
ESCB  at 
the 
the 
independence  of 
prohibition  of  monetary  financing,  the  legislation 
in  Latvia  -  in  particular  the  Law  on  the  Bank  of 
Latvia  - 
the 
compliance duty under Article 131 of the TFEU. 

is  not  fully  compatible  with 

4.2. 

PRICE STABILITY 

4.2.1.  Respect of the reference value 

The  12-month  average  inflation  rate  for  Latvia, 
which is used for the convergence assessment, was 
below  the  reference  value  at  the  time  of  the  last 
convergence  assessment  in  2010.  Average  annual 
inflation declined from above 2% in early 2010 to 
-2% in August 2010, before increasing gradually to 
4.2%  by  end-2011.  In  March  2012,  the  reference 
value  was  3.1%,  calculated  as  the  average  of  the 
12-month  average 
in  Sweden, 
Ireland  and  Slovenia  plus  1.5  percentage  points. 
The  average  inflation  rate  in  Latvia  during  the  12 
months 
i.e.  1.0 
to  March  2012  was  4.1%, 
percentage  point  above  the  reference  value.  It  is 
projected to decrease below the reference value in 
the months ahead. 

inflation  rates 

4.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Article  36  of  the  Law  on  the  Bank  of  Latvia  is 
incompatible  with  the  prohibition  of  monetary 
financing  under  Article  123  of  the  TFEU.  The 
Bank of Latvia is not entitled to issue credits to the 
Government and to buy Government securities on 
the  primary  market,  but  the  scope  of  the  public 
sector entities covered in Article 36 of the  Law on 
the  Bank  of  Latvia  needs  to  be  significantly 
extended to be consistent with the list contained in 
Article 123 of the TFEU. 

4.1.4.  Integration in the ESCB 

Objectives 

There  are  no  incompatibilities  but  there  is  one 
imperfection. The wording of the Bank of Latvia’s 
primary objective (Article 3) does not fully reflect 
Article  127(1)  of  the  TFEU,  given  that  the 
objective of price stability should not be confined 
to territory of the Member State concerned. Article 
3  of  the  Law  on  the  Bank  of  Latvia  should  be 
brought  in  line  with  Article  127(1)  TFEU  and 
Article 2 of the ESCB/ECB Statute, at the latest by 
the date of euro adoption by Latvia. 

Tasks 

incompatibilities  with 

The 
ESCB/ECB tasks are as follows: 

regard 

to 

the 

•  definition  of  monetary  policy  and  monetary 
functions,  operations  and  instruments  of  the 
ESCB (Articles 26 and 34 to 38); 

•  conduct of foreign exchange operations and the 
definition  of  foreign  exchange  policy  (Article 
4); 

•  holding  and  management  of  foreign  reserves 

(Article 5(2)); 

• 

right to authorise the issue of banknotes and the 
volume of coins (Articles 4 and 34); 

•  non-recognition  of  the  role  of  the  ECB  in  the 
field of international cooperation (Article 7). 

The  imperfections  with  regard  to  the  ESCB/ECB 
tasks are as follows: 

46 

 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Table 4.1:

Latvia - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

6.6

1.6

12.6

9.3

7.6

6.7

5.1

6.2

11.8

10.1

3.3

10.4

12.3

14.4

12.9

9.7

9.8

16.6

15.3

2.7

27.3

13.7

27.4

15.4

13.8

13.6

31.8

3.3

0.0

4.0

0.4

6.8

4.7

3.5

-1.9

17.6

-1.2

-3.5

5.4

-0.1

1.0

-4.5

-2.7

-1.4

2.1

4.2

-1.0

13.5

3.8

9.1

0.5

2.4

2.7

7.3

4.1

-0.8

13.1

2.3

8.3

1.0

2.5

2.8

7.6

2012

1000

241

157

101

209

293

742

1000

143

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

Graph 4.1:Latvia - Inflation criterion since 2006
(percent, 12-month moving average)

16

12

8

4

0

-4
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Latvia

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

4.2.2.  Recent inflation developments 

In previous years, Latvia's inflation rate moved in 
a  quite  wide  range  mainly  as  a  consequence  of 
volatile  commodity  price  movements  and  a  very 
factors  were 
intense  business  cycle.  These 
amplified  by  the  composition  of  the  consumer 
basket,  which  includes  a  relatively  high  share  of 
food  and  energy  products  and  by  large  fiscal 
consolidation, significantly affecting tax rates.  

Headline  HICP  inflation  averaged  above  15%  in 
2008, with price dynamics turning around sharply 
after the intra-year collapse of demand. Significant 
nominal  wage  adjustment  and  a  correction  in 
import  prices  led  to  negative  headline  inflation 
between  October  2009  and  November  2010.  The 
inflation  rate  however  rose  from  -2.8%  in  April 
2010  to  4.8%  by  May  2011,  as  the  cycle  turned 
and  a  new  global  commodity  price  shock  set  in, 
exacerbated  by  the  impact  of  a  regional  drought. 
Average  HICP  inflation  was  -1.2%  in  2010  and 
4.2%  in  2011,  a  year  which  also  saw  significant 
indirect  tax  increases.  By  March  2012  year-on-

year  inflation  moderated  to  3.2%,  as  the  impact 
from commodity price and tax increases waned.  

Graph 4.2:Latvia - HICP inflation

(y-o-y percentage change)

20

15

10

5

0

-5

2006

2007

2008

2009

2010

2011

2012

Latvia

Euro area

Source: Eurostat.

for 

responsible 

turned  positive  only 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  has 
moved  broadly  in  parallel  with  headline  inflation 
in  recent  years  and  stood  at 1.4%  in  March 2012. 
Core  inflation  has  usually  been  around  two 
percentage  points  lower  than  headline  inflation  in 
the  past  two  years,  with  rising  energy  prices 
the  difference.  Core 
mainly 
inflation 
in  2011,  but 
processed food prices temporarily lifted it over 3% 
by  mid-year.  Non-energy  industrial  goods  prices 
continued to decline until the latest data of March 
2012. Services prices started to edge up from 2010 
after about two years of a declining trend, as signs 
of  the  recovery  gradually  got  stronger.  Rising 
commodity  prices  and  wages  started  to  feed 
through  to  services  prices  in  2011  although  the 
weaker euro also had some impact. High producer 
price inflation in 2011 and early 2012 indicates the 
existence of some cost pressure in the pipeline.  

47 

 
 
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

4.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy-mix  and  cyclical 
stance 

fiscal 

required  an  EU/IMF 

Real  GDP  growth  was  almost  10%  on  average 
between  2005  and  2007,  but  fell  to  below  -7% 
between  2008-2010.  As  credit  flows  abruptly 
reversed,  Latvia 
led 
international  financial  assistance  programme  and 
consolidation  began.  The 
ambitious 
reallocation  of  resources  to  the  tradable  sector 
created  the  basis  for  an  export-driven  recovery. 
Domestic  demand  revived  only  slowly  under  the 
fiscal 
burden  of 
consolidation,  but  from  2011  it  was  supported  by 
favourable labour market developments. Real GDP 
growth  rebounded  to  5.5%  in  2011  and  it  is 
the  Commission  services'  2012 
projected  by 
Spring Forecast to moderate to 2.2% in 2012, as a 
result of adverse external shocks, before increasing 
to  3.6%  in  2013.  Commission  services  estimate 
that  the  negative  output  gap  will  remain  sizeable 
even in 2013. 

financial  deleveraging  and 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural  balance, deteriorated until  2008, as  pro-
cyclical  fiscal  policy  contributed  to  the  boom  and 
failed to prepare for the crisis. Fiscal policy turned 
restrictive  in  2009,  when  a  huge  adjustment  was 
imposed  by  the  crisis  and  implemented  in  the 
framework  of  the  EU-IMF  assistance  programme. 
As  a  result  of  the  large  fiscal  adjustment,  the 
structural  deficit  improved  to  -3.2%  by  2011 (41). 
According  to  the  Commission  services'  Spring 
2012  Forecast,  the  structural  balance  is  projected 
to improve further to -2.2% in 2012 and to -1.7% 
in 2013. 

The  narrow  fluctuation  band  to  the  euro,  the  high 
degree  of  euroisation  and  integration  with  the 
European financial system constrain the scope and 
effectiveness  of  domestic  monetary  policy.  The 
Bank  of  Latvia  has  left  the  refinancing  rate 
unchanged at 3.5% since March 2010, but lowered 
its  marginal  lending  facility  rates  in  March  2012. 
The  reserve  requirement  was  set  at  3%  for  bank 
liabilities  above  two  years  and  5%  for  all  other 
liabilities  included  in  the  reserve  base  from 
November  2008  until  January  2012,  when  both 

(41)  The  actual  consolidation  effort  was  likely  to  be  much 
higher  during  the  crisis  than  what  is  suggested  by  the 
Commission  services'  structural  balance  estimates  which 
presumably  underestimated  the  actual  revenue  loss  in 
particular in 2009. 

48 

were lowered by 1 percentage point. In July 2010, 
the Bank of Latvia reduced the interest rate on the 
7-day deposit facility by 0.5 percentage points (to 
0.5%)  and  lowered  the  interest  rate  on  the 
overnight  deposit  by  0.125  percentage  points  (to 
0.375%)  with  a  view  to  encouraging  commercial 
banks  to  start  lending.  From  November  2010,  the 
Bank of Latvia lowered its deposit rates further to 
0.375% and 0.25% respectively. Despite abundant 
lats  liquidity  in  the  system,  these  efforts  had  only 
limited  impact  in  encouraging  banks  to  channel 
financial  resources  into  the  economy,  as  the 
banking  sector  in  general  has  been  pursuing  a 
controlled  deleveraging  strategy.  Commercial 
banks  however  turned  more  active  in  providing 
to  export-oriented 
new 
companies,  as  the  economic  situation  started  to 
stabilize and the increase in non-performing loans 
reversed in late 2010.  

in  particular 

loans, 

Wages and labour costs 

A  considerable  wage  adjustment  took  place  in 
Latvia over 2009 and 2010, with compensation per 
employee  falling  by  a  cumulative  19%  in  two 
years,  supported  by  policies  implemented  under 
the  BoP  assistance  programme.  Employment 
declined at a similarly high rate, as jobs were shed 
in  particular  in  the  construction,  manufacturing 
and public sectors. The unemployment rate started 
to  decline  from  above  20%  in  early  2010,  due 
mainly  to  employment  growth,  and  it  is  expected 
to  fall  to  close  to  13%  by  2013.  The  economic 
recovery and imported inflation in 2010 prevented 
nominal  private  sector  wages  from  falling  further 
and they started to rise again amid some tightening 
of  the  labour  market  in  2011.  After  substantial 
declines in 2009 and 2010, growth of nominal unit 
labour costs (ULC) was about 2% in 2011. Labour 
productivity growth is expected to be low over the 
next  two  years,  partly  reflecting  more  cautious 
business investment. 

flexibility 

labour  market 
during 

The  Latvian 
demonstrated 
crisis, 
substantial 
the 
underpinned  by  a  decentralised  wage-setting 
system.  That  said,  large  public  sector  wage  cuts 
indirectly supported nominal wage reduction in the 
private  sector  in  2009  and  2010.  In  2011,  public 
sector  wages  picked  up  somewhat  earlier  than 
those  of  the  private  sector,  partly  reflecting  a 
correction of earlier excessive cuts in some fields. 
In 2012-2013, wages are expected to grow broadly 
in  line  with  productivity,  but  structural  labour 
market problems, in particular regional differences 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Table 4.2:

Latvia - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Latvia 

Euro area

Private consumption deflator

Latvia 

Euro area

6.6

2.2

5.9

2.2

Nominal compensation per employee

Latvia 

Euro area

Labour productivity

Latvia 

Euro area

Nominal unit labour costs

Latvia 

Euro area

Imports of goods deflator

Latvia 

Euro area

23.2

2.5

5.9

1.9

16.4

0.8

9.6

3.9

10.1

2.1

9.9

2.2

35.1

2.6

5.8

1.3

27.7

1.4

5.7

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

15.3

3.3

16.2

2.7

15.7

3.4

-4.2

-0.3

20.7

3.8

9.7

4.2

3.3

0.3

3.2

-0.4

-12.7

1.8

-5.3

-2.4

-7.9

4.2

-6.7

-7.7

-1.2

1.6

-0.5

1.7

-5.5

1.7

4.7

2.5

-9.8

-0.8

7.6

5.7

4.2

2.7

4.9

2.5

4.2

2.2

2.0

1.2

2.1

0.8

6.1

6.9

2.6

2.4

2.6

2.2

1.7

1.9

1.5

0.1

0.3

1.6

2.5

3.6

2.1

1.8

1.8

1.7

2.2

1.9

2.4

1.0

-0.1

0.8

1.9

1.3

and skills mismatches could lead to some pressures 
within a few years, if not addressed. 

Graph 4.3:Latvia - Inflation, productivity and wage trends

(y-o-y % change)

40

30

20

10

0

-10

-20

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

External factors 

Over  the  past  two  years,  consumer  prices  were 
largely  driven  by  global  commodity  prices  and  a 
regional food price shock due to a severe drought 
in  2010.  Latvia's  small  and  open  economy  is  in 
general  highly  sensitive  to  external  impulses,  but 
the  composition  of  the  consumer  basket  and  the 
relatively  high  share  of  material 
in 
production  costs  also  aggravate  the  impact  of 
volatile  commodity  prices.  After  supporting 
disinflation  in  2009,  import  prices,  measured  by 
the  imports  of  goods  deflator  in  the  national 

inputs 

food 

subsequent 

prices.  The 

accounts,  rose  sharply  in  the  second  half  of  2010 
and early 2011, reflecting increasing world energy 
broad 
and 
stabilization in the Brent oil price (in euro terms), 
coupled with a good regional harvest in 2011, led 
to a moderation in the growth of import prices. The 
contribution  of  energy  prices  to  HICP  inflation 
was nevertheless high in 2011, with 2.1 percentage 
points on average. 

the 

lats  was  somewhat  stronger,  as 

The  nominal  effective  exchange  rate  of  the  lats, 
measured  against  a  group  of  35  trading  partners, 
remained  broadly  stable  since  the  beginning  of 
2010. Between late 2008 and early 2010, there was 
a period when the nominal effective exchange rate 
of 
the 
currencies  of  many  of  Latvia's  trading  partners 
depreciated  against  the  euro  during  this  phase  of 
the financial crisis. From May 2010, the currencies 
of  some  of  Latvia's  major  trading  partners  in 
Central and Eastern Europe depreciated against the 
euro  usually  when  the  euro  depreciated  to  the 
dollar,  which  resulted  in  a  broadly  stable  lats 
nominal effective exchange rate. Towards the end 
of  2011,  a  slight  lats  nominal  effective  exchange 
rate appreciation was evident. 

49 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Administered prices and taxes 

Medium-term prospects  

HICP  inflation  is  expected  to  remain  moderate  in 
the  context  of  relatively  weak  domestic  demand. 
The  economic  recovery  is  set  to  be  slowed  by  a 
deteriorating  external  environment,  while  tight 
credit  conditions  and  a  prudent  fiscal  policy  are 
expected  to  contain  demand  pressures  on  prices. 
The  available  data 
inflation 
expectations remained relatively well-anchored, in 
the  context  of  decreasing  headline  inflation  and  a 
worsening  economic  outlook  from  mid-2011.  The 
Commission  services'  Spring  2012  Forecast 
projects  the  average  HICP  inflation  rate  to  fall  to 
2.6%  in  2012  and  to  2.1%  in  2013,  compared  to 
4.2% in 2011.  

indicate 

that 

Risks to the inflation outlook are broadly balanced. 
Upside  risks  are  mainly  related  to  a  possible 
further  rise  in  commodity  prices,  to  which  Latvia 
is  particularly  exposed,  and  to  the  difficulty  of 
controlling wage growth if economic performance 
was to surprise positively. In case of strong output 
growth,  labour  market  conditions  could  tighten 
rapidly,  which  would  lead  to  upward  pressure  on 
wages.  Downside  risks  to  the  inflation  outlook 
could  emerge  with  a  weaker-than-expected 
recovery in Latvia or abroad.  

In Latvia, the level of final consumption prices of 
private  households  stood  at  close  to  70%  of  the 
euro area average in 2010. This suggests potential 
for  further  price  level  convergence  in  the  long 
term,  as  income  levels  (around  47%  of  the  euro-
area average in PPS in 2010) rise towards the euro-
area average.  

Medium-term  inflation  prospects  will  hinge  on 
wages growing in line with productivity. Outward 
migration  in  search  for  higher  living  standards 
could  lead  to  a  shortage  of  well  qualified  labour 
force,  which  could  drive  up  wages  in  Latvia.  On 
the  other  hand,  productivity  growth  will  largely 
in 
depend  on 
the  business 
improvements 
in  attracting  new 
environment  and  progress 
investment.  Increased  market  competition  would 
also  support 
favourable  price  developments. 
Finally,  if  the  rising  trend  of  commodity  prices 
continues  in  the  medium-term,  Latvia  would  be 
severely  affected  due  to  the  composition  of  its 
consumer  basket,  low  energy  efficiency  and  high 
material input share in production. 

Changes  in  administered  prices  and  indirect  taxes 
significantly  contributed  to  inflation  over  the  past 
two  years,  although  the  extent  of  the  contribution 
fluctuated (42). Administered prices, which account 
for about 14% of the HICP basket, to a large extent 
reflected  the  impact  of  volatile  global  energy 
prices,  transmitting  their  generally  rising  price 
trend. Indirect tax increases also raised inflation, as 
the  government  relied  partly  on  revenue-side 
measures in stabilizing public finances.  

The  annual  average  increase  of  administrative 
prices  fell  from  19%  in  2009  to  2.3%  in  2010, 
before  picking  up  again  to  7.3%  in  2011,  largely 
reflecting  the  delayed  impact  of  changes  in  the 
international  price  of  oil.  In  particular,  tariffs  for 
heat  energy  rose  significantly  in  the  first  half  of 
2010,  those  of  natural gas  in  the  summer  of  2010 
and 2011 and those of electricity in the first half of 
2011.  

the  process  of  excise 

The  indirect  tax  changes  over  the  past  few  years 
were motivated mainly by the need for rapid fiscal 
consolidation  and  a  strategy  to  rebalance  taxation 
across  bases,  as 
tax 
harmonisation  with  EU  legal  requirements  has 
been  completed(43).  In  January  2009,  the  standard 
VAT  rate  was  increased  by  3  percentage  points 
and the reduced VAT rate by 5 percentage points. 
In January 2011, there was a further VAT increase 
(of 1 percentage point for the standard rate and of 
2  percentage  points  for  the  reduced  rate)  and  a 
further  broadening  of  the  tax  base  under  the 
standard  VAT  rate.  In  addition,  excise  taxes  on 
alcohol,  tobacco  and  fuel  were  raised  from  mid-
2011.  The  effect  of  these  latter  tax  changes  is 
expected to fade from headline inflation figures by 
late  2012.  Annual  constant-tax  inflation  was  on 
average  2.7%  in  2011,  i.e.  about  1.5  percentage 
points below headline inflation. 

(42)  According to the Eurostat definition, administered prices in 
Latvia  include  inter  alia  electricity,  gas,  heat  energy, 
hospital  services,  public  transport  and  postal  services.  For 
details, 
see  http://epp.eurostat.ec.europa.eu/portal/page/ 
portal/hicp/methodology/administered_prices 

(43)  The  impact  of  indirect  tax  changes  on  inflation  is 
particularly  difficult  to  assess  during  this  turbulent  period 
of  the  Latvian  economy.  Large  excise  tax  and  VAT 
increases  in  2008  and  early  2009  may  have  had  a  lagged 
impact  on  inflation  even  in  late  2010,  as  the  tax  increases 
were not immediately fully passed on to consumers during 
the recession. 

50 

 
                                                           
4.3. 

PUBLIC FINANCES 

4.3.1.  The  excessive  deficit  procedure 

for 

Latvia  

In 

and 

the  Council  decided 

the  period  2010-2012. 

On 7 July 2009, based on a recommendation by the 
that  an 
Commission, 
excessive  deficit  existed  in  Latvia  in  accordance 
with  Article  104(6)  TEC 
addressed 
recommendations  to  Latvia  in  accordance  with 
Article 104(7) TEC with a view to bringing an end 
to the situation of an excessive government deficit. 
The Council recommended that Latvia put an end 
to  the  excessive  deficit  situation  as  rapidly  as 
possible and at the latest by  2012, by ensuring an 
average  annual  fiscal  effort  of  at  least  2¾%  of 
GDP  over 
its 
recommendation, 
the  Council  established  a 
deadline  of  7  January  2010  for  the  Latvian 
government  to  take  effective  action  and  invited 
Latvia  to  implement  the  measures  associated with 
the 16 June 2009 supplementary budget, to adopt a 
fully  articulated  2010  budget  with  high-quality 
the 
consolidation  measures  consistent  with 
envisaged  path  for  the  correction  of  the  excessive 
deficit,  and  to  broadly  outline  the  measures 
envisaged  for  2011  and  2012.    On  16  February 
2010 the Council concluded that Latvia had taken 
action  representing  adequate  progress  towards  the 
correction  of  the  excessive  deficit  within  the  time 
limits set by the Council and that no further action 
the  excessive  deficit  procedure  was 
under 
necessary, 
in 
abeyance (44).  

thereby  putting 

the  procedure 

the  European  Bank 

In  2009-2011  Latvia  benefited  from  a  medium-
term financial assistance programme with the EU, 
which  was  provided  in  conjunction  with  an  IMF 
Stand-by  agreement  and  was  also  financed  by  the 
World  Bank, 
for 
Reconstruction  and  Development,  several  EU 
countries and Norway. This assistance was subject 
to  a  number  of  policy  conditions  including  fiscal 
consolidation  and  structural  reforms  which  were 
the  Council  recommendations 
consistent  with 
under  the  EDP.  The  total  amount  of  the  available 
financing  under  the  programme  was  EUR  7.5 
billion, of which Latvia used EUR 4.5 billion or ca 
60%. Given the improving budgetary situation and 
regained  access  to  international  financial  markets 
from  June  2011,  Latvia  did  not  draw  on 

(44)  An  overview  of  all  ongoing  excessive  deficit  procedures 
can  be  found  at:  http://ec.europa.eu/economy_finance/ 
economic_governance/sgp/deficit/index_en.htm 

Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

programme financing after October 2010 (45). The 
medium-term 
financial  assistance  programme 
expired in January 2012. 

4.3.2.  Recent fiscal developments 

strong  action 

The reversal of the domestic cycle started in 2007 
and  was  aggravated  by  the  global  financial  crisis, 
significantly  affecting 
the  headline  general 
government position. The deficit rose from a close-
to-balance  headline  position  in  2007  to  4.2%  in 
2008  and  9.8%  in  2009,  despite  very  substantial 
consolidation  measures  adopted  during  2009. 
These  consolidation  efforts,  supplemented  by 
further 
in  2010  and  2011, 
nevertheless helped to put public finances back on 
a  sustainable  path.  Although  the  headline  deficit 
was  still  high  at  8.2%  of  GDP  in  2010,  this  was 
partly  a  reflection  of  sizeable  financial  sector 
stabilisation measures undertaken during the crisis. 
In  2011,  the  deficit  rapidly  declined  to  3.5%  of 
GDP,  as  the  tax-to-GDP  ratio  gradually  increased 
due to tax measures and stronger internal demand, 
ratio  declined 
while 
noticeably,  since  exceptional  costs  became  less 
sizeable  and  overall  government  expenditure  was 
kept under tight control.  

the  expenditure-to-GDP 

The  2011  budget  deficit  was  significantly  lower 
than  the  original  target  of  6%  of  GDP  in  the 
ECOFIN  Council  EDP  recommendation  of  July 
2009 and also than the target of 4.5% of GDP set 
in  the  2011  Convergence  Programme  of  Latvia. 
This outcome was achieved in spite of measures to 
support the restructuring of the Mortgage and Land 
Bank  and  to  provide  stop-gap  financing  to  the 
national  airline,  accounting  together  for  around 
¾%  of  GDP.  Without  the  impact  of  exceptional 
measures  to  support  the  banking  sector,  the 
structural  deficit  improved  by  around  3½  percent 
of GDP between 2009 and 2011.  

While  remaining  well  below  60%  of  GDP,  the 
debt-to-GDP  ratio  rose  substantially  in  particular 
in 2009 and 2010, reaching 44.7% of GDP by the 
end of 2010 reflecting high government deficits in 
these  years.  The  debt  ratio  declined  by  2 
percentage points in 2011, as the positive effect of 
the 
nominal  GDP  growth  more 
financing of the deficit and because of a buy-back 
of  government  bonds  from  the  Deposit  Guarantee 
Fund in late 2011. 

than  offset 

(45)  With  an  exception  of  the  last  tranche  of  the  World  Bank 
financing  in  amount  of  EUR  0.1  billion  to  support 
structural reforms. 

51 

 
                                                           
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

2008

2009

2010

2011

2012

2013

(as % of GDP unless indicated otherwise)

Table 4.3:

Latvia - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-0.5

37.8

38.3

0.4

30.8

0.0

-3.0

0.0
-3.0

10.7

11.2

9.2

-0.4

35.6

36.0

0.4

30.8

0.0

-4.3

0.0
-4.3

9.0

9.6

14.2

-4.2

34.9

39.1

0.6

29.7

-3.6

-6.5

0.0
-6.5

19.8

-3.3

8.2

-9.8

34.7

44.4

1.5

27.0

-8.3

-6.9

-0.3
-6.6

36.7

-17.7

-10.3

-8.2

35.7

43.9

1.4

27.5

-6.8

-5.6

-0.6
-5.0

44.7

-0.3

-9.4

-3.5

35.6

39.1

1.5

27.9

-2.0

-2.3

0.8
-3.2

42.6

5.5

-4.3

-2.1

36.0

38.1

1.7

28.2

-0.4

-1.2

1.0
-2.2

43.5

2.2

-3.1

2012
-2.1

-1.2

44.5

2.0

-2.1

34.9

37.0

1.8

27.1

-0.3

-1.7

0.0
-1.7

44.7

3.6

-1.5

2013
-1.4

-0.9

45.8

3.7

2014
-0.8

-0.7

46.7

4.0

2015
-0.3

-0.6

38.9

4.0

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme. 

There are no one-off and other temporary measures in the programme.

Sources: Commission services, the 2012 Convergence Programme of Latvia.

4.3.3.  Medium-term prospects  

The budget for 2012 was adopted by Parliament on 
15 December 2011. It targeted a deficit of 2.5% of 
GDP.  The  measures  taken  to  reach  the  deficit 
target  were  mainly  on  the  expenditure  side  and 
included: i) measures to support the nominal freeze 
of  the  wage  bill  of  the  public  sector,  ii)  limiting 
other  expenditure,  in  particular  that  of  local 
governments, iii) reducing subsidies in the area of 
road  maintenance  and  transport,  iv)  implementing 
stricter  controls  to  limit  the  duration  of  sickness 
benefits.  On  the  revenue  side  the  main  measures 
are  the  broadening  of  the  real  estate  tax  base  and 
giving municipalities the option to abolish the limit 
on  annual  increases  in  real  estate  tax  on  land,  as 
tax 
well  as  several  measures 
administration.  

to  strengthen 

Taking  into  account  these  measures  and  the  full 
year impact of tax increases that entered into force 
in  mid-2011,  the  general  government  deficit  is 
expected  to  decline  to  2.1%  of  GDP  in  2012, 
according  to  the  Commission  services'  Spring 
2012  Forecast.  Under 
the  no-policy  change 
assumption,  the  deficit  is  expected  to  remain 
broadly unchanged in 2013 as the planned increase 
in  state  contributions  to  the  funded  pension 

52 

scheme,  after  their  temporary  lowering  in  2009-
2012,  offsets  the  positive  impact  of  economic 
growth on tax revenue and unemployment outlays. 
Nevertheless, as the current policy implies several 
expenditure  restraints  (notably  freezing  of  the 
public  sector  wage  bill  in  2012  and  of  pension 
indexation in 2012-2013), the underlying structural 
balance 
improving.  The  general 
government  debt  to  GDP  ratio  is  expected  to 
moderately  increase  again  in  2012  and  2013, 
reaching  44.7%  by  the  end  of  the  period,  but  to 
decline 
the 
international  financial  assistance  programme  peak 
in 2014-2015. 

repayments  under 

thereafter  as 

is  gradually 

The  2012  Convergence  Programme,  covering  the 
period  2012-2015,  was  adopted  by  the  Latvian 
government  on  27  April  2012.  The  budgetary 
strategy  in  the  programme  confirms  the  objective 
of  correcting  the  excessive  deficit  by  the  date 
recommended  by  the  Council  (2012),  and  aims  at 
the  medium-term 
subsequently 
objective  (MTO).  The  MTO  itself  was  revised  in 
the  recent  programme  from  a  structural  deficit  of 
1.0%  of  GDP  to  a  more  ambitious  objective  of  a 
to 
structural  deficit  of  0.5%.  According 
recalculated  projections  in  the  programme  (see 
table  4.3),  the  structural  deficit  would  fall  below 

approaching 

 
 
 
 
 
1.0%  of  GDP  already  in  2013,  although  it  would 
come close to the new MTO only by the end of the 
programme  period  (46).  The  new  MTO  has  been 
updated  in  line  with  the  draft  Fiscal  Discipline 
Law  which  aims  at  strengthening 
the  fiscal 
governance  framework;  the  law  is  expected  to  be 
approved  by  Parliament  in  the  course  of  2012.  In 
terms  of  general  government  headline  deficit,  the 
targets set in the convergence programme are 2.1% 
of GDP in 2012, 1.4% of GDP in 2013, and 0.8% 
and 0.3% of GDP in 2014 and 2015. The expected 
deficit  in  2012  is  thus  in  line  with  projections  in 
the  Commission  services'  Spring  2012  Forecast, 
while  the  Commission  services'  forecast  for  2013 
is  based  on  the  assumption  of  an  unchanged 
policy.  

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  Latvia  can  be  found 
in  the  forthcoming  Commission  Staff  Working 
Document (47), 
the 
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme  of  Latvia  and  delivering  a  Council 
Opinion  on  the  2012  Convergence  Programme  of 
Latvia. 

accompanies 

which 

In  March  2012,  Latvia  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 
policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

4.4. 

EXCHANGE RATE STABILITY 

The  Latvian  lats  entered  ERM  II  on  2  May  2005, 
i.e. it has spent more than seven years in ERM II at 
the time of the adoption of this report. The central 
rate was set at the parity at which the lats had been 
re-pegged from the SDR to the euro on 1 January 

(46)  These projections should be seen against the high degree of 
uncertainty  related  to  determining  the  cyclical  position  in 
real  time,  especially  for  countries  undergoing  rapid  and 
significant structural adjustments, and the closeness of the 
structural position to the MTO in those years. 

(47)  Available 

at:http://ec.europa.eu/economy_finance 
/economic_governance/sgp/convergence/programmes/2012
_en.htm 

Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

2005 (LVL 0.702804 per EUR 1), with a standard 
fluctuation band of ±15%. Upon ERM II entry, the 
authorities  unilaterally  committed  to  maintain  a 
tighter  fluctuation  margin  of  ±1%  around  the 
central  rate.  During  the  two  years  preceding  this 
assessment,  the  official  EUR/LVL  exchange  rate 
did  not  deviate  from  its  central  rate  by  more  than 
±1%, in line with the Latvian authorities' unilateral 
commitment.  The 
additional 
indicators also does not suggest that the EUR/LVL 
exchange  rate  was  subject  to  severe  tensions  over 
the  past  two  years,  though  Latvia's  international 
financial  assistance  programme  was  in  place  until 
January 2012. 

evolution 

of 

Graph 4.4:LVL - Spread vs central rate

(as percent, daily values)

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Source: Commission services, ECB, Reuters EcoWin.

by 

band, 

influenced 

In  2007-2008,  the  nominal  exchange  rate  of  the 
lats  was  relatively  volatile  within  the  narrow 
currency 
fluctuation 
devaluation  rumours,  in  the  context  of  large 
macro-imbalances.  Initial  failure  to  stabilize  the 
situation  in  the  banking  sector  in  late  2008  led  to 
capital  outflows  that  forced  the  Bank  of  Latvia  to 
intervene  heavily  to  protect  the  value  of  the  lats. 
The December 2008 agreement on an international 
financial  assistance  package  helped 
to  calm 
markets. However, market stress returned in spring 
2009, as it became evident that the fiscal situation 
was worse  than  expected  and political  uncertainty 
hindered  an  appropriate  policy  response.  Market 
tensions  peaked  in  June  2009,  when  speculation 
about  an  imminent  lats  devaluation  drove  short-
term interest rates to over 30%. More than a third 
of Bank of Latvia's foreign assets was sold during 
the  financial  turmoil  between  February  and  end-
June  to  sustain  the  peg.  Following  the  Latvian 
authorities' supplementary budget in mid-June and 
the  disbursement  of  the  EU's  large  second  loan 
tranche in July, financial market conditions rapidly 
improved.  

The  exchange  rate  peg  did  not  come  under 
significant  pressure  over  the  past  two  years.  The 

53 

 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Payments  assistance (48).  In  June  2011,  Latvia 
successfully  returned  to  the  international  bond 
market  by  issuing  a  10-year  USD  500  million 
bond, with the achieved yield of 5.491% signalling 
good market access. This was followed by a 5-year 
USD  1  billion  issuance  in  February  2012  with 
yield of 5.375%.  

Financial  market  conditions  in  Latvia  improved 
further  since  2010,  demonstrating  resilience  to 
political  uncertainty  ahead  of  the  October  2010 
and  September  2011  parliamentary  elections. 
Rating  agencies  received  positively  the  results  of 
Latvia's  economic  stabilization  programme.  In 
December  2010,  S&P  raised  its  credit  rating  to 
BB+ and, in March 2011, Fitch upgraded Latvia to 
investment grade.  

from 

Over  the  past  two  years,  the  policy  rates  of  the 
Bank of Latvia were broadly aligned with those of 
the ECB, with the overnight deposit rate at 0.25% 
since November 2010. Abundant lats liquidity that 
resulted 
the  off-market  conversion  of 
international  programme  funds  before  2011  kept 
interbank  rates  low,  at  times  even  below  those  of 
the  euro  area,  although  the  interbank  market 
remained  illiquid  beyond  the  very  short  term. 
There  was  some  limited  tension  in  the  Latvian 
money  market  during  the  Krajbanka  insolvency 
case in late 2011, but the situation calmed down by 
early 2012. 

Graph 4.6:Latvia - 3-M Rigibor spread to 3-M Euribor

(basis points, monthly values)

2500

2000

1500

1000

500

0

-500

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

4.5. 

LONG-TERM INTEREST RATES 

For  Latvia,  the  development  of  long-term  interest 
rates  over  the  current  reference  period  is  assessed 

(48)  In  December  2011  Latvia  drew  the  second  development 
policy  loan  of  the  World  Bank's  Safety  Net  and  Social 
Sector Reform Program for an amount of EUR 100 million 
(0.5% of GDP).   

lats remained within, but for most of the time close 
to  the  weak  side  of,  its  fluctuation  band,  and  the 
Bank  of  Latvia  occasionally  had  to  intervene  to 
support  it.  From  the  beginning  of  2011,  the 
Treasury  changed  its  practice  of  converting  funds 
received from the international financial assistance 
programme with the Bank of Latvia and started to 
buy lats on the market (as it had done before mid-
2009).  The  Treasury  pre-announced 
these 
transactions  to  make  the  exchange  rate  impact 
predictable  for  market  participants.  Nevertheless, 
these  transactions  served  effectively  as  intra-band 
interventions  by  selling  foreign  exchange  from 
official reserves in exchange for lats. In early and 
late 2011, large (relative to the size of the Latvian 
lats 
market)  Treasury 
exchange rate to the strong side of the fluctuation 
band.  

transactions  drove 

the 

Graph 4.5:Exchange rates - LVL/EUR
(monthly averages)

0.8

0.7

0.6

0.5

2006

2008
Source: ECB, Reuters EcoWin.

2007

2009

2010

2011

2012

in 

total  amounting 

The  international  reserve  position  of  the  central 
bank  has  been  quite  strong  since  mid-2009  and 
covered  around  200%  of  base  money,  boosted 
the  financial 
mainly  by  disbursements  from 
assistance  programme, 
to 
around  25%  of  GDP.  The  credibility  of  the  peg 
gradually  improved  from  mid-2009,  as  indicated 
by a reversal of deposit euroisation and the return 
of  non-resident  deposits  to  the  Latvian  banking 
system.  On 
the  massive 
the  other  hand, 
deleveraging of the Latvian economy, in particular 
in  early  2009,  was  accompanied  by  large  capital 
outflows  related  to  the  reduction  of  the  banking 
sector's external funding. The continuing, but more 
moderate  outflows  in  the  financial  account  have 
been  broadly  compensated  by  the  surplus  of  the 
current  and  capital  accounts  since  mid-2009.  The 
last disbursements from the IMF and the EU under 
the  programme  took  place  in  August  2010  and 
October  2010,  respectively.  After  that,  Latvia 
opted not to ask for further funds committed by the 
EU and the IMF under the international Balance of 

54 

 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

on the basis of secondary market yields on a single 
benchmark  government  bond  with  a  residual 
maturity of about 9 years. 

Graph 4.7:Latvia - Long-term interest rate criterion

(percent, 12-month moving average)

14

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Latvia

Reference value

Source: Commission services.

The  Latvian  12-month  moving  average  long-term 
interest  rate  relevant  for  the  assessment  of  the 
Treaty  criterion  was  above  the  reference  value  at 
the  2010  convergence  assessment.  It  declined 
strongly  from  almost  13%  in  early  2010  to  below 
6%  by  end-2011.  In  March  2012,  the  last  month 
for  which  data  are  available,  the  reference  value, 
given by the average of long-term interest rates in 
Sweden  and  Slovenia  plus  2  percentage  points, 
stood at 5.8%. In that month, the 12-month moving 
average  of  the  yield  on  the  Latvian  benchmark 
bond stood at 5.8%, i.e. at the reference value.  

Graph 4.8:Latvia - Long-term interest rates

(percent, monthly values)

16

14

12

10

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Latvia

Germany

Source: Eurostat.

Long-term  interest  rate  spreads  vis-à-vis  the  euro 
area were gradually rising from their lows in 2006 
until  late  2008,  when  they  spiked  in  reaction  to 
lats  devaluation  and  Latvia's 
fears  of  a 
deteriorating  fiscal  outlook,  peaking  in  late  2009. 
Spreads compressed in 2010, as confidence in the 
currency  peg  was  regained,  fiscal  consolidation 
yielded  results  and  conversion  of  assistance 
programme  funds  created  ample  lats  liquidity. 
Against  this  background,  the  Treasury  returned  to 

the  10-year  domestic  bond  market  with  several 
smaller  issues  in  the  first  half  of  2011,  thereby 
extending the maturity profile of lats-denominated 
government  papers.  The  favourable  market  trend 
broke  in  July  2011,  as  international  financial 
markets  came  under  renewed  pressure  and  the 
temporarily 
issuance  of  10-year  bonds  was 
suspended. However, the yields on outstanding 10-
year  bonds  weathered  rather  well  the  political 
uncertainty  ahead  of  the  September  2011  early 
parliamentary election and the late 2011 turmoil in 
euro area sovereign debt markets. Spreads against 
the  German  benchmark  bond  stood  around  330 
basis points in March 2012 (49) . 

4.6.  ADDITIONAL FACTORS 

 The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account in the assessment. These additional factors 
–  including  balance  of  payments  developments, 
product  and  financial  market  integration  –  are 
important  indicators  that  the  integration  of  a 
Member  State  into  the  euro  area  would  proceed 
without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance  the  governance  structures  in  EMU,  and 
integrates  the  MIP  results  into  the  assessment. 
Related  to  this,  following  the  adoption  of  the 
legislation  establishing  the  new  procedure  for 
surveillance  and  correction  of  macroeconomic 
imbalances  (MIP) (50),  the  Commission  published 
its  Alert  Mechanism  Report  (AMR)  in  February 
2012 (51).  The  scoreboard  shows 
that  Latvia 
exceeds  the  indicative  threshold  in  two  out  of  ten 
indicators,  one  in  the  area  of  external  imbalances 
(namely  on  net  international  investment  position) 
and  one  in  the  area  of  internal  imbalances  (on 
unemployment).  Based  on  the  conclusion  of  the 

(49)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

(50)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(51)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

55 

 
 
 
                                                           
AMR, Latvia was not subject to an in-depth review 
in the context of the MIP. 

4.6.1.  Developments  of 

the  balance  of 

payments 

The  external  balance  (i.e.  the  combined  current 
and  capital  account)  reversed  in  2008-2009  from 
large deficits during the boom years to a surplus of 
around  11%  of  GDP  in  2009,  which  decreased  to 
4.9% of GDP in 2010 and 0.9% of GDP in 2011. 
The  two  most  important  drivers  of  the  external 
balance  were  the  goods  trade  deficit  and  the 
income balance. The goods trade deficit improved 
substantially  in  2008  and  2009,  but  it  started  to 
the  economic 
slowly  deteriorate  again  with 
recovery.  The  surplus  on  services  trade  kept 
improving  in  2011.  The  income  account  swung 
into surplus in 2009, reflecting the huge loan loss 
provisions  made  by  foreign-owned  banks,  but  it 
returned  to  a  deficit  in  late  2010,  as  the  banking 
sector's  loan  portfolio  started  to  stabilize.  Current 
transfers  and  capital  account  surpluses  reflected 
the net inflows from EU funds.  

regarding 

The large savings-investment gap of the pre-crisis 
years  closed  abruptly  in  2009,  with  the  sudden 
reversal  of  capital  flows  during  the  international 
financial  crisis.  Gross  savings  peaked  in  2009, 
amid  high  uncertainty 
future 
prospects  for  the  economy.  In  contrast,  gross 
public  sector  saving  relative  to  GDP  fell  in  2009 
and increased in 2010 and 2011, when confidence 
returned  and  the  private  sector  gradually  reduced 
its savings. Following the substantial fall in 2008-
2009  (albeit  from  very  high  levels),  investment 
activity started to recover in 2010 and 2011, but it 
remained well below pre-crisis levels.    

the 

Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

effective exchange rate depreciated substantially in 
2009-2010,  but  it  appreciated  somewhat  in  2011 
both deflated by HICP and ULC. The overall real 
exchange  rate  correction  is  even  larger  when  the 
ULC of manufacturing sector is used as a deflator. 
The  nominal  effective  exchanged  rate  helped  to 
improve  cost  competitiveness  in  2009  and  2010, 
but  worked  somewhat  against  it  in  2011 (52). 
Latvia’s goods export market shares in both world 
and EU trade increased in 2010-2011, but the share 
of  its  combined  goods  and  services  exports  with 
regard to its markets increased at a lesser rate. The 
growth in export market share was also supported 
by  non-price  competitiveness  improvements,  such 
as quality upgrades and product differentiation. 

Graph 4.10:Latvia - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

160

140

120

100

80

2006

2007

NEER

2008
REER, HICP deflated

2009

2010

2011
REER, ULC deflated

Source: Commission services.

The  balance  of  payments  assistance  granted  to 
Latvia under the EU-IMF programme of late 2008 
was  successfully  concluded  by  early  2012.  Latvia 
borrowed  altogether  about  EUR  4.5  billion  out  of 
the total EUR 7.5 billion that was available under 
the programme. In confidence of its policies and of 
its  regained  market  access,  Latvia  has  not 
requested a follow-up programme. 

Graph 4.9:Latvia - Saving and investment
(in percent of GDP at market prices)

50

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

External  cost  competitiveness  has 
improved 
markedly  between  2008  and  2011,  followed  by  a 
stabilization  amid  stronger  demand  from  Latvia’s 
export markets and rising import prices. The real-

56 

in 

the 

financial  account 

Outflows 
(without 
reserves)  have  continued  since  2008,  although  for 
varying reasons and at a more moderate pace until 
the  last  quarter  of  2011.  The  net  FDI  balance  has 
improved  considerably  from  2009,  favourably 
affected  by  better  financial  results  in  the  banking 
sector.  Net  other  inflows  turned  negative  during 
the  crisis,  despite 
the 
international  financial  assistance.  This  reflected 
mainly  the  repayment  of  net  external  funding  of 
the  banking  sector,  which  was  very  high  also 
towards the end of 2011. Non-resident banking, an 
important  service  industry  in  Latvia,  recovered 

the  disbursements  of 

(52)  The reference group of 36 trade partners used in this NEER 
this 

include  Russia,  making 

calculation  does  not 
comparison unfavourable to Latvia.   

 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Table 4.4:

Latvia - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Of which International financial assistance

                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

2006

-22.5

-25.7

3.3

-2.7

2.4

1.2

-21.3

20.7

7.5

0.2

22.9

-9.9

30.6

0.6

39.1

16.5

114.5

-69.3

2007

-22.4

-24.0

3.5

-3.2

1.3

2.0

-20.4

21.2

6.8

-2.4

20.2

-3.4

24.7

-0.8

40.0

17.6

128.1

-74.5

2008

-13.2

-17.8

4.0

-1.6

2.2

1.5

-11.7

13.5

3.1

1.1

7.3

4.2

2.0

11.5

-1.8

31.2

18.1

130.0

-79.0

(percentage of GDP)

2009

2010

2011

8.6

-7.1

6.0

6.3

3.4

2.4

11.1

-11.8

0.6

0.7

-8.1

12.5

-5.0

-6.8

0.8

20.5

29.1

156.5

-83.0

3.0

-7.1

6.1

0.3

3.6

1.9

4.9

-5.5

1.5

-0.9

-2.0

6.1

-4.0

-1.5

0.5

20.9

23.9

165.4

-80.8

-1.2

-9.9

6.6

-0.9

3.1

2.1

0.9

-0.3

5.2

-2.3

-7.7

0.5

4.5

-4.8

-0.6

26.2

25.0

145.9

-72.8

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, Bank of Latvia.

strongly  from  2009,  although 
the  European 
financial  market  turmoil  and  the  bankruptcy  of 
Krajbanka  caused  some  headwind  in  late  2011. 
Gross  external  debt  to  GDP  rose  significantly  to 
around 165% by 2010, but it fell sharply in 2011, 
supported  by  strong  nominal  GDP  growth  and  by 
further repayment of inter-company bank funding. 
The  improvement  in  the  international  investment 
position  was  more  modest  and  the  negative  net 
position remained substantial. 

According  to  the  Commission  services'  2012 
Spring  Forecast,  the  external  balance  is  projected 
to remain in a small surplus in 2012 and to decline 
towards balance in 2013, as domestic demand will 
continue  to  recover,  although  at  a  more  moderate 
pace than in 2011. 

4.6.2.  Product market integration 

through 

trade  and 

The  Latvian  economy  is  well  integrated  into  the 
EU  economy 
investment 
linkages.  Latvia  is  a  small  open  economy  with 
increasing  trade  openness  since  its  EU  accession 
(except  for  a  set-back  during  the  crisis  of  2008-
2009), although the share of exports of goods and 
services  to  GDP  is  still  lower  than  in  the  other 

Baltic countries. In 2009, the global crisis resulted 
in  a  temporary  contraction  of  trade  openness,  as 
external  demand  faltered  and  financial  flows 
reversed.  The  rebound  of  global  trade  in  2010-
2011  resulted  in  an  increase  in  openness.  Trade 
integration with the EU is progressing and there is 
a clear reallocation in the long-term of import and 
export  shares  from  Russia  to  EU  trade  partners, 
especially  the  neighbouring  countries.  The  main 
trading partners within EU 27 remained Lithuania, 
Estonia  and  Germany,  while  Russia  remained  the 
main trading partner outside EU 27.  

to 

are 

pointing 

developments 

Latvia  still  has  a  predominant  specialization  in 
technology  products,  although 
medium-to-low 
there 
an 
improvement  of  the  trade  structure  toward  some 
products.  The 
medium-to-high 
technology 
in  machinery, 
cumulated  shares  of  exports 
electrical,  optical 
equipment  
increased  in  the  last  couple  of  years  to  24%  in 
2010  (compared  to  15%  in  2005),  while  their 
cumulated imports shares increased from 34.7% in 
2005  to  almost  40%  in  2007  and  then declined  to 
29%  in  2010  as  a  result  of  the  contraction  of 
investment demand, deleveraging and a temporary 

transport 

and 

57 

 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Table 4.5:

Latvia - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

55.4

32.6

6.2

10.4

3.2

-2.9

4.4

2.8

1.6

1.1

60.1

16.0

100.0

2.5

100.0

55.8

33.1

6.3

11.0

4.2

-3.0

8.4

6.1

3.1

0.5

96.7

16.0

165.5

3.4

133.0

52.6

31.0

6.1

10.0

4.6

-2.4

8.1

7.0

3.8

0.6

63.0

16.0

209.8

4.7

140.0

50.0

28.4

6.2

10.6

4.6

-2.0

3.8

3.0

1.7

0.5

61.1

16.0

161.4

4.6

54.0

44.7

24.4

6.3

9.5

5.3

-1.1

0.4

-2.3

-1.1

0.4

42.1

16.0

93.0

3.2

33.0

54.5

32.1

6.3

12.4

n.a.

n.a.

1.6

1.1

0.5

0.4

57.3

16.0

89.4

2.0

28.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

slow  down  of  FDI  inflows  after  the  beginning  of 
the international financial crisis.  

relatively  low  income  taxes  and  a  flexible  labour 
market. 

FDI inflows peaked at around 8% of GDP in 2007 
due  to  single  market  integration  and  privatisation 
policies, but almost evaporated in the aftermath of 
the  financial  crisis,  before  rebounding  slightly  in 
2010 and more markedly in 2011. The FDI stock at 
the end of 2010 was 45% of GDP, relative to 37% 
in  Lithuania  but  lower  than  the  EU  27  average 
(70%),  pointing 
convergence 
potential in this area. FDI inflows mainly originate 
in  the  EU,  with  Sweden,  the  Netherlands  and 
Estonia  accounting  for  37%  of  the  FDI  stock  at 
end-2011.  The  overwhelming  majority  of  the  FDI 
stock was channelled into the service sector, while 
the share of manufacturing sector was only around 
12%.  The  main  competitive  advantages 
in 
attracting FDI inflows in the medium term include 
the  lower  labour  cost  vis-à-vis  the  EU  average, 

additional 

to 

Between  2001  and  2007,  real  house  prices 
experienced  double-digit  increases  in  most  years. 
The price upswing was strikingly large even when 
compared  to  other  catching-up  Member  States. 
From the peak to the trough in the first quarter of 
2010, real house prices decreased by a cumulative 
51%. Residential construction was very responsive 
to  house  price  developments,  and  increased  from 
about  1.4%  of  GDP  in  2003  to  4.8%  of  GDP  in 
2007,  before  adjusting  rapidly  in  the  downswing 
phase to 2% of GDP in 2010. A significant shift of 
resources  from  construction  and  real  estate  to 
manufacturing  and  transport  sectors  took  place  in 
recent years and seems to be still ongoing. 

the  business  environment,  Latvia 
Concerning 
scores broadly in line with the average of euro area 

58 

 
 
 
 
 
taxation, 

Member  States in  international  rankings  (53).  A 
large number of measures was adopted in 2010 and 
2011 to help micro companies and self-employed, 
especially  through  reducing  start-up  costs  related 
to 
legal  requirements  and  financial 
reporting. As a result, there has been a significant 
growth of new companies in Latvia in the last two 
years. The civil justice system is rather inefficient 
in  Latvia,  with  large  case  backlogs  and  lengthy 
proceedings.  A  major  reform  enacted  in  this  area 
was  the  adoption  of  a  new  insolvency  law  that 
streamlines  the  insolvency  process  and  introduces 
a reorganization option for companies, though the 
need  for  some  adjustment  is  already  evident. 
Further  reforms  include  the  improvement  of  the 
procedures related to the registration of properties 
and  the  reduction  of  the  number  of  days  to  get  a 
permanent 
Finally, 
according  to  the  November  2011  Internal  Market 
Scoreboard,  Latvia  registers  one  of  the  lowest 
transposition deficits in the EU (0.4% compared to 
an EU average of 1.2%) while the share of public 
procurement tenders announced in the EU Official 
Journal is significantly higher than the EU average 
(average  of  63.4%  between  2005  and  2010 
compared to 17.7% in the EU average) (54). 

connection. 

electricity 

4.6.3.  Financial market integration 

Latvia's financial sector is well integrated into the 
EU financial system, particularly through its strong 
linkages  with  Nordic  financial  groups.  The  share 
of  foreign-owned  credit  institutions  in  total  credit 
institution  assets  has  increased  considerably  since 
EU accession. Bank concentration, as measured by 
largest  five  credit 
the  market  share  of 
institutions in total assets, was above the euro area 
average in 2010.  

the 

(53)  For instance, Latvia ranks on 64th and 21st place according 
to  the  2011-2012  Global  Competitiveness  index  and  the 
2012 World Bank Doing Business respectively. 

(54)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may  serves  as  a  proxy  of  the  extent  to  which  national 
public procurement are open to foreign bidders. 

Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

Graph 4.11:Latvia - Foreign ownership and concentration in 
the banking sector

(in percent, weighted averages)

80
70
60
50
40
30
20
10
0

LV, 2004

LV, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

in 

the 

stable 

the  banking  sector  shifted 

Financial  intermediation  in  Latvia  is  performed 
predominantly  by  commercial  banks.  Rapid 
form  of  an 
financial  deepening  – 
unsustainable  credit  boom  –  ended  abruptly  in 
to  a 
2008  and 
deleveraging  strategy,  motivated  by 
funding 
pressures and a deterioration in asset quality. Even 
foreign-owned 
funding 
banks  with 
possibilities  increased  emphasis  on  local  deposit 
collection and aimed to reduce the loan-to-deposit 
ratios  of  their  Latvian  subsidiaries.  Nevertheless, 
the  credit  contraction  abated  in  2011  as  house 
prices bottomed out and lending to export-oriented 
companies  and  household  mortgages  started  to 
recover.  The  share  of  foreign  currency  lending, 
almost  entirely  in  euro,  increased  further  during 
the  crisis  and  reached  around  90%  in  the  private 
sector  by  end-2011.  The  intermediation  of  non-
resident  savings,  which  represents  an  important 
business for domestic banks, recovered quickly as 
confidence in the stability of the Latvian financial 
system  returned  in 2009.  The  reliance  on  external 
funding, the main past vulnerability of the Latvian 
banking system, was reduced further over the past 
two years, but it remains substantial. 

to 

the 

and 

leading 

financial 

ambitious 

assistance 

Latvia's financial system has been heavily affected 
the 
crisis, 
by 
nationalisation of Parex Banka, the second biggest 
bank  in  the  country  at  that  time.  Confidence 
gradually  returned,  in  particular  after  mid-2009, 
supported  by  large  disbursements  of  international 
financial 
fiscal 
consolidation  and  structural 
reforms.  Latvia 
achieved progress in dealing with Parex Banka by 
splitting it into a viable (Citadele) and a resolution 
bank  and  initiated  the  privatisation  of  Citadele 
along with the commercial assets of Mortgage and 
Land  Bank.  The  Latvian  financial  supervisor 
decided in November 2011 to limit the operations 
bankruptcy 
to 
and 
proceedings  against  Krajbanka,  a  subsidiary  of 
Snoras Bank, after Snoras was nationalised by the 

subsequently 

initiate 

59 

 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 4 - Latvia 

The  non-banking  part  of  the  Latvian  financial 
sector  remains  small  compared  to  the  euro  area 
average and has grown only slowly. The dynamic 
increase in second pillar pension savings ended in 
2009 with the partial redirection of social security 
contributions  to  the  budget.  The  accumulated 
second-pillar pension savings amounted to around 
6.5% of GDP at the end of 2010. Voluntary private 
pension fund savings amounted to less than 1% of 
GDP  at  the  end  of  2010.  Assets  managed  by  life 
and  non-life  insurance  companies,  respectively  at 
below  1%  and  about  2%  of  GDP,  are  still  low, 
even in comparison to other new Member States. 

The Riga stock exchange belongs to the NASDAQ 
OMX  group  and  uses  a  single  trading  platform 
together with other exchanges in the Baltic-Nordic 
region.  Nevertheless,  the  stock  market  plays  a 
marginal  role  in  the  financing  of  the  Latvian 
economy.  The  debt  securities  market  remains 
dominated by government issuances and represents 
only  a  limited  source  of  funding  for  private 
companies. Private sector debt of 141% of GDP in 
2010 is still below the euro area average (55). 

Regulation  and  supervision  of  all 
financial 
institutions  is  carried  out  by  the  Financial  and 
Capital Market Commission. In the context of the 
international 
financial  assistance  programme, 
financial  supervision  has  been  strengthened 
considerably.  Cooperation  with  home  country 
supervisors  has  been  further  enhanced.  The 
supervision  of  the  non-resident  banking  business 
poses  additional  challenges  to  the  regulator,  inter 
alia, due to the cross-border nature of transactions. 
the 
Latvia  achieved 
transposition of the FSAP directives and is on the 
way of completing transposition of the post-FSAP 
directives. 

full  compliance  with 

an 

and 

Lithuanian  government 
insolvency 
procedure was launched amid allegations of fraud. 
Krajbanka  had  a  market  share  of  3.4%  and  its 
depositors  were  compensated  from  the  deposit 
guarantee fund. 

Graph 4.12:Latvia - selected banking sector soundness indicators 
relatively to the euro area
25

%

20

15

10

5

0

-5

-10

-15

LV, 2004

LV, 2011

EA, 2004

EA, H1-11

Return on equity

Capital adequacy

Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.
Source: ECB, Financial and Capital Market Commission, EC calculations.

The banking sector recorded a considerable loss in 
2011,  due  mainly  to  new  provisions  for  doubtful 
and  bad  loans  in  the  last  quarter.  However,  the 
surge of non-performing loans (due over 90 days) 
reversed  since  the  second  half  of  2010  and  their 
level  reached  17.2%  at  the  end  of  2011.  The 
Latvian banking sector is well capitalized thanks to 
additional  capital  increases  by  the  owners  during 
the  recession.  The  average  capital  adequacy  ratio 
of the banking sector reached 17.4% at the end of 
2011. 

Graph 4.13:Latvia - Recent development of the  financial 
system relatively to the euro area

200
180
160
140
120
100
80
60
40
20
0

(in percentage of GDP)

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

LV, 2004

LV, 2011

EA, 2004

EA, 2011

Note: Debt  Securities other than shares, excluding financial derivatives.

Source: Eurostat, ECB, Bank of Latvia, Nasdaq OMX Riga, Reuters EcoWin.

(55)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

60 

 
 
 
 
                                                           
5. 

LITHUANIA 

5.1. 

LEGAL COMPATIBILITY 

5.1.1.  Introduction 

The Lietuvos Bankas (Bank of Lithuania – central 
bank  of  Lithuania)  was  founded  in  1922  and  was 
re-established  in  March  1990.  The  Law  on  the 
Bank  of  Lithuania  constitutes  the  legal  basis  for 
the  establishment  of  the  Bank  of  Lithuania.  This 
Law  was  amended  several  times  since  the  last 
Convergence Report of 2010.  

5.1.5.  Assessment of compatibility 

All incompatibilities have been removed gradually, 
the  previous  Convergence 
as  confirmed  by 
Reports.  

There  is  one  imperfection  with  regard  to  central 
bank independence, given that Article 14(4) of the 
Law  on  the  State  Audit  Office  should  be  fully 
brought in line with Article 27.1 of the ESCB/ECB 
Statute. 

5.1.2.  Central bank independence 

5.2. 

PRICE STABILITY 

Pursuant  to  Article  14(4)  of  the  Law  on  the  State 
Audit Office (last amended on 17 November 2011 
–  Law  No  XI-1706),  the  State  Control  (a  public 
state audit office) can conduct a public audit of the 
performance of the activities of the Bank provided 
for in the Law on the Bank of Lithuania, including 
activities  related  to  the  supervision  of  financial 
market,  as  far  as  this  does  not  conflict  with  the 
the 
legal  acts  of 
objectives  and  tasks  of  the  ESCB  established 
therein,  and  if  does  not  infringe  the  ESCB's 
confidentiality  and 
legal 
certainty reasons, the law should clearly define the 
scope  of  control  conducted  by  the  State  Control, 
without  prejudice  to  the  activities  of  the  Bank  of 
Lithuania's 
auditor 
competences,  as  provided  in  Article  27.1  of  the 
ESCB/ECB Statute. 

the  European  Union  and 

independence.  For 

independent 

external 

5.2.1.  Respect of the reference value 

The 12-month average inflation rate for Lithuania, 
which is used for the convergence evaluation, has 
been above the reference value at the time of each 
convergence  assessment  since  2006.  Having 
declined  from  above  11%  at  the  end  of  2008  to 
below  1%  in  June  2010,  average  annual  inflation 
started to increase gradually in late 2010, peaking 
at  above  4%  in  November  2011.  In  March  2012, 
the  reference  value  was  3.1%,  calculated  as  the 
average of the 12-month average inflation rates in 
Ireland, Sweden and Slovenia, plus 1.5 percentage 
in 
points.  The  corresponding 
Lithuania  was  4.2%,  i.e.  1.1  percentage  points 
above  the  reference  value.  The  12-month  average 
inflation  is  projected  to  approach  the  reference 
value in the months ahead. 

inflation 

rate 

5.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

No incompatibilities and imperfections exist in this 
area. 

5.1.4.  Integration in the ESCB 

Objectives 

The  objectives  of  the  Bank  of  Lithuania  are 
compatible with the TFEU. 

Tasks 

No incompatibilities and imperfections exist in this 
area. 

Graph 5.1:Lithuania - Inflation criterion since 2006

(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Lithuania

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

5.2.2.  Recent inflation developments 

Inflation  in  Lithuania  has  been  very  volatile  in 
large 
recent  years, 

in  particular 

reflecting 

61 

 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Table 5.1:

Lithuania - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

3.8

-0.1

7.6

8.0

2.7

4.8

2.4

3.8

6.2

5.8

-0.2

6.8

8.6

10.5

6.8

5.2

5.5

9.7

11.1

1.8

17.9

15.3

15.8

12.2

9.3

10.1

17.0

4.2

0.2

8.2

3.1

5.8

5.8

3.7

0.2

15.8

1.2

-2.9

10.4

-2.3

5.3

-1.5

0.0

-0.3

6.6

4.1

-0.7

12.0

5.0

7.0

1.3

2.4

4.2

5.0

4.2

0.0

11.4

4.3

6.6

1.9

2.7

4.3

5.9

2012

1000

243

164

113

232

248

723

1000

167

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices 

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

variations in the inflation contributions of services, 
food  and  energy,  which  together  represent  around 
75% of the HICP basket. Changes in administered 
prices  and  taxation  further  amplified  inflation 
volatility.   

Annual  HICP  inflation  peaked  at  above  12%  in 
mid-2008  and  then  decreased  rapidly  throughout 
2009  as  the  economy  moved  into  recession. 
Following  a  marginal  year-on-year  decline  in  the 
price level in early 2010, annual inflation increased 
gradually  to  some  5%  in  May  2011,  mainly  as  a 
result  of  substantial  commodity  price  increases. 
Subsequently,  it  declined  slowly  to  below  4%  at 
the  end  of  2011,  largely  due  to  lower  food  price 
inflation.  Annual  inflation  broadly  stabilised  in 
early 2012.    

Graph 5.2:Lithuania - HICP inflation

(y-o-y percentage change)

14

12

10

8

6

4

2

0

-2

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Lithuania

Euro area

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  evolved 
in  parallel  with  headline  inflation  in  recent  years, 
lower.  It 
while  mostly  remaining  somewhat 
declined  gradually  from  mid-2008,  becoming 
negative  in  early  2010,  as  the  large  contraction  in 
domestic  demand  induced  a  decline  in  prices  of 

non-energy  industrial  goods  and  services.  The 
inflation  contributions  of  non-energy  industrial 
goods  and  services  became  positive  again  during 
the first half of 2011, driven by rapidly recovering 
domestic demand. Core inflation declined again in 
late  2011,  mainly  reflecting  a  smaller  inflation 
contribution  of  processed  food.  It  then  remained 
broadly  stable  in  early  2012.  Annual  average 
producer price inflation for total industry increased 
to  above  10%  in  2011,  indicating  elevated  cost 
to  commodity  price 
price  pressures 
increases. 

related 

5.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy-mix  and  cyclical 
stance 

After  contracting  by  almost  15%  in  2009,  GDP 
growth  started  to  recover  in  2010  and  reached 
almost  6%  in  2011.  The  recovery  was  initially 
driven solely by rapid export growth, implying an 
associated  build-up  of  inventories,  but  domestic 
demand  also  expanded  strongly  in  2011,  mostly 
thanks  to  substantial  investment  growth.  As  a 
result, the output gap, which had turned negative in 
2009,  narrowed  considerably  in  2011.  According 
to the Commission services' Spring 2012 Forecast, 
real  GDP  growth  is  projected  to  fall  markedly  to 
2.4% in 2012 before recovering somewhat to 3.5% 
in 2013. 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural balance, was tightened considerably over 
2010 and 2011 in line with the gradual recovery in 
domestic  demand.  Nevertheless,  the  structural 
deficit  is  estimated  to  have  remained  rather 
elevated  at  above  4%  of  GDP  in  2011.  A  further 

62 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Table 5.2:

Lithuania - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Lithuania 

Euro area

Private consumption deflator

Lithuania 

Euro area

3.8

2.2

4.7

2.2

Nominal compensation per employee

Lithuania 

Euro area

Labour productivity

Lithuania 

Euro area

Nominal unit labour costs

Lithuania 

Euro area

Imports of goods deflator

Lithuania 

Euro area

16.7

2.5

5.9

1.9

10.2

0.8

8.8

3.9

5.8

2.1

5.9

2.2

13.9

2.6

6.8

1.3

6.6

1.4

5.0

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

11.1

3.3

10.9

2.7

14.3

3.4

3.6

-0.3

10.4

3.8

9.3

4.2

4.2

0.3

4.5

-0.4

-9.9

1.8

-8.6

-2.4

-1.4

4.2

-11.5

-7.7

1.2

1.6

1.3

1.7

-0.9

1.7

6.9

2.5

-7.3

-0.8

10.9

5.7

4.1

2.7

4.0

2.5

3.4

2.2

3.8

1.2

-0.3

0.8

14.3

6.9

3.1

2.4

3.2

2.2

2.1

1.9

1.8

0.1

0.4

1.6

6.0

3.6

2.9

1.8

3.0

1.7

3.3

1.9

3.0

1.0

0.3

0.8

2.5

1.3

substantial  tightening  of  the  fiscal  stance  is 
foreseen  for  2012,  despite  the  slowing  pace  of 
economic recovery.  

Monetary  conditions  have  been  relatively  tight  in 
recent  years  in  the  framework  of  the  currency 
board  arrangement  within  ERM  II,  although  real 
short-term interest rates turned negative during the 
second  half  of  2010.  Credit  conditions  worsened 
significantly 
the  global 
in  autumn  2008  as 
financial  crisis  escalated.  As  a  result,  the  banking 
sector's  loan  portfolio  has  been  contracting  on  an 
annual basis since mid-2009.  

Wages and labour costs 

The wage bargaining process in Lithuania is highly 
decentralised.  The  labour  market  situation  closely 
reflected  the  sharp  economic  downturn,  with 
unemployment increasing from below 6% in 2008 
to  almost  18%  in  2010  before  declining  to  below 
16% in 2011. At the same time, compensation per 
employee fell by almost 10% in 2009 and then fell 
further in 2010. This adjustment was supported by 
a  reduction  in  public  sector  wages  in  2009, 
followed  by  a  wage  freeze  extended  until  2012.  
As a result, nominal unit labour costs were falling 
in  2009  and  2010  despite  a  significant  labour 
productivity decline in 2009.  

In  line  with  the  strong  recovery  in  economic 
activity, compensation per employee started to rise 
again  in  2011.  However,  due  to  robust  labour 
productivity  growth,  unit  labour  costs  still  fell 
marginally  in  2011.  Lower  labour  productivity 
growth is projected to lead to marginal increases in 
ULC in 2012 and 2013.  

Graph 5.3:Lithuania - Inflation, productivity and wage trends

(y-o-y % change)

20

15

10

5

0

-5

-10

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

External factors 

As  a  small  and  open  economy,  the  evolution  of 
import  prices  significantly  affects  domestic  price 
formation  in  Lithuania.  In  particular,  energy  and 
food  prices  were  an  important  component  of 
imported  inflation  in  the  recent  past,  reflecting 
their  large  weight  in  the  HICP  basket.  Import 

63 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

elevated  level  of  unemployment  should  dampen 
further domestic price increases. According to the 
Commission  services'  Spring  2012  Forecast, 
average  annual  inflation  is  thus  projected  to 
decline to about 3% in 2012 and in 2013. 

Risks to the inflation outlook appear to be broadly 
balanced.  A  negative  external  shock  leading  to  a 
larger-than-expected  decline  in  output  growth  and 
a related increase in the unemployment rate would 
likely further dampen domestic price pressures. On 
the  other  hand,  higher  commodity  price  increases 
final 
would  again  be  swiftly  passed 
consumption  prices,  with 
impact 
amplified  by 
large  weight  of 
commodities in the consumption basket. 

the  relatively 

the  overall 

into 

The level of consumer prices in Lithuania stood at 
about 62.5% of the euro area average in 2010. This 
level 
for 
suggests  potential 
convergence  in  the  long  term,  as  income  levels 
(around  53%  of  the  euro  area  average  in  PPS  in 
2010) rise towards the euro area average. 

further  price 

Medium-term  inflation  prospects  will  depend  on 
wage  growth  remaining  in  line  with  productivity 
gains.  Improvements  in  the  business  environment 
are  important  in  order  to  support  the  job  creation 
process and to attract more FDI into manufacturing 
thus  further  rebalancing  the  economy  towards  the 
tradable  sector.  Diversification  of  supplies  and 
higher  competition  would  also  support  favourable 
price developments in the energy sector. 

5.3. 

PUBLIC FINANCES 

5.3.1.  The  excessive  deficit  procedure 

for 

Lithuania  

in  Lithuania 

On  7  July  2009,  the  Council  decided  that  an 
excessive  deficit 
in 
existed 
accordance  with  Article  104(6)  TEC,  and,  on  a 
recommendation  by  the  Commission,  it  addressed 
recommendations  to  Lithuania  in  accordance  with 
Article 104(7) TEC with a view to bringing an end 
to the situation of an excessive deficit by 2011. In 
its  recommendations,  the  Council  established  a 
deadline of 7 January  2010 for  effective  action  to 
be  taken  and  invited  the  Lithuanian  authorities  to 
implement  all  fiscal  measures  as  planned  in  the 
2009  budget  and  in  the  supplementary  May  2009 
budget,  consider  further  measures  to  limit  the 
deterioration  of  public  finances  in  2009,  and 
device  additional  fiscal  consolidation  measures  in 

effective 

exchange 

prices,  as  measured  by  the  imports  of  goods 
deflator  in  the  national  accounts,  fell  significantly 
in 2009, mainly reflecting the large drop in prices 
of  primary  commodities,  accentuated  by  a 
moderate  nominal 
rate 
appreciation.  Import  prices  surged  in  2010  and 
2011, as commodity prices increased rapidly while 
the  nominal  effective  exchange  rate  depreciated 
somewhat  in  2010  and  then  remained  broadly 
stable in 2011. Growth of import prices is expected 
to  moderate  in  2012,  due  to  a  more  favourable 
outlook 
price 
for 
developments. 

commodity 

primary 

Administered prices and taxes 

in  administered  prices  (56)  and 
Adjustments 
indirect taxes have been important determinants of 
inflation  in  Lithuania  in recent  years. Increases  in 
administered prices, with a weight of around 17% 
in  the  HICP  basket,  significantly  exceeded  HICP 
inflation  in  recent  years.  The  average  annual 
increase  in  administered  prices  declined  from 
almost  16%  in  2009  to  below  7%  in  2010  and 
some  5%  in  2011,  when  it  was  mainly  driven  by 
rising prices of gas, heat energy and passenger rail 
transport.  Growth  of  administered  prices  should 
broadly stabilise in 2012. 

The  standard  VAT  rate  was  raised  twice  in  the 
course of 2009, from 18% to 19% in January and 
then  to  21%  in  September.  In  addition,  excise 
duties  on  cigarettes  were  increased  in  March  and 
September 2009. As a result, the average inflation 
contribution  of  indirect  tax  hikes  is  estimated  to 
have  exceeded  one  percentage  point  in  2010. 
Increases  in  excise  taxes  on  cigarettes  and  diesel 
fuel  implemented  in  January  2011  as  well  as 
another  increase  in  excise  duties  on  cigarettes 
effective  from  March  2012  are  estimated  to  have 
only a marginal impact on average annual inflation 
in 2011 and 2012. 

Medium-term prospects 

The  more 
for  primary 
favourable  outlook 
commodity  price  developments  suggests  that  the 
inflation contributions of energy and food products 
could  be  somewhat  lower  in  2012.  At  the  same 
time,  a  slower  pace  of  output  growth  and  the 

(56)  According to the Eurostat definition, administered prices in 
Lithuania  inter  alia  include  water  supply,  refuse  and 
sewerage  collection,  electricity,  gas,  heat  energy  and 
certain  categories  of  passenger  transport.  For  details,  see 
http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/met
hodology/administered_prices 

64 

 
                                                           
justifying 

for  government 
thereby 

2010  and  2011  with  an  average  fiscal  effort  of  at 
least  1½%  of  GDP.  On  16  February  2010  the 
Council  concluded  that  the  Lithuanian  authorities 
had taken effective action to correct the excessive 
deficit,  but  it  considered  that  unexpected  adverse 
events  with  major  unfavourable 
economic 
finances  had 
consequences 
occurred, 
revised 
recommendations  under  Article  126(7)  TFEU.  A 
new deadline for correction of the excessive deficit 
by  2012  was  given.  This  required  an  average 
annual  fiscal  effort  of  2¼%  of  GDP  over  the 
period  2010-2012,  as  well  as  the  implementation 
of the fiscal measures planned in the 2010 budget, 
adoption of additional measures, if necessary, and 
continued consolidation in 2011 and 2012. A new 
deadline  of  16  August  2010  was  established  for 
Lithuania 
its 
conclusions  of  19  October  2010  the  Council 
assessed  that  Lithuania  was  making  satisfactory 
progress  in  correcting  its  excessive  deficit  and  no 
further action under the excessive deficit procedure 
was  necessary,  thereby  putting  the  procedure  in 
abeyance (57).  

take  effective  action. 

In 

to 

5.3.2.  Recent fiscal developments 

The  recent  crisis  had  severe  repercussions  on 
Lithuania's public finances, as the headline general 
government  deficit  rose  from  1.0%  of  GDP  in 
2007 to 9.4% of GDP in 2009, despite substantial 
consolidation  measures  of  around  8%  of  GDP 
adopted  during  2009.  The  measures  included 
substantial cuts in government current expenditure, 
including  differentiated  cuts 
in  public  sector 
wages,  a  3  percentage  points  increase  in  the 
standard  VAT  rate  and  the  elimination  of  most 
exemptions,  as  well  as  a  reduction  of  transfers  to 
the  second  pillar  pension  funds.  The  2010  budget 
contained further consolidation measures of above 
3%  of  GDP,  mostly  on  the  expenditure  side, 
including  notably  the  public  sector  wage  bill  and 
social  benefits.  On  the  revenue  side,  measures 
were  limited  to  a  full  year  effect  of  the  VAT  rate 
in  non-tax 
increase  of  2009  and 
revenues. As a result, the expenditure-to-GDP ratio 
fell  by  2.9  percentage  points  to  40.9%  in  2010, 
while  the  revenue-to-GDP  ratio  decreased  by  0.6 
to  33.7%.  The  general 
percentage  points 
government deficit went down to 7.2% of GDP in 
2010.  Fiscal  consolidation  continued  in  2011  and 
the  deficit  has  fallen  to  5.5%  of  GDP.  The 

increases 

(57)  An  overview  of  all  ongoing  excessive  deficit  procedures 
can  be  found  at:  http://ec.europa.eu/economy_finance/ 
economic_governance/sgp/deficit/index_en.htm 

Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

expenditure-to-GDP  ratio  decreased  further  to 
37.5%  following  lower  spending  on  personnel, 
goods  and  services  and  social  transfers.  The 
revenue-to-GDP ratio fell further to 32.0%, despite 
the  strong  recovery  of  domestic  demand  and 
government's  efforts  to  improve  tax  compliance, 
mainly reflecting lower tax receipts from corporate 
profits.  

than  planned  deficit  of 

Lithuania’s  general  government  deficit  was  at 
5.5%  of  GDP  in  2011  somewhat  above  the  target 
of  5.3%  of  GDP  set  in  the  2011  Convergence 
Programme,  mainly  due  to  unforeseen  calls  on 
state-guarantees  on  some  corporate  loans  as  well 
as  a  higher 
local 
governments. The structural deficit (the cyclically-
adjusted  balance  net  of  one-offs  and  other 
temporary measures) improved from some 7.2% of 
GDP in 2009 to around 5.1% in 2010 and 4.6% of 
GDP  in  2011  following  the  implementation  of 
fiscal  consolidation  measures  by  the  authorities 
(though structural balances are strongly affected by 
the  large  revisions  in  potential  growth  following 
the rapid growth of the Lithuania's economy before 
the  crisis  and  substantial  drop  during  the  crisis). 
Given  the  need  for  urgent  fiscal  consolidation  as 
well as restoring market confidence, the authorities 
implemented a pro-cyclical fiscal policy during the 
severe  recession  which  in  Lithuania  lasted  from 
the end of 2008 to the beginning of 2010.  

While  remaining  well  below  60%  of  GDP,  the 
debt-to-GDP  ratio  deteriorated  to  38.0%  in  2010 
from  only  15.5%  in  2008  as  a  result  of  high 
government deficits and unfavourable effects from 
the  implicit  interest  rate.  The  ratio  increased 
somewhat  further  to  38.5%  in  2011  despite  high 
nominal  GDP  growth  and  lower  implicit  interest 
rates.  

5.3.3.  Medium-term prospects  

The  Lithuanian  Parliament  adopted  the  2012 
budget  on  22  December  2011  targeting  a  general 
government  deficit  of  3.0%  of  GDP  along  with  a 
medium-term  budgetary  framework  for  2012-
2014.  The  measures  in  the  budget  include  further 
substantial  cuts  in  expenditures,  in  particular 
maintaining  the  public  sector  wage  freeze  for  the 
third  year.  Some  temporary  measures  limiting  the 
growth  of  social  benefits  during  the  crisis  have 
been  made  permanent.  On  the  other  hand,  social 
security pensions, cut at the beginning of the crisis, 
have been brought back to pre-crisis level. On the 
revenue  side,  additional  revenue  will  mainly  be 

65 

 
                                                           
Table 5.3:

Lithuania - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

2008

Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

(as % of GDP unless indicated otherwise)

2009

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-0.4

33.0

33.5

0.7

29.6

0.3

-2.2

0.0
-2.2

17.9

7.8

6.4

-1.0

33.6

34.6

0.7

29.9

-0.3

-3.5

-0.6
-3.0

16.8

9.8

9.4

-3.3

33.9

37.2

0.7

30.4

-2.6

-5.3

-0.1
-5.2

15.5

2.9

7.5

-9.4

34.3

43.8

1.3

29.7

-8.2

-6.8

0.4
-7.2

29.4

-14.8

-9.9

-7.2

33.7

40.9

1.8

27.4

-5.4

-5.0

0.1
-5.1

38.0

1.4

-8.4

-5.5

32.0

37.5

1.8

26.4

-3.7

-4.6

0.0
-4.6

38.5

5.9

-3.3

-3.2

33.5

36.7

2.1

26.9

-1.2

-2.6

0.3
-2.9

40.4

2.4

-2.5

2012
-3.0

-2.6

40.2

2.5

-3.0

33.1

35.9

2.0

26.7

-0.9

-2.6

-0.5
-2.1

40.9

3.5

-1.4

2013
-2.0

-2.1

38.6

3.7

2014
-1.0

-1.5

36.7

3.4

2015
0.0

-0.8

34.9

4.3

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme. One-off and other temporary measures

 taken from the programme (0.1% of GDP in 2011, 0.3% 2012 to 2013, 0.5% in 2014, 0.4% in 2015; 

all deficit-increasing). 

Sources: Commission services, the 2012 Convergence Programme of Lithuania .

collected  from  non-tax  revenues,  including  higher 
dividends  from  state-owned  enterprises  and  sales 
of  carbon  rights.  The  fiscal  plan  includes  a 
contingency  provision  requiring  a  supplementary 
budget  should  revenue  fall  short  of  plan  or  the 
deficit is likely to be above the target. 

in 

the 

2011, 

Taking  into  account  these  measures  and  the 
the 
outcome 
somewhat  worse 
Commission 
forecast 
services'  Spring  2012 
projects  the  deficit  of  3.2%  of  GDP  in  2012.  In 
2013,  some  consolidation  measures  will  expire, 
freeze  of  government  wages. 
including 
However,  overall  expenditure  increase  will  be 
contained by the state budget expenditure rule. The 
government  deficit 
to 
decrease  to  3.0%  of  GDP  in  2013.  The  overall 
fiscal stance in 2012, as measured by the change in 
the structural balance, is expected to be restrictive, 
showing an improvement of above 1½ percentage 
point.  It  will  remain  restrictive  in  2013.  The 
general  government  debt  is  expected  to  increase 
from  38.5%  of  GDP  in  2011  to  nearly  41%  of 
GDP at the end of the forecast period.  

therefore  expected 

is 

correction of the excessive deficit by 2012, within 
the  deadline  recommended  by  the  Council  on  16 
February  2010  and  (ii)  making  progress  towards 
the 
the  medium-term  objective 
budgetary position of a structural surplus (e.g. the 
cyclically-adjusted deficit net of one-off and other 
temporary  measures)  of  0.5%  of  GDP  over  the 
programme period. 

(MTO) 

for 

in 

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  Lithuania  can  be 
the  forthcoming  Commission  Staff 
found 
the 
Working  Document,  which  accompanies 
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme  of  Lithuania  and  delivering  a Council 
Opinion  on  the  2012  Convergence  Programme  of 
Lithuania (58).  

In  March  2012,  Lithuania  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 
policies.  This  Treaty  will  apply  to  contracting 

The  2012  Convergence  Programme,  submitted  on 
27  April  2012,  covers  the  period  2012  to  2015. 
The  main  aims  of  the  programme  are  (i)  the 

(58)  http://ec.europa.eu/economy_finance/ 

economic_governance/sgp/convergence/programmes/2012
_en.htm 

66 

 
                                                           
 
 
 
 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

5.4. 

EXCHANGE RATE STABILITY 

Lithuania entered ERM II on 28 June 2004 and has 
been  participating  in  the  mechanism  for  almost 
eight  years  at  the  time  of  the  adoption  of  this 
report.  The  ERM  II  central  rate  was  set  at  the 
parity  rate  prevailing  under  the  existing  currency 
board  arrangement,  with  a  standard  fluctuation 
band of ±15%. Upon ERM II entry, the authorities 
unilaterally  committed  to  maintain  the  currency 
board  within  the  mechanism.  In  line  with  this 
commitment, there has been no deviation from the 
central  rate  since  the  litas  started  participating  in 
ERM II. 

Graph 5.4:LTL - Spread vs central rate

(as percent, daily values)

1.0

0.5

0.0

-0.5

-1.0

Jan-06

Jan-08
Source: Commission services, ECB, Reuters EcoWin.

Jan-07

Jan-10

Jan-09

Jan-11

Jan-12

The  Bank  of  Lithuania  began  operating 
its 
currency  board  in  April  1994,  with  the  litas 
initially  pegged  to  the  US  dollar  at  4  LTL/USD. 
The litas peg was changed to the euro in February 
2002  at  the  prevailing  market  rate  of  3.4528 
LTL/EUR.  The 
litas  exchange  rate  did  not 
experience tensions during the reference period.  

Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Graph 5.5:Exchange rates - LTL/EUR
(monthly averages)

3.8

3.6

3.4

3.2

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

Under 
the  currency  board  arrangement  all 
domestic  liabilities  of  the  Bank  of  Lithuania  have 
to be backed by foreign exchange reserves or gold. 
International  reserves  remained  broadly  stable 
from  end-2009  until  mid-2011,  hovering  between 
EUR 4.5bn and EUR 5bn. They increased to above 
EUR 6bn at the end of 2011 thanks to strong FDI 
inflows  and  successful  international  sovereign 
bond  issuance.  International  reserves  covered  on 
average around 150% of the monetary base during 
2010-2011,  well  above 
required  100% 
statutory  minimum.  They  accounted  for  some 
157%  of  short-term  external  debt  at  original 
maturity by the end of 2011.  

the 

led 

board 

The  Bank  of  Lithuania  does  not  set  monetary 
policy  interest  rates.  The  domestic  interest  rate 
environment  is  directly  affected  by  the  monetary 
policy  of  the  euro  area  through  the  operations  of 
arrangement. 
Lithuania's 
currency 
Nevertheless,  varying  risk  premia 
to  a 
substantial  divergence  of  money  market  rates, 
especially  during 
the  period  of  heightened 
financial  market  tensions.  After  dropping  sharply 
during the second half of 2009 and in early 2010, 
short-term  interest  differentials  vis-à-vis  the  euro 
area continued to narrow gradually, declining from 
around  90  basis  points  in  mid-2010  to  some  20 
basis points in April 2011. This indicated a steady 
improvement  in  the  liquidity  situation  at  the 
domestic  interbank  market.  Short-term  spreads 
widened  again  to  above  30  basis  points  in  the 
second half of 2011 as monetary policy loosening 
in  the  euro  area  was  not  fully  reflected  in  local 
interbank  rates.  At  the  cut-off  date  of  this  report, 
the  3-month  spread  vis-à-vis 
the  euro  area 
amounted to about 45 basis points. 

67 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Graph 5.6:Lithuania - 3-M Vilibor spread to 3-M Euribor

(basis points, monthly values)

800

700

600

500

400

300

200

100

0

when  they  increased  slightly.  Yield  developments 
must, however, be interpreted with great caution as 
the  long-term  litas-denominated  government  bond 
market  is  extremely  shallow.  Nevertheless,  the 
government  issued  debt  securities  with  original 
maturity of up to 5 years in 2010 and with original 
maturity of up to 7 years in 2011. The Lithuanian 
long-term  interest  spread  vis-à-vis  the  German 
benchmark  bond (59)  stood  at  around  350  basis 
points in early 2012. 

2006

2007

2008

2009

2010

2011

2012

Graph 5.8:Lithuania - Long-term interest rates

Source: Eurostat.

5.5. 

LONG-TERM INTEREST RATES 

examination 

convergence 

The  long-term  interest  rate  in  Lithuania  used  for 
the 
the 
secondary  market  yield  on  a  single  benchmark 
government  bond  with  a  residual  maturity  of 
around  6  years,  due  to  the  absence  of  a  suitable 
alternative bond with longer maturity.  

reflects 

The  Lithuanian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  above  the  reference  value  at 
the  time  of  the  last  convergence  assessment  in 
2010.  It  declined  from  some  14%  at  the  end  of 
2009  to  below  5.2%  in  early  2011  and  then 
remained  rather  stable  until  early  2012.  In  March 
2012, the latest month for which data are available, 
the reference value, given by the average of long-
term  interest  rates  in  Sweden  and  Slovenia  plus 2 
percentage  points,  stood  at  5.8%.  In  that  month, 
the  12-month  moving  average  of  the  Lithuanian 
benchmark bond stood at 5.2%, i.e. 0.6 percentage 
points below the reference value. 

Graph 5.7:Lithuania - Long-term interest rate criterion
(percent, 12-month moving average)

16

14

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Lithuania

Reference value

Source: Commission services.

Long-term  interest  rates  remained  fairly  stable  at 
just  above  5%  from  March  2010  until  late  2011 

68 

(percent, monthly values)

16

14

12

10

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Lithuania

Germany

Source: Eurostat.

5.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance 
in  EMU. 
the  governance  structures 
Related  to  this,  in  February  2012,  following  the 
adoption  of  the  legislation  establishing  the  new 
procedure  for  surveillance  and  correction  of 
macroeconomic  imbalances  (the  Macroeconomic 
Imbalances Procedure - MIP) (60), the Commission 

(59)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

(60)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 

 
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Table 5.4:

Lithuania - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

2006

-10.6

-13.8

3.6

-2.7

2.4

1.2

-9.4

10.4

5.0

-0.8

11.0

-4.9

15.3

-0.9

26.0

15.8

59.9

-48.9

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, Bank of Lithuania.

its 

first  Alert  Mechanism  Report 
published 
(AMR) (61).  The  AMR  scoreboard  showed  that 
Lithuania  exceeded  the  indicative  threshold  for 
two out of ten indicators (namely the international 
investment  position  and  the  unemployment  rate). 
In line with the conclusion of the AMR, Lithuania 
was  not  subject  to  an  in-depth  review  in  the 
context of the MIP. 

5.6.1.  Developments  of 

the  balance  of 

payments 

After  turning  to  a  substantial  surplus  in  2009, 
Lithuania's  external  balance  (i.e.  the  combined 
current  and  capital  account)  deteriorated  again  in 
2010 and 2011, reflecting a worsening of both the 
current  and  the  capital  account  balance.  Despite 
strong export growth, the trade deficit increased in 
2010  and  2011,  as  the  parallel  recovery  in 
domestic  demand  and  the  closure  of  the  Ignalina 
nuclear power plant at the end of 2009 resulted in 
rapidly  rising  imports.  At  the  same  time,  the 

http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(61)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

2007

-14.4

-14.9

1.6

-4.1

3.0

1.7

-12.7

12.8

3.6

-0.7

12.9

-3.0

15.8

-0.1

31.2

16.2

71.5

-55.8

2008

-12.9

-12.9

1.2

-3.4

2.2

1.8

-11.1

11.1

3.4

-0.5

5.8

2.4

8.7

0.0

26.9

13.9

70.9

-51.5

(percentage of GDP)

2009

2010

2011

4.4

-3.2

1.9

1.3

4.4

3.4

7.8

-7.8

-0.4

2.9

-10.6

0.2

-8.1

0.0

10.5

13.2

87.0

-58.6

1.5

-4.6

3.5

-2.3

4.8

2.7

4.2

-4.2

1.8

5.1

-9.2

-1.9

-2.3

0.0

16.4

17.5

87.4

-55.9

-1.6

-4.9

3.6

-3.8

3.5

2.5

0.9

-0.9

2.5

3.8

-2.8

-4.5

3.5

0.0

18.8

17.2

80.8

-52.2

surplus in the balance of primary incomes and net 
current transfers also declined gradually.  

The  primary  driver  behind 
the  gradually 
decreasing  saving-investment  gap  in  2010  and 
2011  was  the  recovery  in  gross  capital  formation. 
Gross  national  saving  also  increased  in  2010, 
driven  by  both  private  and  general  government 
sector,  before  declining  somewhat  in  2011,  as 
gross saving by the private sector decreased.  

Graph 5.9:Lithuania - Saving and investment

(in percent of GDP at market prices)

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

Competitiveness  indicators  continued  to  improve 
in recent years, albeit at a slowing pace. Lithuania 
succeeded in increasing its export market share in 
2010  and  to  a  lesser  extent  also  in  2011.  Mainly 
thanks  to  favourable  domestic  price  and  cost 

69 

 
                                                                                   
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Germany  and  Poland  accounting  for  around  one 
fourth  of  the  total  flow.  Through  its  exports, 
Lithuania  has  strong  ties  to  markets  outside  the 
EU, mainly to Russia, Belarus and Ukraine.  

Low-to-medium-technology  goods  continue 
to 
predominate  in  Lithuania's  exported  goods,  but  a 
gradual  shift  to  high-technology  goods  can  be 
observed.  Exports  of  high  technology  products 
increased  from  3.2%  of  GDP  in  2005  to  7.3%  in 
2007, but dropped to 5.8% in 2009. The increase in 
the  share  of  exported  capital-intensive  goods 
recorded  up  to  2007  was  partly  due  to  rising  re-
exports  of  road  vehicles  to  the  CIS  countries. 
Although 
high-tech 
contribution 
manufacturing  to  growth  is  still  relatively  limited 
compared  to  other  non-euro  area  Member  States, 
the technological trade deficit closed in 2008. 

the 

of 

environment 

and  moderate 

The  stock  of  inward  FDI  amounted  to  some  34% 
of  GDP  in  2009  (up  from  28%  in  2008),  with  a 
constant  share  of  around 80%  of  the  total  coming 
from EU Member States and one third of the total 
from the euro area. Despite a relatively favourable 
business 
taxes, 
Lithuania has been struggling to attract higher FDI 
inflows,  with  FDI  per  capita  substantially  below 
the  average  of  comparable  Central  European 
economies.  The 
frequently 
mentioned for the relatively weak attractiveness of 
the country with respect to FDI relate to red tape, 
corruption,  the  uncompleted  land  reform  and  the 
inefficiency of public administration.  

reasons  most 

Between  2001  and  2007,  real  house  prices 
recorded double digit annual increases, resulting in 
cumulative  growth  of  over  240%.  From  the  peak 
until  the  third  quarter  of  2011,  real  house  prices 
dropped  by  45%.  Most  of  the  adjustment  took 
place  before  the  end  of  2010  and  since  then  real 
prices seem to have levelled off. FDI tilted towards 
non-tradable  and  real  estate  activities  gave  an 
additional  impetus  to  the  housing  upswing.  Over 
2002-2008,  gross  fixed  capital  formation 
in 
dwellings grew from about 1.5% of GDP to close 
to  3.5%  of  GDP,  followed  by  a  sharp  correction 
back to 1.9% of GDP in 2010. 

Concerning  the  business  environment,  Lithuania 
scores broadly in line with the average of euro area 
rankings (62). 
Member  States 
Actions  are  planned  by  the  government  to  cut 

international 

in 

(62)  For  instance,  Lithuania  ranks  on  44th  and  27th  place 
according to the 2011-2012 Global Competitiveness index 
and the 2012 World Bank Doing Business respectively. 

developments,  the  real-effective  exchange  rate 
depreciated  substantially  between  early  2009  and 
mid-2010,  in  particular  when  deflated  by  ULC.  It 
appreciated again somewhat in the course of 2011 
as the robust recovery in domestic demand resulted 
in increased cost and price pressures.  

Graph 5.10:Lithuania - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

130

120

110

100

90

80

2006

2007

2008

2009

2010

2011

NEER

REER, HICP deflated

REER, ULC deflated

Source: Commission services.

Lithuania managed to attract increasing net inflows 
of  foreign  direct  investment  in  2010  and  2011 
while  also  recording  substantial  net  portfolio 
investment,  mainly thanks to successful sovereign 
external  debt  issuance.  Although  slowing  down, 
net outflows of other investment continued in 2010 
and  2011,  driven  by  decreasing  external  loan 
liabilities  in  the  banking  sector.  As  a  result,  total 
gross  external  debt  decreased  to  about  81%  of 
GDP  at  the  end  of  2011  whereas  the  negative  net 
international  investment  position  also  narrowed 
somewhat.  

According  to  the  Commission  services'  Spring 
2012  Forecast,  the  external  surplus  is  expected  to 
broadly stabilise in 2012 and 2013 as the negative 
impact  of  weaker  external  demand  is  foreseen  to 
be  offset  by  a  parallel  decrease  in  domestic 
demand growth. 

5.6.2.  Product market integration 

through 

trade  and 

The  Lithuanian  economy  is  well  integrated  to  the 
investment 
EU  economy 
linkages.  Trade  openness  further  increased  from 
some  61%  in  2005  to  almost  69%  in  2010,  well 
above the EU27 average (40.1%). During the crisis 
in  2009,  Lithuania's  openness  indicator  decreased 
as both imports and exports fell substantially, but it 
recovered  quickly  in  2010  on  the  back  of  rising 
external  demand  and  a  re-orientation  of  the 
economy  from  the  non-tradable  to  the  tradable 
sector.  Around  60%  of  Lithuania's  exports  of 
goods  are  directed  to  the  EU27,  with  Latvia, 

70 

 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Table 5.5:

Lithuania - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

60.9

32.6

5.3

19.8

3.2

-3.4

3.9

:

:

0.4

26.3

26.0

100.0

2.2

100.0

63.9

35.0

5.7

20.4

4.7

-2.3

6.0

9.9

5.3

0.3

28.1

26.0

134.8

2.5

141.0

60.5

35.3

5.8

17.5

7.3

-1.0

5.1

3.7

2.5

0.6

25.6

26.0

175.1

2.8

164.0

65.5

33.7

5.8

23.7

6.5

0.0

4.3

3.3

1.9

0.6

22.2

26.0

168.4

3.4

136.0

55.1

28.8

5.4

18.0

5.8

-0.1

0.5

-0.3

0.1

0.2

29.0

26.0

112.1

3.3

64.0

68.9

35.5

5.3

25.0

n.a.

n.a.

2.1

1.7

0.9

0.5

26.9

22.0

102.3

1.9

71.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

administrative  burden,  and  some  progress  was 
made  as  reflected  by  the  indicator  on  the  time 
necessary  to  start  a  new  company.  According  to 
the  November  2011  Internal  Market  Scoreboard, 
Lithuania  managed  to  get  back  under  the  1.0% 
objective,  down  from  1.2%  in  May  2011.  The 
number  of  infringement  procedures  open  against 
Lithuania has decreased considerably since 2007 (-
39%),  so  that  with  11  cases  Lithuania  was  well 
below the EU average of 34 cases. In recent years 
Lithuania  has  continuously  shown  a  high  value 
share  of  tenders  openly  advertised  in  the  EU 
Official  Journal (63),  with  26.9%  in  2010  well 
above the EU27 average of 18.6%. 

5.6.3.  Financial market integration 

Lithuania’s  financial  sector  is  well  integrated  into 
the  EU  financial  system.  The  share  of  foreign-
owned  banks  increased  to  90%  in  terms  of  total 
assets,  following  the  bankruptcy  of  the  largest 
domestic  bank  Snoras  in  late  2011.  The  banking 
sector  is  quite  concentrated,  with  the  five  largest 
institutions  accounting  for  almost  87%  of  its  total 
assets by end-2011. 

(63)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may serve as a proxy of the extent to which national public 
procurement is open to foreign bidders. 

71 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

Graph 5.11:Lithuania - Foreign ownership and concentration 
in the banking sector

(in percent, weighted averages)

90
80
70
60
50
40
30
20
10
0

20

15

10

5

0

Graph 5.12:Lithuania - selected banking sector soundness 
indicators relatively to the euro area

%

LT, 2004

LT, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

LT, 2004

LT, 2011

EA, 2004

EA, H1-11

Return on equity

Capital adequacy

Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.
Source: ECB, Bank of Lithuania, EC calculations.

strongly  predominate 

The  size  of  Lithuania's  financial  system  is  still 
quite small compared to the euro area average, but 
financial  development  has  progressed  over  recent 
years.  Banks 
among 
financial  intermediaries,  with  their  total  assets 
amounting  to  almost  75%  of  GDP  by  end-2011. 
Bank  lending  expanded  strongly  in  the  run-up  to 
the 2008-09 global financial crisis but banks' loan 
portfolio has been falling on an annual basis since 
mid-2009.  Credit  to  the  non-financial  private 
sector  amounted  to  about  54%  of  GDP  in  2011. 
Following the re-pegging of the litas to the euro in 
2002,  euro-denominated  lending  increased  rapidly 
in  both  the  household  and  the  corporate  sectors. 
Mainly due to the narrowing gap between interest 
rates,  non-financial  corporations  and  households 
recently  started  to borrow more  in  local  currency, 
with  the  share  of  foreign-currency-denominated 
loans declining to 74% in the corporate and 71% in 
the  household  sector  by  end-2011.  Nevertheless, 
the exposure of the private sector to exchange rate 
risk remains substantial. 

The  capital  adequacy  ratio  (CAR)  of  the  banking 
sector  remained  broadly  stable  at  some  14%  in 
2011 with Tier 1 CAR at 12%. At the same time, 
the  quality  of  loan  portfolio  started  to  improve  in 
late  2010,  with  the  share  of non-performing  loans 
declining to about 16% by end-2011, driven by the 
recovery in corporate and consumer loan portfolio 
quality.  As  a  result,  after  two  years  of  negative 
profitability,  return  on  equity  increased  to  above 
15%  in  2011,  partly  thanks  to  a  decline  in 
provisions.  

Insurance  companies, 
leasing  companies  and 
pension  funds  still  play  a  relatively  minor  role  in 
the  local  financial  system.  In  2011,  12  insurance 
companies controlled assets amounting to less than 
3% of GDP, 9 leasing companies held assets worth 
about 6% of GDP while 39 pension funds managed 
assets valued at close to 4% of GDP.  

The Vilnius Stock Exchange (VSE) belongs to the 
NASDAQ  OMX  group  and  uses  a  single  trading 
platform  together  with  other  exchanges  in  the 
Baltic-Nordic  region.  Nevertheless,  stock  market 
capitalisation remains relatively low, amounting to 
some  10%  of  GDP  in  2011.  Reflecting  the 
increasing  level  of  central  government  debt,  the 
outstanding stock of debt securities reached around 
34%  of  GDP  in  2011.  Private  sector  debt (64)  of 
about  80%  of  GDP  in  2010  is  still  far  below  the 
euro area average. 

Graph 5.13:Lithuania - Recent development of the  
financial system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

LT, 2004

LT, 2011

EA, 2004

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.

Source: Eurostat, ECB, Bank of Lithuania, Nasdaq OMX, Reuters EcoWin.

A  joint  financial  sector  supervision  department 
was  established  inside  the  Bank  of  Lithuania  in 
January  2012, which  should  strengthen  the  ability 
of  the  national  authorities  to  identify  and  address 
risks  to  the  financial  system.  A  regulation  on 
responsible  lending  applicable  for  new  credits 
issued  to  natural  persons  came  into  effect  in 

(64)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

72 

 
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 5 - Lithuania 

It  also  obliges  banks 

November 2011. It sets caps on loan-to-value and 
debt-to-income  ratios  as  well  as  maximum  credit 
to  provide 
maturity. 
information to their customers about probable risks 
in  taking  loans  in  a  more  comprehensive  and 
responsible  way.  Moreover,  in  the  context  of  the 
legal  amendments 
Snoras  bankruptcy,  new 
enhancing  the  bank  resolution  framework  were 
adopted  in  late  2011.  Lithuania  achieved  full 
compliance  with  the  transposition  of  the  FSAP 
directives  and  has  transposed  most  of  the  post-
FSAP directives. 

73 

 
6.  HUNGARY 

6.1. 

LEGAL COMPATIBILITY 

6.1.1.  Introduction 

The  Magyar  Nemzeti  Bank  (MNB  –  central  bank 
of  Hungary)  was  founded 
in  1924  and  re-
established  as  a  central  bank  in  1987.  The  Act 
LVIII  of  2001  on  the  MNB  was  amended  several 
times and replaced recently by Act CCVIII of 2011 
(hereafter: MNB Act) which entered into force on 
1  January  2012.  On  the  same  date  "Transitional 
Arrangements" 
the  Fundamental  Law  on 
Hungary  and  concerning  the  MNB  entered  into 
force.  With  a  view 
the  central  bank 
independence  under  Article  130  TFEU,  Hungary 
has  announced  changes  to  the  MNB  Act  and  the 
"Transitional  Arrangements"  to  the  Fundamental 
Law recently.(65) 

to 

to 

6.1.2.  Central bank independence 

Pursuant to Article 34(1) and (2) of the MNB Act, 
the MNB shall submit the agenda of the meetings 
of  the  Monetary  Council  to  the  government  with 
the  latter  being  represented at  the  meetings  of  the 
Monetary Council by the Minister or a person duly 
authorised  by  the  Minister.  Although  a  dialogue 
between  a  central  bank  and  third  parties  is  not 
prohibited  as  such, 
this  dialogue  should  be 
constructed  in  such  a  way  that  the  government 
should not be in a position to influence the central 
bank  when  the  latter  is  adopting  decisions  for 
which its independence is protected by the Treaty. 
The  active  participation  of  the  Minister,  even 
without  voting 
to  discussions  where 
monetary  policy  is  set  would  structurally  offer  to 
the  government  the  possibility  to  influence  the 
central  bank  when  taking  its  key  decisions.  The 
obligation  to  submit  the  agenda  of  the  Monetary 
Council  to  the  government  and  the  systematic 
participation  of 
the 
the  Minister 
possibility for the central bank to hold confidential 
discussions  and  offer  the  possibility  for  the 
government  to  seek  to  influence  them.  Therefore, 

limit  also 

right, 

(65)  On  7  March  2012,  Hungary  submitted  a  draft  law 
amending  the  MNB  act  law  for  consultation  of  the  ECB 
pursuant  to  Article  127(4)  TFEU.  The  draft  law  provides 
for repealing Articles 34, 46(10) and (17) of the MNB act 
as well as of Article 30 of Transitional arrangements to the 
Hungarian  Fundamental  Law.  If  adopted  this  law  will 
remedy the legal problems identified in this document. 

Article  34(1)  and  (2)  is  incompatible  with  Article 
130  of 
the  TFEU,  as  Member  States  must 
undertake not to seek to influence the members of 
the decision-making bodies of the national central 
bank. 

According  to  Article  46(7)  Monetary  Council 
members  –  including  the  Governor  –  must  swear 
an  oath  in  front  of  the  Hungarian  President 
(Governor)  or  the  Hungarian  Parliament  (other 
members  of  the  Monetary  Council).  Compared  to 
the  2010  Convergence  Report  the  text  of  the  oath 
has  been  amended  and  is  no  longer  deemed 
incompatible with the TFEU.  However, the oath is 
still  considered  as  an  imperfection,  as  it  does  not 
contain  an  explicit  reference  to  the  central  bank 
independence  enshrined  in  Article  130  TFEU. 
Since the Monetary Council members are involved 
in the performance of ESCB related tasks, any oath 
should  make  a  clear  reference  to  the  central  bank 
independence under Article 130 of the TFEU. 

into  force  of 

termination  of 

Further  to  Article  46  (17)  of  the  MNB  Act,  the 
Monetary Council shall cease to exist on the day of 
entry 
the 
the 
derogation  pursuant  to  Article  140  TFEU.  Given 
that  the  Governor  is  a  member  of  the  Monetary 
Council,  it  must  be  guaranteed  that  with  the 
abolition of the Monetary Council and its inherent 
ending  of  the  members'  functions,  the  term  of 
office of the Governor does not end automatically, 
but only at the end of his regular mandate, in line 
with  130  TFEU.  This  imperfection  of  Article 
46(17) should be remedied. 

Article  51(1)  of  the  MNB  Act  provides  for  a 
remuneration  scheme  of  the  Governor  to  be 
applied  pursuant  to  Article  66(1)  as  of  entering 
into force of the MNB Act (1 January 2012). The 
MNB  Act  provides  for  a  cap  on  the  salary  to  be 
calculated  in  relation  to  the  Hungarian  average 
monthly  gross  salary  as  introduced  as  a  salary 
adjustment  in  the  Hungarian  public  sector  under 
Law XC of 2010. The MNB Act entered into force 
during  the  term  of  office  of  the  incumbent 
Governor. 
is 
capped 
significantly  lower  compared  to  the  remuneration 
paid  at  the  beginning  of  the  term  of  office  of  the 
Governor. The new remuneration scheme applying 
to  the  incumbent  Governor  can  be  considered  as 
not being a means of pressure prohibited by Article 
the 
to 
130  of 

remuneration 

the  TFEU 

the  extent 

The 

that 

75 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

remuneration  cap  under  Law  XC  of  2010  as 
perpetuated in Article 51 (1) of the MNB act was a 
part  of  a  general  review  of  the  remuneration 
regime  of  the  public  function  in  Hungary  and  not 
solely targeting the Governor.  

Article 30 of the "Transitional Arrangement" to the 
Fundamental  Law  allows  placing  the  Governor 
under  hierarchical  responsibility  of 
the  new 
President of a merged body composed of the MNB 
and the Financial Supervisory Authority, the effect 
of  which  would  be  to  negate  the  Governor's 
independence. This provision is incompatible with 
Article 130 of the TFEU. 

6.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Under  Article  12(4)  of  the  Act  on  the  MNB,  the 
central  bank  is  allowed,  subject  to  the  prohibition 
of  monetary  financing  to  extend  emergency  loans 
to credit institutions in the event of circumstances 
which  jeopardize  the  stability  of  the  financial 
systems.  In  order  to  comply  with  the  prohibition 
on  monetary  financing  of  Article  123  of  the 
TFEU– it should be clearly specified that the loan 
is granted against adequate collateral to ensure that 
the  MNB  would  not  suffer  any  loss  in  case  of 
debtor's default. 

Pursuant  to  Article  13,  the  MNB  may  grant  loans 
in 
the  National  Deposit  Insurance  Fund 
to 
emergency  cases,  subject 
to  prohibition  of 
monetary  financing  under  Article  15  of  the  Act. 
Though  the Act  adequately  reflects  the  conditions 
for  central  bank  financing  provided  to  a  deposit 
guarantee scheme a specific requirement should be 
included  to  ensure  that  the  loans  granted  to  the 
National  Deposit  Insurance  Fund  are  provided 
against adequate collateral to secure the repayment 
of  the  loan.  Therefore,  it  constitutes  therefore  an 
incompatibility  with  the  prohibition  on  monetary 
financing,  as  foreseen  by  the  Article  123  of  the 
TFEU. 

6.1.4.  Integration in the ESCB 

Objectives 

The secondary objective of the MNB (Article 3(2)) 
refers  to  the  general  economic  policy  of  the 
government,  while  it  should  make  a  reference  to 
the  general  economic  policies  in  the  Union,  with 
the latter taking precedence over the former, as it is 
provided under Article 127 of the TFEU. 

Tasks 

The  incompatibilities  in  the  Act  derive  from  the 
following ESCB/ECB tasks: 

•  definition of monetary policy and the monetary 
functions,  operations  and  instruments  of  the 
ESCB (Articles 4 to, 9, 11, 13, 46, 59 and 65); 
Article  41  of 
the  Fundamental  Law  of 
Hungary; 

•  conduct of foreign exchange operations and the 
definition of  foreign  exchange policy  (Articles 
4(3) and (4), 10, 16 and 59(2)); 

•  competences of the ECB and of the Council for 
banknotes  and  coins  (Articles  4(2),  27  to  30 
and 65(1)); 

There  are  also  some  imperfections  in  the  Act 
regarding: 

•  non recognition of the role of the ECB for the 
functioning  of  the  payment  systems  (Articles 
4(5)(a-b), 19 and 20, 23(b) and 65(2-3)); 

•  non  recognition  of  the  role  of  the  ECB  and  of 
the  EU for  the  collection of statistics  (Articles 
4(6), 21, 65(1)); 

•  non  recognition  of  the  role  of  the  ECB  in  the 
international  cooperation  (Article 

field  of 
36(4)); 

•  absence  of  an  obligation  to  comply  with  the 
Eurosystem's regime for the financial reporting 
of NCB operations (Article 49(4)(b) and Law C 
of  2000/95  (IX.21.) 
in  conjunction  with 
Government Decree 221/2000 (XII.19.)); 

•  non recognition of the role of the ECB and the 
the  appointment  of  external 

Council  for 
auditors (Articles 41, 43(1)(b)). 

6.1.5.  Assessment of compatibility 

As regards central bank integration into the ESCB 
at the time of euro adoption, independence as well 
as the prohibition on monetary financing, existing 
Hungarian legislations, in particular the Act on the 
MNB  and  the  Transitional  Provisions  to  the 
Fundamental  Law  of  Hungary,  are  not  fully 
compatible  with  the  compliance  obligations  under 
Article 131 of the TFEU. 

76 

 
6.2. 

PRICE STABILITY 

6.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for the convergence evaluation, has been above the 
reference  value  at  the  time  of  each  convergence 
assessment  since  EU  accession.  After  increasing 
from 3.8% in October 2009 to 5.2% in June 2010, 
average annual inflation declined gradually to just 
below 4% in July 2011. It then remained stable in 
the second half of 2011 before rising again in early 
2012.  In  March  2012,  the  reference  value  was 
3.1%,  calculated  as  the  average  of  the  12-month 
average  inflation  rates  in  Ireland,  Sweden  and 
Slovenia  plus  1.5  percentage  points.  The 
corresponding inflation rate in Hungary was 4.3%, 
i.e.  1.2  percentage  points  above  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected  to  move  well  above  the  reference  value 
in the months ahead. 

Graph 6.1:Hungary - Inflation criterion since 2006

(percent, 12-month moving average)

10

8

6

4

2

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Hungary

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

6.2.2.  Recent inflation developments 

Inflation  has  been  rather  volatile  in  Hungary  in 
recent years, mainly as a reflection of the evolution 
together 
of  energy  and  food  prices,  which 
represent more than 40% of the HICP basket, with 
processed food having the largest impact. Changes 
in  administered  prices  and 
further 
amplified inflation volatility.   

taxation 

rate.  Amid 

Annual  HICP  inflation  peaked  at  above  6%  in 
January  2010,  pushed  up  by  indirect  tax  hikes 
adopted in 2009 and a pass-through from a weaker 
substantial  volatility, 
exchange 
consumer  price 
inflation  broadly  followed  a 
downward  trend,  declining  to  close  to  3%  in  July 
impact  of  one-off 
2011,  as 
measures 
rate 
strengthened.  Annual  inflation  increased  again  in 

inflationary 
and 

the 
faded 

exchange 

the 

Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

the  second  half  of  2011,  driven  mainly  by  energy 
price increases reflecting higher commodity prices 
and a weaker exchange rate. In early 2012, a new 
round of indirect tax hikes induced a further jump 
in consumer prices.  

Graph 6.2:Hungary - HICP inflation

(y-o-y percentage change)

9

6

3

0

-3

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Hungary

Euro area

indirect 

increasing 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  broadly 
mirrored 
inflation, 
the  evolution  of  HICP 
recording  a  large  decline  in  mid-2010  and  then 
slowly 
throughout  2011. 
again 
Processed food prices were the main driver of core 
inflation recently, reflecting both unprocessed food 
tax  hikes. 
price  developments  and 
Inflation  contributions  of  services  and  non-energy 
industrial  goods  decreased  substantially  in  mid-
2010  as  the  inflationary  effect  of  the  July  2009 
VAT hike faded and the sluggish pace of economic 
recovery  limited  further  price  increases.  Although 
increases  in  non-energy  industrial  goods  and 
services  prices  picked  up  somewhat  during  2011, 
they remained far below the headline inflation rate. 
Another increase in the higher VAT rate in January 
2012  pushed  up  all  main  components  of  core 
inflation. Annual producer price inflation for total 
industry  averaged  around  6%  in  2011,  indicating 
to 
significant  cost  price  pressures 
commodity price increases. 

related 

6.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Having  contracted  by  almost  7%  in  2009,  the 
Hungarian  economy  expanded  by  1.3%  in  2010 
and 1.7% in 2011. The sluggish pace of economic 
recovery  was  mainly  caused  by  the  contraction  in 
bank lending constraining household consumption 
and  corporate  investment,  leaving  net  exports  as 

77 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

Table 6.1:

Hungary - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

4.0

-0.4

7.1

15.7

4.1

4.3

2.5

5.3

6.5

7.9

3.7

13.6

11.5

10.3

7.1

6.7

6.6

19.1

6.0

1.3

12.1

4.5

10.9

5.1

5.1

5.9

10.2

4.0

3.5

2.1

6.3

4.4

4.5

4.1

2.2

7.2

4.7

1.9

11.8

5.9

4.0

3.9

3.3

2.5

6.7

3.9

1.3

9.3

2.8

6.1

2.1

3.0

3.7

4.8

4.3

1.9

9.3

0.3

7.1

2.7

3.7

3.7

4.9

2012

1000

231

168

74

199

329

759

1000

170

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

the  only  significant  driver  of  growth.  As  a  result, 
actual  output  remained  a  couple  of  percentage 
the 
points  below  potential.  According 
Commission  services'  Spring  2012  Forecast,  real 
GDP growth is expected to come to a standstill in 
2012,  reflecting  the  slow-down  in  the  country's 
main  export  markets,  before  recovering  back  to 
around 1% in 2013. 

to 

The  fiscal  policy  stance,  as  measured  by  changes 
in  the  structural  balance,  was  loosened  in  recent 
years. After  a counter-cyclical  tightening  in 2009, 
the  structural  balance  deteriorated  in  2010  and 
2011.  During  2009,  significant  fiscal  adjustment 
measures  were  adopted  in  the  context  of  the  EU-
IMF balance of payments assistance programme to 
restore  investor  confidence  in  the  Hungarian 
economy.  However,  once  the  financial  market 
situation  stabilised,  fiscal  policy  was  deployed  to 
support the economic recovery. The fiscal stance is 
expected to be tightened again in 2012.  

Monetary  policy,  conducted  within  an  inflation 
targeting framework (66), was relatively tight in the 
recent period mainly to contain excessive financial 
market  volatility.  As  a  result,  real  short-term 
interest rates remained positive between mid-2010 
and early 2012 despite the slow pace of economic 
recovery. In October 2008, the MNB increased its 
main policy rate by 300 basis points to 11% in an 
attempt to stabilise the exchange rate in the  midst 
of  the  financial  market  turmoil.  Following  the 
granting  of  balance-of-payments  assistance  by 
international  institutions  and  subsequent  gradual 
improvements in the financial market situation, the 

(66)  Following  a  decision  in  August  2005,  the  MNB  has 
pursued  a  continuous  medium-term  inflation  target  of  3% 
for  the  period  starting  in  2007  with  a  permissible  ex  post 
fluctuation band of +/- 1 percentage point. 

78 

policy  rate  was  gradually  decreased  by  625  basis 
points  to  5.25%  by  April  2010.  Faced  with 
accelerating  energy  and  food  price  inflation,  the 
MNB  then  increased  its  main  policy  rate  again  in 
three  successive  25bp  steps  between  November 
2010  and  January  2011.  Thereafter,  it  kept  the 
main  policy  rate  on  hold  until  late  2011  when  in 
view  of  escalating  financial  market  tensions,  the 
monetary  policy  stance  was  tightened  by  two 
successive  50  basis  point  hikes  in  November  and 
December, bringing the policy rate to 7%.  

Wages and labour costs 

The Hungarian labour market is relatively flexible, 
with  a  decentralized  wage  setting  and  a  low 
coverage of collective agreements. Large increases 
in  unit  labour  costs  prior  to  the  2008  crisis  were 
mainly  driven  by  wage  settlements  in  the  public 
influenced  private  sector 
sector,  which  also 
behaviour,  as  well  as  by  sizeable  minimum  wage 
hikes.  The  labour  market  reacted  rather  swiftly  to 
the  sharp  economic  downturn,  with  compensation 
per  employee  declining  over  2009  and  2010 
reflecting wage cuts in the public sector as well as 
surging 
the 
unemployment.  However, 
downward adjustment initially did not fully match 
the  drop  in  labour  productivity,  unit  labour  costs 
only  fell  in  2010  when  labour  productivity  had 
already  recovered  somewhat.  Compensation  per 
employee  started  to  increase  in  2011,  again 
outpacing labour productivity growth. Unit labour 
costs are expected to rise further in 2012 and 2013, 
as  increases  in  compensation  per  employee,  also 
pushed  up  by  a  substantial 
the 
minimum  wage  in  2012,  are  foreseen  to  exceed 
labour  productivity  growth,  which  is  likely  to  be 
negative.  

increase 

as 

in 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

Table 6.2:

Hungary - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Hungary

Euro area

Private consumption deflator

Hungary

Euro area

4.0

2.2

3.5

2.2

Nominal compensation per employee

Hungary

Euro area

Labour productivity

Hungary

Euro area

Nominal unit labour costs

Hungary

Euro area

Imports of goods deflator

Hungary

Euro area

5.6

2.5

3.5

1.9

2.0

0.8

8.0

3.9

7.9

2.1

6.9

2.2

6.4

2.6

0.1

1.3

6.3

1.4

-4.4

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

Graph 6.3:Hungary - Inflation, productivity and wage trends

(y-o-y % change)

9

6

3

0

-3

-6

6.0

3.3

5.3

2.7

6.8

3.4

2.4

-0.3

4.3

3.8

1.7

4.2

4.0

0.3

3.7

-0.4

-1.4

1.8

-4.2

-2.4

2.9

4.2

1.1

-7.7

4.7

1.6

4.2

1.7

-2.3

1.7

0.9

2.5

-3.2

-0.8

1.9

5.7

3.9

2.7

4.4

2.5

5.8

2.2

1.4

1.2

4.4

0.8

5.1

6.9

5.5

2.4

5.5

2.2

3.7

1.9

-1.3

0.1

5.1

1.6

7.8

3.6

3.9

1.8

3.9

1.7

2.9

1.9

-0.4

1.0

3.3

0.8

1.4

1.3

in  2010  and  2011.  The  impact  of  higher  energy 
prices  on  headline  inflation  was  accentuated  by 
their  relatively  high  weight  in  the  HICP  basket. 
Growth of import prices thus accelerated in recent 
years  and  is  expected  to  increase  further  in  2012, 
reflecting  the  recent  substantial  exchange  rate 
depreciation.   

2006

2007

2008

2009

2010

2011

2012

2013

Administered prices and taxes 

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

External factors 

in 

the  high  degree  of  openness  of 

the 
Given 
Hungarian  economy,  developments 
import 
prices  play  an  important  role  in  domestic  price 
formation.  Growth  of  import  prices,  as  measured 
by  the  imports  of  goods  deflator  in  the  national 
accounts,  had  an  inflationary  impact  in  recent 
Import  price  dynamics  have  been 
years. 
rate 
by 
significantly 
fluctuations. Having depreciated by more than 8% 
in  2009,  the  nominal  effective  exchange  rate 
stabilised  in  2010  before  depreciating  sharply  in 
the  second  half  of  2011.  At  the  same  time, 
following  a  substantial  fall  in  2009,  prices  of 
primary  commodities,  including  crude  oil,  surged 

influenced 

exchange 

in 

than  headline 

The  share  of  administered  prices (67) 
the 
Hungarian  HICP  is  around  17%.  From  2004  to 
2011,  the  growth  rate  of  administered  prices  was 
significantly  higher 
inflation, 
reaching  on  average  almost  10%.  Sectors  that 
contributed the most to administered price inflation 
were energy, services related to housing as well as 
transportation.  This  was  mainly  the  consequence 
of global commodity price increases, reductions in 
subsidies as well as substantial investment needs in 
certain  regulated  sectors.  The  average  annual 
increase in administered prices declined from 6.7% 
in  2010  to  below  5%  in  2011,  driven  by  higher 
prices  of  gas,  heat  energy,  postal  services  as  well 

(67)  According to the Eurostat definition, administered prices in 
Hungary  inter  alia  include  water  supply,  refuse  and 
sewerage  collection,  electricity,  gas,  heat  energy, 
  certain  categories  of 
pharmaceutical  products  and 
passenger 
see 
details, 
http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/met
hodology/administered_prices 

transport. 

For 

79 

 
 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

vis the euro area is larger for services than goods. 
This  suggests  potential  for  further  price  level 
convergence  in  the  long  term,  as  income  levels 
(around  60%  of  the  euro  area  average  in  PPS  in 
2010) rise towards the euro area average. 

inflation  prospects  will  depend 
Medium-term 
strongly  on  wage  and  productivity  developments, 
notably  on  efforts 
to  avoid  excessive  wage 
increases in the non-tradable sector and to prevent 
skill  mismatches,  in particular  for  the  low-skilled. 
Further fiscal consolidation will also be important 
to stem inflationary risks, especially when cyclical 
conditions improve. 

6.3. 

PUBLIC FINANCES 

6.3.1.  The  excessive  deficit  procedure 

for 

Hungary 

Hungary is in EDP since the year of its accession 
to  the  EU.  The  Council  decided  on  5  July  2004 
that  an  excessive  deficit  existed  and  made 
recommendations  under  Article  104(7)  of  the 
Treaty  establishing 
the  European  Community 
(TEC) with a view to bringing the excessive deficit 
situation to an end by 2008. After deciding twice, 
in  January  and  November  2005,  in  accordance 
with  Article  104(8)  TEC,  that  Hungary  had  not 
taken  effective  action,  the  Council  issued  for  the 
third time a recommendation on October 2006, this 
time  postponing  the  deadline  to  2009.  In  July 
2009,  the  Council  concluded  that  the  Hungarian 
authorities  could  be  considered  to  have  taken 
effective action and, against the background of the 
economic  and  financial  crisis,  postponed  the 
deadline  by  two  years  to  2011.  On  27  January 
2010 the Commission concluded that Hungary had 
taken  effective  action  within  the  given  six-month 
period,  but  warned  of  considerable  risks.  On  24 
January  2012, 
that 
Hungary had not taken effective action in response 
to  the  latest  Council  Recommendations  of  July 
the  3%  of  GDP 
2009,  as  compliance  with 
reference value by Hungary in 2011 was not based 
on  a  structural  and  sustainable  correction. 
Specifically,  a  structural  deterioration  of  2¾ 
percentage  points  of  GDP  over  2010-2011  was 
estimated  by  the  Commission  services  against  the 
0.5  percentage  points  of  GDP  cumulative 
adjustment 
the  Council. 
Moreover,  the  2013  deficit  was  projected  by  the 
Commission  services  to  surpass  the  reference 
value  again  (at  3¼%  of  GDP)  even  after  taking 

the  Council  established 

recommended  by 

as  refuse  and  sewerage  collection.  Administered 
price inflation is expected to increase somewhat in 
2012  as  a  result  of  the  increase  in  the  main  VAT 
rate. 

Changes  in  taxation  related  to  fiscal  adjustment 
measures  have  also  had  a  substantial  impact  on 
inflation  since  2009.  In  July  2009,  the  VAT  rate 
for  around  85%  of  the  consumer  basket  increased 
from  20%  to  25%,  while  the  VAT  rate  for 
approximately  8%  of  the  basket  declined  from 
20% to 18%. From January 2012, the upper VAT 
rate was raised again to 27%. Due to weak demand 
conditions,  retailers  were  not  immediately  able  to 
pass through to consumers the full extent of these 
VAT  increases.  Excise  duties  have  also  been 
increased gradually to support fiscal consolidation 
efforts  and  to  comply  with  the  minimum  level  of 
excise  duties  on  cigarettes  required  in  the  EU. 
Having  exceeded  1½  percentage  points  in  2010, 
the  inflation  contribution  of  indirect  tax  increases 
is  estimated  to  have  been  only  marginal  in  2011. 
However,  indirect  tax  increases  are  expected  to 
contribute  about  2  percentage  points  to  average 
consumer price inflation in 2012. 

Medium-term prospects 

Inflation  is  currently  driven  by  the  pass-through 
from  the  substantially  weaker  exchange  rate  as 
well  as  by  indirect  tax  increases  adopted  in  late 
2011. As a result, if the exchange rate stabilises, a 
significant disinflation process could arise in 2013 
when  the  inflationary  impact  of  one-off  measures 
is  expected  to  fade.  At  the  same  time,  the 
substantial  negative  output  gap  should  constrain 
underlying  inflationary  pressures  and  potential 
second 
the 
Commission services' Spring 2012 Forecast, HICP 
inflation is thus projected to average 5.5% in 2012 
and just below 4% in 2013. 

effects.  According 

round 

to 

Risks to inflation appear to be broadly balanced. A 
negative  external  shock  leading  to  a  lower-than-
expected output growth and higher unemployment 
would likely heighten the disinflationary impact of 
the negative output gap. On the other hand, higher 
commodity price increases would likely be rapidly 
reflected  in  final  consumption  prices,  with  the 
overall  impact  amplified  by  the  relatively  large 
weight of commodities in the consumption basket. 

The  level  of  consumer  prices  in  Hungary  was  at 
some 62% of the euro area average in 2010. As in 
other new Member States, the remaining gap vis-à-

80 

 
Table 6.3:

Hungary - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

2008

Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

(as % of GDP unless indicated otherwise)

2009

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-9.4

42.7

52.2

3.9

37.4

-5.5

-11.4

-0.3
-11.1

65.9

3.9

4.5

-5.1

45.6

50.7

4.2

40.5

-1.0

-6.4

-0.9
-5.5

67.1

0.1

2.8

-3.7

45.5

49.2

4.2

40.4

0.5

-4.8

-0.4
-4.4

73.0

0.9

2.3

-4.6

46.9

51.4

4.7

40.2

0.1

-2.2

-0.1
-2.2

79.8

-6.8

-5.1

-4.2

45.2

49.5

4.1

37.8

-0.1

-2.4

1.2
-3.6

81.4

1.3

-3.9

4.3

52.9

48.7

4.1

36.9

8.3

5.3

9.6
-4.3

80.6

1.7

-2.3

-2.5

46.1

48.7

4.1

38.3

1.5

-1.3

0.8
-2.1

78.5

-0.3

-2.7

2012
-2.5

-1.9

78.4

0.1

-2.9

44.6

47.7

4.2

37.4

1.2

-2.0

0.0
-2.0

78.0

1.0

-2.0

2013
-2.2

-1.2

77.0

1.6

2014
-1.9

-1.1

73.7

2.5

2015
-1.5

-0.9

72.7

2.5

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme. One-off and other temporary measures 

taken from the programme  (9.4% of GDP in 2011, deficit-reducing; 0.8% of GDP in 2012, deficit-reducing; 

0.2% of GDP in 2013, deficit-reducing; 0.0% in 2014-2015).

Sources: Commission services, the 2012 Convergence Programme of Hungary.

(the 

into  account  additional  measures  announced  in 
mid-December  2011.   A  new 
fifth) 
recommendation  under  Article  126(7)  has  been 
issued  by  the  Council  on  13  March  2012.  The 
Council also endorsed the Commission proposal of 
22  February 
suspend 
commitments  of  the  EU  Cohesion Fund  for  2013, 
because  of  non-compliance  with  the  previous 
Council  recommendation  to  correct  its  excessive 
deficit (68). 

partially 

2012 

to 

6.3.2.  Recent fiscal developments 

Despite the major contraction of the economy of in 
2009,  the  fiscal  adjustment  programme  supported 
by  EU-IMF  financial  assistance  managed 
to 
stabilise  the  headline  deficit  at  around  4-4.5%  of 
GDP  in  2008  and  2009  as  well  as  to  improve  the 
structural  balance  in  2009  by  more  than  2%  of 
GDP;  this  was  based  on  important  consolidation 
efforts  carried  out  from  a  very  high  starting  level 
of over 9% of GDP in 2006. In 2010, the general 
government deficit was 4.2 % of GDP, exceeding 
somewhat  the  target  of  3.8  %  of  GDP.  Although 

(68)  An  overview  of  all  ongoing  excessive  deficit  procedures 
http://ec.europa.eu/economy 

can 
_finance/economic_governance/sgp/deficit/index_en.htm 

found 

at: 

be 

the economic recovery was faster than expected, it 
did not result in higher revenues since the structure 
of GDP turned out to be less tax-rich. This overrun 
was  the  result  of  a  combination  of  important 
expenditure  slippages  and 
revenue  shortfalls 
(partly related to some within-the-year tax cuts of 
around  0.3%  of  GDP)  amounting  to  over  3%  of 
GDP.  On  the other  hand,  this  overrun  was  almost 
counterbalanced 
of 
extraordinary  taxes  on  selected  sectors  amounting 
to  1¼%  of  GDP  and  other  expenditure  savings 
measures, including notably the elimination of the 
extraordinary reserves of 0.6% of GDP. Given the 
nature  of  the  budgetary  correction  package  (one-
off  revenues  compensated  for  the  excess  deficit), 
the structural deficit deteriorated by 1½% of GDP. 

introduction 

the 

by 

In 
the 
the  2011  Convergence  Programme, 
government target was a surplus of 2% of GDP for 
2011, despite significant tax cuts of 2½% of GDP 
in  the  second  half  of  2010  and  in  2011.  The 
budgetary  surplus  was  foreseen  to  be  achieved 
primarily  due  to  huge  one-off  revenues  (the 
transfer  of  the  accumulated  assets    estimated  at 
some  9¾%  of  GDP)  linked  to  the  elimination  of 
the  obligatory  private  pension  scheme.  This  also 
resulted  in  a  permanent  increase  in  revenues  of 

81 

 
                                                           
 
 
 
 
to 

since 

around  1.3%  of  GDP 
the  pension 
contributions  of  the  switched  back  employees 
(97% of all members) are to be paid into the public 
pillar instead of the private one. In June 2011, the 
budget  was  amended 
integrate  additional 
permanent saving measures of close to 1% of GDP 
at  the  line  ministries  which  was  primarily  needed 
to  compensate  for  the  lower  than  originally 
expected  economic  growth  (3%  vs  1.7%).  The 
2011  outturn  was  4.3%  of  GDP,  i.e.  more  than  2 
percentage  points  improvement  compared  to  the 
target.  This  is  chiefly  due  to  the  fact  that  some 
originally  foreseen  one-off  operation  were  not  (or 
only  partially)  implemented:  (i)  instead  of  the 
planned  full  takeover  of  the  1.3%  of  GDP  debt 
stock of public transport companies, only 0.2% of 
GDP  was  assumed  by  the  state,  and  (ii)  the 
government  decided  to  abort  its  0.7%  of  GDP 
programme  to  buy-out  PPP  projects.  The  2011 
deficit  net  of  one-off  effects  is  estimated  to  be 
around 5¼% of GDP.  

Gross public debt increased from 79.7% of GDP in 
2009 to 81.3% in 2010, which primarily reflects an 
adverse  denominator  effect  due  to  low  nominal 
growth.  In  2011,  gross  public  debt  declined 
slightly to 80.6% of GDP. This small improvement 
is the result of a sizeable primary surplus of 8.3% 
of GDP (generated by one-off revenues), which is 
to  a 
the  significant 
depreciation of the forint by over 10% compared to 
its end-2010 level. 

large  extent  offset  by 

6.3.3.  Medium-term prospects  

in 

line  with 

it  also  contains 

the  excise  duties; 

The 2012 budget was adopted by Parliament on 20 
December  2011.  It  targets  a  deficit  of  2.5%  of 
GDP 
latest  Convergence 
the 
Programme.  On  the  revenue  side,  the  budget 
contains  revenue  increasing  measures  of  around 
2%  of  GDP,  including  notably  a  2  percentage 
points hike in the standard VAT rate and increases 
in 
the 
continuation  of  temporary  sectoral  levies  of  0.9% 
of  GDP.  On  the  expenditure  side,  it  incorporates 
several structural measures, mainly in line with the 
Széll  Kálmán  Plan, 
in 
unemployment  benefits,  disability  pensions  and 
pharmaceutical  subsidies.  Moreover,  additional 
measures of around 1% of GDP are also budgeted, 
such  as  the  nominal  wage  freeze  in  the  public 
sector.  In  order  to  counterbalance  the  negative 
budgetary  effect  of  potential  unforeseen  adverse 
developments, 
extraordinary 
budgetary reserve of 1.1% of GDP was established 

in  particular  savings 

substantial 

a 

Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

(on top of the standard general reserve of 0.3% of 
GDP).  In  the  context  of  the  2012  Convergence 
Programme,  the  government  announced  further 
saving measures with a budgetary impact of 0.3% 
of  GDP 
the 
telecommunication services. 

including  a 

in  2012, 

levy  on 

The  Commission  services'  Spring  2012  Forecast 
projects the 2012 deficit to reach 2.5% of GDP. On 
the  basis  of 
the  usual  no-policy  change 
assumption,  it  forecasts  a  deficit  of  2.9%  of  GDP 
for  2013.  Following  a  cumulative  deterioration  of 
more  than  2%  of  GDP  in  2010  and  2011,  the 
structural  balance  is  expected  to  improve  by  over 
2%  of  GDP  to  around  2%  of  GDP  by  2012,  and 
improve slightly further in 2013. Assuming that no 
public  assets  will  be  sold  throughout  the  forecast 
horizon,  the  gross  public  debt  is  expected  to 
decrease to around 78% of GDP in 2013.  

in 

The 2012 Convergence Programme was submitted 
on 23 April. It confirmed the deficit path laid down 
in the 2011 Convergence Programme for the 2012-
2015  period,  targeting  deficits  of  2.5%,  2.2%, 
1.9%  and  1.5%  of  GDP,  respectively.  As  regards 
2012,  the  Commission  services'  Spring  2012 
Forecast  of  2.5%  of  GDP  is  identical  with  the 
official  target.  However,  while  the  authorities' 
forecast  presented 
the  2012  Convergence 
Programme  calculates  with  a  still  remaining 
extraordinary reserve of close to 0.4% of GDP, the 
Commission  services  currently  project  that  no 
further  reserve  will  be  left. (69)  This  difference  is 
explained  by  expenditure  slippages  of 
this 
magnitude  projected  by  the  Commission  services, 
mainly related to the pharmaceutical subsidies, the 
transport  sector  and  budgetary  institutions.  For 
2013,  the  difference  between  the  two  deficit 
projections  is  0.7%  of  GDP.  This  is  chiefly 
explained by the fact that slightly over half of the 
tax 
additional 
increases, the introduction of new taxes such as the 
financial  transaction  tax,  and  expenditure  cuts) 
could not be incorporated in the forecast due to the 
lack  of  specification  and  implementation  risks.  In 
addition,  the  Commission  services  project  weaker 
economic growth for both 2012 and 2013. 

saving  measures 

(including 

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  Hungary  can  be 
the  forthcoming  Commission  Staff 
found 
the 
Working  Document,  which  accompanies 

in 

(69)  This  approach  is  based  on  a  specific  governing  regulation 
contained in the budget bill which is assumed to ensure the 
cancellation of this reserve in case of slippages. 

82 

 
                                                           
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme  of  Hungary  and  delivering  a  Council 
Opinion  on  the  2012  Convergence  Programme  of 
Hungary (70). 

In  March  2012,  Hungary  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 
policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

6.4. 

EXCHANGE RATE STABILITY  

The Hungarian forint does not participate in ERM 
II.  Between  mid-2001  and  early  2008,  the  MNB 
operated  a  mixed  framework  that  combined  an 
inflation target with a unilateral peg of the forint to 
the  euro,  with  a  fluctuation  band  of  +/-15%.  The 
central  parity  was  devalued  once  in  June  2003, 
from  276.1  to  282.4  HUF/EUR.  On  26  February 
2008, the exchange rate bands were abolished and 
a free-floating exchange rate regime was adopted. 
The  move  aimed  at  helping  the  MNB  to  better 
control  inflation  by  removing  possible  conflicts 
between  maintaining  the  exchange  rate  band  and 
the inflation target, thereby more firmly anchoring 
inflation expectations.  

The  forint  exchange  rate  against  the  euro  has 
exhibited  high  volatility  in  recent  years.  After 
having  enjoyed  a  period  of  relative  stability 
between  August  2009  and  April  2010  in  the 
context  of  the  EU-IMF  balance  of  payments 
assistance  programme, 
the  forint  depreciated 
sharply 
in  May  2010  and  remained  weaker 
increased 
throughout 
uncertainty  about  the  future  course  of  economic 
policy  following  parliamentary  elections  and  the 
formation  of  a  new  government  in  spring  2010. 
The forint exchange rate against the euro followed 
a  mild  appreciating  trend  from  September  2010 
until  April  2011  and  then  broadly  stabilised  for 
another 
the  government 
proclaimed  a  strong  commitment  to  public  debt 

three  months,  as 

reflecting 

summer 

the 

(70)  http://ec.europa.eu/economy_finance/economic_ 

governance/sgp/convergence/programmes/2012_en.htm 

Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

reduction  while  the  monetary  policy  stance  was 
also  tightened  somewhat  in  late  2010  and  early 
2011. 

Subsequently,  mounting  financial  market  tensions 
in  weaker  euro  area  economies  started 
to 
negatively  affect  local  FX  markets  in  central  and 
eastern  Europe.  The  forint  suffered  the  largest 
losses,  weakening  by  some  12%  against  the  euro 
between  July  and  December  2011,  also  due  to 
some  controversial  domestic  economic  policy 
measures,  such  as  the  possibility  to  repay  FX 
mortgage  loans  at  historical  exchange  rates.  It 
recovered somewhat in early 2012 amid a pick-up 
in global risk appetite accentuated by expectations 
that  an  agreement  on  precautionary  balance  of 
payments assistance by the EU and the IMF would 
be reached soon. During the two years before this 
assessment, the forint depreciated against the euro 
by 6.5%. 

Graph 6.4:Exchange rates - HUF/EUR

(monthly averages)

320

310

300

290

280

270

260

250

240

230

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

assistance 

The  stock  of  international  reserves  jumped  by 
some  EUR  5  billion  in  November  2008  and  then 
gradually  increased  to  above  EUR  30  billion  in 
summer 2009, reflecting successive disbursements 
of  balance  of  payments 
from 
institutions.  International  reserves 
international 
continued  to  follow  an  upward  trend  until  mid-
2010,  benefiting  from  the  sharp  improvement  in 
the  external  balance  which  turned  into  surplus  in 
the  second  quarter  of  2009.  The  reserve  level 
thereafter  temporarily  stabilised,  before  recording 
further  increases  in  spring  2011  as  a  result  of 
successful  international  sovereign  bond  issuance. 
International  reserves  peaked  at  above  EUR  38bn 
in  October  2011  before  sovereign  external  debt 
redemptions  and  accelerated  deleveraging  in  the 
banking sector led to a decline in the reserve level 
to below EUR 35bn by March 2012. At the end of 
2011,  international  reserves  covered  about  155% 
of short-term external debt at original maturity.  

83 

 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

tightened 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro area declined gradually from above 800 basis 
points  in  July  2009  to  below  450  basis  points  in 
summer  2010,  reflecting  successive  domestic 
monetary  policy  rate  cuts,  which  were  mainly 
enabled  by  the  improving  local  financial  market 
situation.  They  increased  to  around  500  basis 
points in early 2011, as domestic monetary policy 
was 
somewhat,  before  declining 
marginally in spring 2011 due to rising short-term 
rates  in  the  euro  area.  In  late  2011,  rapidly 
deteriorating  financial  market  sentiment  and  the 
associated re-launching of the domestic rate-hiking 
cycle combined with monetary policy loosening in 
the  euro  area  set  spreads  on  a  steep  upward 
trajectory. At the cut-off date of this report, the 3-
month spread vis-à-vis the euro area reached some 
640 basis points. 

Graph 6.5:Hungary - 3-M Bubor spread to 3-M Euribor

(basis points, monthly values)

900

800

700

600

500

400

300

200

100

0

2006

2007

2008

2009

2010

2011

2012

Source: Reuters EcoWin.

6.5. 

LONG-TERM INTEREST RATES 

the  development  of 

For  Hungary, 
long-term 
interest rates is assessed on the basis of secondary 
market  yields  on  a  single  benchmark  bond  with  a 
residual maturity of close to 10 years.  

The  Hungarian  12-month  moving  average  long-
term  interest  rate  relevant  for  the  assessment  of 
convergence has been above the reference value at 
the time of each convergence assessment since EU 
accession.  It  followed  a  downward  trend  since 
August  2009,  falling  to  below  7.3%  in  late  2010, 
starting  to  increase  again  in  the  second  half  of 
2011. In March 2012, the reference value, defined 
by  the  average  of  long-term  interest  rates  in 
Sweden  and  Slovenia  plus  2  percentage  points, 
stood  at  5.8%.  In  that  month,  the  twelve-month 
moving  average  of  the  yield  on  the  Hungarian 
benchmark bond had reached 8.0%, 2.2 percentage 
points above the reference value.  

Graph 6.6:Hungary - Long-term interest rate criterion
(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Hungary

Reference value

Source: Commission services.

Between  September  2009  and  September  2011 
long-term  interest  rates  mainly  oscillated  between 
6.5%  and  8%.  Afterwards,  they  followed  a  steep 
upward  trend  exceeding  9%  in  January  2012  as  a 
number  of  controversial  policy  measures  adopted 
by  the  Hungarian  authorities  raised  investors' 
concerns  regarding  local  financial  stability.  Long-
term  spreads  vis-à-vis  the  German  benchmark 
bond (71) stood at some 690 basis points in March 
2012. 

Graph 6.7:Hungary - Long-term interest rates

(percent, monthly values)

14

12

10

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Hungary

Germany

6.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

(71)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

84 

 
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

Table 6.4:

Hungary - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Of which International financial assistance

                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

2006

2007

2008

2009

2010

2011

(percentage of GDP)

-7.4

-2.7

1.6

-5.9

-0.3

0.8

-6.6

8.8

2.6

5.8

1.5

-1.1

9.9

-2.2

-7.3

-0.7

1.3

-7.4

-0.5

0.7

-6.6

6.6

0.2

-1.6

8.1

-0.1

6.7

0.0

-7.3

-1.1

1.4

-7.1

-0.5

1.0

-6.4

8.5

2.6

-2.4

15.7

6.6

-7.3

15.9

-2.2

-0.1

2.6

2.2

-5.3

0.5

1.2

1.1

-0.7

0.1

-4.1

9.4

8.0

-6.1

5.4

-0.4

1.2

3.3

3.0

-5.5

0.4

1.8

3.0

-1.4

0.7

-0.2

1.2

0.0

-3.1

1.8

-1.7

1.4

4.0

3.2

-6.3

0.5

2.1

3.6

-1.8

-0.1

6.5

-4.3

-2.0

-3.9

2.1

-1.8

Gross capital formation

Gross saving

External debt

International investment position

24.1

16.6

96.8

-107.7

22.4

15.0

104.6

-104.2

23.5

16.6

117.0

-100.7

17.9

17.8

150.0

-122.0

18.4

19.4

142.4

-111.4

19.1

20.1

130.5

-94.5

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, Magyar Nemzeti Bank.

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance 
in  EMU. 
the  governance  structures 
Related  to  this,  in  February  2012,  following  the 
adoption  of  the  legislation  establishing  the  new 
procedure  for  surveillance  and  correction  of 
macroeconomic  imbalances  (the  Macroeconomic 
Imbalances Procedure - MIP) (72), the Commission 
first  Alert  Mechanism  Report 
published 
(AMR) (73).  The  AMR  scoreboard  showed  that 
Hungary exceeded the indicative threshold for two 
out  of  ten  indicators  (namely  the  international 
investment position and public sector debt). In line 
with  the  conclusion  of  the  AMR,  Hungary  was 
subject to an in-depth review in the context of the 
MIP. 

its 

(72)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(73)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

6.6.1.  Developments  of 

the  balance  of 

payments 

After  turning  into  surplus  in  2009,  Hungary's 
external  balance  (i.e.  the  combined  current  and 
capital  account)  improved  further  in  2010  before 
broadly  stabilising  in  2011.  The  adjustment  was 
driven  by  falling  domestic  demand,  dampening 
import  growth,  combined  with  a  robust  export 
performance.  The  improvement  in  the  current 
account  balance  resulted  from  an  increased  trade 
surplus, while the balance of primary incomes and 
net  current  transfers  deteriorated.  The  surplus  in 
the  capital  account  also  increased  due  to  higher 
absorption of EU funds. 

The  improvement  in  the  external  balance  in  2010 
mainly  resulted  from  a  further  increase  in  private 
sector savings whereas gross saving by the general 
government  continued  to  decline.    At  the  same 
time, after increasing somewhat in 2010, domestic 
investment  activity  (as  a  percentage  of  GDP) 
dropped again in 2011. 

85 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

after  mid-2009.  However,  facing  a  deteriorating 
financial  market  situation,  Hungary  asked  for 
precautionary  balance  of  payments  assistance  by 
the  EU  and  the  IMF  in  November  2011.  No 
agreement on a possible assistance programme was 
reached by the end of April 2012. 

The external surplus is expected to further increase 
in 2012 and 2013 due to both a larger trade surplus 
and a higher inflow of EU funds.  

6.6.2.  Product market integration 

through 

trade  and 

The Hungarian economy is highly integrated to the 
EU  economy 
investment 
trade  openness  has 
linkages.  Its  degree  of 
increased rapidly since EU accession, from 67% in 
2005 to above 83% in 2010, reflecting mainly the 
further integration of the Hungarian economy into 
continental  and  global  supply  chains.  Intra-EU 
flows  dominate  both  directions  of  trade.  The  EU 
accounted for 77% of Hungary's exports and 68% 
of  its  imports  in  2010,  with  Germany  alone 
accounting for almost 25% of total external trade. 
The  successful  extension  of  export  markets  to  the 
fast  growing  economies  of  Eastern  Europe  and 
Asia  has  supported  the  further  opening-up  of  the 
economy  as  reflected  by  steady  growth  in  intra- 
and extra-EU trade in goods. Russia and China are 
the  main  non-EU  trade  partners,  with  respective 
shares of 8% and 7% of total imports.  

is  heavily 

tilted 
Hungary’s  export  of  goods 
towards  high-  and  medium-high 
technology 
products. High technology goods account for over 
22%  of  total  exports  in  2010,  one  of  the  highest 
shares in the EU27. This strength is confirmed by a 
significant  technological  trade  surplus  (2.4%  of 
GDP 
revealed 
comparative  advantage  vis-à-vis  the  euro  area  in 
products  such  as  electrical  machinery,  radio,  TV 
and communication equipment.  

in  2009)  and  an 

increasing 

The  major  share  of  the  stock  of  inward  FDI 
(amounting  to  69%  of  GDP  in  2010)  originates 
from  the  EU27,  with  Germany,  the  Netherlands, 
and  Austria  accounting  for  about  half  of  the  total 
FDI  stock.  About  25%  of  the  total  FDI  inflows 
the  manufacturing  sector,  with  an 
went 
increasing share going to the automotive industry, 
suggesting  that  FDI  plays  a  pivotal  role  in 
enhancing Hungary’s export capacity. FDI inflows 
also  contribute  significantly  to  the  integration  of 
Hungary’s financial and product markets in the EU 

to 

Graph 6.8:Hungary - Saving and investment

(in percent of GDP at market prices)

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

Competitiveness  indicators  show  an  improving 
picture. Hungary has continued to record increases 
in its export market share in recent years. The real 
effective  exchange  rate,  measured  by  HICP  or 
ULC,  remained  broadly  stable  between  mid-2009 
and  mid-2011  before  depreciating  significantly  in 
the  second  half  of  2011,  largely  as  a  result  of  the 
evolution of the nominal exchange rate. 

Graph 6.9:Hungary - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

160

150

140

130

120

110

100

90

80

2006

2007

2008

2009

2010

2011

NEER

REER, HICP deflated

REER, ULC deflated

Source: Commission services.

Net  foreign  direct  investment  inflows  remained 
relatively small in 2010 before ceasing entirely in 
2011,  as  larger  direct  investments  by  residents 
abroad  offset  increased  foreign  direct  investments 
in  Hungary.  However,  after  not  having  played  a 
significant  role  in  2010,  net  portfolio  inflows 
increased  substantially  in  2011,  mainly  thanks  to 
successful  sovereign  external  debt  issuance.  This 
was  partly  offset  by  net  outflows  of  other 
investment in 2011 which had recorded a marginal 
surplus in 2010. Total gross external debt declined 
to  some  130%  of  GDP  in  2011  and  the  net 
international  investment  position  also  improved 
remaining  negative  and 
considerably,  while 
elevated.  

The  balance  of  payments  assistance  granted  to 
Hungary  by  the  EU  and  the  IMF  in  autumn  2008 
expired  in  late  2010  with  no  disbursements  from 
the  pre-committed  official  funding  taking  place 

86 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

Table 6.5:

Hungary - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

67.0

44.1

7.2

14.5

19.7

-0.9

7.0

6.7

3.7

0.7

36.9

38.0

100.0

4.6

100.0

78.2

50.9

7.8

17.3

20.3

1.5

6.5

5.6

3.5

0.9

30.3

38.0

101.6

3.8

87.0

80.9

52.0

8.2

18.1

21.4

1.6

2.9

2.4

2.1

1.2

22.3

16.0

99.6

4.1

86.0

81.4

51.3

8.5

18.8

20.2

2.1

4.8

4.8

1.9

0.6

25.4

5.0

95.6

3.6

86.0

75.2

46.6

9.5

16.5

22.3

2.4

1.6

-3.5

-1.7

0.4

27.7

4.0

86.5

3.3

57.0

83.3

51.8

9.3

19.5

n.a.

n.a.

1.4

0.5

-0.1

1.4

24.5

4.0

80.7

2.5

35.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

as  both  financial  intermediation  and  the  retail 
sector make up close to 15% of total FDI inflows. 

The  pre-crisis  period  in  the  Hungarian  real  estate 
market  was  characterised  by  a  cumulative  real 
price increase of over 130% from the beginning of 
1998 to the peak in the fourth quarter of 2004. This 
implied  a  high  average  growth  rate  during  the 
upswing.  Since  their  peak,  house  prices  in  real 
terms  have  been  moderately  declining.  Between 
2005 and the third quarter of 2011, the cumulative 
real  house  price  decrease  amounted  to  27%. 
During  the  recent  period  of  house  price  decline, 
residential  construction  adjusted  as  well,  with  its 
value  falling  from  slightly  above  5  %  of  GDP  in 
2003 to about 2% in 2011. The decline in building 
permits has not bottomed yet, making it difficult to 
determine  whether  construction  activity  will 
stabilise in the coming quarters. 

Concerning  the  business  environment,  Hungary 
scores  below  the  average  of  euro  area  Member 

States  in  international  rankings (74).  It  performs 
particularly poorly in terms of legal and regulatory 
framework, which is complex and unstable due to 
frequent  and  sometimes  ad-hoc  modifications.(75) 
To  address  these  shortcomings,  a  large-scale 
government  programme  was  launched  in  2011 
with  the  aim  of  reducing  the  administrative  costs 
for  businesses.  The  value  share  of  tenders  openly 
advertised  in  the  EU  Official  Journal (76)  has 
decreased recently, but it is still higher than the EU 
average. Finally, according to the November 2011 
Internal  Market  Scoreboard, 
transposition 
deficit of EU Directives went above the threshold 

the 

(74)  For  instance,  Hungary  ranks  on  48th  and  52nd  place 
according to the 2011-2012 Global Competitiveness index 
and the 2012 World Bank Doing Business respectively. 
(75)  In  the  World  Bank  2012  Doing  Business  Hungary  ranked 
far  behind  its  regional  peers  for  the  indicator  “protecting 
investors”. 

(76)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may serve as a proxy of the extent to which national public 
procurement is open to foreign bidders. 

87 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 6 - Hungary 

in recent years. The most problematic areas in this 
respect are transport and energy. 

2008-09  crisis,  reaching  some  13%  for  household 
loans  and  more  than  17%  for  corporate  loans  by 
the end of 2011.  

6.6.3.  Financial market integration 

Hungary's  financial  sector  is  well  integrated  into 
the EU financial system. This integration is visible 
in  the  share  of  foreign  ownership  of  the  banking 
system  as  well  as  in  the  participation  of  the 
Budapest Stock Exchange (BSE) in the CEE Stock 
Exchange Group. The share of bank assets owned 
by  foreign 
through  branches  and 
subsidiaries  reached  58%  at  the  end  of  2010, 
remaining  broadly  unchanged  compared  to  the 
2004  level.  The  Hungarian  banking  system  is  not 
highly  concentrated  with  the  largest  five  credit 
institutions  accounting  for  about  55%  of  its  total 
assets. This moderate concentration ratio has been 
rather stable since EU entry.  

institutions 

Graph 6.10:Hungary - Foreign ownership and 
concentration in the banking sector

(in percent, weighted averages)

70

60

50

40

30

20

10

0

HU, 2005

HU, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

intermediation 

Hungary has one of the better developed financial 
sectors  among  the  new  EU  Member  States. 
Indirect 
is  predominant,  with 
domestic bank credit amounting to almost 67% of 
GDP in 2011. In the few years preceding the 2008 
-09  global  financial  crisis,  the  banking  sector  had 
been  expanding  at  a  fast  pace,  mainly  thanks  to 
rapid  credit  growth.  In  the  last  two  years,  bank 
lending  to  the  non-financial  private  sector  has 
fallen compared to early 2009. Nevertheless, given 
the  high  share  of  foreign-currency-denominated 
loans,  with  a  large  majority  in  Swiss  franc,  the 
exposure of the private sector to exchange rate risk 
will remain substantial in the years to come. 

The  Hungarian  banking  system  remains  well-
capitalized,  with  a  capital  adequacy  ratio  of  some 
13.5% at the end of 2011. However, the return on 
equity was negative at the sector level in 2011 due 
to 
the  early-FX-mortgage-
repayment scheme and the need to pay the special 
bank  levy.  Moreover,  the  level  of non-performing 
loans  has  been  continuously  increasing  since  the 

related 

losses 

to 

88 

Graph 6.11:Hungary - selected banking sector soundness 
indicators relatively to the euro area

%

HU, 2004

HU, 2011

EA, 2004

EA, H1-11

40

30

20

10

0

-10

-20

Return on equity

Capital adequacy

Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.
Source: ECB, National Bank of Hungary, Hungarian FSA, EC calculations.

The  share  of  financial  intermediaries  other  than 
banks and credit cooperatives in total assets of the 
Hungarian  financial  system  has  declined  recently. 
Following  the  outbreak  of  the  financial  crisis 
investment funds were hit by losses suffered on the 
capital  market  and by  withdrawals  of  capital.  The 
pension funds industry suffered a major setback in 
2011  after  most  second-pillar  pension  funds  were 
transferred to the state social security system. 

The  Budapest  Stock  Exchange  (BSE)  does  not 
play  a  decisive  role  in  the  financing  of  the 
economy. Moreover, falling stock prices decreased 
the total market capitalisation of the BSE to below 
15% of GDP in 2011, which is substantially lower 
than the 2004 level of almost 26%. As a result of 
high  central  government  issuance,  the  total  value 
of outstanding fixed income securities amounted to 
some 76% of GDP in 2011. Private sector debt (77) 
of around 155% of GDP in 2010 is still below the 
euro area average. 

Graph 6.12:Hungary - Recent development of the  financial 
system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

HU, 2004

HU, 2011

EA, 2004

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.
Source: Eurostat, ECB, National Bank of Hungary, FESE, Reuters EcoWin.

(77)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

 
 
 
 
                                                           
7. 

POLAND 

7.1. 

LEGAL COMPATIBILITY 

7.1.1.  Introduction 

The Act on the Narodowy Bank Polski (the Act on 
the NBP – central bank of Poland) was adopted in 
1997 and was last amended in 2010 and 2011.  

7.1.2.  Central bank independence 

this  area, 
In 
imperfections exist.  

several 

incompatibilities  and 

The Act on the NBP does not prohibit the NBP and 
members  of  its  decision-making  bodies  from 
seeking or taking outside instructions; it also does 
not  expressly  prohibit 
the  Government  from 
seeking  to  influence  members  of  NBP  decision-
making  bodies  in  situations  where  this  may  have 
an impact on NBP's fulfilment of its ESCB related 
tasks.  This  constitutes  an  incompatibility  with 
Article  130  of  the  TFEU  and  Article  7  of  the 
ESCB/ECB Statute. 

Article 23(1)(2) provides that the NBP's President 
has,  inter  alia,  to  submit  draft  monetary  policy 
guidelines,  to  the  Council  of  Ministers  and  the 
Minister  of  Finance.  This  procedure  provides  for 
the opportunity to exert influence on the monetary 
and  financial  policy  of 
thus, 
constitutes  an  incompatibility  in  the  area  of 
independence,  with  Article  130  of  the  TFEU  and 
Article 7 of the ESCB/ECB Statute. 

the  NBP  and 

Article  9(3)  of  the  Act  on  the  NBP  foresees  that 
the  President  of  the  NBP  shall  assume  his/her 
duties  after  taking  an  oath  before  the  Parliament. 
In this oath it is referred to the observation of the 
provisions  of  the  Polish  Constitution  and  other 
laws, the economic development of Poland and the 
well-being  of  its  citizens.  The  President  of  the 
NBP  acts  in dual  capacity  as  a  member  of NBP’s 
decision-making  bodies  and  of 
the  relevant 
decision-making bodies of the ECB. Article 9(3) of 
the Act needs to be adapted to reflect the status and 
the  obligations  and  duties  of  the  President  of  the 
NBP  as  member  of  the  relevant  decision-making 
bodies of the ECB. What is more, the oath does not 
contain  a 
the  central  bank 
independence enshrined in Article 130 TFEU. The 
oath,  as  it  stands  now,  is  an  imperfection  and 

reference 

to 

should  be  adapted  to  be  fully  in  line  with  the 
TFEU and the ESCB/ECB Statute. 

The grounds for dismissal of the NBP's President, 
according to Articles 9(5) are going beyond those 
of  Article  14.2  ESCB/ECB  Statute,  setting  up 
additional  grounds  for  dismissal.  Moreover,  the 
Law  on  the  State  Tribunal  (Article  25(3)  in 
conjunction  with  Article  3  and  Article  1(1)(3)) 
provides for grounds for NBP's President removal 
from 
the 
Constitution or a law. While Article 9(5) of the Act 
provides  for  an  imperfection  with  regard  to  the 
grounds for dismissal, the provision of the Law on 
the  State  Tribunal  are  incompatible  with  Article 
14.2 of the ESCB/ECB Statute. 

if  he  or  she  violates 

the  office, 

According 
to  Article  203(1)  of  Poland’s 
Constitution,  the  Supreme  Chamber  of  Control 
(Najwyższa  Izba  Kontroli  (NIK))  is  entitled  to 
examine the NBP's activities as regards its legality, 
economic  prudence,  efficiency  and  diligence.  The 
NIK controls are not performed in the capacity of 
an  independent  external  auditor,  as  laid  down  in 
Article  27.1  of  the  ESCB/ECB  Statute  and  thus, 
should be clearly defined respecting Article 130 of 
the Treaty and Article 7 of the ECB/ESCB Statute. 
The  provision  of  the  Constitution  is  therefore, 
incompatible and needs to be therefore adapted in 
order to respects the later.  

7.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Article  42  of  the  NBP  Act  in  conjunction  with 
relevant  provisions  of  the  Law  on  banking,  allow 
to the NBP to extend refinancing loans to banks in 
order  to  replenish  their  funding  and  also  extend 
refinancing  to  banks  for  the  implementation  of  a 
bank 
rehabilitation  programme.  The  current 
wording of those provisions could be interpreted as 
allowing  for  an  extension  of  refinancing  loans  to 
banks  experiencing 
rehabilitation  proceedings 
leading  to,  in  some  cases,  insolvency.  Thus, 
explicit 
effective  preventive  measures 
safeguards  should  be  provided  in  the  law,  in 
particular,  in  Article  42  of  the  Act  to  avoid 
incompatibility with Article 123 of the TFEU. 

and 

89 

 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

7.1.4.  Integration in the ESCB 

Objectives 

•  non  recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Article  5(1) 
and 11(3)); 

Article 3(1) of the NBP Law sets the objectives of 
the NBP. It refers only to the economic policies of 
the  Government  while 
it  should  also  make 
reference  to  the  general  economic  policies  in  the 
Union,  with  the  latter  taking  precedence  over  the 
former.  This  constitutes  an  imperfection  with 
respect to Article 127(1) of the TFEU and Article 
2 of the ESCB/ECB Statute. 

Tasks 

7.1.5.  Assessment of compatibility 

As  regards  the  independence  of  the  central  bank, 
the  prohibition  on  monetary  financing  and  the 
central bank integration into the ESCB at the time 
of  euro  adoption,  the  legislation  in  Poland,  in 
particular the Act on the NBP and the Constitution 
of the Republic of Poland are not fully compatible 
with the compliance duty under Article 131 of the 
TFEU. 

The  incompatibilities  in  the  NBP  Act  and  in  the 
Polish  Constitution  in  this  area  are  linked  to  the 
following ESCB/ECB/EU tasks: 

7.2. 

PRICE STABILITY 

•  definition  and  implementation  of  monetary 
policy 
the 
Constitution,  Articles,  3(2)(5),  12,  23,  38-50a, 
and 53 of the Act on the NBP); 

(Articles  227(1)  and 

(5)  of 

•  holding  and  management  of  foreign  exchange 
operations  and 
foreign 
exchange  policy  (Articles  3(2)(2),      3(2)(3),  
17(4)(2), 24, and 52); 

the  definition  of 

•  competences  of  the  ECB  and  of  the  EU  for 
banknotes  and  coins  (Article  227(1)  of  the 
Constitution  and  Articles  4, 31  to 37 of  the  of 
the  Act  on  NBP).  The  NBP  shall  exercise  its 
responsibility  for  issuing  the national  currency 
as part of the ESCB. 

are 

examined  by 

•  appointment  of  independent  auditors  -  Article 
69(1)  of  the  NBP  Act  foresees  that  NBP 
accounts 
independent 
auditors.  The  Act  does  not  take  into  account 
that  the  auditing  of  a  central  bank  has  to  be 
carried  out  by  independent  external  auditors 
recommended  by  the  Governing  Council  and 
approved  by  the  Council.  It  is  incompatible 
with Article 27.1 of the ESCB/ECB Statute.  

7.2.1.  Respect of the reference value 

in  December  2010,  before 

The  12-month  average  inflation  rate  for  Poland, 
which is used for the convergence evaluation, was 
above  the  reference  value  at  the  time  of  the  last 
convergence  assessment  in  2010.  Average  annual 
inflation declined from above 4% in early 2010 to 
2.7% 
increasing 
gradually  again  in  the  course  of  2011.  In  March 
2012, the reference value was 3.1%, calculated as 
the average of the 12-month average inflation rates 
in  Ireland,  Sweden  and  Slovenia,  plus  1.5 
percentage points. The corresponding inflation rate 
in  Poland  was  4.0%,  i.e.  0.9  percentage  points 
above  the  reference  value.  The  12-month  average 
inflation  rate  is  likely  to  stay  above  the  reference 
value in the months ahead. 

Graph 7.1:Poland - Inflation criterion since 2006

(percent, 12-month moving average)

5

4

3

2

1

There are also some imperfections regarding: 

•  non recognition of the role of the ECB for the 
functioning of the payment systems (Articles 3 
(2)(1)); 

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Poland

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

7.2.2.  Recent inflation developments 

•  non  recognition  of  the  role  of  the  ECB  and  of 
the  EU  for  the  collection  of  statistics  (Article 
3(2)(7) and 23); 

Inflation  in  Poland  has  been  relatively  stable  in 
recent years. Food and energy prices, which have a 
large  weight  (of  almost  30%  and  about  15% 

90 

 
 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

Table 7.1:

Poland - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

1.3

-1.7

4.8

0.8

0.9

2.8

0.6

1.1

4.9

2.6

0.0

4.3

4.4

4.3

2.7

2.0

2.1

3.7

4.2

-0.3

8.5

2.8

7.9

4.4

3.6

3.5

6.4

4.0

0.2

5.9

7.1

5.7

4.5

3.3

3.2

6.9

2.7

0.0

6.2

3.1

4.0

2.5

2.0

2.5

3.9

3.9

1.1

9.2

2.7

6.2

3.0

3.1

3.1

5.3

4.0

1.3

9.4

1.7

6.2

3.4

3.4

3.3

5.3

2012

1000

271

154

91

194

290

755

1000

138

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices 

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

respectively)  in  the  Polish  HICP  index,  were  the 
main  source  of  variation.  Strong  exchange  rate 
fluctuations  and  changes  in  administered  prices 
further amplified inflation volatility.   

Annual  HICP  inflation  declined  gradually  from 
4.5%  to  below  2%  between  July  2009  and  July 
2010,  mainly  reflecting  lower  food  and  service 
price  increases,  as  the  slowdown  in  economic 
activity  and  a  stronger  exchange  rate  contained 
further  upward  pressure  on  prices.  Afterwards, 
inflation started to increase again, driven by rising 
commodity  prices  and  a  VAT  hike  effective  from 
the  beginning  of  2011.  Although  it  declined 
temporarily  between  May  and  September,  largely 
due to a favourable evolution of unprocessed food 
prices, 
the 
exchange rate in late 2011 pushed annual inflation 
up  to  4.5%  in  December  2011.  Annual  inflation 
declined  somewhat  in  early  2012,  mainly  due  to 
favourable base effects. 

the  considerable  weakening  of 

Graph 7.2:Poland - HICP inflation

(y-o-y percentage change)

6

4

2

0

-2

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Poland

Euro area

lower  level.  It  declined  gradually  from  3.8%  in 
July  2009  to  1.3%  in  July  2010,  before  slowly 
rising  to  3.9%  by  end-2011.  The  increase  was 
mainly  induced  by  higher  prices  of  services. 
However, the inflation contributions of non-energy 
industrial  goods  and  processed  food  also  rose 
significantly,  reflecting  strong  growth  of  private 
demand  as  well  as  indirect  tax  increases,  which 
were  further  amplified  by  a  substantial  exchange 
rate  depreciation  in  late  2011.  Core  inflation 
declined  in  early  2012,  as  the  inflationary  impact 
of  one-off  measures  faded.  Annual  average 
producer price inflation for total industry increased 
to  almost  8%  in  2011,  indicating  elevated  cost 
price pressures. 

7.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy-mix  and  cyclical 
stance 

Real GDP growth fell to below 2% in 2009 before 
recovering  to  3.9%  in  2010  and  4.3%  in  2011.  It 
was  mainly  driven  by  domestic  demand  which, 
compared  to  its  regional  peers,  plays  a  more 
important  role 
in  a  relatively  closed  Polish 
economy, resulting in a higher resilience vis-à-vis 
external shocks. The output gap turned negative in 
2009 and, after remaining broadly stable in 2010, it 
is estimated to have narrowed in 2011. According 
to the Commission services' Spring 2012 Forecast, 
real  GDP  growth 
to  decrease 
somewhat  to  2.7%  in  2012  and  2.6%  in  2013, 
leading  to  some  widening  of  the  negative  output 
gap. 

is  projected 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  evolved 
broadly  in  line  with  HICP  inflation,  albeit  at  a 

After  a  counter-cyclical  fiscal  expansion  in  2009, 
the  fiscal  stance,  as  measured  by  changes  in  the 

91 

 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

Table 7.2:

Poland - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Poland 

Euro area

Private consumption deflator

Poland 

Euro area

1.3

2.2

1.2

2.2

Nominal compensation per employee

Poland 

Euro area

Labour productivity

Poland 

Euro area

Nominal unit labour costs

Poland 

Euro area

Imports of goods deflator

Poland 

Euro area

1.9

2.5

3.0

1.9

-1.0

0.8

2.8

3.9

2.6

2.1

2.4

2.2

4.9

2.6

2.2

1.3

2.6

1.4

0.8

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

4.2

3.3

4.3

2.7

8.9

3.4

1.2

-0.3

7.5

3.8

0.3

4.2

4.0

0.3

2.5

-0.4

3.5

1.8

1.2

-2.4

2.2

4.2

8.7

-7.7

2.7

1.6

2.5

1.7

5.7

1.7

3.4

2.5

2.2

-0.8

1.8

5.7

3.9

2.7

4.3

2.5

5.1

2.2

3.3

1.2

1.7

0.8

8.0

6.9

3.7

2.4

3.7

2.2

4.7

1.9

2.4

0.1

2.2

1.6

5.0

3.6

2.9

1.8

3.0

1.7

5.1

1.9

2.2

1.0

2.8

0.8

2.0

1.3

structural  balance,  remained  broadly  neutral  in 
2010.  It  was  tightened  considerably  in  2011  in 
view of a continued robust expansion of domestic 
economic  activity.  Nevertheless,  the  structural 
deficit is estimated at about 5% of GDP in 2011. A 
further substantial tightening of the fiscal stance is 
foreseen for 2012.  

was 

framework (78), 

Monetary  policy,  conducted  within  an  inflation 
targeting 
loosened 
significantly  between  November  2008  and  July 
2009, as the NBP gradually cut its main policy rate 
by a total of 250 basis points to 3.5% amid a rapid 
deterioration  in  the  economic  outlook.  The  NBP 
then  kept  the  policy  rate  unchanged  throughout 
2010 as inflation dropped to within the permissible 
fluctuation band around the inflation target. Faced 
with 
the  NBP 
increased its main policy rate by 100bp in the first 
half of 2011. It then kept the main rate unchanged 
as the economic outlook deteriorated again.  

increasing 

inflation, 

rapidly 

Wages and labour costs 

Wage  negotiations  in  the  private  sector  are  rather 
decentralised  and  flexible,  with  wage  setting 
mostly  at  the  enterprise  level,  although  collective 

(78)  Since  the  beginning  of  2004,  the  NBP  has  pursued  a 
continuous  inflation  target  of  2.5%  with  a  permissible 
fluctuation band of +/- 1 percentage point. 

92 

bargaining  has  a  stronger 
formation 
in 
enterprises, such as mining.  

sectors  dominated  by 

impact  on  wage 
state 

Graph 7.3:Poland - Inflation, productivity and wage trends
12

(y-o-y % change)

9

6

3

0

-3

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

The  economic  slowdown  in  2009  resulted  in 
higher  unemployment.  Consequently, 
the  gap 
between  increases  in  compensation  per  employee 
and  productivity  growth  narrowed  significantly. 
Growth  of  nominal  unit  labour  costs  (ULC)  thus 
moderated from some 7.5% in 2008 to around 2% 
in 2011 even though increases in compensation per 
employee recovered somewhat in 2010-11 despite 
a  wage  freeze  for  central  government  employees 
(excluding  teachers).  ULC  growth  is  expected  to 
accelerate  somewhat  in  2012  and  2013  as  lower 
labour  productivity  growth  might  not  be  fully 

 
                                                           
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

the 

evolution 

of 

employee 

Medium-term prospects 

reflected 
in 
compensation. 

External factors 

Although external trade represents a lower share of 
GDP in Poland than for its regional peers, prices of 
imported goods and services play an important role 
in  domestic  price  formation.  Import  prices,  as 
measured  by  the  imports  of  goods  deflator  in  the 
national  accounts,  surged  in  2009,  driven  by  a 
substantial  nominal  effective  exchange 
rate 
depreciation.  Growth  of  import  prices  moderated 
in  2010,  when 
rate  partially 
recovered,  but  it  accelerated  again  in  2011, 
reflecting  a  somewhat  weaker  exchange  rate  as 
well  as  rapidly  increasing  prices  of  primary 
commodities,  including  crude  oil.  Growth  of 
import prices is expected to decline again in 2012, 
mainly as the result of the more favourable outlook 
for primary commodity price developments. 

the  exchange 

Administered prices and taxes 

Increases in administered prices (79), with a weight 
of  around  14%  in  the  HICP  basket,  significantly 
exceeded  HICP  inflation  in  recent  years.  The 
average  annual  increase  in  administered  prices 
declined to below 4% in 2010 from almost 7% in 
2009,  before  increasing  again  to  above  5%  in 
2011,  driven  by  rising  prices  of  gas,  electricity, 
water  supply  and  sewage  collection.  The  rate  of 
increase  in  administered  prices  should  decline 
somewhat in 2012, mainly due to smaller increases 
in electricity and gas prices. 

In  line  with  the  need  to  reach  the  minimum  level 
required by the EU, excise duties on tobacco have 
increased  continuously  in  recent  years  but  their 
impact on the overall inflation rate was marginal in 
2010  and  2011.  To  support  fiscal  consolidation 
efforts,  the  main  VAT  rate  was  raised  by  2 
percentage points to 23% in 2011, while the VAT 
rate on unprocessed food was lowered to 5%. Due 
to an incomplete pass-through to consumer prices, 
the overall impact of VAT changes on the average 
inflation rate in 2011 is estimated to have remained 
below half a percentage point. A marginal inflation 
contribution  from  higher  excise  duties  on  tobacco 
and diesel is expected in 2012.  

include 

(79)  According to the Eurostat definition, administered prices in 
Poland 
inter  alia  water  supply,  sewerage 
collection,  electricity,  gas,  heat  energy  and  certain 
categories  of  passenger 
transport.  For  details,  see 
http://epp.eurostat.ec.europa.eu/portal/page/portal/hicp/met
hodology/administered_prices 

Price  increases  are  currently  constrained  by  the 
negative  output  gap  and  the  declining  pace  of 
output growth, hampering further improvements in 
the  labour  market  situation.  In  addition,  the 
inflationary  impact  of  one-off  measures  effective 
in  2012.  The 
largely  fade 
in  2011  should 
Commission  services'  Spring  2012  Forecast  thus 
projects  HICP  inflation  to  average  3.7%  in  2012 
and just below 3% in 2013.  

to  be  persistent,  could  result 

Risks to inflation appear to be broadly balanced. A 
stronger  inflation  pass-through  from  the  recent 
exchange  rate  depreciation,  especially  if  it  turns 
in  higher 
out 
consumer  price  growth.  On  the  other  hand,  if 
external  shocks  result  in  slower-than-expected 
GDP growth, a possible further deterioration in the 
labour market situation would have disinflationary 
effects. 

The level of consumer prices in Poland was close 
to  60%  of  the  euro  area  average  in  2010.  This 
suggests  potential 
level 
for 
convergence  in  the  long  term,  as  income  levels 
(about  58%  of  the  euro  area  average  in  PPS  in 
2010) increase towards the euro area average. 

further  price 

Medium-term  inflation  prospects  in  Poland  will 
hinge upon wage and productivity trends as well as 
on  the  functioning  of  product  markets.  Further 
structural  measures  to  increase  labour  supply  and 
facilitate  the  effective  allocation  of  labour  market 
resources will play an important role in alleviating 
potential wage pressures, resulting inter alia from 
negative  demographic  developments.  On  product 
markets, there is scope to enhance the competitive 
environment, especially in the services and energy 
sector. At  the macro  level,  a  prudent  fiscal  stance 
will be essential to contain inflationary pressures. 

7.3. 

PUBLIC FINANCES 

7.3.1.  The  excessive  deficit  procedure 

for 

Poland 

On 7 July 2009, the Council decided in accordance 
with  Article  104(6)  of  the  Treaty  establishing  the 
European  Community  (TEC)  that  an  excessive 
deficit  existed  and  addressed  recommendations  to 
Poland,  in  accordance  with  Article  104(7)  TEC 
with  a  view  to  bringing  an  end  to  the  situation  of 
an  excessive  government  deficit  by  2012.  In 
particular,  the  Council  recommended  that  the 

93 

 
                                                           
Polish  authorities  should:  (a)  implement  the  fiscal 
stimulus measures in 2009 as planned, in particular 
the  public  investment  plan,  while  structuring  a 
supplementary  budget  in  such  a  way  that  any 
further deterioration in public finances is avoided; 
(b) ensure an average annual fiscal effort of at least 
1¼%  of  GDP  starting  in  2010;  (c)  spell  out  the 
detailed  measures  that  are  necessary  to  bring  the 
deficit  below  the  reference  value  by  2012,  and 
reforms  to  contain  primary  current  expenditure 
over  the  coming  years.  On  3  February  2010,  the 
Commission  concluded  that  Poland  had  taken 
action  towards  the  correction  of  the  excessive 
deficit  within  the  time  limits  set  by  the  Council, 
while  emphasising  the  need  for  further  sizeable 
consolidation  measures.  On  2  March  2011, 
following a request from Commissioner Rehn, the 
Polish authorities announced a list of consolidation 
measures  to  be  implemented  in  2011  and  2012. 
The  Commission  considered these  measures  to be 
sufficient  to  ensure  a  correction  of  the  excessive 
deficit  by  2012  and  decided  to  maintain  the 
excessive deficit procedure (EDP) in abeyance.  

On  21  December  2011,  the  Polish  authorities 
announced  further  consolidation  measures  which 
complemented  the  2012  budget.  On  the  basis  of 
information  available  on  11  January  2011,  the 
Commission considered that the Polish authorities 
have  taken  effective  action  towards  a  timely  and 
sustainable correction of the excessive deficit, and 
no further steps in the excessive deficit procedure 
of Poland are needed at present (80).  

7.3.2.  Recent fiscal developments 

the 

impact  of 

In  2009,  as  part  of  the  European  Economic 
Recovery  Plan  (EERP),  the  Polish  authorities 
implemented  a  fiscal  stimulus  programme  to 
the  global  economic 
cushion 
the  Polish  economy.  As  a 
slowdown  on 
consequence, 
the  general  government  deficit 
widened  sharply  from  3.7%  in  2008  to  7.4%  of 
GDP  in  2009.  Despite  a  considerable  acceleration 
in the real GDP growth rate from 1.6% in 2009 to 
3.9% in 2010, the deficit widened further to 7.8% 
amid 
from 
Corporate Income  Tax (CIT),  higher  consumption 
investment  expenditure  and  higher-than 
and 
expected interest expenditure.  

lower-than-expected 

revenues 

(80)  An  overview  of  all  ongoing  excessive  deficit  procedures 
http://ec.europa.eu/economy 

can 
_finance/economic_governance/sgp/deficit/index_en.htm 

found 

at: 

be 

Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

The general government deficit began to decline in 
2011  to  reach  5.1%  of  GDP,  as  a  result  of 
continued  economic  growth  and  ambitious 
consolidation  efforts  by  the  government.  On  the 
revenue  side,  a  number  of  measures,  including  a 
change  in  the  pension  system  that  retains  part  of 
the  contribution  in  the  public  first  pillar,  changes 
in  rates  and  exemption  rules  of  VAT  and  excise 
duties as well as a freeze in Personal Income Tax 
(PIT)  thresholds,  led  to  an  increase  in  revenues 
(from  37.5%  to  38.5%  of  GDP).  Growth  in 
government  spending  has  been  constrained  by  the 
expenditure  rule  limiting  increases  in  all  newly 
enacted  and  existing  discretionary  expenditure 
items  to  1  percentage  point  over  the  rate  of 
inflation, a freeze of the wage fund of public sector 
employees  and  additional  minor  cuts  in  social 
spending,  resulting  in  a  significant  decline  in  the 
expenditure-to-GDP ratio (from 45.4% to 43.6%). 
the  above  measures  are  considered  as 
All 
structural,  although  some  of  them  are  temporary 
and  will  expire  in  the  coming  years.  As  a 
consequence,  the  structural  deficit  fell  from  about 
7.5% of GDP in 2010 to some 5% of GDP in 2011. 
The  reduction  in  the  headline  deficit  was  larger 
the  2011  Convergence 
than 
in 
Programme,  while 
the 
the  composition  of 
budgetary adjustment turned out to be considerably 
more  expenditure-driven  (with  both  revenue  and 
expenditure ratio to GDP lower than expected one 
year before).  

expected 

While  remaining  below  60%,  the  debt-to-GDP 
ratio  rose  significantly  from  50.9%  in  2009  to 
54.8% in 2010 and 56.3% in 2011 as a result of the 
still  high  government  deficit,  unfavourable effects 
from the implicit interest rate and, especially in the 
second  half  of  2011,  a  strong  depreciation  of  the 
national currency. 

7.3.3.  Medium-term prospects  

The  main  consolidation  measures  introduced  in 
2011 continue to apply in 2012. The 2012 Budget 
Law,  adopted  on  2  March  2012,  includes  also 
additional  measures,  mainly  on  the  revenue  side 
e.g. an introduction of a tax on minerals extraction 
and  increases  in  social  security  contributions  and 
the  strong 
some  excise  duties.  Additionally, 
economic  growth  in  2011  is  expected  to  result  in 
higher  dividend  payments 
from  state-owned 
enterprises.  The  only  significant  new  measure 
aimed at reducing public expenditure is a reduction 
in  complementary  national  direct  payments  to 
landowners.  

94 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

2008

2009

2010

2011

2012

2013

(as % of GDP unless indicated otherwise)

Table 7.3:

Poland - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

General government balance

- Total revenues

- Total expenditure

   of which: 

- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-3.6

40.2

43.9

2.7

34.1

-1.0

-4.0

0.0
-4.0

-1.9

40.3

42.2

2.3

34.8

0.4

-2.8

0.0
-2.8

-3.7

39.5

43.2

2.2

34.3

-1.5

-4.6

0.0
-4.6

47.7

45.0

47.1

6.2

1.0

6.8

2.4

5.1

2.2

-7.4

37.2

44.5

2.6

31.8

-4.7

-7.1

0.3
-7.4

50.9

1.6

-0.7

-7.8

37.5

45.4

2.7

31.8

-5.2

-7.5

0.0
-7.5

54.8

3.9

-0.8

-5.1

38.5

43.6

2.7

32.3

-2.4

-5.0

0.0
-5.0

56.3

4.3

-0.2

-3.0

40.1

43.1

2.7

33.8

-0.3

-2.7

0.1
-2.8

55.0

2.7

-0.9

-2.5

39.8

42.4

2.7

33.9

0.2

-1.9

-0.1
-1.9

53.7

2.6

-1.5

2012

2013

2014

-2.9

-2.5

53.7

2.5

-2.2

-1.7

52.5

2.9

-1.6

-1.1

50.6

3.2

2015
-0.9

-0.7

49.7

3.8

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme.

There are no one-off and other temporary measures in the programme.

Sources: Commission services, the 2012 Convergence Programme of Poland.

the 

the  back  of 

As  a  consequence,  the  general  government  deficit 
is  expected  to  decrease  further  in  2012  and  2013, 
according  to  the  Commission  services'  Spring 
2012  Forecast.  In  2012,  reduction  in  the  nominal 
deficit to 3.0% of GDP is expected to be achieved 
on 
implemented  budgetary 
measures  supported  by  GDP  growth.  In  2013, 
given  the  lack  of  significant  additional  measures, 
the consolidation process is forecast to slow down 
with deficit reaching 2.5%, driven mainly by sharp 
reduction 
the 
structural  character  of  most  implemented  reforms 
and a negative but relatively stable output gap, the 
structural  deficit  is  set  to  follow  the  evolution  of 
the headline deficit, falling from about 5% of GDP 
to some 2.8% in 2012 and 1.9% in 2013. 

investment.  Given 

in  public 

The 2012 Convergence Programme was submitted 
on  25  April  2012.  It  confirms  the  government's 
commitment to bring the deficit below 3% of GDP 
in 2012, as recommended by the Council under the 
Excessive  Deficit  Procedure,  and  sets  up  a  2015 
deadline to achieve the Medium Term Objective of 
the structural deficit not exceeding 1% of GDP. To 
reach  this  target,  the  Programme  establishes  a 
consolidation  path,  based  mainly  on  significant 
reductions  in  public  expenditure.  The  nominal 

deficit  is  expected  to  fall  from  5.1%  of  GDP  in 
2011 to 2.9% in 2012, 2.2% in 2013, 1.6% in 2014 
and  0.9%  of  GDP  in  2015.  These  projections  are 
slightly  more  optimistic  than  the  Commission 
services'  Spring  2012  Forecast.  The  difference  of 
0.1  percentage  points  in  2012  and  0.3  percentage 
points  in  2013  results  mainly  from  different 
assumptions  on  the  public  investment  expenditure 
and corresponding inflow of the EU funds towards 
the end of the current EU budgetary perspective.  

Further  details  on  the  assessment  of  the  2012 
Convergence Programme for Poland can be found 
in  the  forthcoming  Commission  Staff  Working 
Document,  which  accompanies  the  Commission 
Recommendation  for  a  Council  Recommendation 
on  the  2012  National  Reform  Programme  of 
Poland  and  delivering  a  Council  Opinion  on  the 
2012 Convergence Programme of Poland (81). 

In  March  2012,  Poland  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 

(81)  http://ec.europa.eu/economy_finance/ 

economic_governance/sgp/convergence/programmes/2012
_en.htm 

95 

 
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

the 

reserve 

to  large  inflows  of  portfolio  and  other  investment 
from  abroad.  Afterwards, 
level 
remained broadly stable at around EUR 75bn until 
the  end  of  2011,  as  financial  market  sentiment 
towards emerging markets deteriorated again. As a 
result,  foreign  exchange  reserves  covered  some 
136%  of  short-term  external  debt  at  original 
maturity by the end of 2011. 

7.4. 

EXCHANGE RATE STABILITY 

Graph 7.5:Poland - 3-M Wibor spread to 3-M Euribor

(basis points, monthly values)

The  Polish  zloty  does  not  participate  in  ERM  II. 
Since  April  2000,  Poland  operates  a  floating 
exchange rate regime, with the NBP preserving the 
right  to  intervene  in  the foreign  exchange market, 
if  it  deems  this  necessary,  in  order  to  achieve  the 
inflation target.  

this  context, 

The  zloty  exchange  rate  against  the  euro  has 
displayed  higher  volatility  recently.  From  January 
2010 until July 2011, the zloty mainly oscillated in 
a  relatively  wide  range  between  some  3.85  and 
the  Polish 
4.15  PLN/EUR.  In 
Treasury  and  the  NBP  jointly  announced  on  21 
April  2011  that  incoming  EU  funds  would  in 
future  be  primarily  converted  from  euro  on  the 
open market to counteract excess zloty liquidity. In 
August 2011 rising financial market tensions in the 
euro area began to also negatively affect local FX 
markets in central and eastern Europe. As a result, 
the  Polish  zloty  weakened  by  some  11%  against 
the  euro  between  July  and  December  2011.  In 
October 2011, the NBP publicly acknowledged FX 
intervention  in  favour  of  the  zloty.  In  early  2012, 
the  zloty  exchange  rate  against  the  euro  partially 
recovered  earlier  losses.  During  the  two  years 
before  this  assessment,  the  zloty  depreciated 
against the euro by 6.1%.  

Graph 7.4:Exchange rates - PLN/EUR
(monthly averages)

5.0

4.5

4.0

3.5

3.0

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

International  reserves  increased  by  some  EUR 
20bn  between  Q4-2009  and  Q1-2011,  mainly  due 

96 

500

400

300

200

100

0

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Short-term  interest  rate  differentials  vis-à-vis  the 
euro area declined from above 350 basis points in 
January  2010  to  below  300  basis  points  in  July 
2010  as  the  liquidity  situation  in  the  Polish 
banking sector improved gradually. They increased 
again  to  above  300  basis  points  in  early  2011, 
reflecting  faster  monetary  policy  tightening  in 
Poland relative to the euro area. Short-term spreads 
widened by some 90 basis points in late 2011 and 
early  2012  as  the  ECB  loosened  its  policy  stance 
while rates on the Polish money  market increased 
somewhat. At the cut-off date of this report, the 3-
month  spread  vis-à-vis  the  euro  area  reached 
almost 410 basis points.  

7.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Poland  used  for  the 
convergence examination reflect secondary market 
yields  on  a  single  benchmark  government  bond 
with  a  residual  maturity  of  below  but  close  to  10 
years.  

The  Polish  12-month  moving  average  long-term 
interest  rate  relevant  for  the  assessment  of  the 
Treaty  criterion  was  above  the  reference  value  at 
the  time  of  the  last  convergence  assessment  in 
2010. It declined slowly from some 6.2% in early 
2010 to about 5.8% by end-2010 before increasing 
marginally again throughout 2011. In March 2012, 
the  latest  month  for  which  data  are  available,  the 

 
 
 
reference value, given by the average of long-term 
interest  rates  in  Sweden  and  Slovenia  plus  2 
percentage  points,  stood  at  5.8%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Polish  benchmark  bond  stood  at  5.8%,  i.e.  at  the 
reference value. 

Graph 7.6:Poland - Long-term interest rate criterion

(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Poland

Reference value

Source: Commission services.

Long-term interest rates decreased from above 6% 
in  early  2010  to  below  5.5%  in  September  2010, 
reflecting  a  substantial  fall  in  domestic  inflation. 
They returned to above 6% by early 2011, as rising 
inflation  necessitated  a  gradual  monetary  policy 
tightening. Long-term interest rates declined again 
to below 6% by mid-2011 and then to below 5.5% 
in early 2012, benefiting from improved investors' 
sentiment  towards  the  country.  As  a  result,  long-
term  interest  rate  spreads  vis-à-vis  the  German 
benchmark bond (82) decreased to about 350 basis 
points in March 2012. 

Graph 7.7:Poland - Long-term interest rates

(percent, monthly values)

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Poland

Germany

Source: Eurostat.

(82)  The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

7.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance 
in  EMU. 
the  governance  structures 
Related  to  this,  in  February  2012,  following  the 
adoption  of  the  legislation  establishing  the  new 
procedure  for  surveillance  and  correction  of 
macroeconomic  imbalances  (the  Macroeconomic 
Imbalances Procedure - MIP) (83), the Commission 
first  Alert  Mechanism  Report 
published 
(AMR) (84).  The  AMR  scoreboard  showed  that 
Poland exceeded the indicative threshold for three 
out  of  ten  indicators,  all  in  the  area  of  external 
the 
imbalances  and  competitiveness 
(namely 
current 
international 
the 
balance, 
investment  position  and  the  nominal  ULC).  ).  In 
line with the conclusion of the AMR, Poland was 
not subject to an in-depth review in the context of 
the MIP. 

account 

its 

7.6.1.  Developments  of 

the  balance  of 

payments 

While  remaining  in  deficit,  Poland’s  external 
balance  (i.e.  the  combined  current  and  capital 
account) improved considerably in 2009. Although 
it  worsened  somewhat  in  2010  due  to  a  higher 
current account deficit, it improved again in 2011, 
on the back of a rapidly increasing surplus on the 
capital  account,  induced  by  higher  absorption  of 
EU  funds,  and  a  lower  current  account  deficit. 
After having  increased  in 2010,  the  external  trade 
deficit  declined  somewhat  in  2011,  as  strong 
export performance was only partially outweighed 
by  rising  imports,  driven  by  robust  domestic 

(83)  The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(84)  http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

97 

 
 
 
                                                           
                                                           
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

Table 7.4:

Poland - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

2006

2007

2008

2009

2010

2011

(percentage of GDP)

-3.8

-2.1

0.2

-2.8

0.9

0.6

-3.2

3.1

3.2

-0.8

1.5

-0.7

3.9

0.1

21.1

18.0

49.7

-46.4

-6.2

-4.4

1.1

-3.8

1.0

1.1

-5.1

5.9

4.3

-1.5

6.1

-3.0

8.9

-0.8

24.4

19.4

54.8

-52.8

-6.6

-5.8

1.0

-2.4

0.6

1.1

-5.4

7.8

1.9

-0.5

5.7

0.7

7.1

-2.4

23.9

19.1

45.9

-47.4

-3.9

-1.7

1.1

-3.8

0.5

1.6

-2.2

5.1

1.9

3.9

2.7

-3.4

8.5

-2.8

20.3

17.3

64.8

-62.0

-4.6

-2.5

0.7

-3.6

0.8

1.8

-2.8

4.8

0.7

5.4

1.9

-3.2

8.0

-2.0

20.9

17.2

67.1

-64.5

-4.3

-2.7

1.2

-3.9

1.2

2.2

-2.1

4.1

1.8

3.1

0.5

-1.3

5.4

-2.0

21.7

17.7

62.5

-59.2

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, National Bank of Poland.

demand  growth.  At  the  same  time,  the  negative 
balance  of  primary  incomes  and  net  current 
transfers remained broadly stable. 

the  saving-investment  balance 

is 
As  far  as 
concerned,  gross  national  saving  (as  a  percentage 
of GDP) followed a declining trend between 2007 
and  2010,  driven  by  falling  gross  saving  by  the 
general  government,  which  was  only  partially 
offset  by  higher  private  sector  saving.  Gross 
national  saving  increased  somewhat  in  2011,  due 
to 
the  general 
government. At the same time, after decreasing in 
2008 and 2009, domestic investment activity (as a 
percentage  of  GDP)  increased  again  in  2010  and 
2011.  

improved  position  of 

the 

Graph 7.8:Poland - Saving and investment
(in percent of GDP at market prices)

30

20

10

0

External competitiveness appears to have remained 
solid,  with  Poland  continuing  to  gain  export 
market shares in 2010 and 2011, albeit at a slower 
pace. After a substantial depreciation in 2008, the 
real  effective  exchange  rate  strengthened  to  some 
extent throughout 2009 and then remained broadly 
stabile until mid-2011, largely in line with nominal 
exchange  rate  developments.  The  real  effective 
exchange  rate  depreciated  substantially  in  the 
second  half  of  2011,  again  as  a  result  of  the 
nominal exchange rate evolution, as inflation rates 
remained  relatively  close  to  those  of  trading 
partners.  

Graph 7.9:Poland - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

140

130

120

110

100

90

80

2006

2007

2008

2009

2010

2011

2006

2007

2008

2009

2010

2011

NEER

REER, HICP deflated

REER, ULC deflated

Gross national saving Gross capital formation at current prices; total economy

Source: Commission services.

Source: Eurostat, Commission services.

98 

 
 
 
 
 
 
 
Net  inflows  of  foreign  direct  investment  (FDI), 
which covered almost 50% of the current account 
deficit  in  2009,  declined  substantially  in  2010, 
mostly  as  a  result  of  lower  direct  investment  in 
Poland,  before  recovering  again  in  2011,  when 
they  accounted  for  some  40%  of  the  current 
account deficit. Due to rapidly increasing holdings 
of government debt securities by non-residents, net 
inflows of portfolio investment have been the main 
source  of  foreign  financing  since  2009.  After 
peaking  in  2007,  net  inflows  of  other  investment 
and  financial  derivatives  have  gradually  declined 
in  recent  years,  mainly  due  to  lower  external 
borrowing  by  the  private  sector.  Total  gross 
external  debt  declined  to  62.5%  of  GDP  in  2011 
while  the  negative  net  international  investment 
position  also  narrowed  considerably.  Balance  of 
payments  stability  was  supported  by  the  IMF's 
Flexible  Credit  Line  arrangement,  which  was 
initially granted in May 2009 and then renewed in 
July  2010  and  in  January  2011,  when  it  was 
increased and extended for another two years. 

According  to  the  Commission  services'  Spring 
2012 Forecast, the external balance is expected to 
improve  somewhat 
to  weaker 
domestic  demand  and  thus  lower  import  growth, 
before deteriorating again in 2013. 

in  2012,  due 

7.6.2.  Product market integration 

in 

than  40%  of  GDP 

The  Polish  economy  is  well  integrated  to  the  EU 
economy  through  trade  and  investment  linkages. 
Trade openness increased between 2005 and 2010, 
with  an  average  share  of  exports  and  imports  of 
recent  years, 
more 
comparable to that of EU countries of similar size. 
The  rebound  of  extra-EU  trade  in  goods  in  2010 
was much weaker (apart from rising imports from 
China and increasing imports of commodities from 
Russia)  than  in  the  case  of  intra-EU  trade  (driven 
by  strong  demand from  Germany).  Polish trade  is 
mainly oriented towards manufacturing. The small 
further growth of intra-EU trade in services, up to 
4.7%  of  GDP  in  2010,  was  mainly  driven  by  a 
growing 
the  business  process 
outsourcing  sector,  which  increased  its  share 
within services exports from 14% in 2004 to 29% 
in 2010.  

importance  of 

towards  medium-to-high 

The  composition  of  Polish  goods  exports  has 
evolved 
technology 
goods,  though  the  share  of  traditional  industries 
(e.g.  metal  products, 
fuels, 
chemicals,  furniture)  remains  high.  In  2010,  the 

food,  mineral 

Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

the 
in 

export structure was dominated by motor transport 
equipment  (16.4%)  radio,  TV  and  communication 
equipment (7.3%) and electrical equipment (5.6%), 
presence 
reflecting 
of  multinational 
corporations 
these  sectors  and  significant 
technology  transfers  following  large  FDI  inflows. 
In  the  medium  term,  the  competitiveness  of  the 
Polish economy will largely depend on its capacity 
to  further  upgrade  the  export  structure  of  the 
country,  shifting  towards  capital-intensive  and 
the 
industries. 
high-technology 
technological  trade  deficit  has  stabilised  around 
−2½% of GDP since early 2000s. This is related to 
the  relatively  limited  inflow  of  FDI  into  high-
technology  sectors  and  its  slow  absorption,  which 
is partly due to low domestic R&D spending, weak 
links between research institutes and private sector 
and  relatively  low quality  of  research  institutional 
framework. 

far, 

So 

in 

seems 

sector, 

investors 

including 

integrated 

to  be  well 

into 
Poland 
international  production  chains. 
Intermediate 
goods  constitute  about  55%  of  all  Polish  imports 
and  this  share  remained  fairly  stable  since  1999, 
while  the  import  content  of  Polish  exports  is 
the 
relatively  high.  Foreign 
manufacturing 
largest 
multinational  corporations  with  extensive  cross-
border  production  and  distribution  chains,  are 
mainly  export-oriented.  The  stock  of  inward  FDI 
from  EU27  reached  35%  of  GDP  in  the  recent 
years  compared  with  6%  of  GDP  for  FDI  from 
non-EU  countries.  Domestic  market  size  and 
growth as well as access to large regional markets 
are  pointed  out  as  main 
the 
attractiveness of the country for FDI.  

reasons 

the 

for 

From the beginning of 2005 until the third quarter 
of  2007,  real  house  prices  cumulatively  increased 
by 104%. Since 2008, there has been a gradual fall 
in  prices  of  flats  on  the  primary  and  secondary 
market in most large cities. The total decline in the 
prices of flats in the period 2008–2011 was 15% to 
25%  in  large  cities.  The  fall  in  the  prices  of  flats 
was mainly driven by the growth of their supply on 
the  primary  market  in  2011.  Nevertheless,  the 
value of the housing stock increased from 170% of 
GDP  in  2002  to  about  200%  in  2009.  This  was 
mainly  the  result  of  a  higher  relative  price  level 
and did not reflect a substantial rise in the volume 
of  housing.  This  observation  is  in  line  with  the 
smooth evolution of residential investment around 
3%  of  GDP.  Concerning  the  rental  market,  the 
formal  rental  segment  is  underdeveloped,  with 

99 

 
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

Table 7.5:

Poland - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

37.5

24.2

3.9

7.3

3.2

-2.5

3.4

2.8

1.6

0.9

47.7

31.0

100.0

2.2

100.1

41.3

26.4

4.4

8.4

3.1

-2.4

5.7

5.0

3.6

0.9

28.6

31.0

135.0

2.5

138.8

42.2

27.2

4.7

8.7

3.0

-2.6

5.5

4.6

2.6

1.7

32.2

31.0

196.1

2.8

204.6

41.9

26.5

4.6

9.0

4.3

-2.5

2.8

2.7

1.5

2.0

38.9

31.0

187.5

3.4

190.2

39.4

25.1

4.6

7.9

5.7

-2.3

3.2

2.6

1.7

1.4

41.2

32.0

178.6

3.3

145.4

2010

42.9

26.9

4.7

9.1

n.a.

n.a.

1.9

1.6

1.3

1.7

42.6

32.0

167.6

1.9

142.6

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

relatively  high  tenant  protection  and  controls  on 
rent increases. 

in 

of 

the 

number 

procedures 

international 

Concerning  the  business  environment,  Poland 
scores  below  the  average  of  euro  area  Member 
rankings (85).  Two 
States 
legislative  packages  were  adopted  in  2011  to 
reduce 
and 
administrative  obligations  imposed  on  businesses, 
including  by  replacing  administrative  certificates 
information 
with  declarations,  and 
obligations. However, the main outstanding issues 
remain high administrative compliance costs, slow 
legislative  processes  and  unstable 
legislation. 
Some improvement in the administration of justice 
was  achieved  through  the  introduction  of  e-
judiciary for small lawsuits in 2010, which slightly 
the  backlog  of  open  court  cases. 
reduced 

to  reduce 

Nevertheless,  there  was  little  progress  in  the 
simplification  of  enforcing  contracts.  Finally, 
according  to  the  November  2011  Internal  Market 
Scoreboard,  Poland  was  the  country  with  the 
second highest transposition deficit and the second 
highest  number  of  directives  not  correctly 
transposed. On the other hand, the share of public 
procurement  tenders  in  Poland  announced  in  the 
EU  Official  Journal(86)  appears  to  be  higher  than 
the EU average. 

7.6.3.  Financial market integration 

Poland's financial sector is well integrated into the 
EU financial system, which is demonstrated by the 
high  degree  of  foreign  ownership  of  financial 
institutions  and  the  increasingly  international  role 
of the Warsaw Stock Exchange. The share of bank 

(85)  For  instance,  Poland  scores  on  41st  and  62nd  place 
according to the 2011-2012 Global Competitiveness index 
and the 2012 World Bank Doing Business respectively. 

(86)  The  value  of  tenders  published  in  the  EU  Official  Journal 
may serve as a proxy of the extent to which national public 
procurement is open to foreign bidders. 

100 

 
                                                           
                                                           
 
 
 
 
institutions 

assets  owned  by  foreign 
through 
branches  and  subsidiaries  reached  almost  70%  in 
2010,  remaining  largely  unchanged  compared  to 
the 2004 level. Concentration in the Polish banking 
sector is relatively low, as the share of total assets 
owned  by  the  five  largest  credit  institutions 
amounted to 43% in 2010, the lowest level among 
Member States with a derogation.  

Graph 7.10:Poland - Foreign ownership and 
concentration in the banking sector

(in percent, weighted averages)

80
70
60
50
40
30
20
10
0

PL, 2004

PL, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

Poland  has  one  of  the  most  developed  financial 
sectors  among  the  non-euro  area  EU  member 
countries. The share of banks in total assets of the 
financial  sector  has  been  decreasing  in  recent 
years.  Although  growth  of  credit  to  the  non-
financial private sector has slowed down following 
the  2008-09  global  financial  crisis,  it  accelerated 
again to about 14% in 2011. As a result, credit to 
the non-financial private sector reached some 52% 
of  GDP  in  2011.  The  share  of  foreign-currency-
denominated  lending  was  significant  for  housing 
loans, amounting to some 63% at the end of 2011. 
However,  since  2009  the  majority  of  newly-
granted loans has been denominated in zloty. 

The  overall  capital  adequacy  ratio  of  the  banking 
sector  reached  almost  14%  in  H1-2011  while 
return  on  equity  exceeded  13%.  After  having 
deteriorated between 2008 and 2010, the quality of 
banks'  loan  portfolio  started  to  improve  in  2011, 
due to a recovery in the corporate loan portfolio.  

Graph 7.11:Poland - selected banking sector soundness 
indicators relatively to the euro area
%

20
18
16
14
12
10
8
6
4
2
0

PL, 2004

PL, H1-11

EA, 2004

EA, H1-11

Return on equity

Capital adequacy

Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.
Source: ECB, Polish FSA, EC calculations.

Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

a 

in 

role 

financial 

institutions  play 

relatively 
Non-banking 
important 
intermediation, 
accounting  for  roughly  30%  of  the  total  assets  of 
Polish  financial  institutions  by  2011.  The  pension 
funds  launched  in  1999  are  the  biggest  players  in 
this  category  and  also  belong  to  biggest  domestic 
institutional  investors.  The  insurance  sector  has 
also been growing, but its size is still far below the 
euro area average. Investment funds have recently 
also increased their assets, although they have not 
yet returned to the 2007 peak level. Credit unions 
(SKOK) have been expanding, but their total assets 
make up only a small part of total financial sector 
assets.  

Following  the  decline  in  equity  prices,  stock 
market  capitalisation  fell  to  29%  of  GDP  in  2011 
from  46%  of  GDP  in  2007.  The  share  of  foreign 
investors in the capitalisation of the Warsaw Stock 
Exchange  (WSE)  exceeds  40%.  The  WSE  has  so 
far not taken part in the European stock exchange 
consolidation  process.  The  debt  securities  market, 
amounting  to  some  56%  of  GDP  in  2011,  is  the 
largest  and  most  liquid  in  the  region.  It  is 
dominated  by  government  bonds  (90%  share); 
corporate bonds account only for about 4% of the 
outstanding  amounts.  Private  sector  debt (87)  of 
close to 75% of GDP in 2010 is still far below the 
euro area average. 

Graph 7.12:Poland - Recent development of the  financial 
system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

PL, 2004

PL, 2011

EA, 2004

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.
Source: Eurostat, ECB, National Bank of Poland, FESE, Reuters EcoWin.

Since 2006, supervision of the financial sector has 
the  Polish  Financial 
been  consolidated  with 
Supervision  Authority  (KNF).  The  KNF  actively 
cooperates  with  its  peers  in  the  European  System 
signed 
of  Financial  Supervisors 
the  home 
memoranda  of  understanding  with 
authorities  of  bank  subsidiaries  operating 
in 
Poland.  While 
transposition  of  EU  financial 
services  legislation  has  been  relatively  slow, 

and  has 

(87)  Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

101 

 
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 7 - Poland 

Poland  achieved  full  compliance  with  the  FSAP 
directives and implemented most of the subsequent 
directives. 

102 

 
8. 

ROMANIA 

8.1. 

LEGAL COMPATIBILITY 

8.1.1.  Introduction 

Banca Naţională a României (BNR – central bank 
of Romania) is governed by Law No. 312 of June 
28,  2004  (hereinafter  "the  BNR  Law  ")  which 
entered into force on July 30, 2004.  

No  amendments  to  the  Law  on  BNR  were 
introduced  with  regard  to  the  incompatibilities 
mentioned in the Convergence Report 2010.  

8.1.2.  Central Bank independence 

In  this  area,  a  number  of  incompatibilities  and 
imperfections  exist  with  respect  to  the  TFEU  and 
the ESCB/ECB Statute.  

According to Article 33(10) of the BNR Law, the 
Minister  of  Public  Finances  and  one  of  the  State 
Secretaries in the Ministry of Public Finances may 
participate,  without  voting  rights,  in  the  meetings 
of the BNR Board. Although a dialogue between a 
central  bank  and  third  parties  is  not  prohibited  as 
such, this dialogue should be constructed in such a 
way  that  the  Government  should  not  be  in  a 
position  to  influence  the  central  bank  when  the 
latter 
its 
independence  is  protected  by  the  Treaty.  The 
active  participation  of  the  Minister,  even  without 
voting  right,  to  discussions  of  the  BNR  Board 
where BNR policy is set could structurally offer to 
the  Government  the  possibility  to  influence  the 
central bank when taking its key decisions. Against 
this  background  Article  33(10)  of  the  BNR  is 
incompatible with Article 130 of the TFEU.  

is  adopting  decisions 

for  which 

Under  Article  3(1)  the  members  of  the  BNR's 
decision-making  bodies  shall  not  seek  or  take 
instructions  from  public  authorities  or  from  any 
other  institution  or  authority.  This  provision  is 
incomplete  with  respect  to  Article  130  of  the 
TFEU  and  Article  7  of  the  ECB/  ESCB  Statute 
given that it does not contain a reference to Union 
institutions,  bodies,  offices  or  agencies.  Article 
3(1)  of  the  BNR  Law  thereby  constitutes  an 
imperfection.  Further,  Article  3  needs  to  be 
adapted  to  fully  reflect  Article  130  of  the  TFEU 
and Article 7 of the ESCB/EC Statute, in order to 
third  parties  from  giving 
expressly  prohibit 

instructions  to  the  BNR  and  the  members  of  its 
decision making bodies. 

Article 33(5) of the BNR Law provides that if the 
Board of BNR becomes incomplete, the vacancies 
shall  be  filled  for  the  respective  office  following 
the procedure for the appointment of the members 
of  the  Board  of  BNR  by  the  Parliament.  Article 
35(5)  of  the  Law  stipulates  that  in  case  the 
Governor  is  absent  or  incapacitated  to  act  the 
Senior  Deputy  Governor 
the 
Governor. The BNR Law, in order to remove this 
imperfection and to ensure smooth and continuous 
functioning  of  BNR  in  case  of  expiry  of  the  term 
of  office,  resignation,  dismissal  or  other  cause  of 
termination  of  office  of  the  Governor,  needs  to 
provide  for  procedures  and  rules  regarding  the 
successor of the Governor in such cases.  

replace 

shall 

Pursuant  to  Article  33(9)  of  the  BNR  Law,  the 
Governor  as  well  as  any  other  member  of  the 
BNR's  Board  can  appeal  against  a  decision  to 
recall  him  from  office  before  the  Romanian  High 
Court  of  Cassation  and  Justice.  This  provision 
constitutes an imperfection with respect to Article 
14.2 of the ESCB/ECB Statute, which provides for 
a right of judicial review by the Court of Justice of 
the EU in the event of the Governor's dismissal.  

Article 33(7) of the Law provides that no member 
of the Board of BNR may be recalled from office 
for  other  reasons  or  following  a  procedure  other 
than  those  provided  for  in  Article  33(6)  of  this 
Law.  Law  161/2003  on  certain  measures  for 
transparency  in  the  exercise  of  public  dignities, 
public functions and business relationships and for 
the  prevention  and  sanctioning  of  corruption (88)  
and Law 176/2010 on the integrity in the exercise 
of  public  functions  and  dignities (89)  define  the 
conflicts 
incompatibilities 
applicable to the Governor and the other members 
of the Board of BNR and require them to report on 
their  interests  and  wealth.  For  the  sake  of  legal 
clarity, 
this 
imperfection  and  provide  a  clarification  that  the 
sanctions for the breach of obligations under those 
Laws do not constitute extra grounds for dismissal 
of the Governor of the Board of BNR, in addition 

recommended 

remove 

interest 

and 

of 

to 

is 

it 

(88)  Published in Monitorul Oficial al României, Part One,  No 

279, 21.4.2003. 

(89)  Published in Monitorul Oficial al României, Part One,  No 

621, 2.9.2010. 

103 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

the  BNR.  It  cannot  be  excluded  that  such  lending 
results  in  the  provision  of  solvency  support  to  a 
credit institution that is facing financial difficulties 
and  thereby  would  breach  the  prohibition  of 
monetary  financing  and  be  incompatible  with 
Article  123  of  the  TFEU.  Article  26  of  the  BNR 
Law  should  be  amended  to  avoid  such  a  lending 
operation. 

Articles 6(1) and 29(1) of the BNR law foresee the 
prohibition of direct purchases by the BNR of debt 
instruments issued by the State, national and local 
public  authorities,  autonomous  public  enterprises, 
national  corporations,  national  companies  and 
other majority state-owned companies. Article 6(2) 
extends  this  prohibition  to  the  debt  instruments 
issued by other bodies governed by public law and 
public  undertakings  of  other  EU  Member  States.  
Article  7(2)  of  the  law  prohibits  the  BNR  from 
granting  overdraft  facilities  or  any  other  type  of 
credit facility to the State, central and local public 
service 
authorities, 
undertakings, 
national 
companies  and  other  majority  state  owned 
companies. Article 7(4) extends this prohibition to 
other  bodies  governed  by  public  law  and  public 
undertakings  of  Member  States.  These  provisions 
do not cover the full list of cases mentioned in the 
Article  123 of  the  TFEU  (a reference  to,  amongst 
others,  the  Union  institutions  is  missing)  and  are 
therefore incompatible with the TFEU.  

autonomous 
national 

public 
societies, 

Pursuant to Article 7(3) of the BNR Law, majority 
State-owned  credit  institutions  are  exempted  from 
the prohibition on granting overdraft facilities and 
any other type of credit facility in Article 7(2) and 
benefit from loans granted by the BNR in the same 
way  as  any  other  credit  institution  eligible  under 
the BNR's regulations. The wording of Article 7(3) 
of  the Law  is incompatible  and  should  be  aligned 
with  the  wording  of  Article  123(2)  of  the  TFEU, 
which  only  exempts  publicly  owned  credit 
institutions  “in  the  context  of  the  supply  of 
reserves by central banks”.  

As  noted  above  in  point  7.1.3.,  Article  43  of  the 
Law  provides  that  the  BNR  shall  transfer  to  the 
State  on  a  monthly  basis  80%  of  its  net  revenues 
after  deduction  of  the  expenses  related  to  the 
financial  year  and  the  uncovered  loss  of  the 
previous  financial  year.  This  provision  does  not 
rule out the possibility of an intra-year anticipated 
profit  distribution  under  circumstances  where  the 
BNR would accumulate profit during the first half 
of a year, but suffer losses during the second half. 

to  those  contained  in  Article  33  of  the  Law  on 
BNR.  

is 

to 

control 

empowered 

According  to  Articles  21  and  23  of  the  Law 
concerning the organisation and functioning of the 
Court  of  Auditors  (No  94/1992),  the  Court  of 
the 
Auditors 
establishment,  management  and  use  of  the  public 
sector’s  financial  resources, 
including  BNR's 
financial resources, and to audit the performance in 
the  management  of  the  funds  of  the  BNR.  Those 
provisions constitute an imperfection and thus, for 
legal  certainty  reasons,  it  is  recommended  to 
define  clearly  in  the  Law  the  scope  of  audit 
performed  by  the  Court  of  Auditors,  without 
the  BNR’s 
the  activities  of 
prejudice 
independent  external  auditors,  as  laid  down  in 
Article 27(1) of the Statute. 

to 

it  has 

insufficient 

Article 43 of the Law provides that the BNR must 
transfer to the State budget an 80% share of the net 
revenues  left  after  deducting  expenses  relating  to 
the  financial  year,  including  provisions  for  credit 
risk,  and  any  losses  relating  to  previous  financial 
years  that  remain  uncovered.  Such  a  procedure 
may, in certain circumstances, be seen as an intra-
year  credit,  which  negatively  impacts  on  the 
financial independence of the BNR. Consequently, 
a  Member  State  may  not  put  its  central  bank  a 
position  where 
financial 
resources to carry out its ESCB tasks, and also its 
its 
tasks,  such  as 
own  national 
administration  and  own  operations.  Article  43(3) 
of  the  BNR  Law  also  provides  that  the  BNR  sets 
up provisions for credit risk in accordance with its 
rules, after having consulted the Ministry of Public 
to 
Finance.  The  central  bank  must  be  free 
independently  create 
to 
financial  provisions 
safeguard  the  real  value  of  its  capital  and  assets. 
Article 43 of the Law is incompatible with Article 
130 of the TFEU and Article 7 of the ECB/ ESCB 
Statute and should therefore be adapted, to ensure 
that the above arrangements do not undermine the 
ability  of  the  BNR  to  carry  out  its  tasks  in  an 
independent manner.  

financing 

8.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

According to Article 26 of the BNR Law, the BNR 
under  exceptional  circumstances  and  only  on  a 
case-by-case  basis  may  grant  loans  to  credit 
institutions,    which  are  unsecured or  secured  with 
assets  other  than  assets  eligible  to  collaterise  the 
monetary or foreign exchange policy operations of 

104 

 
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

The  adjustment  would  be  made  by  the  State  only 
after  the  closure  of  the  financial  year  and  would 
thus imply an intra-year credit to the State, which 
the  prohibition  on  monetary 
would  breach 
financing.  This  provision 
therefore  also 
incompatible with the Article 123 of the TFEU.  

is 

contains  an  imperfection  inasmuch  as  it  should 
contain  a  reference  to  the  general  economic 
policies  in  the  Union  as  per  Article  127(1)  of  the 
TFEU  and  Article  2  of  the  ESCB/ECB  Statute, 
with the latter Articles taking precedence over the 
BNR Law. 

The  Government  Emergency  Ordinance  90/2008 
on  the  statutory  audit  of  the  annual  financial 
statements (90)  and  consolidated  annual  financial 
statements  establishes  rules  on  statutory  auditors 
and audit entities and organises a system of public 
supervision  of  statutory  audits.  With  this  aim,  it 
establishes  the  Council  for  the  Public  Supervision 
of Statutory Audits, which is a public autonomous 
institution,  with  legal  personality  and  designed  to 
carry out the public supervision of statutory audits, 
according  to  the  principles  specified  in  Directive 
2006/43/EC (91) (92).  The  BNR  contributes  funds 
and  human  resources  to  the  functioning  of  this 
Council.  The  provision  of  resources  by  a  central 
bank  to  a  supervisory  authority  does  not  give  rise 
to  monetary  financing  concerns  insofar  as  the 
central bank will be financing the performance of a 
legitimate financial supervisory task under national 
law as part of its mandate, or as long as the central 
bank  can  contribute  to  and  have  influence  on  the 
decision-making  of  the  supervisory  authorities. 
However,  in  this  case  the  involvement  of BNR  in 
the 
statutory  audit  of 
the 
consolidated  and  annual  financial  statements  does 
not  seem  linked  to  the  financial  stability  of  the 
financial  sector  and  thus  constitutes  a  form  of 
financing  of  obligations  pertaining  to  the  public 
sector which infringes the prohibition of monetary 
financing  and  is  incompatible  with  regard  to 
Article  123  of  the  TFEU.  For  this  reason,  the 
Government  Emergency  Ordinance  90/2008 
should be made compliant with Article 123 of the 
TFEU. 

supervision  of 

8.1.4.  Integration in the ESCB 

Objectives 

Further  to  Article  2(3)  of  the  BNR  Law,  the 
secondary  objective  of  the  BNR  is  to  support  the 
State’s  general  economic  policy.  Article  2(3) 

(90)  Published  in  Monitorul  Oficial  al  României  No  481  of  30 

June 2008. 

(91)  Directive  2006/43/EC  of  the  European  Parliament  and  of 
the Council of 17 May 2006 on statutory audits of annual 
accounts  and  consolidated  accounts,  amending  Council 
Directives  78/660/EEC  and  83/349/EEC  and  repealing 
Council Directive 84/253/EEC (OJ L 157, 9.6.2006, p. 87). 
(92)  From  2009  the  Council  is  under  the  responsibility  of  the 

Ministry of Public Finances. 

Tasks 

The incompatibilities in the Statute of the BNR are 
linked to the following ESCB/ECB tasks: 

•  definition  of  monetary  policy  and  monetary 
functions,  operations  and  instruments  of  the 
ESCB (Articles 2(2)(a), 5, 6(3), 7(1), 8, 19, 20 
and 22(3) and 33(1)(a)); 

•  conduct of foreign exchange operations and the 
definition of  foreign  exchange policy  (Articles 
2(2)(a) and (d), 9, , and 33(1)(a); 

•  holding  and  management  of  foreign  reserves 

(Articles 2(2)(e), 9(2)(c), 30 and 31); 

• 

right to authorise the issue of banknotes and the 
volume of coins (Articles 2(2)(c), 12 to 18); 

•  non-recognition  of  the  role  of  the  ECB  and  of 
the  Council  for  regulating,  monitoring  and 
controlling 
transactions 
foreign 
(Articles 10 and 11); 

currency 

• 

the  ECB's  right  to  impose  sanctions  (Article 
57).  

There are also imperfections regarding the:  

•  non-recognition of the role of the ECB and the 
EU for the collection of statistics (Article 49);  

•  non-recognition  of  the  role  of  the  ECB  and  of 
the Council for the appointment of an external 
auditor (Article 36(1));  

•  absence  of  an  obligation  to  comply  with  the 
ESCB/ECB  regime  for  the  financial  reporting 
of NCB operations (Articles 37(3) and 40);  

• 

lack  of  reference  to  the  role  of  the  ECB  for 
payment  systems  (Articles  2(2)(b),  22  and 
33(1)(b)). 

105 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

economic downturn. This was inter alia a result of 
increases  in  Romanian  tobacco  excise  duties, 
inflation  and  persistently  high 
higher  energy 
inflation in services. In July 2010, inflation picked 
up  due  to  a  5  percentage  point  increase  in  the 
standard  VAT  rate.  HICP  inflation,  pushed  even 
higher  by  significant  increases  in  food  prices, 
peaked at a two-year high of 8.5% in May 2011. In 
the second half of 2011, inflation fell sharply to an 
average  of  3.8%  amid  a  VAT-related  base  effect 
and  easing  food  prices  due  to  an  exceptional 
agricultural  harvest.  Inflation  continued  to  recede 
and  fell  close  to  the  euro  area  level  in  the  first 
quarter 2012, averaging 2.7%, partly on account of 
a favourable base effect from higher food prices a 
year ago.  

Graph 8.2:Romania - HICP inflation

(y-o-y percentage change)

10

5

0

-5

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Romania

Euro area

inflation  (measured  as  HICP 

inflation 
Core 
excluding energy and unprocessed food) remained 
relatively  high  in  2009  (at  6.6%  for  the  year  as  a 
whole), particularly due to price rises in processed 
food (partly relating to several tobacco excise duty 
increases) and services. An increase in non-energy 
industrial  goods  inflation  reflected  inter  alia  the 
lagged impact of a significant weakening of the leu 
in  2008.  In  mid-2010,  core  inflation  spiked  (in 
the 
tandem  with  headline 
substantial  VAT  rate  increase.  As  the  one-off 
impact  of 
increases  faded,  core 
inflation declined sharply to an average of around 
4%  in  the  second  half  of  2011.  Annual  average 
producer price inflation for total industry increased 
to just above 8% in 2011, indicating elevated cost 
price  pressures 
to  commodity  price 
increases. 

inflation)  due 

indirect 

related 

tax 

to 

8.1.5.  Assessment of compatibility 

the 

time  of  euro  adoption, 
the  BNR  as  well  as 

As  regards  the  central  bank  integration  into  the 
the 
ESCB  at 
independence  of 
the 
prohibition  on  monetary  financing,  the  legislation 
in Romania, in particular the BNR Law is not fully 
compatible with the compliance duty under Article 
131 of the TFEU. 

8.2. 

PRICE STABILITY 

8.2.1.  Respect of the reference value 

the 

The 12-month average inflation rate for Romania, 
which is used for the convergence evaluation, was 
well  above 
reference  value  at  each 
convergence  assessment  since  EU  accession  in 
2007.  Average  annual  inflation  increased  from 
below 5% in mid-2010 to a two-year high in June 
2011,  before  decreasing  sharply  thereafter.  In 
March  2012,  the  reference  value  was  3.1%, 
calculated as the average of the 12-month average 
inflation  rates  in  Sweden,  Ireland  and  Slovenia 
plus  1.5  percentage  points.  The  corresponding 
inflation  rate  in  Romania  was  4.6%,  i.e.  1.5 
percentage  points  above  the  reference  value.  The 
12-month  average  inflation  is  likely  to  approach 
the reference value in the months ahead. 

Graph 8.1:Romania - Inflation criterion since 2006

(percent, 12-month moving average)

10

8

6

4

2

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Romania
Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

Reference value

8.2.2.  Recent inflation developments  

Romania  recorded  volatile  and,  for  protracted 
periods,  very  high  inflation  rates  in  recent  years. 
After  successful  disinflation  in  2004-2006,  with 
annual HICP inflation bottoming out at just below 
4% in early 2007, inflation spiked to around 9% by 
mid-2008 amid rising food and fuel prices. In 2009 
and  early  2010,  when  the  impact  of  major  cost-
push factors ebbed away, the inflation rate receded 
somewhat but remained elevated despite the sharp 

106 

 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Table 8.1:

Romania - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

6.6

4.1

11.9

4.0

6.6

6.5

5.8

5.4

10.6

4.9

2.6

5.9

1.2

7.9

5.4

5.5

4.2

5.3

7.9

3.0

9.9

7.1

10.9

8.2

7.6

7.1

7.8

5.6

4.1

4.0

3.4

7.3

8.5

6.6

4.0

7.1

6.1

3.5

7.6

2.9

10.4

4.1

6.4

1.8

5.4

5.8

3.3

9.3

5.4

7.5

3.5

5.0

3.8

7.6

4.6

2.8

8.7

1.0

6.6

3.1

4.4

3.6

7.3

2012

1000

265

125

158

220

232

717

1000

145

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

8.2.3.  Underlying  factors  and  sustainability  of 

inflations 

Macroeconomic  policy-mix  and  cyclical 
stance 

The Romanian economy is estimated to have been 
operating well below its potential during the global 
economic crisis. GDP contracted in both 2009 and 
2010,  suffering  from  a  collapse  in  domestic 
demand.  The  economy  gained  some  momentum 
and  grew  by  2.5%  in  2011,  due  to  a  strong 
domestic harvest and solid exports. Available data 
and indicators for the first quarter of 2012 suggest 
a deterioration in economic activity, notably due to 
external 
difficult  weather 
uncertainties.  Real  GDP  growth  is  projected  to 
decline to 1.4% in 2012, but to rebound to 2.9% in 
2013,  according  to  the  Commission  services' 
Spring  2012  Forecast,  amid  a  gradual  increase  in 
private  consumption  and  a  recovery  in  public 
investment 
increased 
an 
absorption  of  EU 
funds).  The  Commission 
services'  estimates  suggest  a  sizeable  negative 
output gap to remain over the medium term. 

(benefiting 

conditions 

from 

and 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural  balance,  was  expansive  in  the  period 
before  the  global  crisis,  as  Romania  followed 
largely  pro-cyclical  policies  throughout  the  boom 
years  around  EU  accession  in  2007.  Fiscal  policy 
has been restrictive since 2010, as significant fiscal 
adjustment measures have been adopted under the 
international  financial  assistance  programme  to 
bring public finances back to a sustainable path. In 
view  of  the  continued  consolidation  efforts  of  the 
Romanian government, a restrictive fiscal stance is 
planned for 2012 and 2013. 

Monetary  policy  was  loosened  in  2009  and  early 
2010 in view of an improved inflation outlook and 
signs  of  stabilisation  in  the  domestic  financial 
markets.  The  BNR,  operating  within  an  inflation 
targeting  framework (93),  kept  the  key  policy  rate 
stable  from  June  2010  to  October  2011  amid 
uncertainties  related  to  a  temporary  spike  in 
inflation  due  to  the  VAT  increase  in  July  2010. 
Between  the  fourth  quarter  of  2011  and  the  first 
quarter of 2012, the BNR cut the key interest rate 
by a cumulative 100 basis points to 5.25% in view 
of  a  more benign  inflation  outlook.  Credit  growth 
to  the  private  sector  weakened  sharply  during  the 
global  crisis  in  the  midst  of  unfavourable  cyclical 
and  financial  conditions, 
though  signs  of  a 
recovery  in  lending  activity  (particularly  to  the 
corporate sector) emerged in 2011.  

Wages and labour costs 

in  2011.  The  unemployment 

The  labour  market  was  considerably  impacted  by 
the 
fell 
economic  downturn.  Employment 
markedly  in  2009-2010  and  staged  only  a  modest 
rate 
recovery 
increased  to  above  7%  in  2010-2011,  up  from  a 
ten-year  low  of  5.8%  in  2008.  Annual  growth  in 
nominal compensation per employee fell sharply to 
an  average  of  around  3%  in  the  period  of  2009-
2011,  and  a  moderate  growth  is  expected  due  to 
continued slack in the labour market in 2012-2013. 
Labour  productivity  growth  became  negative  in 
2009-2010 amid contracting output, before picking 
up slightly in 2011; it is projected to remain muted 
in  2012  and  2013,  in  line  with  a  projected 
moderate  recovery  of  economic  activity.  As  a 
result, growth in nominal unit labour costs (ULC) 

(93)  The  BNR  has  set  inflation  targets    in  terms  of  annual 
consumer  price  index  growth  at  3.0%  (with  a  tolerance 
band of ± 1 percentage point) for end-2011 and end-2012. 

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Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Table 8.2:

Romania - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Romania

Euro area

Private consumption deflator

Romania

Euro area

6.6

2.2

4.9

2.2

Nominal compensation per employee

Romania

Euro area

Labour productivity

Romania

Euro area

Nominal unit labour costs

Romania

Euro area

Imports of goods deflator

Romania

Euro area

12.4

2.5

7.1

1.9

4.9

0.8

-1.2

3.9

4.9

2.1

4.8

2.2

22.0

2.6

5.9

1.3

15.2

1.4

-9.2

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

7.9

3.3

10.0

2.7

31.9

3.4

7.3

-0.3

22.9

3.8

17.2

4.2

5.6

0.3

3.7

-0.4

-1.9

1.8

-4.7

-2.4

2.9

4.2

2.2

-7.7

6.1

1.6

7.9

1.7

7.6

1.7

-0.2

2.5

7.9

-0.8

3.6

5.7

5.8

2.7

5.8

2.5

3.7

2.2

2.0

1.2

1.7

0.8

7.6

6.9

3.1

2.4

3.4

2.2

3.2

1.9

0.9

0.1

2.3

1.6

7.5

3.6

3.4

1.8

3.3

1.7

4.2

1.9

1.7

1.0

2.5

0.8

2.1

1.3

is  expected  to  increase  moderately  in  the  period 
2012-2013. 

Graph 8.3:Romania - Inflation, productivity and wage trends
40

(y-o-y % change)

30

20

10

0

-10

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation
Source: Eurostat, Commission services' Spring 2012 Forecast.

− 

2011,  following  a  25%  wage  cut  in  2010.  The 
budget  for  2012  assumed  a  freeze  in  the  public 
sector  wage  bill,  including  further  reductions  in 
public  sector  employment.  In  May  2011,  the 
government implemented important reforms in the 
areas  of  labour  market  legislation  and  social 
dialogue. 

External factors 

For Romania, given the deepening integration into 
the world economy, developments in import prices 
play an important role in domestic price formation. 
Import price inflation (as measured by the imports 
the  national  accounts) 
of  goods  deflator 
remained broadly contained in 2009-2010, but it is 
expected to outpace headline inflation in the period 
of  2011-2012.  A  moderation  of  import  price 
inflation  is  projected  for  2013  in  line  with  the 
assumed path for commodity prices. 

in 

The  wage-setting  process  is  largely  decentralised, 
although  wage  agreements  in  the  public  sector 
continue  to  play  an  important  signalling  role  for 
private sector wages. Public wage sector restraint – 
after  many  years  of  poor  discipline  –  helped  to 
moderate  wage  costs  for  the  economy  as  a  whole 
in  2010  and  2011.  The  sharper-than-expected 
reduction in public sector employment allowed for 
a  moderate  increase  in  public  sector  wages  in 

Energy  and  food  commodity  prices  have  been  an 
important  determinant  of  import  price  inflation  in 
recent  years,  in  particular  in  view  of  the  large 
weight of these categories in the Romanian HICP. 
In 2010-2011, the energy category of the consumer 
price basket was strongly affected by volatile, but 
on the whole rising, global commodity prices. The 
contribution  of  energy  prices  to  HICP  inflation 
increased  from  around  0.7  percentage  points  in 

108 

 
 
 
 
 
 
 
 
2009 to about 1.4 percentage points on average in 
2010-2011, 
in 
including  significant 
administered  energy  prices.  Easing  global  food 
prices  contributed  to  the  sharp  disinflation  in 
Romania  in  the  second  half  of  2011,  although  an 
important  part  of  the  foodstuffs  is  traditionally  of 
domestic origin. 

increases 

Import  price  dynamics  have  been  influenced  by 
fluctuations  of  the  leu.  After  weakening  by  about 
17%  in  the  second  half  of  2008,  the  leu  nominal 
effective exchange rate (measured against a group 
of  35  trading  partners)  broadly  stabilised  for  a 
prolonged  period  between  early  2009  and  mid-
2011.  A  weakening  impetus  set  in  during  the 
second half of 2011, in the midst of a deterioration 
in  global  risk  sentiment,  when  the  leu's  nominal 
effective  exchange  rate  fell  by  about  3%.  Most 
available estimates suggest that the pass-through of 
the  exchange  rate  into  inflation  in  Romania  is 
substantial  and  fast,  in  particular  for  categories 
such  as  telecommunication  services  (due  to  the 
linking  of  tariffs  to  the  exchange  rate  of  the  leu 
against the euro) and fuel prices.  

Administered prices and taxes 

Changes  in  administered  prices  and  indirect  taxes 
have  been  an  important  driver  of  inflation  in 
Romania in recent years. In particular, changes in 
indirect taxes exerted a permanent upward pressure 
inflation  until  mid-2011.  This 
on  headline 
reflected, inter alia, fiscal consolidation efforts by 
the government as well as EU tax harmonisation of 
excise  duties  (on  fuels  and  tobacco  products). 
Administered  prices  had  a  comparatively  large 
weight in the HICP basket of around 18% in 2011 
(94). 

Annual  inflation  in  administered  prices  increased 
from  5.4%  in  2010  to  7.6%  in  2011.  The 
significant  administered  price  increases  in  2011 
were driven by higher electricity prices, mirroring 
in  particular 
from  higher 
the  pass-through 
commodity prices and the introduction of a tax on 
energy  with 
to  support  renewable 
producers.  Annual  increases  in  heat  energy  prices 
surged to 15.5% in 2011, following the elimination 
of  heating  subsidies  from  the  state  budget  from 
August  2011.  Administered  utility  prices  (e.g. 
to  dwellings) 
water  supply,  services  related 

the  aim 

(94)  According to the Eurostat definition, administered prices in 
Romania  include  inter  alia  regulated  electricity  and  gas 
prices, regulated utility prices, cultural services and part of 
public transport. 

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

in 

tobacco 

increases 

recorded  persistently  high  inflation,  on  average 
around  15%  in  2010-2011.  In  the  area  of  indirect 
excise  duties 
taxes, 
contributed particularly strongly to higher inflation 
in Romania in 2010. The initial pass-through of the 
5  percentage  points  VAT  standard  rate  increase 
with  effect  from  July  2010  was  substantial  and 
implied a durable level shift in the price level, but 
the effect on inflation was temporary.  

Medium-term prospects 

Inflation  is  expected  to remain  lower  in 2012  and 
2013  compared  to  recent  years,  amid  sluggish 
domestic  demand  and  on  assumption  of  moderate 
increases  in  administered  prices.  Available  data 
indicate  a  recent  decline  in  inflation  expectations. 
Inflation will  likely  increase in  the  second half  of 
2012 due to an unfavourable base effect stemming 
from  the  drop  in  food  prices  a  year  ago,  but  it 
should  remain  within  the  upper  margin  of  the 
BNR's 3%±1 percentage point target band. On this 
basis,  the  Commission  services'  Spring  2012 
Forecast projects annual HICP inflation to average 
3.1% in 2012 and 3.4% in 2013. 

Risks  to  the  inflation  outlook  are  tilted  to  the 
upside due to yet unclear prospects of increases in 
administered  prices,  in  particular  in  gas  and 
electricity  for  retail  consumers.  Upside  risks  also 
relate  to  a  possible  further  rise  in  commodity 
prices.  No  major  changes  in  indirect  taxes  are 
foreseen  going  forward,  although  further  upward 
adjustments  cannot  be  excluded  in  the  context  of 
fiscal consolidation efforts. There are currently no 
apparent  excessive  upward  wage  pressures  given 
the  weak  economy,  but  risks  may  appear  if  the 
public  sector  wage  restraint  was  to  be  relaxed. 
Conversely,  a  slower-than-expected  recovery  of 
the  economy  would  have  disinflationary  effects. 
There  is  also  an  important  two-sided  risk  to 
inflation stemming from the leu's exchange rate. 

Over the long run, there is significant potential for 
further  price  level  convergence,  in  line  with  the 
expected  catching-up  of  the  Romanian  economy 
(with income levels at about 43% of the euro area 
average  in  PPS  in  2010).  The  level  of  consumer 
prices in Romania was at around 56% of the euro 
area  average  in  2010,  with  the  relative  price  gap 
widest for services.  

Short  to  medium-term  inflation  prospects  will 
hinge upon productivity and wage developments as 
well  as  on  developments  in  some  categories  of 

109 

 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

deficit  procedure  was  necessary,  thereby  putting 
the procedure in abeyance (95).  

Romania 
is  currently  under  a  precautionary 
medium-term financial assistance programme with 
the EU worth EUR 1.4 billion decided on 12 May 
2011. This assistance-provided in conjunction with 
an  IMF  Stand-By  Agreement (96),  also  treated  as 
precautionary,  is  subject  to  a  number  of  policy 
conditions including continued and enhanced fiscal 
consolidation,  fiscal  governance  and  structural 
reforms.  These  are  consistent  with  the  Council 
recommendations under the EDP (97). 

8.3.2.  Recent fiscal developments 

to 

the 

During  the  crisis,  the  headline  government  deficit 
rose from 2.9% of GDP in 2007 to 9% of GDP in 
2009.  In  early  2010,  the  deteriorating  balance 
implement 
government 
prompted 
consolidation  measures  worth  5%  of  GDP  on  an 
annual basis starting in July. The measures on the 
expenditure  side  were  worth  3.9%  of  GDP  and 
included  inter  alia  a  25%  reduction  in  public 
wages  and  a  15%  reduction  in  social  spending 
excluding pensions. On the revenue side, measures 
worth 1.1% of GDP included a 5 percentage point 
increase in the standard VAT rate. As a result, the 
expenditure  to  GDP  ratio  fell  by  0.9  percentage 
points  to  40.2%,  while  the  revenue  to  GDP  ratio 
increased  by  1.3  percentage  points  to  33.4%, 
thereby  reducing  the  budget  deficit  to  6.8%  of 
GDP  in  2010.  Fiscal  consolidation  continued  in 
2011 when the deficit is estimated to have fallen to 
5.2%  of  GDP.  The  expenditure-to-GDP  ratio  is 
estimated  to  have  decreased  further  to  37.7% 
following  lower  spending  on  other  transfers.  The 
revenue-to-GDP ratio fell to 32.5%.  

be 

at: 

found 

(95)  An  overview  of  all  ongoing  excessive  deficit  procedures 
http://ec.europa.eu/economy 

can 
_finance/economic_governance/sgp/deficit/index_en.htm 
(96)  The  precautionary  international  assistance  package  of  a 
total of EUR 5 billion also includes contributions from the 
IMF  worth  EUR  3.6  billion.  The  previous  financial 
assistance package (available in years 2009-2011) of a total 
of  EUR  20  billion  included  contributions  from  the  IMF 
worth  EUR  12.9  billion  and  the  World  Bank,  EIB  and 
EBRD worth EUR1.9 billion. 

(97)  Previous to the current programme, Romania had received 
medium-term financial assistance from the EU in the form 
of a loan of up to EUR 5 billion decided on 6 May 2009. It 
was  also  provided  in  conjunction  with  an  IMF  Stand-by 
agreement  and  was  subject  to  a  number  of  policy 
conditions 
Council 
also 
recommendations under the EDP. 

consistent  with 

the 

liberalization 

prices.  The 

administered 
of 
electricity  and  gas  markets,  as  agreed  under  the 
arrangements  of  the  EU-IMF  financial  assistance, 
will  imply  sizeable  price  increases  up  until  2015-
2017.  The  impact  of  such  measures  on  inflation 
will  depend  on  the  pace  of  liberalization  and 
in  global  commodity  prices. 
developments 
Anchoring  inflation  expectations  at  a  low  level 
will  be  also  important  going  forward.  A  prudent 
fiscal  policy  and  continued  structural  reforms, 
reaffirmed  by  the  commitments  of  the  Romanian 
authorities  under  the  joint  programme  supported 
by  the  EU  and  the  IMF,  should  help  sustain 
convergence going forward.  

8.3. 

PUBLIC FINANCES 

8.3.1.  The  excessive  deficit  procedure 

for 

Romania  

on 

and, 

On  7  July  2009,  the  Council  decided  that  an 
excessive deficit existed in Romania in accordance 
a 
104(6)  TEC, 
with  Article 
recommendation  by  the  Commission,  it  addressed 
recommendations  to  Romania  in  accordance  with 
Article 104(7) TEC with a view to bringing an end 
to the situation of an excessive deficit by 2011. In 
its  recommendations,  the  Council  established  a 
deadline of 7 January  2010 for  effective  action  to 
be  taken  and  invited  the  Romanian  authorities  to 
implement  all  fiscal  measures  as  planned  in  the 
February 2009 budget and the April 2009 amended 
budget,  and  continue  fiscal  consolidation  in  2010 
and 2011 with an average fiscal effort of at least 1 
½%  of  GDP.  On  16  February  2010  the  Council 
concluded that the Romanian authorities had taken 
effective action to correct the excessive deficit, but 
it  considered  that  unexpected  adverse  economic 
events  with  major  unfavourable  consequences  for 
thereby 
government 
justifying  revised  recommendations  under  Article 
126(7) TFEU. A new deadline for correction of the 
excessive deficit by 2012 was given. This required 
an average annual fiscal effort of 1¾ of GDP over 
the 
the 
implementation  of  the  fiscal  measures  planned  in 
the  2010  budget  law  and  continued  consolidation 
in  2011  and  2012.  A  new  deadline  of  16  August 
2010 was established for Romania to take effective 
action.  In  its  conclusions  of  19  October  2010  the 
Council  assessed 
that  Romania  was  making 
satisfactory  progress  in  correcting  its  excessive 
deficit  and  no  further  action  under  the  excessive 

finances  had  occurred, 

2010-2012, 

as  well 

period 

as 

110 

 
                                                           
Table 8.3:

Romania - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

2008

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

(as % of GDP unless indicated otherwise)

2009

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

-2.2

33.3

35.5

0.8

28.6

-1.4

-4.3

-0.6
-3.6

12.4

7.9

6.8

-2.9

35.3

38.2

0.7

29.1

-2.2

-5.3

-0.1
-5.2

12.8

6.3

7.9

-5.7

33.6

39.3

0.7

28.2

-5.0

-8.8

-0.5
-8.3

13.4

7.3

10.3

-9.0

32.1

41.1

1.5

27.0

-7.5

-9.1

0.5
-9.6

23.6

-6.6

0.4

-6.8

33.4

40.2

1.5

26.7

-5.3

-5.9

0.2
-6.1

30.5

-1.6

-3.2

-5.2

32.5

37.7

1.6

27.4

-3.7

-4.4

-1.1
-3.3

33.3

2.5

-2.8

2010

2011

-2.8

33.4

36.2

1.7

27.7

-1.1

-1.7

0.1
-1.8

34.6

1.4

-3.7

2012
-2.8

-1.7

34.2

1.7

-2.2

33.2

35.4

1.7

27.7

-0.4

-1.2

0.0
-1.2

34.6

2.9

-3.3

2013
-2.2

-1.2

33.7

3.1

2014
-1.2

-0.5

32.8

3.6

2015
-0.9

-0.5

31.8

3.9

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme.  One-off and other temporary measures are:
 0.6% of GDP in 2006, 0.1% of GDP in 2007, 0.5% of GDP in 2008 and 1.1% of GDP, all deficit increasing; 0.5% of GDP in 2009 and 

0.2% of GDP in 2010, all deficit-decreasing.

Sources: Commission services, the 2012 Convergence Programme of Romania.

The 2011 budget deficit was higher than the target 
of  4.9%  of  GDP  fixed  in  the  2011  Convergence 
Programme.  However,  this  was  due  to  a  one-off 
measure  related  to  court  decisions (98).  Without 
this  one-off,  the  deficit  would  have  been  lower 
than  the  4.9%  target  due  to  higher-than-expected 
savings  on  the  expenditure  side.  The  structural 
balance  improved  from  a  deficit  of  9.6%  of  GDP 
in 2009 to a deficit of 6.1% in 2010 and deficit of 
3.3% 
the 
implementation  of 
consolidation 
the 
measures  by  the  authorities.  Given  the  need  for 
urgent  fiscal  consolidation,  the  authorities  had  to 
implement  pro-cyclical  fiscal  policy  during  the 
recession which in Romania lasted from the end of 
2008 to the end of 2010.  

of  GDP 

following 

fiscal 

2011 

in 

While  remaining  well  below  60%  of  GDP,  the 
debt-to-GDP  ratio  increased  to  30.5%  in  2010 
from 23.6% in 2009 as a result of high government 
deficit  and  unfavourable  effects  from  the  implicit 
interest  rate  and  the  stock-flow  adjustment.  The 
ratio increased further to 33.3% in 2011 despite the 

(98)  Further  details  can  be 

forthcoming 
Commission  Staff  Working  Document  available  at: 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/convergence/programmes/2012_en.htm 

found 

the 

in 

positive  contributions  to  debt  reduction  made  by 
nominal GDP growth and the implicit interest rate.  

8.3.3.  Medium-term prospects  

taken 

The budget for 2012 was adopted by Parliament on 
15  December  2011.  The  measures 
to 
continue  fiscal  consolidation  are  mainly  on  the 
expenditure side and include: i) a freeze in wages 
and  further  employment  cuts  in  the  public  sector, 
ii)  a  pension  freeze,  iii)  the  introduction  of  a  new 
social  assistance  code  which  streamlines 
the 
number  of  social  assistance  programmes  and 
targets  them  towards  the  most  vulnerable,  iv)  the 
termination 
programmes 
following  the  end  of  the  extension  period  for 
finishing  them.  On  the  revenue  side  the  main 
measures  are  an  increase  in  the  excise  rate  for 
cigarettes  and  diesel  and  an  increase  in  royalties 
paid  for  the  use  of  the  resources  necessary  to 
produce construction material. Fiscal consolidation 
is expected to decrease the deficit to 2.8% of GDP 
in 2012. 

pre-accession 

of 

The fiscal consolidation measures implemented by 
the authorities will lead to a further decrease in the 
expenditure-to-GDP  ratio  in  2012  to  36.2%  from 
37.7% in 2011. This is mainly due to a fall in the 

111 

 
                                                           
 
 
 
 
share  in  GDP  of  compensation  of  employees 
following  the  continued  freeze  in  wages  and  the 
reduction  in  the  size  of  the  public  sector  operated 
in  past  years.  Social  benefits  will  also  further 
decrease  as  a  percent  of  GDP  as  a  result  of  the 
application of the new pension law which tightens 
the  eligibility  criteria  for  early  and  special 
pensions,  the  pension  freeze  and  the  introduction 
of the new social assistance  code. Finally, current 
expenditure  will  also  fall  as  a  share  of  GDP 
following  the  termination  of  the  pre-accession 
programmes.  Revenue  as  a  percent  of  GDP  is 
expected to increase in 2012 to 33.4% from 32.5% 
in 2011. In 2013 the deficit is expected to decrease 
further to 2.2% of GDP under a no-policy-change 
assumption,  mainly  as  a  result  of  a  further  fall  in 
the  expenditure-to-GDP  ratio 
to  35.4%.  The 
underlying fiscal position this year as measured by 
the  change  in  the  structural  balance  (cyclically-
adjusted  balance  excluding  one-offs  and  other 
temporary  measures)  in  the  Commission  services'  
Spring  2012  Forecast  is  restrictive,  following  the 
implementation  of  further  consolidation  measures 
in  a  context  of  relatively  weak  economic  growth. 
The  structural  balance  will  improve  further  to 
1.2%  of  GDP  in  2013.  The  debt-to-GDP  ratio  is 
expected  to  stabilise  in  2012  and  2013,  after 
several years of strong growth due to the economic 
crisis.  

submitted 

the  Council's  recommendations 

Romania 
the  2012  Convergence 
Programme  on  11  May  2012.    The  Programme 
aims  to  correct  the  excessive  deficit  this  year,  in 
line  with 
to 
Romania  under  the  EDP procedure,  and  reach  the 
MTO  in  2014.  The  Convergence  Programme 
foresees a deficit of 2.8% of GDP in 2012, 2.2% of 
GDP in 2013, 1.2% of GDP in 2014 and 0.9% of 
GDP  in  2015.  The  Commission  services'  Spring 
2012  Forecast  expects  the  deficit  to  decrease  to 
2.8% of GDP in 2012 and further to 2.2% of GDP 
in 2013 under a no-policy-change assumption.  

in 

Further  details  on  the  assessment  of  the  2012 
Convergence  Programme  for  Romania  can  be 
found 
the  forthcoming  Commission  Staff 
Working  Document  (99),  which  accompanies  the 
Commission  Recommendation 
for  a  Council 
the  National  Reform 
Recommendation  on 
Programme  2012  of  Romania  and  delivering  a 
Council  Opinion  on 
the  2012  Convergence 
Programme of Romania. 

(99)  Available 

at: 

http://ec.europa.eu/economy_finance 
/economic_governance/sgp/convergence/programmes/2012
_en.htm 

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

In  March  2012,  Romania  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 
policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

8.4. 

EXCHANGE RATE STABILITY  

through 

The Romanian leu does not participate in ERM II.  
Romania  has  been  operating  a  de  jure  managed 
floating  exchange  rate  regime  since  1991  with  no 
preannounced  path  for  the  exchange  rate (100).  De 
facto, 
the  exchange  rate  regime  had  moved 
gradually  from  a  strongly  managed  float  – 
including 
the  use  of  administrative 
measures  until  1997  –  to  a  more  flexible  one.  In 
2004,  the  BNR  increased  the  flexibility  of  the 
exchange rate and moved to a regime characterized 
by less frequent interventions. A further change in 
the  monetary  policy  strategy  followed  in  2005, 
when  Romania  shifted 
inflation 
targeting  framework  –  combined  with  a  floating 
exchange  rate  regime.  The  BNR  has  stressed, 
nonetheless,  that  currency  intervention  remains 
available as a policy instrument.  

to  a  direct 

late  2008, 

The  nominal  exchange  rate  of  the  leu  against  the 
euro  fluctuated  in  a  wide  range  in  the  pre-crisis 
years.  As  of  mid-2007,  the  leu  appreciated  to  a 
five-year high amid capital inflows sparked by EU 
membership and economic catching-up (facilitated 
by  full  capital  account  liberalisation  in  2006). 
leu's 
Between  mid-2007  and 
exchange rate followed a broad depreciation trend 
in the midst of intensifying global market tensions. 
Country-specific factors also played a role in view 
of  rising  investors'  concerns  about  large  and 
widening domestic macroeconomic imbalances. In 
autumn 2008, Romania was downgraded by major 
rating  agencies;  CDS  spreads  on  sovereign  debt 
rates 
increased  substantially,  money  market 
surged,  while  the  leu's  exchange  rate  recorded  a 
particularly strong depreciation.  

the 

(100) On 1 July 2005 the Romanian Leu (ROL) was replaced by 
the  new  leu  (RON),  with  a  conversion factor  of  1  RON  = 
10,000  ROL.  For  convenience,  however,  the  text  of  this 
report  consistently  refers  to  leu,  meaning  ROL before and 
RON after the conversion. 

112 

 
                                                           
                                                           
a 

Following  agreement  in  early  2009  to  provide 
Romania  with 
coordinated  package  of 
international  financial  assistance,  financial  market 
pressures  eased  and  the  leu  broadly  stabilised 
against the euro – at levels that then prevailed for 
most  of  the  period  from  2009  to  2011.  The  lower 
short-term  volatility  of  the  leu  has  reflected  –  in 
addition  to  the  positive  effects  associated  with 
international  financial  assistance  to  Romania  and 
easing  global  market  conditions  –  also  operations 
by  the  BNR  in  the  interbank market  as  well  as  in 
the  foreign  exchange  market.  The  leu's  exchange 
rate temporarily depreciated at times of heightened 
global  risk  aversion  (in  spring  2010  and  autumn 
2011),  but  the  weakening  was  more  moderate  in 
comparison  with  regional  peers  with  a  floating 
exchange  rate  regime.  The  leu's  exchange  rate 
against  the  euro  remained  broadly  stable  in  early 
2012, though at a moderately weaker level than the 
2009-2011  average.  During  the  two  years  before 
this  assessment,  the  leu  depreciated  against  the 
euro by 6.4%. 

Graph 8.4:Exchange rates - RON/EUR
(monthly averages)

4.5

4.0

3.5

3.0

2.5

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

The level of gross international reserves remained 
robust in 2011, amounting to above 100% of short-
term  external  debt  at 
remaining  maturity. 
International reserves were notably boosted by the 
disbursements  of  international  financial  assistance 
since  2009.  Fluctuations  in  the  level  of  gross 
international  reserves  over  recent  years  also 
reflected  changes  in  the  foreign  exchange  reserve 
requirements  of  the  credit  institutions  and  foreign 
exchange operations by the government. 

In  autumn  2008,  the  market  turmoil  and  the 
ensuing  lack  of  liquidity  drove  up  short-term 
interest  rate  differentials  significantly.  Short-term 
spreads  eased  markedly  in  2009.  This  reflected 
lower  key  policy  interest  rates  of  the  BNR  and 
improved  conditions  on  the  Romanian  money 
market.  Short-term  interest  rates  fell  further  in 
early 2010, in line with key rate cuts by the BNR 

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

the 

and  a  stabilisation  of 
interbank  market. 
Between June 2010 and September 2011, the BNR 
maintained  the  key  policy  rate  stable,  though 
abundant 
liquidity  conditions  kept  short-term 
interbank rates well below the policy rate for most 
of  2011  and  early  2012.  The  BNR's  key  interest 
rate  was  lowered  to  5.25%  by  April  2012,  i.e.  to 
425 basis points above the ECB reference rate. 

Graph 8.5:Romania - 3-M Robor spread to 3-M Euribor

(basis points, monthly values)

2000

1750

1500

1250

1000

750

500

250

0

2006

2007

2008

2009

2010

2011

2012

Source: Reuters EcoWin.

8.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Romania  used  for  the 
convergence examination reflect secondary market 
yields  on  a  single  government  benchmark  bond 
with  a  residual  maturity  of  around  9  years. 
However,  the  limited  number  of  Romanian  long-
term  bonds  issued  and  the  illiquidity  of  the 
secondary  market  may  pose  some  difficulties  in 
interpreting the data (101). 

The  Romanian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty criterion stayed above the reference value at 
each  convergence  assessment  since  EU  accession 
in  2007;  it  peaked  at  9.7%  in  the  fourth  quarter 
thereafter  and 
2009,  but  gradually  declined 
hovered  at  just  above  7%  since  early  2011.  In 
March  2012,  the  latest  month  for  which  data  are 
available, the reference value, given by the average 
of long-term interest rates in Sweden and Slovenia 
plus  2  percentage  points,  stood  at  5.8%.  In  that 
month, the 12-month moving average of the yield 
on  the  Romanian  benchmark  bond  stood  at  7.3%, 
i.e.  1.5  percentage  points  above  the  reference 
value.  

(101) The Ministry of Public Finance lengthened maturities of its 
debt instruments in the course of 2011, though the average 
remaining  maturity  of  government  debt  denominated  in 
domestic currency remains comparatively low (at 2.6 years 
by year-end). 

113 

 
 
 
                                                           
Graph 8.6:Romania - Long-term interest rate criterion
(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Romania

Reference value

Source: Commission services.

largely  reflected 

Long-term  interest  rates  increased  sharply  as  the 
global financial crisis intensified in late 2008. The 
widening spread between Romanian and euro area 
benchmark  bonds 
increasing 
country  and  currency  risk  premia.  Long-term 
interest  rates  in  Romania  then  declined  sharply  in 
late 2009 and remained at just above 7% for most 
of  the  period  2010-2011,  before  falling  to  the 
lowest  level  since  EU  accession  in  early  2012.  A 
decreasing  country  risk  premium  due  to  a  solid 
fiscal  consolidation  track  record  and  a  gradual 
downward  adjustment  in  the  expected  path  of 
interbank rates contributed to driving yields down. 
the  German 
The 
benchmark  bond  widened  sharply  in  the  midst  of 
the  euro  area  turmoil  in  the  third  quarter  2011, 
before  stabilising  at  around  500  basis  points  in 
early 2012 (102) .  

long-term  spread  vis-à-vis 

Graph 8.7:Romania - Long-term interest rates

(percent, monthly values)

14

12

10

8

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Romania

Germany

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance  the  governance  structures  in  EMU (103). 
Related to this, in February 2012, the Commission 
its  Alert  Mechanism  Report 
published 
(AMR) (104).  The  scoreboard  shows  that  Romania 
exceeds the indicative threshold in three out of ten 
indicators,  all  of  them  in  the  area  of  external 
the  current  account 
imbalances 
balance,  international  investment  position  and 
nominal  unit  labour  costs).  Romania  currently 
benefits  from  a  precautionary  EU-IMF  assistance 
programme totalling up to about EUR 5 billion that 
is  made  available  until  early  2013.  In  2012, 
Romania – as a programme country and in order to 
avoid the duplication of surveillance procedures – 
the  macroeconomic 
is  not  examined  under 
imbalances procedure.   

(namely  on 

8.6.1.  Developments  of 

the  balance  of 

payments 

three  years 

Romania's  external  balance  (i.e.  the  combined 
current  and  capital  account)  improved  markedly 
during  the  global  crisis.  The  external  deficit 
declined  from  a  peak  of  around  13%  of  GDP  in 
2007 to an average of around 4% of GDP in 2009-
2011. The narrowing of the external shortfall over 
past 
in  particular  a 
reflected 
significantly  lower  merchandise  trade  deficit,  due 
to  a  sharper  decline  in  imports  than  exports  amid 
plummeting  domestic  demand.  Net 
income 
outflows  fell  amid  a  decline  in  profits  related  to 
FDI.  The  capital  account  recorded  only  a  modest 
surplus,  as  EU 
remained 
comparatively low in recent years.  

funds  absorption 

8.6.  ADITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 

(102) The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

(103) The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 
http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(104) http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

114 

 
 
 
                                                           
                                                           
In  terms  of  the  saving-investment  balance,  the 
deterioration  in  the  external  deficit  in  pre-crisis 
years  was  largely  accounted  for  by  an  increase  in 
domestic 
reflected 
investment.  This  notably 
improved  access  to  credit,  partly  channelled  into 
the  Romanian  economy  though  foreign-owned 
banks. Part of the widening external gap mirrored 
an  increase  in  the  general  government  deficit  in 
2006-2008.  The  savings-investment  gap  shrunk 
sharply  and  stabilised  at  close  to  4%  of  GDP 
during  the  economic  crisis.  In  2009,  it  reflected 
mainly  plummeting  domestic  demand  due  to 
balance  sheet  adjustment  in  the  private  sector, 
while a widening of the fiscal gap operated against 
the  correction  of  the  external  shortfall.  In  2010-
2011, the improvement in the general government 
balance  contributed  to  narrowing  of  the  external 
gap,  while  a  moderate  deterioration  in  the  private 
saving-investment  balance  –  amidst  the  signs  of 
economic stabilisation – acted broadly as an offset. 

Graph 8.8:Romania - Saving and investment

(in percent of GDP at market prices)

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

The  real  effective  exchange  rate  appreciated 
strongly  in  the  period  from  2006  to  2007,  partly 
due to trend nominal appreciation of the leu. Since 
the  onset  of  the  financial  crisis,  price  and  cost 
competitiveness  has  improved  on  the  back  of  a 
weakening nominal  effective  exchange  rate  of  the 
leu  –  although  positive  differentials  in  relative 
consumer  prices  developments  and  unit  labour 
costs vis-à-vis main trading partners acted partly as 
an  offset.  The  continued  gains  in  world  export 
market  share,  driven  by  EU  membership  and 
export  product  diversification,  support  the  view 
that Romania's competitiveness remains adequate. 

Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Graph 8.9:Romania - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

240

200

160

120

80

40

2006

2007

NEER

2008
REER, HICP deflated

2009

2010

2011
REER, ULC deflated

Source: Commission services.

international 

Romania  has  been  a  recipient  of  international 
the 
financial  assistance  since  2009.  When 
international  financial  turmoil  escalated  in  late 
2008,  the  large  external  shortfall  in  combination 
with  the  banking  system's  heavy  reliance  on 
foreign  funding  raised  concerns  about  external 
debt  sustainability.  In  early  2009,  a  co-ordinated 
package  of 
financial  assistance 
totalling  up  to  EUR  20  billion  was  provided  to 
Romania  amid  tightening  market  conditions  and 
growing government refinancing needs. Nearly all 
of 
funds  were  disbursed 
between 2009 and early 2011. In spring 2011, after 
the  successful  completion  of  the  first  balance-of-
payments assistance programme, a follow-up joint 
EU-IMF precautionary programme (available until 
early  2013)  totalling  up  to  about  EUR  5  billion 
was made available to Romania.  

the  pre-committed 

External  financing  pressures  eased  markedly  in 
2010-2011  amid  the  sharp  improvement  in  the 
external  balance,  disbursements  of  international 
financial  assistance  and  recovery  in  global  risk 
appetite.  Romania's  financial  account  surplus 
shrank  from  about  13%  of  GDP  recorded  before 
the crisis to an average of just above 4% of GDP in 
2010-2011. Net FDI fell sharply amid deteriorating 
investors'  sentiment  towards  Romania.  Net  other 
inflows remained positive throughout the crisis due 
to  disbursements  of 
financial 
assistance.  The  rising  level  of  gross  external  debt 
was  mainly  driven  by  public  debt,  despite  the 
marked  reduction  in  the  fiscal  shortfall  over  the 
past  there  years;  this  reflects  disbursements  of 
financial  assistance  and  partly 
international 
renewed international bond issuance (105). In 2011, 

international 

(105) The  Romanian  Treasury  had  launched  its  first  5-year 
internationally  issued  euro-denominated  bond  under  the 
medium  term  notes  programme  in  June  2011,  but  further 
issuances  in  autumn  2011  were  postponed  amid  global 
market tensions. In January 2012, the Treasury successfully 

115 

 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Table 8.4:

Romania - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Of which International financial assistance

                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

2006

-10.5

-12.1

0.0

-3.3

5.0

0.0

-10.5

9.6

8.9

-0.2

6.3

-5.4

15.0

0.9

26.5

15.9

42.1

-37.7

2007

-13.4

-14.3

0.3

-3.3

3.9

0.7

-12.8

13.5

5.7

0.4

11.0

-3.6

17.0

-0.7

31.0

17.4

47.0

-43.5

2008

-11.6

-13.6

0.5

-2.7

4.3

0.4

-11.1

12.6

6.7

-0.4

6.3

0.1

12.6

-1.5

31.3

19.8

51.8

-49.4

(percentage of GDP)

2009

2010

2011

-4.2

-5.8

-0.2

-1.6

3.5

0.5

-3.6

4.7

3.0

0.4

2.3

7.5

-1.0

5.8

-1.1

25.4

21.2

68.7

-62.4

-4.4

-6.1

0.3

-1.5

2.9

0.2

-4.2

4.6

1.8

0.7

4.7

6.4

-2.6

7.2

-0.4

24.8

20.9

74.5

-62.7

-4.4

-5.5

0.3

-1.8

2.6

0.3

-4.1

3.6

1.4

1.5

1.5

1.7

-0.7

4.4

0.6

28.8

24.7

72.1

-60.5

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services, National Bank of Romania.

total  gross  external  debt  stood  at  about  72%  of 
GDP and the negative net international investment 
position at just above 60% of GDP.  

France)  and  has  been  increasing  since  the  EU 
accession in 2007.  

According  to  the  Commission  services'  Spring 
2012  Forecast,  the  external  deficit  is  expected  to 
remain  below  5%  of  GDP 
in  2012-2013. 
Romania's  external  position  is  expected  to  benefit 
from  a  higher  absorption  of  EU  funds,  while 
supported by the precautionary EU-IMF assistance 
programme.  

8.6.2.  Product market integration 

Romania's  economy  is  well  integrated  to  the  EU 
economy  through  trade  and  investment  linkages. 
The trade openness of Romania has however been 
lower  compared  to  other  non  euro  area  Member 
States  with  derogation;  it  declined  temporarily 
during  the  global  crisis,  but  recovered  in  2010  to 
its long-term average of just below 40% of GDP in 
2010.  Trade  with  other  EU  Member  States  is 
predominant (particularly with Germany, Italy and 

returned to markets with a US dollar-denominated issuance 
of 10-year bonds. 

Romania's trade specialisation is mostly in low and 
medium-to-low 
technology  goods.  Recently, 
however,  the  country's  comparative  advantage  in 
labour-intensive  goods  has  diminished,  and  the 
in  capital-intensive  goods  has 
specialisation 
somewhat increased. The cumulated share of a few 
sectors,  namely  machinery,  transport,  optical  and 
electrical  equipment,  increased  significantly  from 
27%  to  47%  in  2005  and  2010  respectively.  The 
share  of  high  value-added  goods  in  exports 
reached 8.2% of GDP in 2010, reflecting a gradual 
upward  shift  in  the  specialisation  pattern.  The 
technological trade deficit almost halved as a share 
in  GDP  in  2009  compared  to  2005,  as  a  result  of 
investment,  deleveraging  and  a 
the  reduced 
significant  fall 
inflows.  The  export 
performance  of  Romania  would  benefit  from  a 
greater technological content of exports to build up 
non-price  competitiveness  and  become 
less 
dependent on labour cost advantages. 

in  FDI 

Due to its competitive wages, favourable corporate 
tax  rates  and  relatively  large  domestic  market 
Romania  attracted  substantial  FDI  inflows  over 

116 

 
                                                                                   
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Table 8.5:

Romania - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

38.2

22.6

3.9

11.7

3.1

-2.9

6.5

6.7

3.3

:

:

11.0

100.0

2.0

100.0

38.3

22.5

4.1

11.6

3.8

-2.9

9.2

8.6

4.4

:

:

11.0

146.0

1.8

118.0

36.2

23.2

4.0

9.2

3.5

-2.6

5.8

5.2

2.6

0.8

32.5

9.0

211.0

2.4

130.0

37.0

22.7

4.6

9.7

5.4

-2.2

6.8

6.1

3.1

0.4

31.6

9.0

170.9

3.2

140.0

33.6

21.2

4.6

7.6

8.2

-1.5

2.9

3.1

1.5

0.3

25.0

9.0

126.0

3.0

112.0

2010

38.1

24.5

4.0

9.4

n.a.

n.a.

1.8

1.7

0.9

0.5

23.3

9.0

107.8

n.a.

97.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

past years, which supported a gradual restructuring 
of  the  economy.  Romania's  FDI  stock  reached 
around  43%  of  GDP  in  2009,  but  it  remained 
significantly lower as compared to EU-27 average 
(71%)  as  well  as  to  other  non-euro  area  Member 
States  (106).  FDI  inflows  mainly  originate  in  the 
EU,  while  the  Netherlands,  Austria  and  Germany 
accounted  for  more  than  half  of  the  FDI  stock  in 
2009. The majority of FDI (55% of the total stock 
in 2009) was in services, while about 32% went to 
a 
manufacturing  –  which 
strengthening  of  the  export  capacity.  FDI  is  not 
evenly distributed across regions in the country, as 
the  capital  region  had  attracted  almost  two  thirds 
of the total stock by 2010.  

contributed 

to 

House prices and residential construction spiked in 
the period around the EU accession in 2007, before 

undergoing 
significant  downward  adjustment 
during  the  crisis.  Real  house  prices  increased  at  a 
cumulated  rate  of  142%  between  2005  and  the 
third  quarter  of  2007.  Since  the  peak,  real  house 
prices  have  adjusted  by  58%.  Residential 
construction increased from 1% of GDP in 2000 to 
3% of GDP in 2008, but adjusted to around 2% of 
GDP  in  2009-2010.  Moreover,  after  reaching  a 
peak  in  2008,  the  evolution  of  building  permits, 
considered as a leading indicator for the sector, is 
also on a downward path and back to 2005 levels. 

Concerning  the  business  environment,  Romania 
scores  poorly  compared  to  euro  area  Member 
international  rankings  (107).  From  a 
States in 
comparative  perspective,  this  weak  performance 
can  be  explained  by  particularly  low  scores  for 
starting  a  business,  trading  across  borders,  and 

(106) In  2009,  a  part  of  the  FDI  stock  level  increase  has  to  be 
attributed  to  important  valuation  effects  related  to  the 
exchange rate fluctuations of the leu. 

(107) For  instance,  Romania  ranks  on  77th  and  72nd  place 
according to the 2011-2012 Global Competitiveness index 
and the 2012 World Bank Doing Business respectively. 

117 

 
                                                           
                                                           
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

period  2008-2011,  though  roughly  half  of  this 
increase is accounted for by the depreciation of the 
domestic currency.  

taken  by 

In spite of potential spill-overs from the peripheral 
euro area countries, the Romanian financial sector 
has  weathered  the  financial  crisis  well  and  no 
rescue  measures  have  been 
the 
government  thus  far.  The  banking  system  has 
remained well-capitalised, with a capital adequacy 
ratio  of  around  14.2%  by  end-2011.  Although  the 
high  share  of  foreign  currency  lending  and  rather 
severe adjustment in the housing market during the 
crisis  may  pose  a 
to  macro-financial 
threat 
stability,  there  seems  to  be  no  evidence  of  large-
in  Romania. 
scale  mortgage 
Nonetheless,  the  ongoing  deterioration  in  asset 
quality  and  the  increase  in  loan-loss  provisions 
have  negatively  impacted  profitability  in  2011. 
Non-performing loans (90 days overdue definition) 
increased significantly throughout the crisis period 
(up to 14.1% by end-2011).  

foreclosures 

Graph 8.11:Romania - selected banking sector soundness 
indicators relatively to the euro area

%

RO, 2007

RO, 2011

EA, 2007

EA, H1-11

25

20

15

10

5

0

-5

Return on equity

Capital adequacy

Non performing loans

Note: For 2007 and 2011, EU-27 non performing loans are a proxy for EA.

For 2007, EA RoE and CAR averages are unweighted.

Source: ECB, National Bank of Romania, EC calculations.

the 

impacted  by 

to  2009.  Insurance  penetration 

Market penetration rates for non-bank services are 
low  and  were  also 
the  recent 
economic  downturn.  In 
insurance  sector, 
written  premiums  declined  by  7.5%  in  2010 
in 
compared 
Romania  stood  at  about  1.5  %  of  GDP  in  2010, 
which  is  one  of  the  lowest  levels  in  the  EU.  In 
2007, Romania introduced a private pension funds 
system  comprising  two  pillars:  the  mandatory 
private  pension  funds  (pillar  II)  and  the  voluntary 
private pension funds (pillar III). Notwithstanding 
the  difficult  economic  environment,  the  net  assets 
of  both  pillar  II  and  pillar  III  pension  funds 
followed  a  positive  trend  in  the  last  two  years. 
Albeit  from  a  low  level,  the  assets  of  the  second 
pillar  increased  by  some  169%  in  2011  compared 
to  2009.  The  assets  of  the  third  pillar  went  up  by 
roughly 113% in the same period. 

registering  property.  According  to  the  November 
2011 
Internal  Market  Scoreboard,  Romania 
equalled  the  EU  average  transposition  deficit    of 
1.2%.  The  share  of  public  procurement  tenders 
announced in the EU Official Journal is marginally 
higher than the EU average (108). 

8.6.3.  Financial market integration 

The  Romanian  financial  sector  has  been  well 
integrated into the EU financial sector, particularly 
through  strong  interbank  linkages.  The  share  of 
assets of foreign-owned credit institutions – mainly 
euro  area  banks  –  in  total  assets  of  credit 
institutions  in  Romania  hovered  at  around  80% 
since  EU  accession.  Bank  concentration,  as 
measured  by  the  market  share  of  the  largest  five 
credit 
remains 
somewhat above the euro area average. 

total  assets, 

institutions 

in 

Graph 8.10:Romania - Foreign ownership and 
concentration in the banking sector

(in percent, weighted averages)

90
80
70
60
50
40
30
20
10
0

RO, 2007

RO, 2010

EA, 2007

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

he EU banking sector, December 2011.

is 

intermediation 

Financial 
performed 
predominantly by banks, though Romania still lags 
considerably  behind  the  euro  area  concerning  the 
evolution  of  bank  credit  to  the  private  non-
financial  sector.  After  a  rapid  financial  deepening 
over  the  period  2004-2008,  credit  activity  in 
Romania weakened considerably during the crisis. 
Annual credit growth to the private sector fell from 
above 50% in 2008 to about 7% by end-2011. As a 
result,  domestic  bank  credit  to  the  private  sector 
relative  to  GDP  stabilised  below  40%  of  GDP  in 
reflect  both 
2009-2011.  These  developments 
tightened  bank  lending  standards  and  low  credit 
demand  due  to  weak  economic  activity  and  debt 
deleveraging,  while 
the  reliance  on  external 
funding  was  significantly  reduced  in  recent  years. 
The foreign currency lending continued to play an 
important role in private sector lending throughout 
the  crisis;  its  share  in  total  lending  increased  by 
about 9 percentage points to around 63% over the 

(108) The  value  of  tenders  published  in  the  EU  Official  Journal 
may  serves  as  a  proxy  of  the  extent  to  which  national 
public procurement are open to foreign bidders. 

118 

 
 
                                                           
 
Convergence Report 2012 - Technical annex 

Chapter 8 - Romania 

Romania  has  transposed  all  FSAP  directives  into 
national  legislation,  whereas  the  transposition  rate 
of post-FSAP directives stood at just below 70% in 
January 2012. Although the transposition deadline 
has  already  passed,  the  Commission  has  not 
received  the  notification  for  the  transposition  of 
the amendments to the undertakings for collective 
investment  in  transferable  securities  (Directive 
2009/65/EC)  as  well  as  of  the  amendments  to  the 
reporting  and  documentation  requirements  in  the 
(Directive 
case  of  mergers  and  divisions 
2009/109/EC).  Romania  partially  notified  to  the 
Commission 
transposition  of  Omnibus  I 
(Directive 2010/78/EU). 

the 

Graph 8.12:Romania - Recent development of the  
financial system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

RO, 2007

RO, 2011

EA, 2007

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.
Source: Eurostat, ECB, National Bank of Romania, FESE, Reuters EcoWin.

equity 

despite 

significant 

debt  markets 

Romanian 
are 
and 
comparatively  underdeveloped.  Stock  market 
increases 
capitalisation, 
recorded  in  2006-2007,  continued  to  be  very  low 
in comparison with the euro area. During the crisis, 
the  stock  market  capitalisation  gap  vis-à-vis  the 
euro  area  remained  broadly  unchanged  amid  high 
market  volatility,  as  the  Romanian  market  largely 
moved  in  sync  with  global  markets.  The  debt 
securities  markets  have  been  dominated  by 
issuances  of  T-bills  and  bonds  by  central 
government,  while  the  issuance  of  corporate  and 
municipal  bonds  has  been 
traditionally  very 
limited. Available data and indicators also suggest 
that  non-resident  holdings  of  domestically  issued 
government  securities  remain  at  a  low  level. 
Private  sector  debt,  at  around  78%  of  GDP  in 
2010, stood well below the euro area average (109). 

(109) Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

119 

 
 
                                                           
 
9. 

SWEDEN 

9.1. 

LEGAL COMPATITABILITY 

9.1.1.  Introduction 

The  role  of  the  Riksbank  as  a  central  bank  dates 
back  to  1897  when  the  first  Riksbank  Act  was 
adopted  concurrently  with  a  Law  giving  the 
Riksbank the exclusive right of issuing banknotes. 
The legal basis for its establishment is contained in 
both  the  Instrument  of  Government  (Swedish 
Constitution)  and  the  Sveriges  Riksbank  Act 
adopted in 1988. 

No  amendments  to  the  Riksbank  Act  have  been 
introduced  with  regard  to  the  incompatibilities 
mentioned in the 2010 Convergence Report.  

9.1.1.  Central Bank Independence 

In Chapter 3, Article 2 of the Riksbank Act and in 
Chapter  9,  Article  13  of  the  Instrument  of 
Government,  the  prohibition  on  the  members  of 
the  Executive  Board  to  seek  or  take  instructions 
only  covers  monetary  policy 
the 
provisions do not provide for their independence in 
the  performance  of  the  other  ESCB  related  tasks, 
the  principle  of  the  central  bank's  institutional 
independence is not respected. Both provisions are 
therefore  considered  as  incompatible  with  Article 
130 of the TFEU and Article 7 of the ESCB/ECB 
Statute. 

issues.  As 

Chapter  6,  Article  3  of  the  Riksbank  Act  obliges 
the  Riksbank  to  inform  the  minister  appointed  by 
the Swedish Government about a monetary policy 
decision of major importance, prior to its approval 
by  the  Riksbank.  The  obligation  to  inform  the 
minister about a monetary policy decision of major 
importance,  prior  to  its  approval  by  the  Riksbank 
limits  the  possibility  for  the  Central  Bank  to 
independently 
the 
possibility for the Government to seek to influence 
them.  Therefore,  such  procedure  is  incompatible 
with  the  prohibition  on  giving  instructions  to  the 
Central Bank, pursuant to Article 130 of the TFEU 
and  Article  7  of  the  ESCB/ECB  Statute  and  thus 
should be adapted accordingly. 

take  decisions  and  offers 

Chapter  1,  Article  4  of  the  Act  provides  for  the 
replacement of the Governor, in case of absence or 
incapacity,  by  the  Vice-Governors  nominated  by 

the  General  Council.  To  ensure  smooth  and 
continuous functioning of the Riksbank in case of 
expiry of the term of office, resignation, dismissal 
or  other  cause  of  termination  of  office,  the  Act 
needs to remove this imperfection and provide for 
procedures and rules regarding the successor of the 
Governor in cases of termination of office. 

Pursuant  to  Chapter  10,  Article  4  of  the  Act,  the 
Parliament approves the Central Bank's profit and 
loss  account  and  its  balance  sheet  and  determines 
the  allocation  of  the  Central  Bank's  profit.  This 
practice impinges on the financial independence of 
the Riksbank and is incompatible with Article 130 
of the TFEU. The right of the Parliament should be 
to acknowledge the Central Bank's decision on the 
profit  allocation.  The  Parliament  should  not  be 
involved  in  the  relevant  central  bank's  decision-
making process.  

According  to  Chapter  8,  Article  14(2)  of  the 
Instrument  of  Government,  the  Parliament  may 
direct  the  Riksbank  in  an  act  of  law  within  its 
sphere of responsibility under Chapter 9 (financial 
power).  This  provision  does  not  respect  the 
principle of the Central Bank's independence in the 
performance  of  its  tasks  conferred  upon  by  the 
TFEU and the ESCB/ECB Statute and is therefore 
considered as incompatible. 

9.1.2.  Prohibition  of  monetary  financing  and 

privileged access 

Under  Chapter  6,  Article  8  of  the  Act,  the 
Riksbank may, in exceptional circumstances, grant 
credits  or  provide  guarantees  on  special  terms  to 
banking  institutions  and  Swedish  companies  that 
are under the supervision of the Financial Services 
Authority. In order to comply with the prohibition 
on monetary financing of Article 123 of the TFEU 
–  it  should  be  clearly  specified  that  the  loan  is 
granted  against  adequate  collateral  to  ensure  that 
the Riksbank would not suffer any loss in case of 
debtor's  default.  The  absence  of  such  a  provision 
constitutes  therefore,  an  incompatibility  with  the 
prohibition  on  monetary  financing  as  foreseen  by 
the Article 123 of the TFEU. 

Pursuant  to  Chapter  8,  Article  1  of  the  Act,  the 
Riksbank shall not extend credits or purchase debt 
instruments directly from the State, another public 
body  or  an  institution  of  the  EU.  Article  1  is 

121 

 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

subordination to the ECB’s legal acts (Chapter 
1, Article 1); 

•  definition  of  monetary  policy  and  monetary 
functions,  operations  and  instruments  of  the 
ESCB  (Chapter  1,  Article  2  and  Chapter  6, 
Articles 2, 3 and 5 and 6, Chapter 11, Article 1 
and 2a of the Act; Chapter 9, Article 13 of the 
Instruments of Government); 

•  conduct of foreign exchange operations and the 
definition of  foreign  exchange policy  (Chapter 
7 of the Act; Chapter 8, Article14 and Chapter 
9,  Article  12  of 
Instruments  of 
Government);  Articles  1  to  4  of  the  Law  on 
Exchange    Rate Policy. 

the 

• 

right to authorise the issue of banknotes and the 
volume of coins and definition of the monetary 
unit  (Chapter  5  of  the  Act;  Chapter  9,  Article 
14 of the Instruments of Government); 

•  ECB's  right  to  impose  sanctions  (Chapter  11, 

Articles 2a, 3 and 5). 

are 

There 
regarding the: 

furthermore 

some 

imperfections 

•  non-recognition  of  the  role  of  the  ECB  and  of 
the  EU for  the  collection of statistics  (Chapter 
6, Articles 4(2) and Article 9); 

•  non-recognition of the role of the ECB for the 
functioning  of  payment  systems  (Chapter  1, 
Article 2; Chapter 6, Article 7); 

•  non-recognition  of  the  role  of  the  ECB  and  of 
the Council for the appointment of an external 
auditor; 

•  non-recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Chapter  7, 
Article6). 

9.1.4.  Assessment of compatibility 

As regards the prohibition on monetary financing, 
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  and  the  Law  on  Exchange  Rate 
Policy, is not fully compatible with the compliance 
duty under Article 131 of the TFEU. 

debt 

from 

incompatible with the wording of Article 123(1) of 
the  TFEU  and  21(1)  of  the  ESCB/ECB  Statute. 
Thus,  it  should  define  more  clearly  the  entities 
concerned.  According  to  the  same  Article,  fourth 
sentence,  the  Riksbank  may  grant  credit  to  and 
purchase 
financial 
instruments 
institutions  owned  by  the  State  or  another  public 
body.  This  provision  of  Article  1  does  not  fully 
comply  with  Article  123(2)  of  the  TFEU  and 
Article  21.3  of 
the  ESCB/ECB  Statute  and 
constitutes  a  further  imperfection.  It  should  be 
added that, in the context of the supply of reserves 
by  central  banks,  these  publicly  owned  credit 
institutions  should  receive  the  same  treatment  as 
private credit institutions.  

As noted above under paragraph 8.1.3, Chapter 10, 
Article  4  of  the  Act  sets  provisions  for  the 
allocation  of  Riksbank’s  profit.  These  provisions 
are  supplemented  by  non-statutory  guidelines  on 
profit  distribution,  according  to  which  Riksbank 
should pay 80% of its profit to the Swedish State, 
after  adjustment  for  exchange  rate  and  gold 
valuation effects and based on a five-year average, 
with  the  remaining  20%  used  to  increase  its  own 
capital.  Although,  these  guidelines  are  not  legally 
binding and there is no statutory provision limiting 
the  amount  of  profit  that  may  be  paid  out,  such 
practice  could  constitute  an  incompatibility  with 
the  principle  on  the  prohibition  of  monetary 
financing under Article 123 of the TFEU. For legal 
certainty  reasons  the  law  should  ensure  that 
Riksbank’s reserve capital is left unaffected in any 
case  and  that  the  actual  contribution  to  the  State 
budget  does  not  exceed  the  amount  of  the  net 
distributable profit. 

9.1.3.  Integration in the ESCB 

Objectives 

Chapter  1,  Article  2  of  the  Act  should  include  a 
reference to the secondary objective of the ESCB, 
while  the  promotion  of  a  safe  and  efficient 
payment  system  should  be  subordinated  to  the 
primary and secondary objectives of the ESCB. 

Tasks 

The  incompatibilities  of  the  Riksbank  Act  with 
regard to the ESCB/ECB tasks are as follows: 

•  absence of a general reference to the Riksbank 
as  an  integral  part  of  the  ESCB  and  to  its 

122 

 
9.2. 

PRICE STABILITY 

9.2.1.  Respect of the reference value 

The  12-month  average  inflation  rate  for  Sweden, 
which is used for the convergence evaluation, was 
above  the  reference  value  at  the  time  of  the  last 
convergence  assessment  in  2010.  Since  then, 
inflation  has  gradually  declined.  In  March  2012, 
the  reference  value  was  3.1%,  calculated  as  the 
average of the 12-month average rates in Sweden, 
Ireland  and  Slovenia  plus  1.5  percentage  points. 
The  corresponding  inflation  rate  in  Sweden  was 
1.3%, 
the 
reference  value.  Sweden's  12-month  average 
inflation  rate  is  likely  to  remain  well  below  the 
reference value in the months ahead. 

i.e.  1.8  percentage  points  below 

Graph 9.1:Sweden - Inflation criterion since 2006

(percent, 12-month moving average)

5

4

3

2

1

0
Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Sweden

Reference value

Note: The dots  in December 2012 show the projected 
reference value and 12-month average inflation in the country.
Sources: Eurostat, Commission services' Spring 2012 Forecast.

9.2.1.  Recent inflation developments 

Graph 9.2:Sweden - HICP inflation

(y-o-y percentage change)

6

4

2

0

-2

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Sweden

Euro area

After  averaging  3.3%  in  2008,  inflation  has  been 
below  2%  in  the  following  years,  as  the  stronger 
krona  in  2010  together  with  subdued  unit  labour 
costs  have  held  back 
inflationary  pressure. 
Inflation temporarily picked up in the second half 
of  2010  amid  higher  energy  prices  (overall  HICP 
inflation  almost  doubled  between  August  and 

Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

December 2010, from 1.1% to 2.1%). In the course 
of 2011, inflation slowed down and averaged 1.4% 
in  2011.  HICP  inflation  stood  at  1.1%  in  March 
2012. 

effects 

relating 

Core  inflation  (measured  as  HICP  excluding 
energy and unprocessed food) has hovered around 
1%  since  mid-2010.  Important  factors  behind  this 
subdued  underlying  trend  include  low  resource 
utilisation, 
strong 
appreciation  of  the  krona  and  falling  unit  labour 
costs.  This  resulted  in  a  slowdown  in  the  rate  of 
price 
increases  for  services  and  non-energy 
industrial  goods,  the  latter  turning  negative  in  the 
second  half  of  2010.  Processed  food  inflation  has 
gradually  come  down  from  very  high  levels  in 
2008, but began to increase again in 2011. 

the 

to 

9.2.1.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy-mix  and  cyclical 
stance 

The Swedish economy recovered strongly from the 
2008-2009 recession, with GDP growth of 6.1% in 
2010.  The  upturn  was  broad-based  and  covered 
both  exports  and  domestic  demand.  Swedish 
exports picked up, partly driven by rapid economic 
growth  in  emerging  economies.  The  economy 
continued  to  expand  rapidly  during  most  of  2011 
but growth slowed down considerably towards the 
end  of  the  year  as  lower  external  demand,  falling 
stock  prices  and  increased  economic  uncertainty 
firms  more  cautious. 
made  households  and 
in  2011. 
Overall,  GDP  expanded  by  3.9% 
Although  some  of  the  negative  momentum  from 
the end of 2011 is expected to spill over into early 
2012,  survey  data  point  to  a  return  to  positive 
economic  growth  already  in  early  2012.  The 
recovery is, however, expected to be subdued and 
relatively 
fragile.  The  Commission  services'  
Spring  2012  Forecast  projects  GDP  growth  of 
0.3% in 2012 and 2.1% in 2013. 

Despite the deep economic downturn in 2008 and 
2009,  Sweden  recorded  only  a  small  budget 
deficit.  Part  of  the  reason  was  the  strong  initial 
position  of  public  finances,  with  high  budget 
surpluses  and  a  relatively  low  government  debt 
ratio. The fiscal policy framework introduced after 
the banking crisis in early 1990s (a budget surplus 
rule,  central  government  nominal  expenditure 
ceilings  and  balanced  budget  requirements  for 
local  governments)  played  an  important  role.  The 

123 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Table 9.1:

Sweden - Components of inflation

(percentage change)1)

weights  

in total   

2006

2007

2008

2009

2010

2011

Mar-12

HICP

Non-energy industrial goods

Energy

Unprocessed food 

Processed food

Services

HICP excl. energy and unproc. food
HICP at constant taxes 2)
Administered prices HICP

1.5

-0.4

6.9

2.6

0.1

1.3

0.5

1.4

1.1

1.7

0.6

0.5

2.2

3.7

2.1

1.8

1.3

2.2

3.3

-0.1

9.5

6.5

7.6

2.2

2.3

2.7

1.8

1.9

1.5

-0.8

3.3

2.7

2.6

2.3

1.8

2.6

1.9

0.9

5.5

0.9

1.8

1.8

1.5

1.9

1.9

1.4

-0.5

4.8

-1.8

2.7

1.7

1.1

1.4

1.9

1.3

-0.6

3.9

-1.7

2.8

1.7

1.1

1.4

2.3

2012

1000

284

117

58

135

406

825

1000

158

1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices

   in the previous period.

2) Last observation for HICP at constant taxes is February 2012.

Sources: Eurostat, Commission services.

fiscal  policy  stance  (measured  by  the  change  in 
structural  balance)  has  been  expansionary  since 
2010  and  is  likely  to  tighten  in  2012,  as  some 
previous measures expire. 

targeted 

Since  1995, 
the 
the  Riksbank  has 
domestic CPI with the aim to keep inflation at 2%. 
In  2010,  the  Riksbank  removed  the  tolerance 
interval  of  ±  1  percentage  points  that  had  been  in 
place  since  1995  from  its  specification  of  the 
inflation  target.  While  there  have  been  long 
periods when inflation deviated significantly from 
the  target,  long-term  inflation  expectations  have 
remained well anchored since the late 1990s. (110) 

The  non-conventional  monetary  policy  measures 
adapted  by  the  Riksbank  following  the  financial 
crisis in 2008 were phased out during 2010 as the 
funding  situation  for  Swedish  banks  improved. 
After  cutting  the  repo  rate  to  0.25%  during  the 
crisis,  the  Riksbank  embarked  on  a  tightening 
cycle  in  July  2010.  The  repo  rate  was  gradually 
raised  from  0.25%  to  2.0%  one  year  later  amid 
growing  inflationary  pressure  and  concerns  about 
strong  household  credit  growth.  Appreciation  of 
the krona since early 2011 has also contributed to 
tightening monetary conditions. In December 2011 
and  February 2012,  the  Riksbank cut  its repo  rate 
in  two  steps  by  50  basis  points  to  1.50%  as  a 
deteriorating  outlook  for  global  growth  and  a 
slowdown  in  the  Swedish  economy  was  expected 
to  keep  inflationary  pressure  low  in  the  period 
ahead. 

(110) The  difference  between  HICP  and  domestic  CPI  can 
occasionally  be  relatively  large,  reflecting  above  all  the 
non-inclusion  of  interest  costs  for  owner-occupied  homes. 
This  was  the  case  in  2009  when  drastic  repo  rate  cuts 
implemented during the crisis contributed to a rapid fall of 
CPI inflation, which became negative. 

124 

Wages and labour costs 

in 

The  Swedish  labour  market  fared  relatively  well 
during the crisis as labour hoarding dampened the 
increase 
unemployment.  Unemployment 
increased  by  around  3  percentage  points  from 
August  2008  to  a  peak  of  9.1%  in  April  2010. 
Unemployment  has  since  then  gradually  declined 
and  stabilised  at  around  7.5%  since  mid-2011. 
Annual  growth  of  nominal  compensation  per 
employee slowed down markedly during 2008 and 
2009,  largely  due  to  reductions  in  overtime  pay 
and other variable supplements. In 2010, growth in 
compensation  per  employee  picked  up  as  the 
labour  market 
improved,  although  remaining 
below pre-crisis levels. The following year, growth 
in compensation slowed down considerably due to 
historically low wage agreements made in 2010. A 
large  drop  in  output  per  worker  caused  nominal 
unit  labour  costs  (ULC)  to  surge  in  2009  before 
becoming  negative  in  2010  as  output  per  worker 
recovered  sharply.  In  2011,  nominal  unit  labour 
costs  increased  modestly.  Public  sector  wages 
increased  at  a  slightly  higher  pace  than  in  the 
private  sector  during  2010  and  for  most  of  2011. 
According  to  the  Commission  services'  Spring 
2012  Forecast, 
nominal 
compensation per employee is expected to increase 
to 2.9% in 2012 and 3.1% in 2013. This, together 
with  a  weakening  of  productivity  growth,  implies 
an increase in nominal unit labour costs (ULC) of 
2.8% in 2012. The following year, growth in ULC 
is expected to slow down to 1.4%. 

growth 

the 

of 

 
                                                           
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Table 9.2:

Sweden - Other inflation and cost indicators

2006

2007

2008

2009

2010

(annual percentage change)

20111)

20122)

20132)

HICP inflation

Sweden

Euro area

Private consumption deflator

Sweden

Euro area

1.5

2.2

1.2

2.2

Nominal compensation per employee

Sweden

Euro area

Labour productivity

Sweden

Euro area

Nominal unit labour costs

Sweden

Euro area

Imports of goods deflator

Sweden

Euro area

2.1

2.5

2.6

1.9

-0.5

0.8

3.9

3.9

1.7

2.1

1.4

2.2

5.2

2.6

1.0

1.3

4.2

1.4

0.2

1.0

1) 2011 data (except HICP inflation) are estimates. 

2) Commission services' Spring 2012 Forecast.

Source: Eurostat, Commission services.

3.3

3.3

3.1

2.7

1.5

3.4

-1.5

-0.3

3.1

3.8

4.3

4.2

1.9

0.3

2.1

-0.4

1.6

1.8

-2.7

-2.4

4.4

4.2

-1.0

-7.7

1.9

1.6

1.4

1.7

3.0

1.7

5.0

2.5

-1.9

-0.8

-0.2

5.7

1.4

2.7

1.3

2.5

0.8

2.2

1.7

1.2

-0.9

0.8

-0.4

6.9

1.1

2.4

1.1

2.2

2.9

1.9

0.1

0.1

2.7

1.6

1.5

3.6

1.5

1.8

1.3

1.7

3.1

1.9

1.7

1.0

1.4

0.8

1.5

1.3

Graph 9.3:Sweden - Inflation, productivity and wage trends

(y-o-y % change)

9

6

3

0

-3

-6

2006

2007

2008

2009

2010

2011

2012

2013

Productivity (real GDP per person employed)

Nominal compensation per employee

Nominal unit labour costs

HICP inflation

Source: Eurostat, Commission services' Spring 2012 Forecast.

The  Swedish  wage  formation  system  is  based  on 
collective  bargaining,  both  in  the  public  and 
private  sector.  The  social  partners  are  responsible 
for  wage  formation  themselves,  and  in  principle 
engage  in  it  without  any  interference  from  the 
political  authorities.  The  majority  of  wage 
or 
place 
bargaining 
establishment  level,  within  the  framework  of  a 
sectoral  agreement.  The  Industrial  Agreement  has 
played a prominent role since 1997, confirming the 
role of the industry as wage leader. The 2010 wage 
bargaining  round  (covering  over  3.3  million 
employees)  was  strongly 
the 
economic crisis and uncertainty about the outlook. 

influenced  by 

company 

takes 

at 

This  resulted  in  lower  centrally-agreed  wage 
increases  than  in  previous  bargaining  rounds 
during the 2000s. Wage agreements for 2.7 million 
employees  are  being  renegotiated  during  the  12-
month  period  until  September  2012.  The  first 
agreement  within  the  manufacturing  industry  was 
signed  in  December  2011  and  contained  wage 
increases of 3% over a period of 14 months (2.6% 
annually).  The  agreements  signed  subsequently 
have  so  far  followed  the  norm  set  by  the 
manufacturing industry.  

External factors 

rapidly 

Import  price  growth,  as  measured  by  the  imports 
of goods deflator in the national accounts, has been 
negative  since  2009.  The  decline  in  2009  was 
international 
mainly  due 
falling 
to 
these  prices 
commodity  prices,  and  when 
recovered  in  2010,  a  stronger  krona  pushed  down 
import  prices.  In  2011,  the  krona's  appreciation 
came  to  a  halt  but  import  prices  continued  to  fall 
due to a reversal of the commodity price trend. In 
2012, import prices are expected to rise somewhat 
as higher oil prices are not expected to be offset by 
further strengthening of the krona. 

Following  the  deep  drop  in  global  oil  prices  after 
the  financial  crisis,  energy  prices  in  HICP  fell  by 
0.8% in 2009 but gradually increased as oil prices 

125 

 
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Medium-term prospects 

is 

to 

raise  unit 

HICP inflation is expected to slow down in 2012, 
mainly  due  to  a  stable  commodity  prices  outlook 
and strong carry-over effects from the last quarter 
of  2011,  when  inflation  dropped  much  more  than 
expected  across  most  categories  of  the  consumer 
basket.  Although  the  ongoing  wage  bargaining 
round  has  so  far  resulted  in  moderate  wage 
increases, the expected dip in output per worker in 
2012 
labour  costs 
likely 
is  however 
significantly.  Underlying 
expected  to  remain  subdued  throughout  2012  as 
low  demand  and  capacity  utilisation  restrain  the 
inflationary impact. In the second half of 2012, as 
the  recovery gains  some  traction  and employment 
growth resumes, cost pressures are expected to re-
emerge  and  inflation  to  pick  up  gradually.  The 
Commission  services'  Spring  2012  Forecast 
projects annual HICP inflation to average 1.1% in 
2012 and 1.5% in 2013. Inflation expectations are 
well  anchored  around  the  Riksbank's  inflation 
target. 

inflation 

The  Swedish  relative  price  level  has  gradually 
decreased since Sweden joined the EU in 1995. In 
2010,  the  Swedish  price  level  increased  to  some 
120% of  the  EU-27  average compared  to  close  to 
110%  the  previous  year.  The  increase  likely 
reflects  the  significant  strengthening  of  the  krona 
in 2010. 

9.3. 

PUBLIC FINANCES 

9.3.1.  Recent fiscal developments 

Swedish public finances were strong in the run-up 
to  the  global  financial  crisis,  with  the  general 
government  surplus  amounting  to  3.6%  and  2.2% 
in  2007  and  2008,  respectively.  The  strong  result 
was  achieved  due  to  a  long-standing  commitment 
to respecting the fiscal rules requiring a 1% surplus 
over the cycle and a cap on expenditure. Due to the 
impact  of  the  recession  and  the  discretionary 
stimulus  measures  that  the  government  undertook 
to counteract its effects, the balance briefly turned 
into  a  small  deficit  in  2009.  As  the  economic 
recovery  got  underway,  the  balance  swung  back 
into  a  surplus  in  2010,  despite  further  stimulus 
measures  being  taken.  The  government  balance 
remained  in  surplus  in  2011,  as  economic  growth 
remained  robust  until  the  third  quarter.  The 
gyrations in the government balance observed over 
the  last  couple  of  years  have  been  driven  by 
cyclical swings in both revenues and expenditures, 

recovered. In 2010 and 2011, energy prices in the 
HICP  index  increased  by  around  5%  on  average. 
Easing  global  food  inflation  since  early  2010 
contributed 
in  annual 
to  a  marked  decline 
unprocessed  food  price  inflation  in  2010  (from 
3.3%  in  2009  to  0.9%  in  2010).  The  following 
year,  unprocessed  food  price  inflation  turned 
negative, with prices falling by 1.8% on average in 
2011. 

in 

the  six  months  following 

The  krona's  nominal  effective  exchange  rate 
(measured  against  a  group  of  35  trading  partners) 
lost  13% 
the 
intensification of  the  financial  crisis  in  September 
2008.  The  downward  trend  reversed  in  the  spring 
2009  and  the  krona's  nominal  exchange  rate 
appreciated  by  close  to  20%  in  the  period  up  to 
March 2011 before levelling off.  

Administrative prices and taxes 

Administrative prices account for 16% of the total 
HICP basket (111). The most important item is rents 
(9%  of  total  HICP),  which  are  substantially 
regulated in Sweden. 

Administrative  price  inflation  has  outpaced  the 
increase  in  total  HICP  inflation  in  recent  years. 
Administrative price inflation picked up during the 
second  half  of  2009,  mainly  because  of  the  base 
effect from an increase in dental subsidies one year 
earlier.  In  2010,  administrative  price  inflation 
subsided  in  response  to  broad-based  declines 
across  subgroups.  A  gradual  increase  in  actual 
rents  during  2011  was  offset  by  lower  municipal 
refuse  collection,  pharmaceutical 
charges  on 
products, hospital and dental services. As a result, 
administered  price  inflation  was  stable  at  1.9%  in 
2011. 

The changes in indirect taxes foreseen for 2012 are 
expected to have a neutral effect on inflation. The 
VAT reduction for restaurant and catering services 
from  25%  to  12%  is  estimated  to  reduce  headline 
inflation by 0.2 percentage points. This effect will 
be  counterbalanced  by  an  increase  in  the  excise 
duty on tobacco and the indexing of energy taxes.  

(111) According  to  the  Eurostat  definition,  administered  prices 
inter  alia  include  actual  rents  for  housing,  combined 
passenger  transports,  medical  and  dental  services.  For 
details, 
see  http://epp.eurostat.ec.europa.eu/portal/page/ 
portal/hicp/methodology/administered_prices  

126 

 
                                                           
Table 9.3:

Sweden - Budgetary developments and projections
Outturn and forecast 1)

2006

2007

2008

Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

(as % of GDP unless indicated otherwise)

2009

2010

2011

2012

2013

General government balance

- Total revenues

- Total expenditure

   of which: 
- Interest expenditure

p.m.: Tax burden

Primary balance

Cyclically-adjusted balance

One-off and temporary measures
Structural balance 2)
Government gross debt

p.m: Real GDP growth (%)

p.m: Output gap

Convergence programme
General government balance
Structural balance 2) 3)
Government gross debt

p.m. Real GDP (% change)

2.3

54.9

52.7

1.6

48.7

3.9

0.7

0.0
0.7

45.3

4.3

2.8

3.6

54.5

51.0

1.7

47.8

5.3

1.7

0.0
1.7

40.2

3.3

3.4

2.2

53.9

51.7

1.7

46.9

3.8

1.8

0.3
1.5

38.8

-0.6

0.6

-0.7

54.0

54.9

1.0

47.1

0.2

2.5

0.0
2.5

42.6

-5.0

-5.6

0.3

52.4

52.5

0.8

46.0

1.1

1.1

0.0
1.1

39.4

6.1

-1.4

0.3

51.4

51.3

1.0

44.9

1.3

0.0

0.0
0.0

38.4

3.9

0.4

-0.3

51.8

52.3

1.1

45.2

0.8

0.3

0.0
0.3

35.6

0.3

-1.0

2012
-0.1

1.0

37.7

0.4

0.1

51.8

51.9

1.1

45.3

1.2

0.4

0.0
0.4

34.2

2.1

-0.6

2013
0.5

1.6

35.4

3.3

2014
1.7

2.4

31.8

3.7

2015
3.0

3.4

27.5

3.6

1) Commission services’ Spring 2012 Forecast.

2) Cyclically-adjusted balance excluding one-off and other temporary measures.

3) Commission services’ calculations on the basis of the information in the programme.

There are no one-off and other temporary measures in the programme.

Sources: Commission services, the 2012 Convergence Programme of Sweden.

as employment and unemployment were changing 
with the cycle.  

9.3.1.  Medium-term prospects 

in 

than 

targeted 

The  budgetary  outcome  in  2011  was  somewhat 
the  Convergence 
weaker 
Programme of 2011, with the general government 
budget  showing  a  surplus  of  0.3%  of  GDP, 
compared  with  an  initial  target  of  0.6%  of  GDP. 
The structural balance shrank by 1.4% and 1.1% of 
potential  GDP  in  2010  and  2011,  respectively.  At 
least  for  2010  this  reflects  active  discretionary 
measures being taken, such as a fourth step in the 
so  called  in-work  tax  credit,  active  labour  market 
policy  initiatives  and  additional  state  transfers  to 
local  governments  to  counteract  the  effects  of  the 
crisis. 

in  2011.  The 

With the economic recovery and the improvement 
in the budgetary balance, the debt ratio resumed its 
previous downward trend, only briefly interrupted 
by  the  2008/09  recession,  and  fell  to  38.4%  of 
stock-flow 
GDP 
adjustments  in  the  form  of  privatisation  proceeds 
observed until 2009 have been more modest in the 
2010-11  period,  both  due  to  adverse  market 
conditions  and  weaker  support  in  parliament  for 
further ambitious privatisations. 

substantial 

The  2012  Budget  Bill,  which  was  adopted  on  20 
December  2011,  includes  discretionary  measures 
of  about  SEK  15  billion  (around  ½%  of  GDP), 
including  a  reduction  of 
the  VAT  rate  for 
restaurant and catering services, which entered into 
force on 1 January 2012 and some further spending 
on infrastructure and training. 

The  Commission  services'  Spring  2012  Forecast 
projects  that  the  general  government  balance  will 
record  a  deficit  of  around  0.3%  of  GDP  in  2012 
and then return to a small surplus of 0.1% of GDP 
in 2013 reflecting the economic slowdown in 2012 
and  the  subsequent  expected  muted  recovery. 
Rather  subdued  employment  growth  limits  the 
improvement. The structural balance is expected to 
improve  slightly  from  0%  in  2011  to  0.3%  and 
0.4% in 2012 and 2013 respectively. Gross debt as 
a  share  of  GDP  is  expected  to  continue  its 
downward  trend  and  amount  to  34.2%  of  GDP  in 
2013, mostly due to nominal GDP growth, but also 
to some expected privatisation receipts. 

The  medium-term  budgetary  strategy  of  the  2012 
Convergence Programme, which was submitted on 
16  April  2012,  aims  at  achieving  government's 

127 

 
 
 
 
 
target  of  a  general  government  surplus  of  1%  of 
GDP  over  the  cycle.  Until  2011,  this  target 
coincided with Sweden's Medium-Term Objective 
(MTO). However, as from 2012, the MTO will be 
-1% of GDP, i.e. the minimum required according 
to  Commission 
calculations.  The 
services' 
Convergence Programme explains the change with 
a  wish  to  separate  the  minimum  requirements 
following  from  the  fact  that  Sweden  is  an  EU 
member  from  its  own  more  ambitious  surplus 
target.  The  authorities  rely  on  a  number  of 
indicators 
target  fulfilment.  The 
programme  foresees  a  general  government  deficit 
of 0.1% of GDP in 2012 and a surplus of 0.5% of 
GDP 
in  2013.  With  a  general  government 
structural balance of 0.0% in 2011, the MTO was 
not fulfilled, but is expected to be so in 2012 and 
2013,  when  the  recalculated  balance  is  1.0%  and 
1.6%,  respectively.  Based  on  a  no-policy  change 
scenario, the target is expected to be fulfilled with 
increasing margin as from 2014.  

to  measure 

(112),  which 

Further  details  on  the  assessment  of  the  2012 
Convergence Programme for Sweden can be found 
in  the  forthcoming  Commission  Staff  Working 
Document 
the 
Commission  Recommendation 
for  a  Council 
Recommendation  on  the  2012  National  Reform 
Programme  of  Sweden  and  delivering  a  Council 
Opinion  on  the  2012  Convergence  Programme  of 
Sweden. 

accompanies 

In  March  2012,  Sweden  signed  the  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
EMU.  This  implies  an  additional  commitment  to 
conduct  stability-oriented  and  sustainable  fiscal 
policies.  This  Treaty  will  apply  to  contracting 
Member  States  with  a  derogation  which  have 
ratified  the  Treaty  as  from  the  date  when  the 
decision abrogating that derogation will come into 
force  unless  they  declare  their  intention  to  be 
bound  at  an  earlier  date  by  some  or  all  of  the 
provisions on the fiscal compact and on economic 
policy coordination and convergence. 

9.4. 

EXCHANGE RATE STABILITY 

The Swedish krona does not participate in ERM II. 
Sweden  pursues  a  floating  exchange  rate  regime 
and inflation targeting since the early 1990s.  

Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

The  krona  depreciated  strongly  vis-à-vis  the  euro 
at  the  onset  of  the  financial  crisis  in  September 
2008  but  then  quickly  recovered.  The  krona 
reached  a  ten-year  high  against  the  euro  in 
February  2011,  strengthening  by  some  20%  since 
March 2009. Unlike in previous periods of severe 
financial market stress, the krona remained broadly 
stable  when  the  euro  area  sovereign  debt  crisis 
intensified in the third quarter of 2011. After some 
weakening  in  the  first  half  of  2011,  the  krona 
just  above  9.1  SEK/EUR  before 
stabilised 
strengthening  to  on  average  8.8  SEK/EUR  in  the 
first  four  months  of  2012  as  Sweden's  strong 
public  finances  triggered  safe-haven  flows  into 
krona.  Overall,  the  krona  has  appreciated  against 
the  euro  by  8%  during  the  two  years  before  this 
assessment. 

Graph 9.4:Exchange rates - SEK/EUR

(monthly averages)

11.5

11.0

10.5

10.0

9.5

9.0

8.5

2006

2007

2008

2009

2010

2011

2012

Source: ECB, Reuters EcoWin.

Sweden's  strong  public  finances  triggered  safe-
haven  flows  into  SEK.  The  krona  was  also 
supported  by  a  significant  widening  of  short-term 
interest  rate  differentials  vis-à-vis  the  euro  area 
after the Riksbank embarked on a monetary policy 
tightening  cycle 
in  July  2010.  The  spread 
temporarily  narrowed  in  spring  2011  as  the  ECB 
increased its benchmark rate in two steps from 1% 
to  1.50%,  but  widened  again  after  the  ECB 
reversed  the  increases  towards  the  end  of  2011. 
The Riksbank also cut its repo rate in two steps by 
a  total  of  50  basis  points  in  December  2011  and 
February  2012.  In  2012,  the  spread  has  widened 
significantly  as  euro  area  short-term  interest  rates 
have  declined  significantly  in  the  wake  of  the 
increase  in  excess  liquidity  following  the  two  3-
year longer-term refinancing operations carried out 
by the ECB in December 2011 and February 2012. 
On April 30, the spread was 1.5 percentage points.  

(112) Available 

at: 

http://ec.europa.eu/economy_finance 
/economic_governance/sgp/convergence/programmes/2012
_en.htm 

128 

 
                                                           
 
Graph 9.5:Sweden - 3-M Stibor spread to 3-M Euribor

(basis points, monthly values)

200

150

100

50

0

-50

-100

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

The  Riksbank  replenished  its  foreign  currency 
reserves  in  2009  by  borrowing  the  equivalent  of 
SEK  100  billion  from  the  Swedish  National  Debt 
Office.  Hence,  the  level  of  foreign  currency 
reserves increased to SEK 338 billion in 2009 from 
close to SEK 200 billion in the years preceding the 
crisis.  The  Riksbank's  participation  in  the  IMF’s 
various  loan  arrangements  has  increased  in  scope 
in  recent  years  and  prompted  the  central  bank  to 
reinforce  its  foreign  currency  reserves  by  an 
additional SEK 10 billion in February 2012. 

9.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Sweden  used  for  the 
convergence examination reflect secondary market 
yields  on  a  single  benchmark  government  bond 
with a residual maturity of just over 10 years. 

The Swedish 12-month moving average long-term 
interest  rate  relevant  for  the  assessment  of  the 
Treaty criterion has gradually declined since 2008. 
In March 2012, the latest month for which data are 
available, the reference value, given by the average 
of long-term interest rates in Sweden and Slovenia 
plus  2  percentage  points,  stood  at  5.8%.  In  that 
month,  the  12-month  average  of  the  yield  on  the 
Swedish  benchmark  bond  stood  at  2.2%,  i.e.  3.6 
percentage points below the reference value.  

Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Graph 9.5:Sweden - Long-term interest rate criterion
(percent, 12-month moving average)

12

10

8

6

4

2

0
Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Sweden

Reference value

Source: Commission services.

rates 

strong 

interest 

Sweden's 

long-term 

After steady declines since the beginning of 2009, 
long-term  interest  rates  in  Sweden  and  abroad 
started  to  drift  higher  in  2010  on  the  back  of  an 
improved  economic  outlook  and  higher  inflation. 
The  upward  trend  was  reversed  in  2011  and 
reached 
Swedish 
historically  low  levels  in  the  second  half  of  the 
year. 
macroeconomic 
performance  and  stable  public  finances  have 
increased  the  interest  of  foreign  investors  in 
Swedish  government  bonds.  These  safe  haven 
flows accelerated towards the end of 2011, pushing 
down yields. Sweden has issued government bonds 
at  record-low  yields,  facing  very  high  demand 
from  investors.  Swedish  long-term  interest  rates 
have 
long-term 
benchmark  yields (113).  Yield  spreads  vis-à-vis 
German  long-term  benchmark  bonds  widened  to 
around 30 basis points towards the end of 2010 but 
turned negative during the curse of 2011. Spreads 
stood at 12 basis points at end-March 2012. 

followed  German 

closely 

Graph 9.7:Sweden - Long-term interest rates

(percent, monthly values)

6

4

2

0

2006

2007

2008

2009

2010

2011

2012

Source: Eurostat.

Sweden

Germany

(113) The  reference  to  the  German  benchmark  bond  is  included 
for illustrative purposes, as a proxy of the euro area long-
term AAA yield. 

129 

 
 
 
 
                                                           
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Table 9.4:

Sweden - Balance of payments

Current account

of which: Balance of trade in goods

                 Balance of trade in services

                 Income balance 

                 Balance of current transfers

Capital account
External balance 1)
Financial account

of which: Net FDI

                Net portfolio inflows
                Net other inflows 2)
                Change in reserves (+ is a decrease)

Financial account without reserves

Errors and omissions

Gross capital formation

Gross saving

External debt

International investment position

1) The combined current and capital account.

2) Including financial derivatives.

Sources: Eurostat, Commission services.

2006

2007

2008

2009

2010

2011

(percentage of GDP)

8.4

5.4

2.4

1.9

-1.3

-0.7

7.8

-8.2

0.6

-5.0

-3.5

-0.4

-7.8

0.5

18.7

26.6

164.3

-13.2

9.2

3.8

3.4

3.1

-1.1

-0.1

9.2

-2.5

-2.4

3.2

-3.3

0.1

-2.5

-6.7

20.3

28.9

172.7

-1.1

8.8

3.2

3.4

3.5

-1.3

-0.2

8.6

4.8

1.2

-6.1

9.7

0.0

4.9

-13.5

20.2

29.0

181.9

-9.3

7.0

3.2

3.3

1.8

-1.3

-0.1

6.9

-2.6

-3.9

15.6

-10.5

-3.7

1.1

-4.3

16.5

23.3

218.0

-11.8

6.9

2.5

3.9

1.9

-1.4

-0.1

6.7

-7.7

-4.2

4.2

-7.7

0.1

-7.8

0.9

18.6

25.4

203.5

-9.0

7.2

2.4

3.8

2.3

-1.3

-0.1

7.1

-8.4

-3.0

4.7

-10.1

-0.1

-8.3

1.3

19.6

26.7

197.3

-6.9

9.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
financial  market 
developments,  product  and 
integration  –  is  an  important  indication  that  the 
integration  of  a  Member  State  into  the  euro  area 
would proceed without difficulties.  

The  section  on  additional  factors  makes  reference 
inter  alia  to  the  surveillance  of  macroeconomic 
imbalances  under  the  Macroeconomic  Imbalance 
Procedure (MIP - see also Box 1.5), embedded in 
the  broader  "European  semester"  approach  to 
enhance 
in  EMU. 
the  governance  structures 
Related  to  this,  in  February  2012,  following  the 
adoption  of  the  legislation  establishing  the  new 
procedure  for  surveillance  and  correction  of 
macroeconomic  imbalances  (the  Macroeconomic 
Imbalances 
the 

-  MIP) (114), 

Procedure 

Commission  published  its  first  Alert  Mechanism 
Report (AMR) (115). The AMR scoreboard showed 
that  Sweden  exceeded  the  indicative  threshold  in 
the case of four out of ten indicators, linked to both 
external  and  internal  imbalances  (namely  the 
current  account  balance,  export  market  shares, 
house  prices  and  private sector  debt).  In  line  with 
the conclusion of the AMR, Sweden was subject to 
an in-depth review in the context of the MIP. 

9.6.1.  Developments  of 

the  balance  of 

payments 

Sweden has had a substantial and growing external 
surplus  (i.e.  on  the  combined  current  and  capital 
account) since the economic crisis at the beginning 
of  the 1990s, driven by  high  net  exports  in  goods 
and recently also in services. Prior to that, Sweden 
usually had external deficits for extended periods. 
The external surplus hovered around 8-9% of GDP 
in the years prior to the financial crisis, increasing 
from  around  4%  in  the  early  2000s.  The  surplus 

(114) The  package  of  six  legislative  proposals  to  strengthen  the 
economic  governance  of  the  EU  entered  into  force  in 
2011. 
December 

http://europa.eu/rapid/pressReleasesAction.do?reference=
MEMO/11/898 

(115) http://ec.europa.eu/economy_finance/articles/ 

governance/2012-02-14-alert_mechanism_report_en.htm 

130 

 
                                                           
                                                                                   
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

decreased  somewhat  in  the  period  2009  to  2011, 
averaging around 7% of GDP. 

occurred  in  2011  as  Swedish  consumer  prices 
increased at a slower pace then the EU average. 

The  surpluses  after  the  1990s  economic  crisis 
reflected  a  high  level  of  domestic  saving.  These 
savings  are  to  a  large  extent  channelled  abroad 
rather  than  being  used  for  domestic  investments. 
Sweden  has  had  a  lower  investment  ratio  (as  a 
percentage of GDP) than the EU average since the 
1990s. The difference is almost entirely explained 
by lower investment in the construction sector. 

Graph 9.8:Sweden - Saving and investment
(in percent of GDP at market prices)

40

30

20

10

0

2006

2007

2008

2009

2010

2011

Gross national saving Gross capital formation at current prices; total economy

Source: Eurostat, Commission services.

The  financial  account  deficit  picked  up  in  2010-
2011 to stand at around 8% of GDP, down from a 
deficit  of  2.6%  in  2009.  The  increase  in  the 
financial  account  deficit  was  driven  by  lower 
foreign  direct  investment  inflows  (FDI)  and  net 
portfolio  inflows.  Foreign  holdings  of  Swedish 
government  debt  have  increased  steadily  since 
March 2011 and the pace of increase accelerated in 
the fourth quarter of 2011. 

Despite  the  sizeable  current  account  surplus, 
Sweden has a negative net international investment 
position.  This  can  be  explained  by  the  large 
expansion of cross-border capital flows during the 
last  decade,  resulting  in  large  gross  stocks  in  the 
international  investment  position.  Hence,  changes 
in  the  Swedish  krona  exchange  rate,  equity  prices 
and the value of direct investment companies have 
a  large  impact  on  the  investment  position.  The 
strong appreciation of the krona in 2009-2011 had 
a  negative  effect  on  Sweden's  net  international 
investment  position.  Total  gross  external  debt 
continued  to  increase  rapidly  during  the  financial 
crisis,  peaking  at  218%  of  GDP  in  2009,  before 
falling below 200% again in 2011. 

The real effective exchange rate, measured both by 
consumer  prices  (HICP)  and  unit  labour  costs 
(ULC), weakened substantially  at  the  onset  of  the 
financial crisis but has since then recovered. Some 
improvement  in  external  price  competitiveness 

According  to  the  Commission  services'  Spring 
2012 Forecast, the external balance is expected to 
remain in surplus in 2012-2013.  

Graph 9.9:Sweden - Effective exchange rates

(vs. 35 trading partners;  monthly averages;
index numbers, 2006 = 100)

120

110

100

90

80

2006

2007

2008

2009

2010

2011

NEER

REER, HICP deflated

REER, ULC deflated

Source: Commission services.

9.6.1.  Product market integration 

Sweden's  economy  is  highly  integrated  to  the  EU 
economy  through  trade  and  investment  linkages. 
The openness and level of integration with the EU 
of the Swedish economy has continued to increase 
steadily  since  2005  and  this  trend  was  only 
temporarily  interrupted  by  the  economic  crisis  in 
2008-2009.  This  process  was  induced  by  trade 
globalisation  in  general  and  strengthened  trade 
links  with  the  countries  of  Central  and  Eastern 
Europe after their EU accession in 2004. Sweden's 
main  trading  partners  are  other  EU-27  Member 
States,  particularly  Germany  and  its  Scandinavian 
neighbours.  Between  2005  and  2010,  services 
accounted for a larger share of intra-EU trade as a 
result of the increasing role of outsourcing services 
in  the  industry.  As  regards  extra-EU  trade,  the 
importance of the United States has declined since 
2005  while  the  importance  of  the  BRICs  has 
increased.   

The  composition  of  trade  in  goods  reflects  the 
features  of  Sweden's  manufacturing 
main 
industries,  which  are  mainly  concentrated 
in 
capital-intensive  sectors,  particularly  in  high  and 
medium-high  technology  industries,  despite  the 
declining  technological  balance  since  2005.  The 
increased share of high-technology exports in 2009 
is 
and 
telecommunication equipment, which were hit less 
than  other  exported  products  during  the  global 
crisis.  Looking  at  the  import  content  of  exports, 
about  one  third  of  Swedish  exports  consist  of 

electronic 

exports 

due 

of 

to 

131 

 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

Table 9.5:

Sweden - Product market integration

Trade openness 1) (%)
Intra-EU trade in goods GDP ratio 2) (%)
Intra-EU trade in services GDP ratio 3) (%)
Extra-EU trade in goods GDP ratio 4) (%)
Export in high technology 5) (%)
Technological balance 6) (%)
Total FDI inflows GDP ratio 7) (%)
Intra-EU FDI inflows GDP ratio 8) (%)
FDI intensity 9)
Internal Market Directives 10) (%)
Value of tenders in the EU Official Journal 11)
Time to start up a new company 12)
Real house price index 13)
Residential investment 14) (%)
Building permits index 15)

2005

2006

2007

2008

2009

2010

44.5

21.0

5.8

11.7

14.2

0.8

3.2

2.9

4.0

0.9

17.8

15.0

100.0

3.2

100.0

47.1

22.2

6.2

12.2

13.4

0.8

7.2

4.1

3.9

1.3

17.1

15.0

110.4

3.6

139.0

48.1

22.9

6.6

11.9

13.6

0.6

5.9

4.8

3.3

1.0

17.2

15.0

120.0

3.9

91.0

50.2

23.1

6.9

12.8

13.4

0.6

7.9

8.2

6.3

0.9

19.3

15.0

120.3

3.5

77.0

44.7

19.4

7.2

11.4

14.8

0.4

2.9

3.6

4.6

0.4

21.0

15.0

120.2

2.8

69.0

46.6

20.6

7.0

12.6

n.a.

n.a.

-0.3

1.2

0.4

0.9

24.5

15.0

128.3

3.2

89.0

 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments).

 2) (Intra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 3) Intra-EU-27 trade in services (average credit and debit in % of GDP at current prices) (Balance of Payments).

 4) (Extra-EU-27 Imports + Exports of goods / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics).

 5) Taken directly from Eurostat's databases: Exports of high technology products as a share of total exports.

 6) (Exports - imports in high tech) / GDP at current prices x 100, since 2007 the data based upon SITC Rev. 4 (earlier SITC Rev. 3).

 7) Total FDI inflows (in % of GDP at current prices).

 8) Intra-EU-27 FDI inflows (in % of GDP at current prices).

 9) FDI intensity (average intra-EU-27 inflows and outflows in % of GDP at current prices).

10) Percentage of internal market directives not yet communicated as having been transposed, in relation to the total number.

11) Public procurement - Value of public procurement which is openly advertised in the EU Official Journal in total public procurement.

12) Time to start a new company (in days), Doing Business World Bank.

13) Experimental house price index (2005=100), Eurostat.

14) Gross capital formation in residential buildings (in % of GDP), Eurostat.

15) Number of new residential buildings (2005=100), Eurostat. 

Sources: Eurostat, Sectoral Performance Indicators Database (SPI), Commission services.

imported  goods:  raw  materials,  input  goods  and 
intermediate  services  from  sub-contractors  around 
the  world.  This  share  has  increased  slightly  over 
the  last  decade  in  line  with  the  global  trend 
towards 
fragmentation  of  manufacturing 
operations in various countries.  

a 

Total  FDI  inflows  have  been  generally  increasing 
over  the  period.  Almost  half  of  the  inward  FDI 
stock is in the manufacturing sector, particularly in 
the chemical and pharmaceutical industry, which is 
clearly export-oriented. The other main prominent 
sectors for FDI in 2010 were financial services, the 
utilities  sector,  and  goods  trade.  Approximately 
80% of total FDI emanates from other EU Member 
States  but  the  main  source  is  from  the  euro  area 
with 60% of the total coming from there. (116) The 

(116) However, the data is somewhat biased, and the high share 
of Luxembourg and the Netherlands is probably due to the 
fact  that  many  companies  choose  to  register  holding 
companies in these two countries. 

132 

attractiveness of Sweden for FDI can be attributed 
to  a  business-friendly  climate,  a  transparent  legal 
and  regulatory  framework,  skilled  labour  force, 
and 
macroeconomic 
framework.  

stability-oriented 

a 

House prices in Sweden rose very sharply over the 
last 15 years.  From the trough of 1996 to the pre-
crisis  peak  of  2007,  Swedish  house  prices  had 
climbed by over 130% in real terms. In contrast to 
other  countries,  house  prices  reacted  to  the  2008-
2009  crisis  with  only  a  temporary  dip  and  soon 
resumed their upward trend. In 2011, house prices 
stabilised  and  in  the  second  half  of  the  year  even 
declined in both real and nominal terms.  

Regarding 
the  business  environment,  Sweden 
scores  well  above  the  average  of  euro  area 

 
                                                           
 
 
 
 
in 

international  rankings (117),   
Member  States 
particularly  due  to  the  high  level  of  technological 
adoptions,  innovations,  internet  access,  higher 
education  and  quality  of  public  and  private 
institutions. The Swedish government has adopted 
a  large  number  of  measures  in  2011  to  reach  its 
target  of  25%  reduction  in  administrative  burden 
by  2012.  These  measures  include  a  simplification 
programme  for  2011-2014,  a  series  of  actions  to 
improve  and  assess 
interactions  between 
the 
businesses and local authorities.  

The  mandate  of  the  Swedish  Better  Regulation 
Council,  set  up  in  2009  to  promote  reduction  of 
administrative  burden,  has  been  extended  until 
2014.  Transaction  costs  related  to  starting  or 
closing  a  business  are  relatively  low  in  Sweden. 
However,  additional  efforts  could  be  made  to 
further simplify procedures for new firms.  

legislation, 

in  national 

The time to start a business in Sweden (15 days) is 
slightly longer than the EU average. While the EU 
directives  on  public  procurement  have  been 
transposed 
there  are 
nevertheless  indications  that  there  remains  room 
for improvement. Progress has been made in recent 
years  to  open  national  procurement  markets  to 
international  competition.  The  value  of  tenders 
published in the EU Official Journal has increased 
from  17.2%  in  2007  to  24.5%  in  2010,  which  is 
higher than the EU average. (118)   

Finally,  according  to  the  November  2011  Internal 
transposition  of  EU 
the 
Market  Scoreboard, 
Internal Market directives has been improving over 
the  period  under  review  and  Sweden  has  again  a 
transposition  deficit  below  the  1%  EU  target  and 
below the EU average. 

9.6.1.  Financial market integration 

Sweden's financial sector is well integrated into the 
EU  financial  system.  The  integration  of  Sweden's 
financial  sector  into  the  broader  EU  sector  relates 
mainly to links with other Nordic countries and the 
Baltic  States.  The  main  channels  of  integration 
financial 
have 
intermediaries  in  the  Nordic/Baltic  region  and  the 

ownership 

been 

the 

of 

(117) For instance, Sweden ranks on 3rd and 14th place according 
to  the  2011-2012  Global  Competitiveness  index  and  the 
2012 World Bank Doing Business index respectively. 
(118) The  value  of  tenders  published  in  the  EU  Official  Journal 
may  serves  as  a  proxy  of  the  extent  to  which  national 
public procurement are open to foreign bidders. 

Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

transformation of the Swedish stock exchange into 
the OMX Group of Nordic stock exchanges, which 
was subsequently bought by Nasdaq. The share of 
assets of foreign banks stood at 6% in 2010 but has 
increased  compared  to  the  early  2000s.  The 
Swedish banking sector is dominated by four large 
banks and bank concentration, as measured by the 
market share of the largest five credit organisations 
in total assets, is considerably higher than the euro 
area  average.  Mortgage 
institutions  play  a 
relatively  important  role  in  the  Swedish  banking 
system,  providing  about  45%  of  the  total  lending 
in 2010. 

Graph 9.10:Sweden - Foreign ownership and 
concentration in the banking sector

(in percent, weighted averages)

70

60

50

40

30

20

10

0

SE, 2004

SE, 2010

EA, 2004

EA, 2010

Concentration in the banking sector (CR5 ratio)

Share of foreign institutions as % of total assets

Source: ECB, Structural indicators for the EU banking sector, December 2011.

The  Swedish  banks  have  managed  the  euro  area 
sovereign debt crisis relatively well. They are well-
capitalised  and  have  small  direct  exposure  to  the 
countries affected by the sovereign debt crisis. The 
banks  have  benefitted  from  the  strong  growth  in 
the  Swedish  economy,  which  together  with  the 
stabilisation  in  the  Baltics  have  increased  their 
resilience.  The  profitability  of  the  major  banks, 
measured  as  return  on  equity,  has  increased  from 
just above 5% in 2009 to 12% in 2011, supported 
by  volume  increases,  low  credit  losses  and higher 
earnings  after  the  Riksbank's  interest  rate  hikes. 
All  Swedish  banks  passed  the  2011  European 
Banking  Authority  (EBA)  EU-wide  stress  tests 
with  a  margin,  the  result  is  also  in  line  with  the 
tests  conducted  by 
the  Swedish  Financial 
Supervisory Authority. The banks in Sweden have 
traditionally been funded largely by deposits from 
bank  customers,  but  in  recent  years  the  share  of 
market funding has increased. The major Swedish 
banks  currently  receive  around  half  of  their 
funding  from  financial  markets.  Of  this,  almost 
half  is  in  foreign  currency  (split  equally  between 
US dollars and euro).  

133 

 
                                                           
 
 
 
 
 
 
 
Convergence Report 2012 - Technical annex 

Chapter 9 - Sweden 

The Swedish equity market is comparatively large 
and liquid. The main trading activity takes place at 
the  Stockholmsbörsen,  but  the  investor  base  has 
significantly expanded via the OMX group. Stock 
market capitalisation is high compared to the euro 
area.  Debt  securities  markets  are  dominated  by 
issuances  of  bonds  by  mortgage  institutions  and 
central government.  The market for corporate debt 
is  relatively  small  and  bank  loans  are  the primary 
source  of funding  for  firms. Issuance  of bonds by 
municipals and county councils is also limited.  

The  assets  of  non-bank  financial  intermediaries 
account  for  about  40%  of  the  total  assets  of 
financial institutions. Sweden has a developed and 
relatively  large  insurance  sector,  including  more 
than 300 domestic companies and over 30 foreign 
branches.(120)  The  total  premium  signed  in  2010 
corresponded  to  8.2%  of  GDP,  with  the  life 
business accounting for about three quarters of the 
total.(121) The insurance companies managed assets 
amounting  to  around  90%  of  GDP.  The  assets 
under  management  of  Swedish  investment  funds 
corresponded  to  about  60%  of  GDP,  while  the 
state  pension  funds  (AP  Funds)  total  assets' 
accounted for about 30% GDP. 

the  Finansinspektionen  (Swedish 
Since  1991, 
Financial Supervisory Authority) has been a single 
for 
supervisor 
securities  and 
the  banking, 
insurance 
sectors.  Cooperation  with  other 
authorities  responsible  for  financial  stability  and 
crisis  management  is  ensured,  in particular  by  the 
Memorandum  of  Understanding  signed  in  2009 
between 
the  Sveriges 
Riksbank, the Ministry of Finance and the Swedish 
National  Debt  Office.  Sweden  has  a  good  track 
record  in  implementing  EU  financial  services 
legislation  and  has  transposed  most  of  the  post-
FSAP directives. 

the  Finansinspektionen, 

Graph 9.11:Sweden - selected banking sector soundness 
indicators relatively to the euro area

%

18
16
14
12
10
8
6
4
2
0

SE, 2004
Return on equity

SE, H1-11

EA, 2004

EA, H1-11

Capital adequacy

Non performing loans

Note: For 2011, EU-27 non performing loans are a proxy for EA.

SE: Non performing loans data: end 2011.

Source: ECB, Swedish FSA, EC calculations.

Developments in the Swedish housing market have 
prompted  concerns  about 
sustainability  and 
implications for financial stability. Swedish house 
prices  continued  to  increase  almost  continuously 
throughout  the  financial  crisis.  Also,  the  rate  of 
household  lending  remained  high,  supported  by 
historically  low  interest  rates.  The  loan-to-value 
ratio  was  relatively  high  for  new  borrowers  and 
amortisation  payments  have  been  small.  To  curb 
lending, 
the  Swedish  Financial  Supervisory 
Authority  in  October  2010  imposed  a  cap  on 
mortgage  borrowing  (85%  of  the  market  value  of 
the  house).  The 
lending  mortgage 
stricter 
regulations  in  combination  with  rising  mortgage 
rates  contributed  to  a  slowdown  of  lending  to 
households  in  2011.  House  prices  levelled  off  at 
high  levels  in  late  2010  and  started  to  fall  back 
towards the end of 2011. The stock of private debt 
increased to 237% of GDP in 2010 (119). The Alert 
Mechanism  Report  from  February  2012  showed 
that  Sweden,  inter  alia,  exceeded  the  indicative 
thresholds for house prices and private sector debt. 
As  a  result,  Sweden  was  subject  to  an  in-depth 
review  in  the  context  of  the  Macroeconomic 
Imbalance Procedure. 

Graph 9.12:Sweden - Recent development of the  
financial system relatively to the euro area

(in percentage of GDP)

200
180
160
140
120
100
80
60
40
20
0

SE, 2004

SE, 2011

EA, 2004

EA, 2011

Debt securities

Stock market capitalisation

Credit to non-financial corporations

Credit to households

Note: Debt  Securities other than shares, excluding financial derivatives.
Source: Eurostat, ECB, Statistics Sweden, Nasdaq OMX, Reuters EcoWin.

(119) Data  on  private  sector  debt  are  based  on  unconsolidated 
ESA 95 data of non-financial corporations and households 
(and  non-profit  institutions  serving  households)  sectors' 
liabilities related to loans and securities other than shares. 

(120) As  at  the  end  of  2010.  Sveriges  Riksbank  (2011)  The 

Swedish Financial Market  

(121) Swiss Re Sigma (2011) World Insurance in 2010 

134