COMMISSION STAFF WORKING DOCUMENT Convergence Report 2016 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2016 (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union)
Date: 2016-06-07
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Sweden, convergence criteria, report, stability programme

EN 

   EN 

   EUROPEAN COMMISSION  Brussels, 7.6.2016  SWD(2016) 191 final   COMMISSION STAFF WORKING DOCUMENT Convergence Report 2016 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2016  (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union)  {COM(2016) 374 final}  
 
 
European Commission 

Directorate-General for Economic and Financial Affairs 

Convergence Report 2016 

EUROPEAN ECONOMY 

4/2016 

 
 
 
 
ABBREVIATIONS 

Member States 

Bulgaria 
Czech Republic 
Croatia 
Hungary 
Poland 
Romania 
Sweden 
Euro area  

BG 
CZ 
HR 
HU 
PL 
RO 
SE 
EA 
EA-19   Euro area, 19 Member States 
EA-18  Euro area, 18 Member States before 2015 
EA-17    Euro area, 17 Member States before 2014 
EU-28  European Union, 28 Member States 
EU-27  European Union, 27 Member States before July 2013 (i.e. EU-28 excl. HR) 
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 
BGN  Bulgarian lev 
Swiss franc 
CHF 
CZK 
Czech koruna 
HRK  Croatian kuna 
HUF  Hungarian forint 
PLN 
RON  Romanian leu (ROL until 30 June 2005) 
SEK 

Swedish krona 

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) 
HNB  Hrvatska narodna banka (Croatian National Bank – central bank of Croatia) 
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 

AMR  Alert Mechanism Report 
BoP 
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 
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 
Excessive Deficit Procedure 
EDP 

ii 

 
 
 
 
European Union 

European System of Accounts 

Foreign direct investment 
Funding for Growth Scheme 
Financial Supervisory Authority 

EMU  Economic and monetary union 
ERM II  Exchange rate mechanism II 
ESA 
ESCB  European System of Central Banks 
EU 
Eurostat Statistical Office of the European Union 
FDI 
FGS 
FSA 
FSAP  Financial Sector Action Plan 
GDP  Gross domestic product 
HICP  Harmonised index of consumer prices 
HFSA  Hungarian Financial Supervisory 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 
REER  Real effective exchange rate 
SNB 
Swiss National Bank 
TFEU  Treaty on the Functioning of the European Union 
ULC   Unit labour costs 
VAT  Value added tax 
WSE  Warsaw Stock Exchange 

Najwyższa 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 

iii 

 
 
ACKNOWLEDGEMENTS 

The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic 
and Financial  Affairs. The  main  contributors  were  Balázs Forgó, Anton Jevčák,  Julda Kielytė  and  Erik 
Sonntag. 

Other  contributors  were  Hanna  Aspegren,  Wojciech  Balcerowicz,  Laura  Bardone,  Francisco  Barros 
Castro, Eugeniu Colesnic, Karl Croonenborghs, Iván Csaba, Angela D'Elia, Patrick D'Souza, Jari Friebel, 
Isabel Grilo, Zoltán Gyenes, Julien Hartley, Michal Havlát, Nora Hesse, László Jankovics, Isabelle Justo, 
Csanád Sándor Kiss, Cvetan Kyulanov, Milan Lisický, Allen Monks, Aurora Mordonu, Kristian Orsini, 
Wojciech  Paczynski,  Mona  Papadakou,  Janka  Petőcz,  Presiyan  Petkov, Ventsislav  Petrov,  Lucia  Piana, 
Dominik  Pripužić,  Elena  Reitano,  Monika  Sherwood,  Outi  Slotboom,  Michael  Stierle,  Caroline 
Vandierendonck, Bartlomiej Wiczewski and Rafał Wielądek.  

Statistical assistance was provided by Eric Mc Coy, Gerda Symens and André Verbanck, administrative 
assistance by Lina Chahrour, Greet De Pauw and Martine Meijer.  

The  report  was  coordinated  by  Balázs  Forgó  under  the  supervision  of  Paul  Kutos,  Head  of  Unit  and 
approved by Lucio Pench, Director, Servaas Deroose, Deputy Director General, and Marco Buti, Director 
General. 

Questions and comments may be referred to Balázs Forgó (balazs.forgo@ec.europa.eu). 

iv 

 
CONTENTS 

Convergence Report 2016 

Convergence Report 2016 - Technical annex 

1. 

Introduction 

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.  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.  Recent fiscal developments 

2.3.2.  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.  Market integration 

3.  Czech Republic 

3.1. 

LEGAL COMPATIBILITY 

3.1.1. 

Introduction 

3.1.2.  Central Bank independence 

3.1.3.  Prohibition of monetary financing and privileged access 

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.  Recent fiscal developments 

3.3.2.  Medium-term prospects 

3.4.  EXCHANGE RATE STABILITY 

3.5. 

LONG-TERM INTEREST RATES 

v 

1 

3 

5 

5 

5 

6 

7 

9 

12 

12 

13 

15 

15 

15 

15 

16 

16 

16 

17 

17 

17 

17 

20 

20 

21 

22 

23 

23 

24 

25 

29 

29 

29 

29 

30 

30 

30 

30 

30 

31 

31 

34 

34 

34 

35 

36 

 
3.6.  ADDITIONAL FACTORS 

3.6.1.  Developments of the balance of payments 

3.6.2.  Market integration 

4.  Croatia 

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 Croatia 

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.  Market integration 

5.  Hungary 

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.  Recent fiscal developments 

5.3.2.  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.  Market integration 

6. 

Poland 

6.1. 

LEGAL COMPATIBILITY 

6.1.1. 

Introduction 

6.1.2.  Central Bank independence 

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 

37 

37 

38 

41 

41 

41 

41 

41 

41 

41 

41 

41 

42 

42 

44 

44 

45 

45 

46 

47 

48 

48 

49 

53 

53 

53 

53 

54 

55 

56 

56 

56 

56 

57 

59 

59 

60 

61 

62 

63 

63 

65 

67 

67 

67 

67 

68 

68 

68 

69 

69 

vi 

 
 
6.2.2.  Recent inflation developments 

6.2.3.  Underlying factors and sustainability of inflation 

6.3.  PUBLIC FINANCES 

6.3.1.  Recent fiscal developments 

6.3.2.  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.  Market integration 

7. 

Romania 

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.  Recent fiscal developments 

7.3.2.  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.  Market integration 

8. 

Sweden 

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 inflation 

8.3.  PUBLIC FINANCES 

8.3.1.  Recent fiscal developments 

8.3.2.  Medium-term prospects 

8.4.  EXCHANGE RATE STABILITY 

8.5. 

LONG-TERM INTEREST RATES 

8.6.  ADDITIONAL FACTORS 

8.6.1.  Developments of the balance of payments 

8.6.2.  Market integration 

vii 

69 

70 

72 

72 

73 

74 

74 

75 

75 

77 

81 

81 

81 

81 

82 

83 

83 

83 

83 

84 

85 

87 

87 

88 

89 

90 

90 

91 

92 

95 

95 

95 

95 

95 

96 

97 

97 

97 

97 

98 

100 

100 

101 

102 

103 

104 

104 

105 

 
 
 
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 - 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 - Market integration 

4.1.  Croatia - Components of inflation 

4.2.  Croatia - Other inflation and cost indicators 

4.3.  Croatia - Budgetary developments and projections 

4.4.  Croatia - Balance of payments 

4.5.  Croatia - Market integration 

5.1.  Hungary - Components of inflation 

5.2.  Hungary - Other inflation and cost indicators 

5.3.  Hungary - Budgetary developments and projections 

5.4.  Hungary - Balance of payments 

5.5.  Hungary - Market integration 

6.1.  Poland - Components of inflation 

6.2.  Poland - Other inflation and cost indicators 

6.3.  Poland - Budgetary developments and projections 

6.4.  Poland - Balance of payments 

6.5.  Poland - Market integration 

7.1.  Romania - Components of inflation 

7.2.  Romania - Other inflation and cost indicators 

7.3.  Romania - Budgetary developments and projections 

7.4.  Romania - Balance of payments 

7.5.  Romania - Market integration 

8.1. 

8.2. 

8.3. 

8.4. 

8.5. 

Sweden - Components of inflation 

Sweden - Other inflation and cost indicators 

Sweden - Budgetary developments and projections 

Sweden - Balance of payments 

Sweden - Market integration 

LIST OF GRAPHS 

2.1.  Bulgaria - Inflation criterion since 2010 

2.2.  Bulgaria - HICP inflation 

2.3.  Bulgaria - Inflation, productivity and wage trends 

2.4.  Bulgaria - BGN/EUR exchange rate 

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 

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

3.1.  Czech Republic - Inflation criterion since 2010 

3.2.  Czech Republic - HICP inflation 

18 

19 

21 

24 

25 

32 

33 

35 

38 

39 

43 

44 

45 

49 

50 

57 

58 

60 

64 

65 

69 

70 

72 

76 

77 

84 

85 

88 

91 

93 

98 

99 

101 

105 

106 

17 

17 

18 

22 

22 

23 

23 

24 

25 

26 

26 

27 

31 

31 

viii 

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

3.4.  Czech Republic - CZK/EUR exchange rate 

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 

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

4.1.  Croatia - Inflation criterion since 2010 

4.2.  Croatia - HICP inflation 

4.3.  Croatia - Inflation, productivity and wage trends 

4.4.  Croatia - HRK/EUR exchange rate 

4.5.  Croatia - 3-M Zibor spread to 3-M Euribor 

4.6.  Croatia - Long-term interest rate criterion 

4.7.  Croatia - Long-term interest rates 

4.8.  Croatia - Saving and investment 

4.9.  Croatia - Effective exchange rates 

4.10.  Croatia - Foreign ownership and concentration in the banking sector 

4.11.  Croatia - Selected banking sector soundness indicators 

4.12.  Croatia - Recent development of the financial system relative to the euro area 

5.1.  Hungary - Inflation criterion since 2010 

5.2.  Hungary - HICP inflation 

5.3.  Hungary - Inflation, productivity and wage trends 

5.4.  Hungary - HUF/EUR exchange rate 

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

5.6.  Hungary - Long-term interest rate criterion 

5.7.  Hungary - Long-term interest rates 

5.8.  Hungary - Saving and investment 

5.9.  Hungary - Effective exchange rates 

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

5.11.  Hungary - Selected banking sector soundness indicators 

5.12.  Hungary - Recent development of the financial system relative to the euro area 

6.1.  Poland - Inflation criterion since 2010 

6.2.  Poland - HICP inflation 

6.3.  Poland - Inflation, productivity and wage trends 

6.4.  Poland - PLN/EUR exchange rate 

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

6.6.  Poland - Long-term interest rate criterion 

6.7.  Poland - Long-term interest rates 

6.8.  Poland - Saving and investment 

6.9.  Poland - Effective exchange rates 

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

6.11.  Poland - Selected banking sector soundness indicators 

6.12.  Poland - Recent development of the financial system relative to the euro area 

7.1.  Romania - Inflation criterion since 2010 

7.2.  Romania - HICP inflation 

7.3.  Romania - Inflation, productivity and wage trends 

7.4.  Romania - RON/EUR exchange rate 

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

7.6.  Romania - Long-term interest rate criterion 

7.7.  Romania - Long-term interest rates 

7.8.  Romania - Saving and investment 

7.9.  Romania - Effective exchange rates 

32 

36 

36 

36 

37 

37 

38 

39 

40 

40 

42 

42 

43 

46 

47 

47 

47 

48 

48 

50 

50 

51 

56 

56 

58 

62 

62 

63 

63 

64 

64 

66 

66 

66 

69 

69 

71 

74 

74 

75 

75 

76 

77 

78 

78 

79 

83 

84 

86 

89 

90 

90 

90 

92 

92 

ix 

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

7.11.  Romania - Selected banking sector soundness indicators 

7.12.  Romania - Recent development of the financial system relative to the euro area 

8.1. 

8.2. 

8.3. 

8.4. 

8.5. 

8.6. 

8.7. 

8.8. 

8.9. 

Sweden - Inflation criterion since 2010 

Sweden - HICP inflation 

Sweden - Inflation, productivity and wage trends 

Sweden - SEK/EUR exchange rate 

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 

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

8.11.  Sweden - Selected banking sector soundness indicators 

8.12.  Sweden - Recent development of the financial system relative 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) 

93 

94 

94 

97 

97 

99 

102 

103 

103 

103 

104 

105 

106 

107 

107 

6 

8 

10 

13 

14 

x 

 
 
 
 
 
 
 
Convergence Report 2016 

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

 
 
2 

 
 
  
Convergence Report 2016 

Technical annex 

 
 
1. 

INTRODUCTION 

1.1. 

ROLE OF THE REPORT 

The  euro  was  introduced  on  1  January  1999  by 
eleven Member States. Since then, Greece (2001), 
Slovenia  (2007),  Cyprus  and  Malta  (2008), 
Slovakia (2009), Estonia (2011), Latvia (2014) and 
Lithuania (2015) have adopted 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  for  such 
Member States. Denmark and the United Kingdom 
negotiated  opt-out  arrangements  before 
the 
adoption  of  the  Maastricht  Treaty (1)  and  do  not 
participate  in  the  third  stage  of  EMU.  Until  these 
to 
Member  States 
participate  in  the  third  stage  and  adopt  the  euro, 
they  are  not  the  subject  of  an  assessment  as  to 
whether they fulfil the necessary conditions.  

they  wish 

indicate 

that 

latest 

In  2014,  the  Commission  and  the  ECB  adopted 
regular  Convergence  Reports (2). 
their 
Following  the  Convergence  Reports  and  on  the 
basis  of  a  proposal  by  the  Commission,  the 
Council  decided  in  July  2014  that  Lithuania 
fulfilled  the  necessary  conditions  for  adopting  the 
euro  as  of  1  January  2015 (3).  None  of  the  other 
Member  States  assessed  was  deemed  to  meet  the 
necessary conditions for adopting the euro.  

In 2016, two years will have elapsed since the last 
regular  reports  were  prepared.  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,  Croatia,  Hungary,  Poland, 

(1)  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. 

(2)  European  Commission,  Convergence  Report  2014, 
COM(2014)  326  final,  4  June  2014;  European  Central 
Bank, Convergence Report 2014, June 2014. 

(3)  Council Decision of 23 July 2014 (OJ L 228, 31.7.2014, p. 

29–32). 

5 

Romania  and  Sweden.  This  Commission  Staff 
Working  Document  is  a  Technical  Annex  to  the 
Convergence  Report  2016  and  includes  a  detailed 
assessment of the progress with convergence. 

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

The  remainder  of  the  first  chapter  presents  the 
methodology  used  for  the  application  of  the 
assessment criteria. Chapters 2 to 8 examine, on a 
country-by-country  basis, 
the 
convergence criteria and other requirements in the 
order  in  which  they  appear  in  Article  140(1)  (see 
Box  1.1).  The  cut-off  date  for  the  statistical  data 
included  in  this  Convergence  Report  was  18  May 
2016. 

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 
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). 

to 

 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

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  130  and  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.  

  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 

financing 

6 

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."  
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

legal  basis  for 

October  1995  a  framework  regulation (4)  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.  

in 

inflation 

the  percentage  change 

As has been the case in past convergence reports, a 
is 
Member  State’s  average  rate  of 
measured  by 
the 
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  inflation  of  the  three 
'best-
performing  Member  States  in  terms  of  price 
stability'  plus  1.5  percentage  points.  Accordingly, 
the reference value is currently 0.7%, based on the 
data  of  Bulgaria  (-1.0%),  Slovenia  (-0.8%)  and 
Spain  (-0.6%)  over  the  12-month  period  covering 
May 2015-April 2016.  Cyprus  and  Romania  were 
identified  as  outliers,  as  their  inflation  rates 
deviated  by  a  wide  margin  from  the  euro  area 
average 
reflecting  country-specific  economic 
circumstances (see Box 1.2). 

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  as 
the  financial  crisis  exposed  unsustainable  price 
developments 
in  many  EU  Member  States, 
including  euro  area  countries,  in  the  pre-crisis 
period. 

Inflation sustainability implies that the satisfactory 
inflation  performance  must  essentially  be  due  to 
the  adequate  behaviour  of  input  costs  and  other 
in  a 
influencing  price  developments 
factors 
the 
structural  manner,  rather 
influence  of  cyclical  or 
factors. 
Therefore, this Technical Annex also takes account 
of  the  role  of  the  macroeconomic  situation  and 
cyclical position in inflation performance, 

than  reflecting 
temporary 

(4)  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  by  Regulations  (EC) 
No  1882/2003  and  No  596/2009  of 
the  European 
Parliament and of the Council. 

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. The national provisions on the tasks of 
the  national  central  bank  are  assessed  against 
the  relevant  rules  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”. 

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”.  

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 

they  do  not  constitute 

7 

 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

(Continued on the next page) 

8 

Box 1.2: Assessment of price stability and the reference valueThe 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, EU-27 for reports between 2007 and 2013 and EU-28 for reports since 2014.  The notion of 'best performer in terms of price stability' is not defined explicitly in the Treaty. It is appropriate to interpret this notion in a non-mechanical manner, 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. 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. Outliers were also identified in 2013 (Greece) and 2014 (Greece, Bulgaria and Cyprus). At the current juncture, it is warranted to identify Cyprus and Romania as outliers, as their inflation rates deviated by a wide margin from the euro area average, driven by country-specific factors that limit their scope to act as meaningful benchmarks for other Member States. In case of Cyprus, deeply negative inflation mainly reflected the adjustment needs and exceptional situation of the economy. In case of Romania, it was mainly due to large VAT reductions. In April 2016, the 12-month average inflation rate of Cyprus and Romania were respectively -1.8% and -1.3% and that of the euro area 0.1%.    
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

in 

developments  in  unit  labour  costs  as  a  result  of 
labour  productivity  and  nominal 
trends 
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. 

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 (5).  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 

(5)  Based  on  the  Commission  services'  Spring  2016  Forecast, 
the inflation reference value is forecast to stand at 1.0% in 
December 2016.  

9 

1.2.3.  Public finances 

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  details  of 
the  excessive  deficit 
procedure  are  defined  in  Regulation  1467/97  as 
amended in 2005 and 2011 (under the "Six-Pack") 
which  sets  out  the  way  in  which  government 
deficit and debt levels are assessed to determine  

  Table 1:Inflation reference value in previous and current Convergence ReportsConvergence ReportCut-off monthThree bestReferenceEuro area averageadoption dateperformers 1) 2)value 3)inflation rate 4)1998January 1998Austria, France, Ireland2.71.52000March 2000Sweden, France, Austria2.41.42002April 2002United Kingdom, France, Luxembourg 5)3.32.42004August 2004Finland, Denmark, Sweden2.42.12006 May March 2006Sweden, Finland, Poland2.62.32006 DecemberOctober 2006Poland, Finland, Sweden2.82.22007March 2007Finland, Poland, Sweden3.02.12008March 2008Malta, Netherlands, Denmark3.22.52010March 2010Portugal, Estonia, Belgium 1.00.32012March 2012 Sweden, Ireland, Slovenia3.12.82013April 2013Sweden, Latvia, Ireland2.72.22014April 2014Latvia, Portugal, Ireland1.71.02016April 2016Bulgaria, Slovenia, Spain0.70.11) EU15 until April 2004; EU25 between May 2004 and December 2006; EU27 between January 2007 and June 2013; EU28 from July 2013 onwards.2) In case of equal rounded average inflation for several potential best performers, the ranking is determined on the basis of unrounded data.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.5) Based on revised data, Germany would replace Luxembourg as one of the three Member States with the lowest    12-month average inflation in April 2002. This change would not affect the price and long-term interest rate reference values in April 2002.Sources: Eurostat and Commission services.     
                                                           
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

(Continued on the next page) 

10 

Box 1.3: Excessive deficit procedureThe 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 and correction 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 shall 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:  whether the ratio of the planned or actual government deficit to gross domestic product exceeds a reference value, specified in the Protocol on the EDP as 3 percent of GDP, 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;  whether the ratio of government debt to gross domestic product exceeds a reference value, specified in the Protocol on the EDP as 60 percent of GDP, 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 ESA2010 (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.  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                                                            (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), as amended. (3) Regulation (EU) No 549/2013 of the European Parliament and of the Council of 21 May 2013 on the European system of national and regional accounts in the European Union, OJ L 174, 26.6.2013, p 1–727). (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.  
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

whether  an  excessive  deficit  exists,  under  article 
126 of TFEU. The convergence  assessment in the 
budgetary area is therefore judged by whether the 
Member  State  is  subject  to  a  Council  decision 
under 126(6) on the existence of an excessive 

  deficit (6). 

(6)  The definitions of the government deficit and debt used in 
this  report  are  in  accordance  with  the  excessive  deficit 

11 

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. In the next step of the procedure, the Economic and Financial Committee (EFC) formulates an opinion on the Commission report, within at most two weeks after its publication (Article 126(4), Article 3.1 of Regulation 1467/97). 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 and after an overall assessment, which includes any observation that the concerned Member State may have, the Council decides, whether an excessive deficit exists (Article 126(6)).  If the Council decides that an excessive deficit exists, it has to issue without delay a recommendation to the Member State concerned with a view to correcting the deficit within a given period (Article 126(7)). According to Regulation 1467/97, 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 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 underlying the 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. 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 State 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)). More information about the EU fiscal surveillance framework could be found in the Vade Mecum on the Stability and Growth Pact, European Economy Institutional Paper 021, March 2016: http://ec.europa.eu/economy_finance/publications/eeip/pdf/ip021_en.pdf   
                                                           
 
 
 
 
Long-term 
finances 
sustainability  of  public 
deserves  particular  attention  at  a  time  when  the 
financial  crisis  has  significantly  impacted  on  the 
fiscal  positions  and  debt  levels  in  many  Member 
States. In response to this, economic governance in 
the  EMU  was  substantially  strengthened  in  2011, 
which included, inter alia, the operationalisation of 
the  debt  criterion 
the  Excessive  Deficit 
Procedure (7). 

in 

1.2.4.  Exchange rate stability 

third 

The Treaty refers to the exchange rate criterion in 
the 
indent  of  Article  140(1)  as  “the 
observance  of  the  normal  fluctuation  margins 
provided  for  by  the  exchange-rate  mechanism  of 
the  European  Monetary  System,  for  at  least  two 
years, without devaluing against the euro”.  

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” (8). Based on the Council Resolution 

procedure, as was the case in previous convergence reports. 
These  definitions  are  laid  out  in  the  amended  Council 
Regulation  (EC)  No  479/2009.  In  particular,  government 
debt  is  general  government  consolidated  gross  debt  at 
nominal value. Information regarding the excessive deficit 
procedure  and  its  application  to  different  Member  States 
since 
at: 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm. 

found 

2002 

can 

be 

and 

two 

new 

regulations 

surveillance 

frameworks, 

the  Stability 

three 
and  Growth  Pact 

(7)  A  directive  on  minimum  requirements  for  national 
on 
budgetary 
regulations 
macroeconomic 
amending 
and 
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 
Box  1.3, 
introduced  a  number  of 
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 

(8)  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. 

Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

on  the  establishment  of  the  ERM  II (9),  the 
European  Monetary  System  has  been  replaced  by 
the 
the  Exchange  Rate  Mechanism  II  upon 
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 
measures, 
exchange 
interventions, and international financial assistance 
wherever  relevant,  in  maintaining  exchange  rate 
stability.  

including 

foreign 

In  principle,  the  assessment  of  this  criterion 
verifies the participation in ERM II and examines 
exchange rate behaviour within the mechanism. As 
currently  none  of  the  Member  States  assessed  in 
this  Convergence  Report  participates  in  ERM  II, 
de  facto  exchange  rate  stability  is  reviewed  for 
analytical  purposes.  The  relevant  period  for 
assessing  exchange  rate  stability  in  this  Technical 
Annex is 19 May 2014 to 18 May 2016. 

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 
levels”.  Article  4  of 
the 
convergence  criteria  further  stipulates  that  “the 
criterion  on  the  convergence  of  interest  rates  (…) 
shall mean that, observed over a period of one year 
before the examination, a Member State has had an 
average  nominal  long-term  interest  rate  that  does 
not  exceed  by  more  than  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 

the  assessment  of 

For 
the 
convergence of interest rates, yields on benchmark 
long-term bonds have been taken, using an average 
rate over the latest 12 months. 

the  criterion  on 

(9)  97/C 236/03 of 16 June 1997, OJ C 236, 2.8.1997, p.5. 

12 

 
                                                                                   
 
 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

the  situation  and  development  of  the  external 
balance (10). Market integration is assessed through 
trade,  foreign  direct  investment  and  a  smooth 
internal  market.  Finally, 
functioning  of 
progress  in  financial  integration  is  examined, 
together  with  the  main  characteristics,  structures 
and trends of the financial sector.  

the 

is  aligned  with 

Starting  with  the  2012  Convergence  Report,  the 
convergence  assessment 
the 
broader  European  Semester  approach  which  takes 
an 
the  economic  policy 
fiscal 
challenges 
sustainability,  competitiveness,  financial  market 
stability and economic growth.  

look  at 
facing  EMU 

in  ensuring 

integrated 

(10)  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. 

The reference value for April 2016 is calculated as 
the  simple  average  of  the  average  long-term 
interest  rates  in  Bulgaria  (2.5%),  Slovenia  (1.8%) 
and  Spain  (1.8%),  plus  2  percentage  points, 
yielding a reference value of 4.0%. 

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 
labour 
include  financial,  product  and 
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  section  on  price 
stability. 

The  assessment  of  additional  factors  gives  an 
important indication of a Member State's ability to 
integrate into the euro area without difficulties. As 
regards  the  balance  of  payments,  the  focus  is  on 

13 

Box 1.4: Data for the interest rate convergenceThe 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 as close as possible 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 residual maturity of the benchmark bond is above 9.5 years. For eleven Member States, the residual maturity of the benchmark bond is below 9.5 years, in particular for Luxembourg with a residual maturity below 8 years. All yields are calculated on the basis of secondary market rates. For the Czech Republic and Germany a basket of bonds is used, while a single benchmark bond is used in twenty-five 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.L.L40.CI.0000.Currency Code.N.Z).  
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 1 - Introduction 

The  section  on  additional  factors  makes  reference 
to  the  surveillance  of  macroeconomic  imbalances 
under  the  Macroeconomic  Imbalance  Procedure, 
which  was  adopted  in  December  2011  as  one  of 
the  key  elements  of  the  legislative  package  (the 
"Six-Pack")  to  enhance  the  governance  structures 
in  EMU,  and  integrates  its  results  into  the 
assessment (see Box 1.5). 

14 

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 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 "Six-Pack") to enhance the governance structures in EMU.  The overall design of the MIP provides for preventive action and corrective action for more serious cases. 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 (second step), 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 excessive imbalances in a Member State, the Council could declare the existence of an excessive imbalance and adopt a recommendation asking the Member State to present a Corrective Action Plan (CAP). Although the Commission had identified cases of excessive imbalances, the Excessive Imbalances Procedure has never been launched, as specific monitoring and decisive policy action has been deemed as sufficient response to these situations.   The alert mechanism scoreboard: design and rationale The scoreboard is an element of the alert mechanism and is intended to facilitate the identification of potential 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, change in total financial sector liabilities, house prices and four employment indicators). 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 2016 Alert Mechanism Report (AMR) and In-Depth Reviews (IDR) As the first step of the MIP process of 2016, the Commission published its fifth Alert Mechanism Report in November 2015. The AMR made an economic reading of the scoreboard, based on which 18 Member States were identified for the conduct of IDR. Five of them are Member States covered in this report (Bulgaria, Croatia, Hungary, Romania and Sweden). The Commission concluded that Hungary and Romania do not experience macroeconomic imbalances in the MIP sense. Sweden was found to be experiencing imbalances, while Bulgaria and Croatia are continuing to experience excessive imbalances.  
 
 
 
 
 
 
2. 

BULGARIA 

2.1. 

LEGAL COMPATIBILITY 

2.1.1.  Introduction 

The  legal  basis  for  the  Bulgarska  narodna  banka 
(BNB – central bank of Bulgaria), the Law on the 
Bulgarian National Bank (the BNB Law) of 1997, 
has  been  amended  to  some  degree  since  the  2014 
Convergence Report by repealing Article 14(2) of 
the  BNB  Law.  The  2014  Convergence  Report 
indicated  that  as  regards  the  Governor  such 
provision  stipulating  that  "where  the  duties  of  a 
Governing Council member cease before the term 
of  office  has  expired,  another  person  shall  be 
elected/appointed for the outstanding period of the 
term of office" was not in line with Article 14.2 of 
the ESCB/ECB Statute pursuant to which the term 
of  office  of  a  Governor  shall  be  no  less  than  five 
years.  Further  comments  provided  in  the  2014 
Convergence  Report  are  largely  repeated  in  this 
year's assessment. 

2.1.2.  Central Bank independence 

Article 14(1) of the BNB Law does not accurately 
mirror  the  grounds  for  dismissal  of  the  Governor 
set  out  exhaustively 
the 
ESCB/ECB Statute. 

in  Article  14.2  of 

Pursuant  to  Article  14(1)  of  the  BNB  Law,  a 
member of the BNB Governing Council, including 
the  Governor,  may  be  relieved  from  office  (1)  "if 
he no longer fulfils the conditions required for the 
performance of his duties under Article 11(4)", (2) 
"if he is in practical inability to perform his duties 
for  more  than  six  months"  or  (3)  "if  he  has  been 
guilty of serious professional misconduct". 

Whereas  the  second  ground  for  dismissal  is  not 
provided in Article 14.2 of the ESCB/ECB Statute, 
the  third  dismissal  ground  provided  in  Article 
14(1) of the BNB Law narrows down the concept 
of  "serious  misconduct"  of  Article  14.2  of  the 
to  "serious  professional 
ESCB/ECB  Statute 
misconduct". 
these 
imperfections  and  limit  interpretation  problems, 
Article 14(1) of the BNB Law should be amended. 

remove 

order 

In 

to 

Furthermore, the ground for dismissal provided in 
the  Conflict 
and 
Ascertainment  Act  of  2008  which  has  been 

Interest  Prevention 

of 

15 

to 

of 

Interest  Prevention 

applicable 
the  BNB  Governor,  Deputy 
Governors and the members of the BNB Managing 
Board  since  December  2010  has  to  be  brought  in 
line  with  Article  14.2  of  the  ESCB/ECB  Statute. 
Article  33(1)  in  conjunction  with  Article  3(13)  of 
the  Conflict 
and 
Ascertainment  Act  provides  that  the  breach  of  its 
provisions  and  the  existence  of  a  conflict  of 
interest 
for  dismissal.  This 
incompatibility  should  be  removed  by  specifying 
that a dismissal of the Governor is only admissible 
if,  as  set  out  in  Article  14.2  of  the  ESCB/ECB 
Statute,  the  breach  of  the  duty  is  a  lack  of 
fulfilment  of  the  conditions  required  for  the 
performance  of  the  Governor's  duties  or  is  a 
serious  misconduct  of  which  the  Governor  has 
been guilty. 

are  grounds 

Pursuant  to  Article  12(1)  of  the  BNB  Law,  the 
the  National 
Governor  shall  be  elected  by 
Assembly.  The  National  Assembly  has  taken  the 
view  that  it  has  the  power  to  annul  or  amend  its 
decisions,  including  decisions  under  Article  12(1) 
of  the  BNB  Law.  The  National  Assembly  has 
substantiated this assertion by stating that pursuant 
to  a  Constitutional  Court  decision  of  26  February 
1993, 
the  Bulgarian  Constitution  does  not 
explicitly  prohibit  the  National  Assembly  from 
its  decisions.  Such 
amending  or  annulling 
understanding  would  allow  the  dismissal  of  the 
Governor  under  conditions  other 
those 
mentioned  in  Article  14.2  of  the  ESCB/ECB 
Statute.  It  should  be  ensured  that  the  Governor, 
when  properly  elected  or  appointed,  may  not  be 
dismissed  under  conditions  other 
those 
mentioned  in  Article  14.2  of  the  ESCB/ECB 
Statute. 

than 

than 

Article  44  of  the  BNB  Law  should  be  amended 
with a view to achieving compatibility with Article 
130 of the TFEU and Article 7 of the ESCB/ECB 
Statute.  Pursuant  to  Article  44  of  the  BNB  Law, 
the  members  of  the  Governing  Council,  in  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. 
this 
It  should  be  clarified 
encompasses national, foreign and EU institutions 
or  bodies.  In  this  context,  it  is  also  noted  that 
Article  3  of  the  BNB  Law  provides  that  "in  the 
formulation of the general outlines of the monetary 
policy, the BNB and the Council of Ministers shall 

that 

 
inform  each  other".  This  procedure  provides  for 
the opportunity for the government to exert ex ante 
influence  on  the  monetary  policy  of  the  BNB.  As 
from the date of the formal adoption of the euro in 
Bulgaria or after the currency board agreement has 
been 
an 
incompatibility  in  the  area  of  independence,  with 
Article  130  of  the  TFEU  and  Article  7  of  the 
ESCB/ECB. 

this  might 

suspended 

constitute 

2.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Article 45(1) and (2) of the BNB Law are not fully 
consistent  with  Article  123  of  the  TFEU  and 
Article  21.1  of  the  ESCB/ECB  Statute  and  thus 
should be amended. 

Article  45(1)  of  the  BNB  Law  provides  that  the 
BNB  shall  not  extend  credits  and  guarantees, 
including through purchase of debt instruments, to 
the Council of Ministers, municipalities, as well as 
to  other  governmental  and  municipal  institutions, 
organizations  and  enterprises.  Article  45(1)  of  the 
BNB  Law  should  be  amended  with  a  view  to 
including  all  entities  mentioned  in  Article  123(1) 
of  the  TFEU  and  Article  21.1  of  the  ESCB/ECB 
Statute.  Furthermore,  while  the  prohibition  of 
monetary  financing  does  not  allow  the  direct 
purchase  of  public  sector  debt,  purchases  on  the 
secondary  market  are  not  prohibited  unless  they 
qualify  as  a  circumvention  of  the  objective  of 
Article 123 of the TFEU. For this reason, the word 
‘direct’  should  be  inserted  in  Article  45(1)  of  the 
BNB Law. 

Pursuant  to  Article  45(2)  in  conjunction  with 
Article 33(2) of the BNB Law, Article 45(1) of the 
BNB  Law  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.  The  scope  of 
this  exemption  should  be  amended  to  be  fully 
consistent  with  the  wording  of  Article  123(2)  of 
the  TFEU  and  Article  21.3  of  the  ESCB/ECB 
Statute. 

2.1.4.  Integration in the ESCB 

Objectives 

The objectives of the BNB are compatible with the 
Treaty on the Functioning of the European Union. 

Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

Tasks 

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

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

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

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

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

•  ECB's  right  to  impose  sanctions  (Article  61,  62 
of the BNB Law). 

There are also numerous imperfections regarding: 

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

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

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

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

2.1.5.  Assessment of compatibility 

The  BNB  Law  and  the  Conflict  of  Interest 
Prevention  and  Ascertainment  Act  are  not  fully 
compatible  with  Article  131  of  the  TFEU  as 
regards central bank independence, the prohibition 
of  monetary  financing  and  the  integration  in  the 
ESCB at the time of euro adoption. 

16 

 
 
 
2.2. 

PRICE STABILITY 

2.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  well  below 
the  reference  value  at  the  time  of  the  last 
convergence  assessment  of  Bulgaria  in  2014. 
Average  annual inflation fell  to  -1.7%  by  January 
2015, before starting to slowly rise again. In April 
2016, the reference value was 0.7%, calculated as 
the average of the 12-month average inflation rates 
in  Bulgaria,  Slovenia  and  Spain  plus  1.5 
percentage  points.  The  average  inflation  rate  in 
Bulgaria  during  the  12  months  to  April  2016 
was  -1.0%,  i.e.  1.7  percentage  points  below  the 
reference  value.  The  12-month  average  inflation 
rate is projected to remain well below the reference 
value in the months ahead. 

2.2.2.  Recent inflation developments 

factors, 

The  annual  HICP  inflation  rate  in  Bulgaria  has 
been  negative  since  summer  2013.  This  was 
initially due to an unusually strong combination of 
i.a.  a  good  harvest, 
disinflationary 
administrative  energy  price 
reductions  and 
declining  import  prices.  Weak  domestic  demand 
and  low  inflation  in  the  euro  area  sustained  the 
falling  oil 
disinflationary  environment  and 
commodity  prices  represented  a  new  downward 
price  shock  in  2014  and  2015.  The  inflation  rate 
reached  its  trough  of  -2.4%  at  the  beginning  of 
2015  and  then  increased  somewhat  with  the 
passing  or  even  partial  reversal  of  the  above 
mentioned 
inflation  was 
approaching positive territory by early 2016, but it 
fell  back  sharply  again  in  March  and  April,  due 
mainly  to  unprocessed  food  and  fuel  prices.  The 
inflation rate in Bulgaria has remained below that 
of the euro area throughout the past two years. 

shocks.  Headline 

Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

in  2014  and 

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  stayed 
above  headline  inflation  during  most  of  2014  and 
2015,  highlighting  the  effect  of  plunging  energy 
prices  on  inflation.  Core  inflation  bottomed  out 
at  -1.9%  in  late  2014  and  increased  to  0.4%  by 
October 2015. It then reversed and turned negative 
again in early 2016, reaching -0.6% in April 2016. 
The  components  of  core  inflation  had  trended 
downwards over the past few years, reaching their 
lows  at  different  points 
they 
demonstrated  no  clear  trend  since  then.  Processed 
food prices were the first to turn around, partly due 
to rising unprocessed food prices. After becoming 
positive again in April 2015, they reached 1.0% at 
end-2015.  Non-energy  industrial  goods  inflation 
reflected  both  lower  import  prices  and  weak 
domestic  demand,  as  consumers  have  remained 
cautious in spending, despite the strong growth in 
real  wages  over  the  past  years.  It  bottomed  in 
autumn  2014  at  -2.4%,  but  remained  deeply 
negative even in early 2016. Services inflation was 
the  lowest  in  November  2014  at  -2.7%,  and  after 
increasing  to  1.2%  by  October  2015,  it  fell  back 
to  -0.5%  by  April  2016.  Negative  producer  price 
inflation  confirmed  the  lack  of  cost  pressures  in 
2014-2015 and reached about -4% in early 2016. 

2.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

The economic recovery has accelerated in Bulgaria 
with  GDP  growth  of  1.5%  in  2014  and  3%  in 
2015. Domestic demand had a good year in 2014, 
but its growth slowed somewhat in 2015, while net 
exports  picked  up.  According  to  the  Commission 
services' Spring 2016 Forecast, the main driver of 
to  shift 
Bulgaria's  GDP  growth 

is  expected 

17 

-2-1012345Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16BulgariaReference valueGraph 2.1: Bulgaria -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-4-20246201020112012201320142015BulgariaEuro areaGraph 2.2: Bulgaria -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

moderate  0.4%  in  2014  and  2015.  This  together 
with  a  decrease  in  the  labour  force,  partly  due  to 
emigration,  helped  to  reduce  the  unemployment 
rate  from  13%  in  2013  to  about  9%  in  2015. 
Nominal wage growth was dampened by negative 
inflation  over  the  past  few  years,  in  particular  in 
2015,  despite  continuing  wage  convergence 
pressures and skills shortages in some sectors.  

gradually  back  to  domestic  demand  by  2017.  The 
purchasing  power  of  households  has  been  buoyed 
by  growth  in  real  wages  in  a  low-inflation 
environment  and  economic  sentiment  remains 
relatively  high.  Public  investment  is  however 
expected  to  decrease  in  2016,  with  the  slowdown 
of  the  implementation  of  projects  co-financed  by 
the EU. GDP growth is forecast to moderate to 2% 
in  2016,  before  picking  up  to  2.4%  in  2017.  This 
relatively modest growth momentum would imply 
a persistent negative output gap. 

The fiscal stance, as measured by the change in the 
structural  balance,  has  shifted  over  recent  years. 
Following years of consolidation, the fiscal stance 
was  expansionary  in  2014  and  broadly  neutral  in 
2015.  According  to  the  Commission  services' 
Spring  2016  Forecast,  the  structural  balance  is 
projected  to  remain  broadly  unchanged  in  2016, 
but to tighten in 2017. 

In the context of its currency board arrangement to 
the  euro,  most 
standard  monetary  policy 
instruments  are  not  available  to  Bulgaria.  In 
response  to  these  limitations,  the  BNB  has  set 
relatively  conservative 
liquidity  and  capital 
requirements  on  the  banking  sector.  Bank  interest 
rates decreased over the past two years, reflecting 
monetary easing in the euro area. However, private 
sector  lending  continued  to  stagnate,  with  new 
loans  merely 
replacing  maturing  ones.  The 
domestic banking crisis in 2014 caused disruption 
in  financial  intermediation.  Overall,  weak  lending 
still  contributes 
low-inflation 
environment. 

the  current 

to 

Wages and labour costs 

The labour market has started to improve gradually 
increased  by  a 
over  2014-15.  Employment 

Labour  productivity  growth  was  weak  in  2013-
2014,  as  the  decline  in  employment  ended,  but  it 
picked  up  in  2015  with  higher  output  growth. 
Nominal  unit  labour  cost  growth  slowed  down 
over the past two years, which mainly reflected the 
rapidly declining growth of nominal compensation 
per  employee.  Labour  productivity  growth  is 
expected  to  remain  moderate  over  2016-17,  given 
the  gradual  stabilisation  of  the  labour  market  and 
the lack of sufficient new investment. According to 
the  Commission  services'  Spring  2016  Forecast, 
ULC growth is projected to pick up again in 2016 
and  2017,  in  line  with  the  evolution  of  nominal 
compensation per employee. 

18 

-40481220102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflation(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast.Graph 2.3:Bulgaria -Inflation, productivity and wage trendsTable 2.1:weights  Bulgaria - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP3.03.42.40.4-1.6-1.1-1.01000Non-energy industrial goods0.3-0.4-0.8-1.5-2.2-1.6-1.5276Energy9.28.97.9-1.7-3.8-6.7-6.7107Unprocessed food -1.61.64.44.4-0.80.6-1.075Processed food7.57.71.51.3-0.40.61.1214Services1.51.92.41.1-1.30.10.2328HICP excl. energy and unproc. food2.52.61.20.3-1.3-0.3-0.1818HICP at constant taxes2.13.22.40.4-1.6-1.1-1.11000Administered prices HICP3.62.54.9-1.1-1.01.60.51611) 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.Sources: Eurostat, Commission services. 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

the  other  hand, 

assessment  period.  On 
the 
depreciation  of  the  euro  (and  hence  of  the  lev) 
against  the  US  dollar  in  2014-2015  cushioned 
somewhat  the  disinflationary  impact  of  lower  oil 
prices. 

Administered prices and taxes 

inflation 

The  growth  rate  of  administered  prices (11)  was 
above  headline  consumer  price 
in 
Bulgaria  over  the  past  two  years,  but  indirect  tax 
changes played overall a negligible role. The share 
of  administered  prices  in  the  HICP  basket  is 
relatively  high 
in  Bulgaria  at  around  16% 
compared  to  13%  in  the  euro  area.  The  annual 
change  of  administered  prices  turned  from  a  1% 
decline in 2014 to an increase of 1.5% in 2015. In 
particular,  household  electricity  prices  were 
increased  in  mid-2014  and  in  late  2014.  Overall, 
administered  prices  raised  headline  inflation  in 
(by 
2014  by  about  0.1  percentage  points 
decreasing  less  than  the  headline)  and  in  2015  by 
about 0.5 percentage points.  

(11)  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://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b 

External factors 

the  high  openness  of 

Given 
the  Bulgarian 
economy,  developments  in  import  prices  play  an 
important role in domestic price formation. Global 
energy and food prices are particularly relevant for 
inflation,  given  their  relatively  large  share  in  the 
consumer  basket  and  the  high  energy  intensity  of 
the  Bulgarian  economy.  Import  prices  (measured 
by  the  imports  of  goods  deflator)  had  a  strong 
disinflationary  effect  over  the  past  three  years, 
falling by nearly -3% per year. This reflects mainly 
the  lower  international  oil  price  and  the  stronger 
nominal effective exchange rate of the lev. Import 
prices  are  expected  to  continue  declining  also  in 
2016.  In  particular,  the  fall  in  the  oil  price  is 
expected  to  pass  through  to  lower  energy-related 
inflation. It should be noted that Bulgaria depends 
on a single source of gas supply and negotiates gas 
prices  bilaterally,  occasionally  diverging  from 
global price trends. 

The  nominal  effective  exchange  rate  of  the  lev 
(measured  against  a  group  of  36  trading  partners) 
appreciated  by  about  4%  from  mid-2013  until 
early  2014,  as  some  currencies  of  major  trading 
partners depreciated against the euro (Turkish Lira, 
Russian  Rouble,  Romanian  Leu).  About  half  of 
this appreciation had been unwound by early 2016, 
but  the  stronger  nominal  effective  exchange  rate 
the 
contributed 

import  prices  over 

lower 

to 

19 

Table 2.2:Bulgaria - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationBulgaria3.03.42.40.4-1.6-1.1-0.70.9Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorBulgaria2.44.53.6-2.5-0.1-0.8-0.70.9Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeBulgaria9.96.87.78.85.61.83.64.3Euro area2.22.21.81.71.31.21.51.9Labour productivityBulgaria4.13.92.81.71.22.61.72.0Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsBulgaria5.62.84.87.04.4-0.71.92.3Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorBulgaria8.59.03.8-2.8-2.9-3.7-3.01.6Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
Indirect 
tax  changes  had  on  aggregate  an 
insignificant  effect  on  inflation  over  2014-15. 
During this period, annual constant-tax HICP was 
on average at the same level as headline inflation. 
In  early  2016,  a  tobacco  excise  tax  increase  took 
place,  but  annual  constant-tax  HICP  was  on 
average  broadly  at  the  same  level  as  headline 
inflation during the assessment period.  

Medium-term prospects 

to 

inflation 

is  expected 

Annual  HICP 
rise 
gradually  as  the  effect  from  the  decline  in 
commodity prices slowly tapers off; however it is 
to  remain  negative  throughout  the  first  three 
quarters of 2016. In the meantime, the weaker euro 
and 
labour  market 
conditions  are  expected  to  exert  some  upward 
price  pressure.  Accordingly, 
the  Commission 
services'  Spring  2016  Forecast  projects  HICP 
inflation  to  average  -0.7%  in  2016  and  0.9%  in 
2017. 

tightening  domestic 

the 

Risks  to  the  inflation  outlook  appear  broadly 
balanced, with the most significant risks related to 
global energy and food price developments, given 
their  relatively 
the  Bulgarian 
consumer  basket.  Additional  inflation  risk  factors 
are core inflation movements elsewhere in the EU 
and administered prices changes.  

large  share 

in 

The  level  of  consumer  prices  in  Bulgaria  was  at 
47%  of  the  euro  area  average  in  2014.  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  44%  of  the  euro  area 
average in PPS terms in 2014). 

Medium-term  inflation  prospects  will  depend  on 
wage and productivity developments, as well as on 
global  commodity  price  trends.  Tax  policy  is 
expected  to  have  only  a  limited  impact  on 
inflation. 

2.3. 

PUBLIC FINANCES 

2.3.1.  Recent fiscal developments 

On 22 June 2012, the Council decided to abrogate 
the  decision  on  the  existence  of  an  excessive 
deficit  according  to  Article  126  (12)  TFEU, 
thereby closing the excessive deficit procedure for 

Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

Bulgaria (12).  The  general  government  deficit  was 
kept well below the Treaty reference value of 3% 
of GDP in 2012 and in 2013. Although the general 
government deficit reached 5.4% of GDP in 2014, 
the  Commission  concluded  in  its  November  2015 
report in accordance with Art 126(3) of the TFEU 
that  the  excess  over  the  reference  value  could  be 
qualified  as  exceptional  and  temporary  and  also 
taking into account all relevant factors the opening 
suggested (13).  The 
of  an  EDP  was  not 
expenditure-to-GDP  ratio  increased  by  2.6  pp. 
between  2013  and  2015  to  40.2%,  which  was 
somewhat  counterbalanced  by  an  increase  in  the 
revenue  ratio  by  1.0  pp.  of  GDP  to  38.2%.  The 
increase  in  the  expenditure  ratio  mainly  reflects  a 
higher  investment  ratio,  partly  stemming  from 
increased  absorption  of  EU  funds.  The  higher 
revenue  ratio  reflects  both  more  capital  transfers 
from  the  EU  and  more  tax  revenue  partly  in  light 
of enhanced tax collection. 

The  general  government  deficit  in  2015  reached  
2.1%  of  GDP,  i.e.  below  the  target  of  2.8%  of 
GDP  in  the  2015  Convergence  Programme.  The 
better outcome mainly reflects higher tax revenues, 
mostly attributable to improved tax administration. 
Those additional revenues more than offset various 
expenditure  slippages,  such  as  the  incomplete 
implementation  of  the  planned  reduction  of  the 
public  wage  bill.  In  structural  terms,  the  deficit 
improved  by  0.1  pp.  in  2015.  As  the  output  gap 
remained  broadly  unchanged  (slight  negative)  in 
the  period  of  2013-2015, 
the  actual  growth 
performance  had  a  neutral  impact  on  the  fiscal 
consolidation. 

General  government  gross  debt  increased  from 
17.1%  of  GDP  in  2013  to  27%  of  GDP  in  2014. 
This  reflected  not  only  the  underlying  budget 
deficit  in  2014  but also  the  pay-out of guaranteed 
deposits,  support  to  the  financial  sector  via  a 
liquidity  scheme  and  pre-financing  for  a  roll-over 
of  a  large  bond  maturing  in  January  2015.  The 
gross public debt ratio slightly decreased to 26.7% 
of GDP in 2015. 

(12)  An  overview  of  all  excessive  deficit  procedures  can  be 

found at: http://ec.europa.eu/economy_finance/economic_ 

governance/sgp/deficit/index_en.htm 

(13)  The  2014  deficit  was  negatively  affected  by  the  statistical 
re-classification  inside  the  general  government  of  the 
Deposit  Insurance  Fund  following  the  repayment  of  the 
guaranteed  deposits  in  the  Corporate  Commercial  Bank 
(KTB) amounting to around 3.0% of GDP. 

20 

 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

the  structural  deficit 

is 
estimated  by  2017, 
projected to be 1.4% of GDP.  The public-debt-to-
GDP ratio is forecast to increase from 27% in 2014 
to around 29% by 2017. 

the  achievement  of 

the  2016  update  of 

Bulgaria  submitted 
the 
Convergence  Programme  on  15  April  2016.  The 
Programme  aims  at  the  gradual  improvement  of 
the  general  government  balance  from  1.9%  of 
GDP in 2016 to 0.8% of GDP in 2017 and further 
to  0.2%  of  GDP  in  2019.  Also,  the  Programme 
targets 
the  medium-term 
objective  of  a  structural  deficit  of  1%  of  GDP  in 
2017.  In  2017,  compared  with  the  Commission 
forecast  of  1.6%  of  GDP, 
targeted 
improvement  of  the  deficit  is  ambitious  and 
specification of further deficit decreasing measures 
are  likely  to  be  needed  to  be  achieved.  Based  on 
the assessment of the convergence programme and 
taking  into  account  the  Commission  services' 
Spring  2016  Forecast,  the  Commission  is  of  the 
opinion  that  Bulgaria  is  expected  to  broadly 
comply  with  the  provisions  of  the  Stability  and 
Growth  Pact.  Further  details  can  be  found  in  the 

the 

2.3.2.  Medium-term prospects 

The 2016 budget was adopted by Parliament on 2 
December  2015.  It  aims  at  achieving  a  general 
government  deficit  of  1.9%  of  GDP  based  on  a 
number  of  measures  both  on  the  revenue  and  on 
the  expenditure  side.  First,  strengthening  of  tax 
compliance in light of exercising fiscal control and 
forced collection of arrears is expected to increase 
tax  revenues  by  ¼%  of  GDP.  Increase  in  excise 
duty  on  fuel  and  cigarettes  would  imply  higher 
revenues  of  0.2%  of  GDP,  which  could  be  partly 
off-set by the fuel voucher system provided in the 
agriculture  sector.  Higher  revenues  from  the  hike 
of road tolls and the concession revenues related to 
the  transport  sector  as  well  as  the  lower  national 
co-financing  related  to  the  absorption  of  the  EU-
funds  are  partly  counterbalanced  by  the  budgeted 
higher  public  investments  from  own  resources. 
According  to  the  Commission  services'  Spring 
2016  Forecast,  the  general  government  deficit  is 
foreseen to be 2% of GDP.  

In  2017,  the  Commission  forecasts  the  general 
government  balance  to  improve  and  achieve  a 
deficit  of  1.6%  of  GDP  in  light  of  some  revenue 
increasing  measures  and  of  the  economic  growth. 
Taking  into  account  the  negative  output  gap 

21 

Table 2.3:Bulgaria - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance-3.2-2.0-0.3-0.4-5.4-2.1-2.0-1.6- Total revenues33.532.134.437.236.638.237.037.2- Total expenditure36.734.134.737.642.140.238.938.7   of which: - Interest expenditure0.70.70.80.70.91.01.01.0p.m.: Tax burden26.425.526.728.028.129.830.130.3Primary balance-2.4-1.30.50.3-4.6-1.1-0.9-0.5Cyclically-adjusted balance-2.6-1.9-0.1-0.3-5.2-2.0-1.8-1.4One-off and temporary measures-0.10.00.00.0-3.2-0.10.00.0Structural balance 2)-2.5-1.8-0.1-0.3-2.0-1.9-1.8-1.4Government gross debt15.515.316.817.127.026.728.128.7p.m: Real GDP growth (%)0.11.60.21.31.53.02.02.4p.m: Output gap-1.8-0.4-0.6-0.3-0.7-0.3-0.6-0.5Convergence programme 2016201720182019General government balance-1.9-0.8-0.4-0.2Structural balance 2) 3)-1.7-0.5-0.20.0Government gross debt31.731.231.830.8p.m. Real GDP growth (%)2.12.52.72.71) Commission services’ Spring 2016 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.Sources: Commission services, the 2016 Convergence Programme of BulgariaThere are no one-off and other temporary measures in the programme. 
 
 
 
 
 
Assessment  of  the  2016  Convergence  Programme 
for Bulgaria (14). 

the  national  fiscal  framework 

As  far  as 
is 
concerned – which refers to numerical fiscal rules, 
medium-term  budgetary  frameworks,  independent 
fiscal  institutions,  and  budgetary  procedures  –  the 
Bulgarian system has gradually been strengthened 
over  the  last  few  years,  also  driven  by  EU  legal 
requirements.  Bulgaria  declared  its  intention  to 
apply  the  provisions  of  the  Fiscal  Compact (15). 
The  main  milestones  of  the  reform  were  the 
introduction of a wide set of numerical rules at the 
general  government 
improved 
medium-term budgetary framework in 2014. Over 
the  course  of  2015,  the  reform  process  was 
continued  by  the  stipulation  of  an  automatic 
correction  mechanism  in  case  of  a  significant 
divergence  from  the  targeted  structural  balance 
position  as  well  as  by  the  establishment  of  the 
Fiscal  Council,  entrusted  with  a  broad  mandate 
including  monitoring  compliance  with  national 
fiscal  rules.  The  Fiscal  Council  members  were 
appointed  by  Parliament  at  the  end  of  2015, 
however, the body is not yet fully operational. 

level,  and  an 

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 

(14)

http://ec.europa.eu/economy_finance/economic_gov

ernance/sgp/convergence/index_en.htm 

(15)  Title  III  of  the  intergovernmental  Treaty  on  Stability, 
the  Economic  and 

in 

Coordination  and  Governance 
Monetary Union. 

Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

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  serves 
as a key macroeconomic policy anchor.  

liabilities  and  euro  at 

Over  the  past  two  years,  the  CBA  continued  to 
operate  in  a  challenging  environment,  with    low 
nominal  GDP  growth,  weak  credit  flows  and 
contagion  risks  in  the  banking  sector  related  both 
to 
the  failing  domestic  banks  and  Greece. 
However,  growing  exports,  a  favourable  external 
funding position of the banking sector and sizable 
reserve buffers have underpinned the resilience of 
the CBA. 

Bulgaria's  international  reserves  increased  from 
around  EUR  14  billion  to  over  EUR  20  billion 
between  mid-2014  and  end-2015.  International 
reserves were boosted by the issuance of EUR 3.1 
billion  in  long-term,  foreign-currency  government 
debt in March 2015 and by BNB macroprudential 
action  to  reduce  spill-over  risks  from  Greece  via 
the  repatriation  of  banking  sector  foreign  assets. 
International reserves covered around 144% of the 
monetary base, about 166% of short-term debt (16), 
54% of broad money (M3) and about 46% of GDP 
as  of  end-2015.  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  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 

(16)  Based on estimated residual maturity 

22 

1.81.92.02.12010201120122013201420152016Graph 2.4:Bulgaria -BGN/EUR exchange rate(monthly averages)Source: ECB.01002003004002010201120122013201420152016Graph 2.5:Bulgaria -3-M Sofibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
 
                                                           
 
 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

euro area were quite stable over the past two years. 
The  3-month  spread  hovered  around  55  basis 
points  till  end  2015  and  declined  to  around  40 
basis points in early 2016.  

2.5. 

LONG-TERM INTEREST RATES 

the  development  of 

For  Bulgaria, 
long-term 
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  below  the  reference  value  at 
the  2014  convergence  assessment  of  Bulgaria.  It 
declined from around 3.5% in mid-2014 to around 
2.5% by end-2015. In April 2016, the latest month 
for  which  data  are  available,  the  reference  value, 
given by the average of long-term interest rates in 
Bulgaria,  Slovenia  and  Spain  plus  2  percentage 
points,  stood  at  4.0%.  In  that  month,  the  twelve-
month  moving  average  of  the  yield  on  the 
Bulgarian  benchmark  bond  stood  at  2.5%,  i.e. 
about  1.5  percentage  points  below  the  reference 
value. 

Spreads to the Bund increased by almost 100 basis 
points  between  mid-2014  and  November  2014, 
partly  reflecting  Bulgaria's  banking  problems. 
Then  they  started  to  decline  gradually,  reaching 
post-2008 financial crisis lows in mid-2015, before 
rising again from late 2015, partly linked with the 
Fed's policy tightening. The spread to the German 
benchmark bond was at around 230 basis points in 
April 2016 (17). 

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, 
financial 
market integration – gives an important indication 
of  a  Member  State's  ability  to  integrate  into  the 
euro area without difficulties.  

labour  and 

threshold 

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (18) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Bulgaria  exceeded  the 
indicative 
in  four  out  of  fourteen 
indicators,  two  in  the  area  of  external  imbalances 
(i.e.  the  net  international  investment  position  and 
nominal  unit  labour  cost)  and  two  in  the  area  of 
internal  imbalances  (i.e.  unemployment  and  long-
term  unemployment  rate).  In 
the 
conclusion of the AMR 2016 (i.e. that imbalances 
had  been  identified  for  Bulgaria  in  the  previous 

line  with 

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

(18)

http://ec.europa.eu/europe2020/pdf/2016/ags2016_al

ert_mechanism_report.pdf 

in  mid-2014,  partly  reflecting 

The  long-term  interest  rate  of  Bulgaria  increased 
somewhat 
its 
domestic  banking  sector  problems.  Bulgarian 
benchmark bond yields started to fall again at end-
2014,  as  the  political  situation  stabilised  with  the 
formation  of  a  new  government  and  depositors  of 
KTB were finally able to access their frozen bank 
deposits.  In  early  2015,  Bulgaria's  long-term 
interest rate fell significantly, supported by strong 
demand for its government securities, partly due to 
the  spill-over  from  the  ECB's  public  sector  asset 
purchase programme. 

23 

024681012Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16BulgariaReference valueGraph 2.6:Bulgaria -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.024682010201120122013201420152016BulgariaGermanyGraph 2.7:Bulgaria -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

MIP  round),  Bulgaria  was  subject  to  an  in-depth 
review,  which  found  that  Bulgaria  continued  to 
experience  excessive  macroeconomic  imbalances. 
The  economy 
is  characterised  by  remaining 
fragilities in the financial sector and high corporate 
indebtedness in a context of limited labour market 
adjustment. 

increased in the last couple of years, from 1.1% of 
GDP in 2013 to over 3% of GDP in 2015, mainly 
due  to  an  increase  in  the  absorption  of  EU  funds. 
The  primary  income  balance  stayed  negative, 
reflecting the negative net international investment 
position,  but  it  was  counterbalanced  by  a  surplus 
of secondary income. 

2.6.1.  Developments  of 

the  balance  of 

payments 

Bulgaria's  external  balance  (i.e.  the  combined 
current  and  capital  account)  has  been  in  surplus 
since  2011,  following  a  rapid  adjustment  from 
deficits  above  20%  of  GDP  in  2007-08.  The 
surplus  of  the  external  balance  reached  3.1%  of 
GDP  in  2014  and  rose  to  4.6%  of  GDP  in  2015, 
partly due to strong export growth. The latter was 
also reflected in the trade balance of goods, which 
although  still  negative  has  improved  strongly  in 
2015, by more than two percentage points of GDP. 
The 
in  services  has  remained 
positive  owing  to  stable  growth  in  the  tourism, 
transportation  and  business  process  outsourcing 
sectors and reached about 6% of GDP both in 2014 
and  2015.  The  capital  account  surplus  also 

trade  balance 

The  large  saving-investment  gap  of  the  Bulgarian 
economy  observed  in  2007-08  closed  by  2013. 
supported  by 
saving  was 
Gross  national 
households  and  companies,  and  reached  around 
23% of GDP both in 2013 and 2015. On the other 

24 

102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 2.8:Bulgaria -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.Table 2.4:Bulgaria - Balance of payments(percentage of GDP)201020112012201320142015Current account-1.70.3-0.91.30.91.4of which: Balance of trade in goods-9.5-6.6-9.6-7.0-6.5-4.3                 Balance of trade in services6.46.76.26.35.96.1                 Primary income balance -2.7-3.9-2.5-3.8-2.3-4.1                 Secondary income balance4.04.15.05.73.83.7Capital account0.81.21.31.12.23.2External balance 1)-1.01.60.52.43.14.6Financial account 2)1.83.32.32.1-0.76.3of which: Direct investment-2.5-2.9-2.6-3.0-2.1-3.4                Portfolio investment1.80.92.10.3-2.8-1.3                Other investment 3)3.24.9-2.46.00.02.6                Change in reserves-0.60.45.1-1.34.28.4Financial account without reserves2.52.9-2.83.4-4.9-2.1Errors and omissions2.81.71.8-0.3-3.81.7Gross capital formation22.921.622.121.421.421.3Gross saving20.922.020.822.924.223.2Gross external debt100.391.693.291.197.482.9International investment position-93.2-83.4-78.4-73.5-74.8-60.71) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, Bulgarian National Bank. 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

hand, private investment remained low, as negative 
inflation, which started in mid-2013, increased the 
burden  of  debt-servicing.  In  addition,  the  still 
unsupportive  business  environment  and  increased 
perceived risks from the financial sector turmoil in 
2014 influenced the investment climate negatively. 
its 
the  public  sector 
Meanwhile, 
investment  in  2014-2015,  thanks  mainly  to  EU 
funds. 

increased 

Competitiveness  seems  to  have  been  preserved  in 
the  past  two  years,  although  relevant  indicators 
show a somewhat mixed picture. The real effective 
exchange  rate,  deflated  by  ULC,  appreciated 
significantly between mid-2012 and early 2014. It  
then depreciated for about a year and has stabilised 
long  period  of 
since  early  2015.  After  a 
improvement,  Bulgaria's  export  performance 
deteriorated  in  2014,  before  it  picked  up  again  in 
2015. 

25 

The  financial  account  without  official  reserves 
recorded significant net inflows in 2014 and 2015. 
Net  FDI  inflows  have  remained  at  low  levels  by 
pre-crisis  standards,  reaching  around  2%  of  GDP 
in 2014 and 3% of GDP in 2015. The net inflow of 
portfolio  investment  in  2014  and  2015,  reflected 
i.a. increased government borrowing. The positive 
balance  of  net  other  inflows  in  2015  represented 
mainly  the  build-up  of  foreign  assets  of  the 
banking sector. Although still high, gross external 
debt  has  improved  further  in  the  past  two  years, 
from about 91% of GDP in 2013 to around 83% of 
GDP in 2015, due to reduced foreign liabilities of 
the 
corporate 
deleveraging.  The  net  international  investment 
position  has  also  improved,  from  around  73%  of 
GDP in 2013 to around 61% of GDP in 2015. 

banking 

sector 

some 

and 

According  to  the  Commission  services’  Spring 
2016  Forecast,  the  external  surplus  is projected  at 
3.5% of GDP 2016 and at 3.8% of GDP in 2017. 

2.6.2.  Market integration 

a 

small  open 

economy,  Bulgaria 

The Bulgarian economy is well integrated with the 
euro  area  through  trade  and  investment  linkages. 
As 
is 
characterised  by  a  high  ratio  of  trade  openness, 
which  increased  from  a  low  post-crisis  level  of 
56%  in  2010  to  around  69%  in  2015.  Trade  with 
the  euro  area  expressed  in  percentage  of  GDP 
reached about 31% in 2015. Beyond the euro-area, 
the main trading partners are Romania, Russia and 
Turkey. 

90100110120130201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 2.9:Bulgaria -Effective exchange rates(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100)Source: Commission services.Table 2.5:Bulgaria - Market integration201020112012201320142015Trade openness 1) (%)56.262.966.368.369.169.3Trade with EA in goods & services 2)+3) (%)24.628.028.829.730.731.5Export performance (% change) 4)7.15.60.87.5-3.45.8World Bank's Ease of Doing Business Index rankings 5)575966583638WEF's Global Competitiveness Index rankings 6)717462575454Internal Market Transposition Deficit 7) (%)0.40.90.60.30.90.7Real house price index 8)100.090.485.685.987.290.3Residential investment 9) (%)2.72.31.71.71.61.6 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

total  bank  assets  reached  76%  in  2014.  Bank 
concentration, as measured by the market share of 
the  five  largest  credit  institutions  in  total  assets, 
remained somewhat above the euro area average in 
2014. 

The  banking  system  came  under  strong  liquidity 
pressure  in  June  2014  due  to  deposit  withdrawals 
by  individuals  and  firms.  This  led  to  placing  the 
fourth-largest  bank,  Corporate  Commercial  Bank 
(KTB),  and  its  subsidiary  in  a  regime  of  special 
supervision.  In  addition,  the  third-biggest  bank, 
First Investment Bank, required state liquidity aid. 
Guaranteed  deposits  of  KTB  became  available 
only  in  December  2014,  more  than  five  months 
its  banking  activities  were  suspended. 
after 
Nevertheless,  public  confidence  in  banks  appears 
to  have 
recovered  and  deposit  flows  have 
normalised since the summer 2014 liquidity crisis. 
bank-resolution 
The 
frameworks  were 
the 
transposition  of  the  relevant  EU  directives  into 
national law. 

strengthened  with 

deposit-guarantee 

and 

The  stock  of  FDI  in  Bulgaria  amounted  to  some 
80% of GDP in 2014, with FDI mainly originating 
in  the  Netherlands,  Austria,  the  UK  and  Greece. 
The  main  recipient  sectors  of  FDI  were  services 
(chiefly real estate, renting and business activities, 
financial  intermediation  and  trade)  and  to  a  lesser 
extent  manufacturing  (17%  of  the  total)  and 
construction.  

the  euro-area  average 

Concerning  the  business  environment,  Bulgaria 
performs  in  general  worse  than  most  euro-area 
Member  States  in  international  rankings.  The 
difference 
is  more 
to 
pronounced  based  on 
the  WEF's  Global 
Competitiveness  Index  than  on  the  World  Bank's 
Ease  of  Doing  Business  indicator,  but  Bulgaria's 
position deteriorated with the latter in 2015. Public 
administration  as  a  whole  scores  relatively  poorly 
according 
the  World  Bank's  Worldwide 
Governance  Indicators.  According  to  the  May 
2015 
Internal  Market  Scoreboard,  Bulgaria's 
transposition deficit of EU Directives was at 0.7% 
which  is  above  the  target  (0.5%)  proposed  by  the 
European  Commission  in  the  Single  Market  Act 
(2011). 

to 

The  Bulgarian  labour  market  adjusted  to  the 
economic shock of 2008-2013 by shedding labour 
rather  than  by  lowering  wages,  in  a  context  of 
generally 
flexible  wage-setting  conditions. 
Following the initial labour shedding, the economy 
has not been able to absorb the available supply of 
labour  because  of  structural  issues,  including  the 
employability  effects  of  long-term  unemployment 
and  skills  mismatches.  The  Bulgarian  labour 
market was characterised by persistent emigration, 
which is fundamentally driven by the large income 
gap with other EU Member States.  

Bulgaria's  financial  sector  is  well  integrated  with 
the  EU  financial  sector,  in  particular  through  a 
high  level  of  foreign  ownership  in  its  banking 
system. The share of foreign-owned institutions in 

Based  on  the  available  data,  the  capital  adequacy 
of  the  banking  sector  measured  by  standard 
regulatory  ratios  is  somewhat  higher  than  in  the 
euro area. The average capital adequacy ratio stood 
close to 22% in September 2015. The deterioration 
of the loan portfolio that started in 2008 has halted, 
but the share of non-performing loans still reached 
13% at end-September 2015, well above the euro-
area average. Profitability of the domestic banking 
sector  remained  above  the  euro-area  level,  with 
average return on equity (RoE) above 4% in 2014. 
However, a robust assessment of the soundness of 
the banking sector can only be made based on the 
results  of  the  ongoing  asset  quality  review  and 
stress  test,  which  are  expected  to  end  in  August. 
Similar  reviews  are  currently  being  conducted  in 
the insurance and pension fund sectors. 

26 

0102030405060708090BG, 2010BG, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 2.10: Bulgaria -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators.0510152025BG, 2010BG, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 2.11:Bulgaria -Selected banking sector soundness indicators%Source: ECB, EC calculations. 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 2 - Bulgaria 

After  the  pre-2009  boom,  real  house  prices  in 
Bulgaria  fell  till  2012.  There  has  been  a  slow 
recovery since then, but the real house price index 
reached still only 90.3% of its 2010 level in 2015. 
Residential investment hovered below 2% of GDP 
in  recent  years  as  the  stock  of  loans  for  house 
purchases decreased in 2014-2015. 

it  denominated 

The financial system in Bulgaria is smaller relative 
to GDP than that of the euro area. Domestic bank 
credit stood at around 56% of GDP in 2015, with 
in  foreign-
the  majority  of 
currencies.  The  capitalization  of  the  stock  market 
reached less than 10% of GDP in 2015, well below 
the  euro-area average of 60%.  The debt  securities 
market remains small in comparison with the euro 
area  average  (25%  vs.  158%  of  GDP)  and  is 
mainly  used  for  financing  a  part  of  Bulgaria's 
relatively low public debt. The consolidated stock 
of private sector debt at 124% of GDP in 2014 was 
somewhat below the euro-area average of 138%. 

27 

020406080100120140160180BG, 2010BG, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 2.12: Bulgaria -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
 
 
3.  CZECH REPUBLIC 

3.1. 

LEGAL COMPATIBILITY 

3.1.1.  Introduction 

Česká národní banka (ČNB – Czech national bank) 
was established on January 1, 1993. Its main legal 
basis  is  the  Czech  National  Council  Act  No. 
6/1993 Coll. on the Czech National Bank, adopted 
on 17 December 1992 (the ČNB Law).  

Following the Convergence Report 2014, the ČNB 
Law  was  amended  by  several  laws. (19)  However, 
since  there  have  been  no  amendments  as  regards 
the 
the 
the 
Commission's  2014  Convergence  Report, 
comments made in the latter are largely repeated in 
this year's assessment.  

incompatibilities 

highlighted 

in 

3.1.2.  Central Bank independence 

Article  9(1)  of  the  ČNB  Law  prohibits  the  ČNB 
and  its  Board  from  taking  instructions  from  the 
President  of  the  Czech  Republic,  Parliament,  the 
Government,  administrative  authorities,  European 
Union  institutions,  any  government  of  a  Member 
State of the European Union or any other body.  

Further, Article 9(1) of the ČNB Law needs to be 
adapted  to  fully  reflect  the  provisions  of  Article 
130 of the TFEU and Article 7 of the Statute and 
consequently  expressly  prohibit  third  parties  from 
giving  instructions  to  the  ČNB  and  its  Board 
members  who  are  involved  in  the  performance  of 
ESCB-related tasks. 

The  power  for  the  Chamber  of  Deputies  of  the 
Parliament  to  impose  modifications  to  the  annual 
financial  report  which  was  previously  submitted 
and rejected (Article 47(5) of the ČNB Law) could 
hamper  the  ČNB’s  institutional  independence. 
Moreover,  it  is  formulated  in  a  very  general 
manner  which  could  create  situations  where  the 
Parliament requests changes affecting the financial 
independence  of  the  ČNB.  Thus,  the  current 

(19)  Act 135/2014 Coll., Act 204/2015 Coll, Act 375/2015 Act 
and  377/2015  Coll.  In  particular,  Act  375/2015  Coll. 
amending  relevant  legislation  in  relation  to  the  enactment 
of  the  Financial  Crisis  Prevention  and  Resolution  Act  and 
to  the  changes  in  the  deposit  insurance  system  adds 
provisions in the field of resolution and the possibility for 
the  ČNB  to  provide  at  its  discretion  emergency  liquidity 
assistance to the Financial Market Guarantee System. 

29 

wording  of  Article  47(5)  of  the  ČNB  Law 
constitutes  an  incompatibility  which  should  be 
removed from the Act. 

Article  6(10)  of  the  ČNB  Law  provides  that 
members  of  the  Bank  Board,  which  also  includes 
the Governor, may be relieved from office only if 
they no longer fulfil the conditions required for the 
performance  of  their  duties  or  if  they  have  been 
guilty  of  serious  misconduct.  Although  article 
6(10)  of  the  ČNB  Law  extends  the  protection 
offered by article 14.2 of the ESCB/ECB Statute to 
Governors  against  arbitrary  dismissal  to  all  Bank 
Board  members  of  the  ČNB,  it  remains  silent  on 
the Governor’s right in case of dismissal to seek a 
remedy before the Court of Justice of the European 
Union.  However,  pursuant  to  footnote  22,  the 
Commission  understands  that  the  possibility  to 
seek legal redress by the Governor before the ECJ, 
as  enshrined  in  article  14.2  of  the  ESCB/ECB 
Statute,  would  apply.  However,  the  ČNB  Law 
would benefit from a more explicit clarification.  . 

to  attend 

Pursuant  to  Article  11(1)  of  the  ČNB  Law,  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.  Article  11(2) 
entitles  the  Governor  of  the  ČNB,  or  a  Vice-
Governor  nominated  by  him, 
the 
meetings  of  the  Government  in  an  advisory 
capacity. With regard to Article 11(1) of the ČNB 
Law,  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 
its 
independence is protected by the TFEU. The active 
participation  of  the  Minister,  even  without  voting 
right,  to  discussions  where  monetary  policy  is  set 
would  structurally  give  to  the  Government  the 
opportunity  to  influence  the  central  bank  when 
taking  its  key  decisions.  Therefore,  Article  11(1) 
of the ČNB Law is incompatible with Article 130 
of the TFEU, as Member States have to undertake 
not  to  seek  to  influence  the  members  of  the 
decision-making  bodies  of  the  national  central 
bank.  

is  adopting  decisions 

for  which 

 
                                                           
3.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

institutions  or  other  entities  of 

Article 34a(1) first half-sentence of the ČNB Law 
prohibits 
the  ČNB  from  providing  overdraft 
facilities or any other type of credit facility to the 
bodies, 
the 
European Union, central governments, regional or 
local  authorities  or  other  bodies  governed  by 
public  law,  other  entities  governed  by  public  law 
or public undertakings of the Member States of the 
European Union. The list of entities does not fully 
mirror the one in Article 123(1) of the TFEU and, 
therefore, has to be amended. 

Moreover,  the  footnote  in  Article  34a(1)  of  the 
ČNB  Law  should  refer  to  Article  123(2)  of  the 
TFEU  instead  of  globally  to  Article  123  of  the 
TFEU. 

3.1.4.  Integration in the ESCB 

Objectives 

Pursuant  to  Article  2(1)  of  the  ČNB  Law,  "in 
addition"  to  the  ČNB's  primary  objective  of 
maintaining price stability, the ČNB shall work to 
ensure financial stability and the safety and sound 
operation  of  the  financial  system  and  –  without 
prejudice  to  its  primary  objective  –  support  the 
general  economic  policies  of  the Government  and 
the European Union. Article 2(1) of the ČNB Law 
needs  to  be  amended  with  a  view  to  achieving 
compatibility with Article 127 TFEU and Article 2 
of  the  ESCB/ECB  Statute.  Compatibility  with  the 
ESCB's  objectives  requires  a  clear  supremacy  of 
the primary objective over any other objective. 

Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

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  of  the  ČNB 
Law); 

ECB's right to impose sanctions (Article 46a of the 
ČNB Law).  

 

policy 
the 

the  possibility  for  Parliament 
to  demand 
amendments  to  the  report  of  the  ČNB  on 
to 
monetary 
determine 
the 
extraordinary report in view of the absence of a 
specification 
non-forward 
looking  nature  of  the  reports  (Article  3  of  the 
ČNB Law) 

developments 
content/scope 

regarding 

and 
of 

the 

There are also some imperfections regarding: 

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

non-recognition  of  the  role  of  the  ECB  in  the 
functioning  of  the  payment  systems  (Articles  2.2 
c), 38 and 38a of the ČNB Law); 

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

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

non-recognition of the role of the ECB in the field 
of  international  cooperation  (Article  2(3)  of  the 
ČNB Law). 

Tasks 

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

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

instruments  of 

3.1.5.  Assessment of compatibility 

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

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

3.2. 

PRICE STABILITY 

holding  and  management  of  foreign  reserves 
(Articles 35(c), 36 and 47a of the ČNB Law); 

3.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  below  the 

30 

 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

reference value at the time of the last convergence 
assessment  of  the  Czech  Republic  in  2014.  It 
declined  gradually  to  below  0.4%  in  early  2015 
and  then  remained  broadly  stable  up  to  late  2015 
when  it  fell  below  0.3%.  In  April  2016,  the 
reference  value  was  0.7%,  calculated  as  the 
average of the 12-month average inflation rates in 
Bulgaria,  Slovenia  and  Spain  plus  1.5  percentage 
points.  The  corresponding  inflation  rate  in  the 
Czech  Republic  was  0.4%,  i.e.  0.3  percentage 
points  below  the  reference  value.  The  12-month 
average inflation rate is projected to remain below 
the reference value in the months ahead. 

nominal effective exchange rate and strengthening 
domestic  demand.  Prices  of  processed  food 
continued  to  increase  but  at  a  slower  rate  than  in 
2011-2013,  due  to  lower  contributions  from  input 
prices and changes in indirect taxes. These factors 
also led to slower growth in the price of services in 
2014,  although  growth  accelerated  in  2015  amid 
strengthening  domestic  demand.  Core  inflation 
exceeded headline inflation in 2014 and 2015 as a 
result of the negative contribution of energy prices 
to  the  headline  rate  in  these  years.  Producer  price 
inflation  for  total  industry  was  negative  in  both 
years, falling to -3.2% in 2015, highlighting weak 
supply-side cost pressures. 

3.2.2.  Recent inflation developments 

Price growth moderated significantly in 2014, with 
the HICP inflation rate slowing to 0.4% from 1.4% 
in  the  previous  year.  This  was  largely  due  to  a 
large  negative  contribution  from  energy  prices, 
reflecting the pass-through of a sharp decline in oil 
prices  to  domestic  fuel  prices.  Falling  food  prices 
also  contributed  to  weak  price  growth  in  the 
second  half  of  2014. 
Inflation  accelerated 
somewhat  during  the  first  half  of  2015,  as  the 
negative  contribution  of  energy  prices  moderated 
while food and administered prices recorded some 
modest increases. There was a sharp slowdown in 
the  second  half  of  the  year,  however,  amid 
renewed  declines  in  food  and  energy  prices.  The 
annual HICP inflation rate averaged 0.3% in 2015. 
It picked up somewhat in early 2016 and stood at 
0.5% in April 2016. 

in  2014-2015, 

inflation  (measured  as  HICP 

Core 
inflation 
excluding energy and unprocessed food) averaged 
about  1% 
reflecting  weak 
underlying  price  pressures  in  the  economy.  Prices 
industrial  goods,  which  had 
of  non-energy 
declined every year since 2002, rose moderately in 
2014  and  2015,  reflecting  the  koruna's  weaker 

31 

3.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

significant 

The  Czech  Republic  emerged  from  a  2-year 
recession in 2014, with domestic demand acting as 
the  main  driver  of  growth.  The  growth  rate  of 
private consumption accelerated in 2014 and 2015, 
amid  falling  unemployment  and  higher  real 
disposable  income.  Gross  fixed  capital  formation 
has  contributed  positively  to  real  GDP  growth  in 
the  last  two  years,  particularly  in  2015,  also 
in  public 
reflecting  a 
investment co-financed by EU funds. The level of 
such  investment  is  expected  to  fall  in  2016, 
however, contributing to slower real GDP growth. 
According  to  the  Commission  services'  Spring 
2016  Forecast,  real  GDP  growth  is  expected  to 
slow to 2.1% in 2016, compared to 4.2% in 2015. 
Growth  is  then  expected  to  accelerate  to  2.6%  in 
2017  amid  renewed  growth  in  investment.  While 
the  Czech  economy  is  estimated  to  have  operated 
below  its  potential  in  the  period  2009-2014,  the 

increase 

012345Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16Czech RepublicReference valueGraph 3.1: Czech Republic -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-20246201020112012201320142015Czech RepublicEuro areaGraph 3.2: Czech Republic -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

to  5.1%  in  2015,  one  of  the  lowest  in  the  EU.  At 
the  same  time,  the  number  of  employed  persons 
increased by 0.6% in 2014 and 1.2% in 2015. This 
occurred despite falls in the population of working 
age  and  was  made  possible  by  an  increase  in  the 
participation  rate,  as  more  workers  were  drawn 
into the labour market. Nominal wage growth has 
accelerated,  reaching  2.4%  in  2015,  while  real 
wage  growth  has  also  turned  positive  in  an 
environment of low inflation. 

Labour  productivity  sharply  accelerated  in  2014 
and 2015 as the number of persons employed grew 
more  moderately  than  real  GDP.  With  labour 
productivity growing faster than compensation per 
employee,  nominal  unit  labour  costs  fell  in  2015, 
after having remained broadly stable in 2014. As a 
consequence  of 
labour 
productivity  is  also  expected  to  increase  at  a 
slower  rate  in  2016  and  2017.  At  the  same  time, 
increasingly tight labour market conditions should 
give  rise  to  faster  growth  of  compensation  per 
employee.  As  a  result,  nominal  unit  labour  costs 
are expected to increase in 2016 and 2017. 

lower  GDP  growth, 

32 

output gap is estimated to have closed in 2015 and 
is projected to be positive in 2016 and 2017. 

The fiscal stance, as measured by the change in the 
structural  balance,  was  accommodative  in  2014. 
The  structural  balance  deteriorated  from  a  minor 
surplus in 2013 to a deficit of about 0.8% of GDP 
in  2014  before  improving  again  to  -0.4%  of  GDP 
in 
reflected 
evolution 
developments  in  the  headline  deficit  and  fading 
one-off factors. The structural balance is expected 
to deteriorate somewhat in 2016 and 2017. 

largely 

2015. 

Its 

the 

inflation 

Monetary  policy,  conducted  within  an  inflation 
targeting  framework (20),  has  remained  highly 
accommodative.  The  ČNB's  main  policy  rate  (the 
2-week  repo  rate)  has  been  set  at  0.05%  since 
November  2012.  Moreover,  in  view  of  projected 
undershooting  of 
target  for  a 
protracted  period  of  time,  the  ČNB  decided  in 
November 2013 to start using the exchange rate as 
an  additional  instrument  for  easing  monetary 
conditions  by  allowing  the  koruna  exchange  rate 
against the euro to float freely only on the weaker 
side  of  the  27  CZK/EUR  level.  Following  its 
meeting  on  5  May  2016,  the  Bank  Board  of  the 
ČNB  reiterated  that  it  would  not  discontinue  the 
use  of  the  exchange  rate  as  a  monetary  policy 
instrument before 2017. 

Wages and labour costs 

The  labour  market  has  performed  strongly  since 
the economy emerged from recession at the end of 
2013.  The  unemployment  rate,  which  had  peaked 
at 7% in 2012 and 2013, fell to 6.1% in 2014 and 

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

-303620102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 3.3: Czech Rep. -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast.Table 3.1:weights  Czech Republic - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP1.22.23.51.40.40.30.41000Non-energy industrial goods-2.4-1.7-0.5-0.50.40.50.6242Energy4.37.27.70.6-3.8-3.0-3.0137Unprocessed food 3.50.77.67.21.20.72.477Processed food2.15.95.03.02.71.10.5209Services1.91.13.11.00.60.91.1335HICP excl. energy and unproc. food0.41.42.51.01.10.80.8786HICP at constant taxes-0.12.22.20.40.30.10.21000Administered prices HICP5.12.88.33.50.40.50.81021) 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.Sources: Eurostat, Commission services. 
                                                           
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

External factors 

the  size  and  openness  of 

Given 
the  Czech 
economy,  import  prices  have  a  sizeable  effect  on 
domestic  price  formation.  This  has  particularly 
been  the  case  in  recent  years,  when  there  have 
been  significant  negative  price  shocks  in  global 
commodity  markets.  Developments  were, 
however,  quite  mixed  across  categories  of 
imported  goods  with  the  price  of  oil  falling  in 
koruna  terms  and  contributing  to  falling  energy 
prices  in  the  domestic  economy  while  prices  of 
other energy goods increased. 

The  exchange  rate  provided  an 
inflationary 
impulse  to  domestic  price  developments  in  2014, 
with 
rate 
the  nominal  effective  exchange 
(measured  against  a  group  of  36  trading  partners) 
weaker  by  more  than  5%.  As  a  result,  Czech 
import prices increased by 1.9% compared to a fall 
of  2.6%  in  the  euro  area.  Developments  in  the 
exchange  rate  had  only  a  moderate  impact  on 
inflation in 2015 as the koruna's nominal effective 
exchange  rate  remained  on  average  close  to  its 
2014 level. 

in 2015. It stood at 11% in 2015 (21), compared to 
13%  in  the  euro  area.  Changes  in  administered 
prices  were  not  a  significant  driver  of  inflation  in 
2014  and  2015,  with  growth  rates  broadly  in  line 
with  those  of  headline  HICP  inflation.  Falling 
retail energy prices and the abolition of regulatory 
fees  in  the  healthcare  sector  contributed  to  weak 
growth  in  administered  prices  in  these  years.  Tax 
changes had a marginally positive impact on HICP 
inflation in 2014 and 2015.   

Medium-term prospects 

Annual  HICP  inflation  is  expected  to  remain 
subdued  in  2016  as  the  decline  in  oil  and  food 
prices during the second half of 2015 will continue 
to  exert  a  dampening  impact  on  the  year-on-year 
rate.  At  the  same  time,  domestic  price  pressures 
are expected to become stronger, particularly with 
regards  to  services  prices.  According  to  the 
Commission  services'  Spring  2016  Forecast, 
annual HICP inflation is expected to average 0.5% 
in 2016, accelerating in the second half of the year. 
This  acceleration  is expected  to  continue  in 2017, 
with HICP inflation forecasted to average 1.4%. 

Administered prices and taxes 

The  share  of  administered  prices  in  the  HICP 
basket  has  been  on  a  generally  declining  trend  in 
recent  years,  although  there  was  a  slight  increase 

(21)  According to the Eurostat definition, administered prices in 
the  Czech  Republic  include  inter  alia  heat  energy,  public 
transport, pharmaceuticals, medical and social services. For 
details, 
see: 
http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b 

33 

Table 3.2:Czech Republic - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationCzech Republic1.22.23.51.40.40.30.51.4Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorCzech Republic0.51.62.20.90.50.10.51.4Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeCzech Republic3.32.81.7-0.31.52.43.23.6Euro area2.22.21.81.71.31.21.51.9Labour productivityCzech Republic3.42.2-1.3-0.81.43.01.72.3Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsCzech Republic0.00.63.10.60.1-0.51.51.3Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorCzech Republic1.42.93.80.01.9-1.9-2.41.3Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

The  debt-to-GDP  ratio  declined  from  its  peak  of 
45.1% of GDP in 2013 to 41.1% of GDP in 2015, 
remaining well below the 60% threshold. The fall 
was  mainly  induced  by  a  favourable  stock-flow 
adjustment, reflecting better liquidity management.   

3.3.2.  Medium-term prospects 

According  to  the  Commission  services'  Spring 
2016  Forecast,  the  headline  deficit  is  projected  to 
increase  to  0.7%  of  GDP  in  2016,  largely  as  a 
result of fading one-off factors and stabilisation of 
tax  revenues  in  line  with  lower  economic  growth. 
The  revenue-to-GDP  ratio  is  expected  to  drop  to 
40.7% while the expenditure-to-GDP ratio is set to 
fall  to  41.4%,  as  co-financing  of  EU-funded 
investment  should  decline  due  to  lower  expected 
drawdown  of  EU  funds  in  the  new  programming 
period.  The  structural  balance  is  set  to  deteriorate 
somewhat in 2016. 

is  expected 

The  headline  deficit 
to  decline 
marginally  to  0.6%  of  GDP  in  2017  due  to  the 
continued improvement in economic performance.  
The  structural  deficit  should,  however,  further 
worsen  to  almost  1%  of  GDP.  The  debt-to-GDP 
ratio is projected to fall to 40.9% of GDP in 2017. 

The 2016 Convergence Programme was submitted 
by  the  Czech  authorities  on  11  May  2016.  The 
authorities expect the headline deficit to decline to 
0.6% of GDP in 2016 and then to stabilise at 0.5% 
of  GDP  beyond.  The  Czech  Republic  over-
achieved its medium-term budgetary objective, set 
as  a  structural  deficit  of  1  %  of  GDP,  which 
continues  to  be  met  over  the  programme  horizon. 
According  to  the  convergence  programme,  the 
government  debt-to-GDP  ratio  is  expected  to 
remain  at  41.1%  in  2016  and  to  fall  to  39.3%  in 
2019. Based on its assessment of the convergence 
the 
programme 
Commission  services'  Spring  2016  Forecast,  the 
Commission  is  of  the  opinion  that  the  Czech 
Republic is expected to comply with the provisions 
of  the  Stability  and  Growth  Pact.  Further  details 
can  be  found  in  the  Assessment  of  the  2016 
Convergence 
the  Czech 
Republic (23).  

Programme 

account 

taking 

into 

and 

for 

Risks to the inflation outlook are broadly balanced. 
The  main  downside  risks  relate  to  weaker-than-
expected economic activity which could stem from 
a  slowdown  in  external  demand.  On  the  upside, 
faster-than-expected  growth  in  domestic  wages 
could give rise to inflationary demand pressures. 

The  level  of  consumer  prices  in  the  Czech 
Republic  dropped  to  below  63%  of  the  euro-area 
average in 2014, with the relative price gap widest 
for  services.  This  suggests  there  is  potential  for 
further  price  level  convergence  in  the  long  term. 
After  having  basically  stagnated  between  2007 
until  2013,  Czech  GDP  per  capital  in  purchasing 
power standards increased by almost 2 percentage 
points  to  above  79%  of  the  euro-area  average  in 
2014. 

Medium-term  inflation  prospects  will  be  affected 
by productivity and wage developments as well as 
the  functioning  of  product  markets.  Given  the 
openness  of  the  Czech  economy  and  its  limited 
resource  base,  commodity  prices  and  other 
external  price  shocks  will  continue  to  exercise 
significant influence on domestic inflation.  

3.3. 

PUBLIC FINANCES 

3.3.1.  Recent fiscal developments 

On 17 June 2014, the Council decided to abrogate 
the  decision  on  the  existence  of  an  excessive 
deficit  according  to  Article  126  (12)  TFEU, 
thereby closing the excessive deficit procedure for 
the  Czech  Republic  (22).  The  general  government 
deficit  declined  substantially  from  1.9 %  of  GDP 
in 2014 to 0.4% of GDP in 2015.  Total revenue-
to-GDP ratio increased to 42.2% of GDP in 2015, 
up from 40.8% in 2014, while total expenditure-to-
GDP remained broadly stable at 42.6% of GDP in 
2015, compared to 42.8 % in 2014.  

in 

The  2015  headline  deficit  outcome  is  well  below 
the  2015 
target  of  1.9 %  of  GDP 
the 
Convergence  Programme.  This 
significantly 
better-than-expected  outcome  was  due  to  several 
temporary  factors  including  an  exceptionally  high 
absorption  rate  of  EU  funds,  which  boosted  GDP 
growth.    The  structural  balance  improved  in  2015 
on  the  back  of  a  rapidly  closing  negative  output 
gap.  

(22)  An  overview  of  all  excessive  deficit  procedures  can  be 

(23)

found at: http://ec.europa.eu/economy_finance/economic_ 

http://ec.europa.eu/economy_finance/economic_gov

governance/sgp/deficit/index_en.htm 

ernance/sgp/convergence/index_en.htm 

34 

 
                                                           
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

with a floating exchange rate regime, allowing for 
foreign  exchange  market  interventions  by  the 
central  bank.  The  exchange  rate  of  the  koruna 
against  the  euro  remained  broadly  stable  between 
early  2010  until  late  2013,  oscillating  between  24 
and 26 CZK/EUR.  

On  7  November  2013,  the  ČNB  began  using  the 
exchange  rate  as  an  additional  instrument  for 
easing  monetary  conditions  in  view  of  projected 
price developments indicating an undershooting of 
the inflation target for a protracted period of time. 
The ČNB announced that it would intervene on the 
foreign exchange market to weaken the koruna, so 
that its exchange rate against the euro was close to 
27,  and  clarified  that it  regarded  this  commitment 
as  one-sided,  allowing  the  exchange  rate  to  float 
freely  on  the  weaker  side  of  this  level.  The 
announcement  and  initial  market  interventions 
proved  to  be  effective  as  the  koruna  swiftly 
weakened  from  below  26  CZK/EUR  to  above  27 
CZK/EUR.  

The  koruna  traded  on  average  at  around  27.5 
CZK/EUR  throughout  2014  and  the  first  half  of 
2015, amid low volatility. It strengthened close to 
27 CZK/EUR in mid-2015 and then remained near 

the  national  fiscal  framework 

As  far  as 
is 
concerned – which refers to numerical fiscal rules, 
medium-term  budgetary  frameworks,  independent 
fiscal  institutions,  and  budgetary  procedures  –  the 
Czech Republic scores low compared to other EU 
Member 
budgetary 
States.  Medium-term 
framework  and  expenditure  ceilings  exist  but 
enforcement  and  monitoring  is  weak.  The  draft 
reform  package  aimed  at  strengthening 
the 
framework  was  revamped  several  times.  This 
package 
the 
transposition  of 
the  Directive  on  national 
budgetary  frameworks (24)  into  Czech  legislation, 
which Member States were obliged to carry out by 
the end of 2013. Its latest version was approved by 
the  government  in  February  2015  but  still  awaits 
adoption by the parliament.  

also  meant 

complete 

to 

is 

3.4. 

EXCHANGE RATE STABILITY 

The Czech koruna does not participate in ERM II. 
Since the late 1990s, the ČNB has been operating 
an explicit inflation targeting framework combined 

(24)  Council  Directive  2011/85/EU  of  8  November  2011  on 
requirements  for  budgetary  framework  of  the  Member 
States 

35 

Table 3.3:Czech Republic - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance-4.4-2.7-3.9-1.3-1.9-0.4-0.7-0.6- Total revenues38.640.440.741.640.842.240.740.7- Total expenditure43.043.244.742.842.842.641.441.3   of which: - Interest expenditure1.31.31.41.31.31.11.01.0p.m.: Tax burden32.633.934.435.134.435.035.135.2Primary balance-3.1-1.4-2.50.1-0.60.70.30.4Cyclically-adjusted balance-3.9-2.6-3.2-0.1-1.0-0.4-0.8-0.9One-off and temporary measures0.20.0-1.8-0.1-0.20.00.00.0Structural balance 2)-4.0-2.6-1.50.0-0.8-0.4-0.7-0.9Government gross debt38.239.944.745.142.741.141.340.9p.m: Real GDP growth (%)2.32.0-0.9-0.52.04.22.12.6p.m: Output gap-1.2-0.3-1.6-2.8-2.20.00.20.7Convergence programme2016201720182019General government balance-0.6-0.5-0.5-0.5Structural balance 2) 3)-0.5-0.7-0.6-0.2Government gross debt41.140.740.239.3p.m. Real GDP (% change)2.52.62.42.41) Commission services’ Spring 2016 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.3) Commission services’ recalculated structural balance on the basis of the information in the programme. One-off and other      and 0.0% of GDP in both 2016 and 2017.Sources: Commission services, the 2016 Convergence Programme of Czech Republic.temporary measures in the convergence programme of April 2016 are -0.2% of GDP in 2015, deficit-increasing; 
                                                           
 
 
 
 
 
its lower bound set be the ČNB during the second 
half  of  2015  and  in  early  2016.  During  the  two 
the  koruna 
years  before 
appreciated against the euro by some 1.6%. 

assessment, 

this 

International  reserves  held  by  the  ČNB  increased 
by  more  than  EUR  8  billion  to  above  EUR  40 
billion  (27%  of  GDP)  in  late  2013,  largely  as  a 
result of its foreign exchange market interventions. 
They continued to increase gradually over the next 
two  years,  with  the  pace  of  reserve  accumulation 
accelerating  considerably  in  the  second  half  of 
2015.  As  a  result,  they  reached  almost  EUR  60 
billion by end-2015 (36% of GDP). 

Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

ECB  asset  purchase  programmes.  The  widening 
trend  accelerated  in  late  2015  and  early  2016, 
following further ECB deposit facility rate cuts. At 
the  cut-off  date  of  this  report,  the 3-month spread 
vis-à-vis the euro area was some 54 basis points. 

3.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  the  Czech  Republic 
used  for  the  convergence  examination  reflect 
secondary  market  yields  on  a  basket  of 
government  bonds  with  a  residual  maturity  of 
about 10 years.  

The  Czech  12-month  average  long-term  interest 
rate  relevant  for  the  assessment  of  the  Treaty 
criterion was well below the reference value at the 
time  of  the  last  convergence  assessment  of  the 
Czech  Republic  in  2014.  It  remained  broadly 
stable at just above 2% in the first half of 2014 and 
then  declined  gradually  to  below  0.6%  by  end-
2015.  In  April  2016,  the  latest  month  for  which 
data are available, the reference value, given by the 
average  of  long-term  interest  rates  in  Bulgaria, 
Slovenia and Spain plus 2 percentage points, stood 
at  4%.  In  that  month,  the  12-month  moving 
average of the yield on the Czech benchmark bond 
stood at 0.6%, i.e. 3.4 percentage points below the 
reference value. 

The 3-month interest rate differential vis-à-vis the 
euro  area  tightened  to  below  10  basis  points  in 
early 2014 as a result of koruna liquidity injections 
related  to  the  ČNB's  foreign  exchange  market 
interventions  combined  with  declining  excess 
liquidity  in  the  euro  area.  It  widened  again  to 
above  10  basis  points  in  June  2014  and  above  20 
basis points in September 2014 following the ECB 
deposit  facility  rate  cuts.  It  then  continued  to 
widen gradually throughout late 2014 and 2015 as 
excess liquidity in the euro area increased through 

Long-term  interest  rates  in  the  Czech  Republic 
followed a downward trend from early 2014 up to 
April  2015,  declining  from  above  2.4%  to  below 
0.3%, mainly thanks to strong investment demand. 
As  a  result,  the  spread  against  the  German  long-
term  benchmark  bond  narrowed  from  some  70 
basis points to about 10 basis points over this time 
period.  Long-term  interest  rates  jumped  to  above 
1%  in  June  2015,  largely  mirroring  the  bond 
market  correction  in  the  euro  area,  but  then 

36 

2022242628302010201120122013201420152016Graph 3.4:Czech Republic -CZK/EUR exchange rate(monthly averages)Source: ECB.-500501002010201120122013201420152016Graph 3.5:Czech Republic -3-M Pribor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat.0246810Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16Czech RepublicReference valueGraph 3.6:Czech Republic -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services. 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

below 1% of GDP in 2014 to above 3% of GDP in 
2015. The improvement reflected higher surpluses 
in  both  the  current  and  capital  accounts.  The 
current  account  surplus  increased  from  0.2%  of 
GDP  in 2014  to  0.9%  of GDP  in 2015, due  to  an 
increase in the income balance. The higher capital 
account  surplus  largely  reflected  a  substantial 
drawdown of funds from the EU budget. 

However, according to the national accounts data, 
gross capital formation has actually increased at a 
faster pace than savings since 2013, giving rise to a 
more  negative  savings-investment  balance.  This 
increase  was 
the  general 
largely  driven  by 
government  sector  as  public  investment  increased 
significantly  in  2014  and  2015.  In  contrast,  gross 
capital  formation  by  the  household  and  corporate 
sectors  fell  over  this  period  and  the  savings-
investment  gap  of  the  private  sector  as  a  whole 
improved.  

declined  again  gradually  throughout  the  second 
half  of  2015.  The  spread  against  the  German 
benchmark  bond  oscillated  at  around  25  basis 
points in early 2016 (25).  

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 
financial  market 
developments,  product  and 
integration  –  gives  an  important  indication  of  a 
Member  State's  ability  to  integrate  into  the  euro 
area without difficulties.  

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (26) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  that  the  Czech  Republic 
exceeded  the  indicative  threshold  in  one  out  of 
fourteen 
international 
i.e. 
investment position. In line with the conclusions of 
the  AMRs  2012-16,  the  Czech  Republic  has  not 
been  subject  to  in-depth  reviews  in  the  context  of 
the MIP. 

indicators, 

the  net 

3.6.1.  Developments  of 

the  balance  of 

payments 

According  to  the  balance  of  payments  data,  the 
the 
Czech  Republic's  external  balance 
combined current and capital account) remained in 
surplus  over  the  last  two  years,  increasing  from 

(i.e. 

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

(26)  http://ec.europa.eu/europe2020/pdf/2016/ags2016_alert_ 

mechanism_report.pdf 

37 

Export  performance  improved  significantly  in 
2014,  reflecting  a  sharp  depreciation  of 
the 
nominal  effective  exchange  rate  in  late  2013  and 
stronger external demand as the euro area emerged 
from  recession.  Export  growth  remained  buoyant 
in  2015  but  slowed  down  somewhat  compared  to 
the  previous  year.  External  price  and  cost 
competitiveness, as measured by ULC- and HICP-
deflated  real  effective  exchange  rates,  improved 
considerably  in  late  2013  and,  to  a  lesser  degree, 
throughout 2014. The real effective exchange rate 
then increased somewhat in the course of 2015 as a 
result  of  the  nominal  effective  exchange  rate 
appreciation. 

The financial account balance remained positive in 
2014  and  2015,  increasing  quite  sharply  in  2015. 
This increase was largely driven by rising official 
reserves, as the pace of external asset accumulation 
by the ČNB accelerated in the second half of 2015. 
The  contribution  of  net  FDI  flows  also  increased 
while  net  portfolio  investment  flows  contributed 

02462010201120122013201420152016Czech RepublicGermanyGraph 3.7:Czech Republic -Long-term interest rates(percent, monthly values)Source: Eurostat.0102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 3.8:Czech Republic -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services. 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

negatively  in  2015.  Although  gross  external  debt 
increased  gradually  to  almost  71%  of  GDP  in 
2015,  the  net  international  investment  position 
continued to improve. 

3.6.2.  Market integration 

The  Czech  economy  is  highly  integrated  with  the 
euro  area  through  trade  and  investment  linkages. 
Trade  openness  of  the  Czech  Republic  remains 
very  high.  It  has  continued  to  increase  in  recent 
years,  reaching  almost 94%  of GDP  in  2015.  The 
share  of  trade  with  the  euro  area  expressed  in 
percentage  of  GDP  is  high  and  has  also  been 
further  increasing  in  recent  years,  exceeding  57% 
in  2015  as  neighbouring  euro-area  countries 
belong  to  the  Czech  Republic's  largest  trade 
partners.  

to 

in 

The  Czech  Republic  has  attracted  a  high  share  of 
its 
thanks 
tradable  sector 
the 
FDI 
geographical  proximity 
to  EU  core  markets, 
relatively  good  infrastructure  and  highly  educated 
labour  force.  FDI  inflows  mainly  originate  in  the 
euro  area,  with  the  Netherlands,  Germany,  and 
Austria  accounting  for  more  than  half  of  the  total 
stock.  

According  to  the  Commission  services'  Spring 
2016  Forecast,  the  trade  balance  is  expected  to 
improve in 2016 and 2017, contributing to further 
improvement  in  the  current  account  balance.  The 
risks  to  this  outlook  are,  however,  tilted  to  the 
downside,  as  lower  than  expected  world  demand 
could give rise to a weaker trade performance. 

38 

8090100110120201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 3.9:Czech Republic -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100)Table 3.4:Czech Republic - Balance of payments(percentage of GDP)201020112012201320142015Current account-3.7-2.1-1.6-0.50.20.9of which: Balance of trade in goods1.01.93.14.15.24.7                 Balance of trade in services2.02.01.91.71.31.7                 Primary income balance -6.4-5.6-5.9-6.1-6.1-5.5                 Secondary income balance-0.3-0.5-0.7-0.3-0.20.0Capital account1.00.31.32.00.82.4External balance 1)-2.7-1.8-0.31.50.93.3Financial account 2)-3.2-1.90.31.71.54.3of which: Direct investment-2.4-1.1-3.00.2-1.90.6                Portfolio investment-3.8-0.1-1.4-2.32.1-3.7                Other investment 3)2.0-0.22.7-0.7-0.5-0.5                Change in reserves1.1-0.42.04.51.77.9Financial account without reserves-4.2-1.4-1.7-2.8-0.2-3.6Errors and omissions-0.5-0.10.50.20.51.0Gross capital formation27.227.026.324.825.326.7Gross saving22.022.524.123.623.324.6Gross external debt55.254.860.263.568.670.7International investment position-46.1-45.3-46.1-41.6-37.0-31.21) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, Czech National Bank. 
 
 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

The Czech banking sector is well capitalised with 
the average capital adequacy ratio of 16.7% in the 
third quarter of 2015, similar to 16.2% in the euro 
area.  Moreover,  its  profitability  has  held  up 
remarkably  well  in  recent  years,  with  the  average 
return  on  equity  (RoE)  reaching  almost  10%  in 
Q3-2015, compared to about 4% in the euro area. 
At  the  same  time,  the  share  of  non-performing 
loans has remained broadly stable at around 5½% 
while it exceeded 6% in the euro area. 

After  having  followed  a  declining  trend  between 
end-2008 and end-2013, the real house price index 
started recovering again in 2014 and it exceeded its 
2010 level by end-2015. However, the GDP share 
of  residential  investment  remained  quite  stable  in 
recent  years  even 
to 
households for house purchase expanded by some 
14% between end-2013 and end-2015. 

though  bank 

lending 

As  far  as  the  business  environment  is  concerned, 
the  scores  received  by  the  Czech  Republic  in 
international  rankings  have  improved  in  recent 
years,  converging  close  to  the  euro-area  average. 
At  the  same  time,  the  Czech  Republic's  deficit  in 
the transposition of EU directives was just 0,5% in 
2015.  

(as  measured  by 

Protection  of  permanent  employees  against 
collective  and  individual  dismissals  is  relatively 
the  2013  OECD 
strict 
employment  protection  indicator).  Cross-border 
migration flows have remained relatively subdued 
although net immigration into the Czech Republic 
seems to have picked up somewhat recently. 

financial  sector 

The  Czech 
remains  highly 
integrated  into  the  EU  financial  sector.  The  main 
channel of integration is through a high degree of 
foreign  ownership  of  financial  intermediaries  as 
about 87%  of banking  sector's  assets  was  in 2014 
held by foreign institutions via local branches and 
subsidiaries.  Bank  concentration,  as  measured  by 
largest  five  credit 
the  market  share  of 
institutions in total assets, has remained above the 
euro-area average over the past years at just above 
60%. 

the 

39 

0102030405060708090100CZ, 2010CZ, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 3.10: Czech Republic -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators. Table 3.5:Czech Republic - Market integration201020112012201320142015Trade openness 1) (%)72,279,183,184,291,793,9Trade with EA in goods & services 2)+3) (%)45,249,250,851,556,357,7Export performance (% change) 4)3,33,22,9-1,45,23,1World Bank's Ease of Doing Business Index rankings 5)706465753336WEF's Global Competitiveness Index rankings 6)363839463731Internal Market Transposition Deficit 7) (%)1.21,90,20,40,30,5Real house price index 8)100,098,494,994,195,999,6Residential investment 9) (%)4,13,73,73,33,23,2 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
to 

bank 

The  financial  system  in  the  Czech  Republic  is 
smaller relative to GDP than that of the euro area. 
non-financial 
credit 
Outstanding 
companies and households reached 51% of Czech 
GDP  in  2015,  compared  to  92%  in  the  euro  area. 
The  stock  of  quoted  shares  issued  by  Czech 
enterprises declined to below 15% of GDP in 2015 
from  above  20%  of  GDP  in  2010.  It  was  thus  far 
below  the  euro-area  level  of  60%  of  GDP.  The 
total  amount  of  outstanding  debt  securities 
increased  from  54%  of  GDP  in  2010  to  63%  of 
GDP in 2015, while it exceeded 150% of GDP in 
the  euro  area.  The  consolidated  stock  of  private 
sector debt increased from 68% of GDP in 2010 to 
almost  73%  of  GDP 
remaining 
significantly below the euro-area average of 138%. 

in  2014, 

Convergence Report 2016 - Technical annex 

Chapter 3 - Czech Republic 

40 

024681012141618CZ, 2010CZ, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 3.11: Czech Republic -Selected banking sector soundness indicators%Source: ECB, IMF,  EC calculations.020406080100120140160180CZ, 2010CZ, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 3.12: Czech Republic -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
 
 
 
 
4.  CROATIA 

4.1. 

LEGAL COMPATIBILITY 

4.1.1.  Introduction 

The  main  legal  rules  governing  the  Croatian 
National  Bank  (Hrvatska  narodna  banka  –  HNB) 
are  laid  down  in  Article  53  of  the  Constitution  of 
the  Republic  of  Croatia (27)  and  the  Act  on  the 
Croatian  National  Bank  (the  HNB  Act) (28).  The 
HNB  Act  was  amended  in  2013  with  a  view  to 
Croatia  entering  the  European  Union  on  1  July 
2013. The Act provides for specific rules applying 
to  the  HNB  as  of  EU  accession  of  Croatia  and  a 
specific  chapter  for  rules  applying  to  the  HNB  as 
of  the  moment  the  euro  becomes  the  official 
currency of the Republic. 

4.1.2.  Central Bank independence 

The principle of independence of the HNB is laid 
down  in  Article  53  of  the  Constitution  and  in 
Articles 2 (2) and 71 of the HNB Act. Article 71 of 
the  HNB  Act  contains  a  specific  reference  to  the 
principle  of  central  bank 
independence  as 
enshrined in the TFEU, stating that the HNB shall 
be  independent  in  achieving  its  objective  and 
carrying out its tasks under the Act in accordance 
with Article 130 of the TFEU. As regards the rules 
on a possible removal of the HNB Governor from 
office, Article 81 of the HNB Act makes a specific 
reference to the relevant wording of Article 14.2 of 
the ESCB/ECB Statute. 

No incompatibilities and imperfections exist in this 
area. 

4.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

No incompatibilities and imperfections exist in this 
area.  The  rules  on  prohibition  of  lending  to  the 
public  sector  pursuant  to  Article  78  of  the  HNB 
Act include a specific reference to the prohibition 
of monetary financing as laid down in Article 123 
of the TFEU. 

(27)  Constitution  as  amended  and  published  in  the  Official 
Journal  of  the  Republic  of  Croatia  no.  56/90,  135/97, 
113/2000,  123/2000,  124/2000,  28/2001,  55/2001  and 
76/2010. 

(28)  Official Journal of the Republic of Croatia no. 75/2008 and 

54/2013. 

41 

4.1.4.  Integration in the ESCB 

Objectives 

The  objectives  of  the  HNB  are  laid  down  in 
Articles  3  and  72  of  the  HNB  Act  and  are  fully 
compatible  with  the  objectives  applying  to  the 
European  System  of  Central  Banks  pursuant  to 
Article 127 of the TFEU. 

Tasks 

The provisions under chapter VIII of the HNB Act 
define  the  tasks  the  HNB  has  to  carry  out  as 
integral  part  of  the  European  System  of  Central 
Banks  pursuant  to  the  rules  of  the  TFEU  and  the 
ESCB/ECB  Statute.  No  incompatibilities  exist 
with  regard  to  these  tasks.  The  Commission 
understands  that  the  competence  of  the  HNB 
Council  to  decide  on  the  HNB's  membership  in 
international  institutions  pursuant  to  Article  104 
(11)  of  the  HNB  Act  is  without  prejudice  to  the 
ECB's  powers 
international 
cooperation involving tasks entrusted to the ESCB 
under Article 6.1 of the ESCB/ECB Statute. 

the  field  of 

in 

4.1.5.  Assessment of compatibility 

The  Constitution  and  the  Act  on  the  Croatian 
National  Bank  are  fully  compatible  with  Articles 
130  and  131  of  the  TFEU.  This  assessment  is 
without  prejudice  to  an  analysis  of  the  potential 
changes to the HNB Act on the basis of a draft law 
which is pending in the Croatian Parliament at the 
moment of writing the 2016 Convergence Report. 

4.2. 

PRICE STABILITY 

4.2.1.  Respect of the reference value 

time  of 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  below  the 
reference  value  at 
the  2014 
the 
convergence  assessment  of  Croatia.  It  declined 
gradually throughout 2014 to around 0.1% in early 
2015  and  dropped  into  negative  territory  in  the 
second  half  of  2015.  In  April  2016,  the  reference 
value  was  0.7%,  calculated  as  the  average  of  the 
12-month  average  inflation  rates  in  Bulgaria, 
Slovenia and Spain plus 1.5 percentage points. The 
the  Croatia 
corresponding 

inflation 

rate 

in 

 
                                                           
was  -0.4%,  i.e.  1.1  percentage  points  below  the 
reference  value.  The  12-month  average  inflation 
rate  is  projected  to  fall  well  below  the  reference 
value in the months ahead. 

4.2.2.  Recent inflation developments 

food  dampened  growth  of 

After  having 
temporarily  exhibited  negative 
growth  rates  in  early  2014, annual  HICP  inflation 
in  Croatia  averaged  0.2%  in  2014  as  declining 
industrial  goods  and 
prices  of  non-energy 
unprocessed 
the 
headline rate. The inflation rate dropped again into 
negative  territory  in  December  2014  and  then 
remained negative throughout most of 2015 due to 
rapidly  falling  energy  prices.  HICP  inflation  thus 
averaged -0.3% in 2015. It declined further in early 
2016 and stood at -0.9% in April 2016. 

Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

processed  food  prices  also  increased  at  a  slower 
pace  than  in  preceding  years.  Prices  of  services, 
which  account  for  about  a  third  of  the  HICP 
basket,  thus  became  the  main  driver  of  core 
inflation  in  2014  and  2015.  Industrial  producer 
prices  continued  to  decline  throughout  2014  and 
2015. 

4.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

The pace of economic contraction slowed in 2014 
with  real GDP declining  by some  0.4%. After  six 
years  in  recession,  the  Croatian  economy  finally 
expanded again in 2015 as real GDP increased by 
1.6 %.  The  recovery  was  mainly  driven  by 
domestic  demand  which  was  supported  by  falling 
energy  prices,  a  stabilising  labour  market  and  a 
reformed personal income tax regime. The related 
pick-up  in  import  growth  offset  continued  export 
acceleration  and  thus  led  to  a  reduction  in  the 
growth  contribution  of  net  exports.  Real  GDP 
growth  is  expected  to  accelerate  to  about  1.8%  in 
2016  and  2.1%  in  2017,  driven  by  domestic 
demand, with investment growth partly spurred by 
EU  funds.  As  a  result,  the  negative  output  gap  is 
estimated to almost fully close by 2017. 

the  back  of  a  sizeable  drop 

The fiscal stance, as measured by the change in the 
structural  balance,  was  loosened  slightly  in  2014. 
It was then tightened considerably in 2015, largely 
on 
in  public 
investment. The structural deficit is thus estimated 
to have dropped to below 2% of GDP in 2015. In 
view of the gradually closing output gap, the fiscal 
stance  is  projected  to  be  mildly  expansionary  in 
2016 and 2017. 

to  pursue 

The  HNB  has 
an 
continued 
accommodative  monetary  policy  by  preserving 
high  levels  of  liquidity  in  the  monetary  system  in 
order  to  ease domestic  financing  conditions  while 
simultaneously  maintaining  a  broadly  stable 
exchange  rate  of  the  kuna  against  the  euro. 
However, the high degree of euroisation constrains 
the  scope  of  domestic  monetary  policy,  while  its 
effectiveness 
the  shallow 
domestic  money  market  and  relatively  high 
concentration in the banking sector. 

limited  by 

is  also 

energy 

unprocessed 

inflation  (measured  as  HICP 

inflation 
Core 
excluding 
food) 
and 
decelerated sharply from 2.1% in 2013 to 0.6 % in 
2014.  It  then  broadly  stabilised  at  0.8%  in  2015 
and  at  around  0.7%  in  early  2016.  The  decline 
reflected a contraction and subsequent stabilisation 
industrial  goods  prices  while 
of  non-energy 

42 

-1012345Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16CroatiaReference valueGraph 4.1: Croatia -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-20246201020112012201320142015CroatiaEuro areaGraph 4.2: Croatia -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

collapse  registered  in  the  aftermath  of  the  global 
financial  crisis,  reaching  about  47%  of  GDP  in 
2015.  Import  prices  (measured  by  the  imports  of 
goods deflator) declined by some 1% in 2014 and 
1.4% in 2015, largely as a result of lower prices of 
imported commodities.  

The  nominal  effective  exchange  rate  (measured 
against a group of 36 trading partners) depreciated 
somewhat in the second half of 2014 and in early 
2015. It subsequently recovered a part of its losses 
and then remained broadly stable up to early 2016. 
The  exchange  rate 
thus  did  not  provide  a 
substantial  inflationary  impulse  to  domestic  price 
developments over the last two years. 

Administered prices and taxes 

Administered  prices  represent  almost  20%  of  the 
HICP  basket (29),  compared  to  about  13%  in  the 
euro  area.  Increases  of  administered  prices  have 
contributed  positively  to  inflation  in  recent  years, 
despite  having  followed  a  downward  trend.  Their 
subdued growth in 2014 and 2015 mainly reflected 
significant increases in prices of water supply and 
sewerage  collection  as  well  as  hospital  and  postal 
services,  which  were  partly  offset  by  falling 
electricity and later also gas prices. 

Tax  changes  provided  a  significant  positive 
contribution  to  HICP  inflation  in  2014.  This  was 
due  to  the  increase  in  the  lower  VAT  rate  from 
10%  to  13%,  higher  excise  taxes  on  tobacco  and 

Wages and labour costs 

The  labour  market  situation  started  improving  in 
the 
2015.  After  having  stagnated 
unemployment rate declined close to 16% in 2015 
while employment continued increasing. This was, 
however,  not  yet  reflected  in  nominal  wage 
developments  as  wages  continued  to  decline  in 
2015. 

in  2014, 

costs 

(ULC) 

Nominal  compensation  per  employee  contracted 
significantly  in  2014.  As  a  result,  despite  the 
parallel  drop  in  labour  productivity,  nominal  unit 
labour 
declined.  Nominal 
compensation per employee decreased also in 2015 
while  labour productivity stabilised,  resulting  in  a 
further  reduction  in  nominal  ULC.  As  continued 
labour  market  recovery  should  result  in  positive 
wage  growth,  nominal  ULC  are  expected  to 
increase in 2016 and 2017. 

External factors 

External  factors  have  a  significant  impact  on 
domestic  price  dynamics.  The  ratio  of  imports  to 
GDP  has  been  constantly  increasing  since  the 

(29)  According to the Eurostat definition, administered prices in 
Croatia  include  inter  alia  water  supply,  refuse  and 
sewerage collection, electricity, gas and heat energy as well 
as  dental,  hospital  and  postal  services.  For  details,  see: 
http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b 

43 

-8-404820102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 4.3:Croatia -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast.Table 4.1:weights  Croatia - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP1.12.23.42.30.2-0.3-0.41000Non-energy industrial goods-0.6-0.21.2-0.1-1.10.10.3267Energy9.97.010.81.80.7-5.9-6.3108Unprocessed food -2.21.55.54.5-3.60.8-0.682Processed food0.15.62.75.30.90.60.6201Services1.6-0.10.71.61.71.41.2343HICP excl. energy and unproc. food0.31.51.62.10.60.80.8811HICP at constant taxes0.62.12.51.9-0.6-0.6-0.71000Administered prices HICP4.31.47.63.41.70.40.21511) 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.Sources: Eurostat, Commission services. 
 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

refined  petroleum  products  as  well  as 
the 
introduction of fiscal levies on mobile services. A 
more modest inflationary impact of tax changes in 
2015  was  largely  related  to  further  excise  tax 
hikes. 

level  convergence  in  the  long  term.  However, 
Croatian  GDP  per  capita  in  purchasing  power 
standards has stagnated at around 55% of the euro-
area average in recent years.  

Medium-term prospects 

According  to  the  Commission  services'  Spring 
2016  Forecast,  annual  HICP  inflation  is  projected 
to  remain  negative  throughout  2016  mainly  as  a 
result  of  falling  energy  prices,  including  a  sharp 
reduction  of  administered  gas  tariffs  as  of  April 
2016. Annual inflation is expected to turn positive 
in  2017  as  the  negative  impact  of  lower  energy 
fades  out  while  continued  economic 
prices 
expansion  should  support  consumer  price  growth. 
Annual  HICP  inflation  is  thus  forecasted  to 
average -0.6% in 2016 and 0.7% in 2017.  

Risks to the inflation outlook are broadly balanced. 
A  slower-than-expected  GDP  expansion,  possibly 
induced by a less favourable external environment, 
would  further  limit  inflationary  pressures.  On  the 
other hand, higher-than-expected increases in some 
administered  prices  could  contribute  positively  to 
inflation developments.    

The level of consumer prices in Croatia declined to 
close  to  65%  of  the  euro-area  average  in  2014. 
This  suggests  there  is  potential  for  further  price 

Medium-term  inflation  prospects  will  be  affected 
by productivity and wage developments as well as 
the  extent  of  spare  capacity  in  the  economy.  The 
rebalancing  of  the  economy  towards  the  external 
sector  is  expected  to  continue  as  Croatia  deepens 
its  integration  in  the  EU  value  chains.  With 
continued economic recovery, it will be crucial to 
ensure 
line  with 
that  wages 
productivity growth.  

increase 

in 

4.3. 

PUBLIC FINANCES 

4.3.1.  The  excessive  deficit  procedure 

for 

Croatia 

On  28  January  2014,  the  European  Council 
decided that an excessive deficit existed in Croatia 
in accordance with Article 126(6) of the Treaty on 
the  Functioning  of  the  European  Union  (TFEU). 
The  Council  issued  a  recommendation  to  Croatia 
in  accordance  with  Article  126(7)  TFEU  with  a 
view  to  bringing  to  an  end  the  situation  of  an 
excessive  deficit  by  2016.  In  particular,  the 
Council  recommended  to  the  Croatian  authorities 
to gradually reduce the general government deficit 

44 

Table 4.2:Croatia - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationCroatia1.12.23.42.30.2-0.3-0.60.7Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorCroatia1.52.43.21.9-0.4-0.5-0.50.7Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeCroatia2.24.20.2-0.7-5.2-0.51.11.6Euro area2.22.21.81.71.31.21.51.9Labour productivityCroatia2.13.71.51.5-2.80.00.70.7Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsCroatia0.10.6-1.3-2.2-2.4-0.50.40.9Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorCroatia1.46.32.9-0.4-1.0-1.4-0.80.4Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

to  4.6%,  3.5%  and  2.7%  of  GDP  in  2014,  2015, 
and  2016,  respectively,  consistent  with  an  annual 
improvement  in  the  structural  balance  of  0.5%, 
0.9%  and  0.7%  of  GDP  in  the  three  respective 
years.  The  Commission  considered  in  June  2014 
that Croatia had taken effective action and that no 
further  steps  in  the  excessive  deficit  procedure 
were  needed.  Since  then,  the  excessive  deficit 
procedure for Croatia has been held in abeyance.  

4.3.2.  Recent fiscal developments 

The  general  government  deficit  declined  from 
5.5%  of  GDP  in  2014  to  3.2%  of  GDP  in  2015. 
The main driver of the sizeable improvement was a 
22% drop in public investment. This, together with 
a  further  reduction  in  public  subsidies  and  the 
wage  bill,  resulted  in  a  0.8%  decrease  in  general 
government  expenditure 
terms, 
bringing  the  expenditure-to-GDP  ratio  down  to 
46.9%. At the same time, revenues grew by a solid 
4.4%,  mainly  on  account  of  strong  growth  in 
indirect  taxes.  The  share  of  revenues  in  GDP 
increased  to  43.7%.  The  primary  balanced  turned 
to a surplus of 0.4% of GDP in 2015, for the first 
time since more than a decade.  

in  nominal 

The  2015  deficit  outcome  was  well  below  the 
5.0%  of  GDP  targeted  in  the  2015  Convergence 
Programme. The structural balance improved from 
some  -3.5%  of  GDP  in  2014  to  about  -1.7%  in 
2015, after having marginally deteriorated in 2014. 

In  2014,  general  government  debt  increased  by 
more  than  4  percentage  points  to  86.5%  of  GDP, 
mostly  due  to  the  underlying  deficit  dynamics.  In 
2015, the debt-to-GDP ratio increased only slightly 
to 86.7% of GDP, reflecting the lower deficit and a 
draw-down of government deposits. 

4.3.3.  Medium-term prospects 

Due  to  the  parliamentary  elections  in  November 
2015,  a  temporary  financing  arrangement  was  in 
place in the first quarter of 2016. The 2016 Budget 
Act was adopted by Parliament on 21 March 2016. 
The budget does not present ESA-based targets for 
the developments in the general government sector 
in  2016. The  budget  does  not  outline  sizeable 
measures  on  the  revenue  side,  apart  from  an 
increase  in  the  supplementary  health  insurance 
premium,  but  it  envisages  moderate  restraints  in 
most spending categories. 

45 

Table 4.3:Croatia - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance-6.2-7.8-5.3-5.3-5.5-3.2-2.7-2.3- Total revenues41.341.041.742.542.643.744.144.4- Total expenditure47.548.847.047.848.146.946.846.6   of which: - Interest expenditure2.63.03.43.53.53.63.63.6p.m.: Tax burden36.135.235.936.436.537.237.237.4Primary balance-3.6-4.8-1.9-1.8-2.00.40.91.3Cyclically-adjusted balance-5.5-7.3-4.0-3.6-3.6-1.8-1.9-2.1One-off and temporary measures0.00.00.0-0.2-0.1-0.10.00.0Structural balance 2)-5.5-7.3-4.0-3.3-3.5-1.7-1.9-2.1Government gross debt58.365.270.782.286.586.787.687.3p.m: Real GDP growth (%)-1.7-0.3-2.2-1.1-0.41.61.82.1p.m: Output gap-1.4-1.3-2.8-3.7-4.0-2.9-1.7-0.3Convergence programme2016201720182019General government balance-2.6-2.0-1.6-1.0Structural balance 2) 3)-1.7-1.6-1.7-1.6Government gross debt85.984.782.880.0p.m. Real GDP (% change)2.02.12.32.51) Commission services’ Spring 2016 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. Sources: Commission services, the 2016 Convergence Programme of Croatia.There are no one-off and other temporary measures in the programme. 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

rules  could  be 

adjustments.  Finally,  the  design  of  the  numerical 
fiscal 
the 
independence  of  the  monitoring  body,  the  Fiscal 
Policy Commission, is not yet fully guaranteed. 

improved,  and 

4.4. 

EXCHANGE RATE STABILITY 

The Croatian kuna does not participate in ERM II. 
The  HNB  operates  a  tightly  managed  floating 
exchange  rate  regime,  using  the  exchange  rate  as 
the  main  nominal  anchor  to  achieve  its  primary 
objective  of  price  stability.  The  HNB  does  not 
target  a  specific  level  or  band  for  the  kuna 
exchange  rate  against  the  euro  but,  through  its 
foreign  exchange  transactions,  it  aims  to  prevent 
excessive exchange rate fluctuations.  

The kuna's exchange against the euro has remained 
broadly  stable  over  the  past  two  years,  oscillating 
around  7.6  HRK/EUR.  It  continued  to  follow  an 
intra-year  pattern  of  temporarily  appreciating  in 
spring  as  a  result  of  foreign  exchange  inflows 
generated by the tourism sector.  

The  Commission  services'  Spring  2016  Forecast, 
which  takes  into  account  the  adopted  budget, 
projects  the  general  government  deficit  to  decline 
to  2.7%  of  GDP  in  2016  and  further  to  2.3%  of 
GDP  in  2017  on  a  no-policy-change  basis.  The 
structural  balance  is  expected  to  deteriorate  by 
about 0.2 pp. both in 2016 and 2017. On the back 
of  strengthening  primary  surplus,  public  debt  is 
expected  to  peak  at  87.6%  of  GDP  in  2016  and 
then to decline slightly in 2017. 

target 

for  2017 

The 2016 Convergence Programme was submitted 
on  28  April  2016.  It  confirms  the  government’s 
commitment  to  reduce  the  general  government 
deficit 
to  below  3%  of  GDP  by  2016,  as 
recommended  by  the  Council.  In  particular,  the 
general government deficit is targeted to gradually 
decline  from  3.2%  of  GDP  in  2015  to  2.6%  of 
GDP  in  2016  and  2.0%  of  GDP  in  2017.  The 
deficit  target  for  2016  is  broadly  in  line  with  the 
Commission  services'  Spring  2016  Forecast.  The 
deficit 
the 
Commission  projection,  largely  on  account  of  the 
conservative 
services'  more 
Commission 
assessment of the impact of measures presented in 
the  programme.  Based  on  its  assessment  of  the 
convergence  programme  and  taking  into  account 
the Commission services' Spring 2016 forecast, the 
Commission  is  of  the  opinion  that  there  is  a  risk 
that Croatia will not comply with the provisions of 
the  Stability  and  Growth  Pact.  Therefore,  further 
measures  will  be  needed  to  ensure  compliance  in 
2017.  Further  details  can  be  found 
the 
Assessment  of  the  2016  Convergence  Programme 
for Croatia (30).  

lower 

than 

in 

is 

As  far  as  the  fiscal  framework  is  concerned  – 
which  refers  to  numerical  fiscal  rules,  medium-
term  budgetary  frameworks,  independent  fiscal 
institutions  and  budgetary  procedures  – 
the 
Croatian  framework  remains  relatively  weak, 
despite  improvements  in  recent  years,  which 
notably  materialised  in  the  amendments  to  the 
Budget  Act  and  the  adoption  of  the  Fiscal 
Responsibility  Law.  In  particular,  the  multiannual 
expenditure framework is one of the least binding 
in the European Union: its consistency with annual 
budgets  (whose  allocations  are  also  frequently 
revised) is limited, and its expenditure ceilings are 
revised without public explanation. In addition, the 
budgetary  process  gives  little  consideration  to  the 
sizeable  off-budget  transactions  and  accounting 

(30)

http://ec.europa.eu/economy_finance/economic_gov

ernance/sgp/convergence/index_en.htm 

International  reserves  held  by  the  HNB  hovered 
above  EUR 12  billion  (29%  of  GDP)  throughout 
2014.  They  increased  to  above  EUR  14  billion  in 
the  first  quarter  of  2015  but  then  declined  again 
and stood at some EUR 13.7 billion (31% of GDP) 
by  end-2015.  They  were  negatively  affected  by 
losses related to the legislated conversion of CHF-
denominated  housing  loans  into  euros  which 
created  a  currency  mismatch  on  the  banking 
sector's  balance  sheet  and  thus  necessitated  an 
injection of foreign-exchange liquidity by the HNB 
with  a  negative  impact  of  almost  EUR  0.3  billion 
on  its  international  reserve  level.  By  end-2015, 
to  have 
international  reserves  are  estimated 
covered  about  140%  of  Croatia's  short-term 
external debt and some 36% of broad money (M4). 

46 

7.07.27.47.67.88.02010201120122013201420152016Graph 4.4:Croatia -HRK/EUR exchange rate(monthly averages)Source: ECB. 
                                                           
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

The HNB does not actively use changes in interest 
rates  on  its  lending  and  deposit  facilities  as  a 
monetary policy tool given their weak transmission 
in  a  shallow  domestic  money  market.  As a  result, 
the  evolution  of  short-term  rates  mainly  reflects 
changes in kuna liquidity in the monetary system. 
The  3-month  interest  rate  differential  against  the 
euro area widened from around 60 basis points in 
the first half of 2014 to above 100 basis points in 
September 2014 as money market rates declined in 
the  euro  area  due  to  the  ECB  deposit  facility  rate 
cuts  while  the  domestic  benchmark  rate  Zibor 
increased  somewhat.  The  short-term 
interest 
differential  remained  at  around  100  basis  points 
until  September  2015  when 
legislated 
conversion  of  CHF-denominated  housing  loans 
resulted  in  a  considerable  tightening  of  money 
market  conditions  in  Croatia.  Domestic  money 
market  conditions  then  eased  again  in  late  2015 
and  early  2016.  At  the  cut-off  date  of  this  report, 
the  3-months  spread  vis-à-vis  the  euro  area  stood 
at some 107 basis points. 

the 

interest rates in Bulgaria, Slovenia and Spain plus 
2  percentage  points,  stood  at  4%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Croatian  benchmark  bond  stood  at  3.7%,  i.e.  0.3 
percentage points below the reference value.  

4.5. 

LONG-TERM INTEREST RATES 

The long-term interest rate in Croatia used for the 
convergence  examination  reflects  the  secondary 
market  yield  on  a  single  benchmark  government 
bond  with  a  residual  maturity  of  close  to,  but 
below, 10 years. 

The Croatian 12-month average long-term interest 
rate  relevant  for  the  assessment  of  the  Treaty 
criterion was below the reference value at the time 
of the 2014 convergence assessment of Croatia. It 
declined  gradually  from  around  4.8%  in  the  first 
half  of  2014  to  below  3.5%  in  mid-2015,  before 
increasing slightly in late 2015. In April 2016, the 
last  month  for  which  data  are  available,  the 
reference value, given by the average of long-term  

the  German 

Long-term  interest  rates  in  Croatia  declined  from 
above 5% in early 2014 to about 3% in the second 
quarter of 2015. This was largely due to favourable 
financial  market developments in the euro area as 
the  spread  vis-à-vis 
long-term 
benchmark bond narrowed to a more limited extent 
from above 330 to below 250 basis points over the 
same  time  period.  Long-term  interest  rates  then 
increased  to  around  3.9%  in  the  second  half  of 
2015,  mainly  due  to  the  deterioration  in  domestic 
financial  market  sentiment,  with  the  spread  to  the 
German  benchmark  bond  widening  back  to  some 
340  basis  points.  In  April  2016,  the  long-term 
interest rate stood at 3.6% and the spread vis-à-vis 
the  German  benchmark  bond  at  about  350  basis 
points (31). 

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

47 

-10001002003004005002010201120122013201420152016Graph 4.5:Croatia -3-M Zibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat.02468101214Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16CroatiaReference valueGraph 4.6:Croatia -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.02468102010201120122013201420152016CroatiaGermanyGraph 4.7:Croatia -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
 
                                                           
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.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  product  and 
financial  market 
integration  –  gives  an  important  indication  of  a 
Member  State's  ability  to  integrate  into  the  euro 
area without difficulties. 

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (32) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Croatia  exceeded  the 
indicative 
threshold  for  six  out  of  fourteen 
indicators,  two  in  the  area  of  external  imbalances 
(i.e.  the  net  international  investment  position  and 
change in the export market share), two in the area 
of  internal  imbalances  (i.e.  general  government 
gross  debt  and  the  unemployment  rate)  and  two 
new  employment  indicators  (long-term  and  youth 
unemployment). In line with the conclusion of the 
AMR  2016,  Croatia  was  subject  to  an  in-depth 
review,  which  found  that  Croatia  continued  to 
experience  excessive  macroeconomic  imbalances. 
Vulnerabilities  were  linked  to  high  levels  of 
public, corporate and external debt in a context of 
high unemployment. 

4.6.1.  Developments  of 

the  balance  of 

payments 

The  current  account  surplus  remained  broadly 
stable at below 1% of GDP in 2014. This masked 
an  improvement  in  the  balance  of  trade  in  goods 
and  services  which  was  offset  by  a  worsening  of 
both  the  primary  and  the  secondary  income 
balance.  In  2015,  the  current  account  registered  a 
record surplus of above 5% of GDP. This reflected 
a  further  improvement  in  the  trade  balance  and  a 
higher surplus on the secondary income balance as 
well  as  a  large  temporary  fall  in  the  primary 
income deficit, which was mainly related to losses 
incurred  by  the  foreign-owned  banking  sector  in 
the aftermath  of the legislated conversion of CHF 
loans. The capital account balance remained close 
to zero in 2014 and then increased to 0.4% of GDP 
the 
in  2015.  Croatia's  external  surplus  (i.e. 
thus 
combined  current  and  capital  account) 

(32)

http://ec.europa.eu/europe2020/pdf/2016/ags2016_al

ert_mechanism_report.pdf 

Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

increased significantly from 1% of GDP in 2014 to 
some 5.6% of GDP in 2015.   

The  improvement  in  the  external  balance  reflects 
the  ongoing  weakness  of  investment  and  residual 
deleveraging pressures in the household sector and 
among  financial  corporations  which  were  only 
partly  offset  by  the  continued  high  borrowing 
needs of the general government. As a result, while 
gross  capital  formation  remained  below  19%  of 
GDP  in  2014  and  2015,  gross  national  saving 
increased  from  below  20%  of  GDP  in  2014  to 
above 23% of GDP in 2015. 

In  2014  and  2015,  export  performance  was  very 
good as Croatia swiftly increased its export market 
share.  Exports  were  supported  by  improved  cost 
and price competitiveness as the ULC- and HICP-
deflated  real  effective  exchange  rates  depreciated 
throughout  2014  before  broadly  stabilising  in 
2015.  The  improvement  in  the  ULC-based  REER 
was  more  pronounced  than  in  the  case  of  the 
HICP-based  REER  which  continued  to  move 
largely in sync with the NEER. 

48 

0102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 4.8:Croatia -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.708090100110201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 4.9:Croatia -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100) 
                                                           
 
 
 
   
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

The financial account posted a marginally negative 
balance  in  2014  before  displaying  a  substantial 
surplus  in  2015.  The  turnaround  mainly  reflected 
the evolution of international reserves held by the 
HNB,  which  increased  in  2015,  after  having 
declined in 2014. At the same time, net inflows of 
foreign  direct  investment  declined  from  some  3% 
of GDP in 2014 to just 0.3% of GDP in 2015 while 
the  positive  contribution  of  other  investment 
increased  by  about  1  pp.  in  2015.  On  the  other 
hand,  the  contribution  of  portfolio  investment 
turned  negative  again 
in  2015.  The  net 
international  investment  position  (NIIP),  which 
remained broadly stable at around -88% of GDP in 
2014,  improved  to  -79%  of  GDP  by  the  end  of 
2015  while gross external debt declined to below 
77% of GDP. 

According  to  the  Commission  services'  Spring 
2016  Forecast,  the  external  surplus  is  expected  to 
contract somewhat in 2016 and 2017. 

trade  openness 

The  degree  of 
increased 
considerably in recent years to above 50% of GDP 
in 2015 but remains relatively low given the small 
size of the Croatian economy. Trade with the euro 
area  amounted  to  about  29%  of  GDP  and  thus 
constituted  over  half  of  total  trade,  with  Italy, 
Germany  and  Slovenia  as  Croatia's  largest  trade 
partners.  There,  nevertheless,  remains  significant 
room for a deepening of trade integration with the 
euro area. 

FDI  has  so  far  been  mainly  directed  into  the 
banking,  real  estate  and  retail  sectors,  with  the 
largest  inflows  originating  from  the  Netherlands, 
Austria  and  Germany.  On  the  other  hand,  Croatia 
failed  to  attract  significant  FDI  inflows  into  the 
tradable  goods  sector  and  it  is  thus  weakly 
integrated  into  global  supply  chains.  Relatively 
high 
an  unfavourable  business 
environment  appear  to  be  the  main  obstacles  to 
attracting FDI.     

costs  and 

4.6.2.  Market integration 

The  Croatian economy  is  well  integrated  with  the 
euro  area  through  trade  and  investment  linkages. 

With  regard  to  the  business  environment,  Croatia 
performs  worse  than  most  euro-area  Member 
States  according 
to  several  commonly  used 
indicators,  including  the  World  Bank's  Ease  of 

49 

Table 4.4:Croatia - Balance of payments(percentage of GDP)201020112012201320142015Current account-1.1-0.8-0.11.00.85.2of which: Balance of trade in goods-13.2-14.3-14.3-15.1-14.8-15.1                 Balance of trade in services12.813.814.815.516.817.9                 Primary income balance -3.1-3.0-3.4-2.0-3.3-0.7                 Secondary income balance2.42.72.82.62.13.1Capital account0.10.10.10.10.20.4External balance 1)-1.0-0.70.01.11.05.6Financial account 2)-2.9-3.2-0.9-0.9-0.24.6of which: Direct investment-2.1-2.5-2.7-1.9-3.1-0.3                Portfolio investment-0.9-1.5-4.0-4.41.7-0.2                Other investment 3)-0.2-0.15.71.22.43.4                Change in reserves0.20.90.14.2-1.21.7Financial account without reserves-3.1-4.1-1.0-5.11.02.9Errors and omissions-2.0-2.4-0.9-2.0-1.3-1.0Gross capital formation21.420.619.319.118.218.3Gross saving20.420.019.820.719.323.4Gross external debtn.a.88.883.282.383.676.8International investment position-95.6-91.8-90.9-89.3-88.3-79.01) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, Croatian National Bank. 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

Doing  Business  Index  and  the  World  Economic 
Forum’s  Global  Competitiveness  Index. At  the 
same time, Croatia's deficit in the transposition of 
EU directives was just 0.1% in 2015.  

Activity  and  employment  rates  are  low  compared 
to the euro-area average, which is partly related to 
underlying  institutions  and  policies  such  as  early 
retirement schemes, pension eligibility criteria, and 
the tax-benefit system. The 2013 and 2014 labour 
market reforms have significantly reduced the gap 
with other EU economies in terms of employment 
protection  legislation,  with  a  positive  impact  on 
employment  growth  but  also 
to  a 
significant  increase  in  the  use  of  temporary 
contracts.  Inefficient  wage  determination  in  the 
public  sector  still  hampers  government’s  control 
over  the  public  wage  bill  and  may  hinder  wage 
responsiveness. 

leading 

foreign ownership of the banking sector, as around 
90%  of  its  assets  are  held  by  subsidiaries  of 
foreign  banks.  Market  concentration  is  relatively 
high,  with  the  largest  five  banking  institutions 
accounting  for  more  than  70%  of  banking  sector 
assets. 

The banking system in Croatia is well capitalized. 
In  the  third  quarter  of  2015,  its  capital  adequacy 
ratio exceeded 18%, compared to 16% in the euro 
area.  However,  the  quality  of  the  loan  portfolio 
deteriorated  significantly  between  2010  and  2015 
as  the  share  of  non-performing  loans  (NPLs) 
reached 13% in Q3-2015 while it increased to 6% 
in the euro area. Profitability of the banking sector 
legislated 
was  negatively  affected  by 
conversion  of  CHF  loans  resulting  in  a  negative 
return  on  equity  in  Q3-2015,  compared  to  almost 
4% return in the euro area. 

the 

The financial sector in Croatia is highly integrated 
into  the  EU  financial  sector,  in  particular  through 

The real house price index has continued to decline 
in  recent  years,  falling  to  below  85%  of  its  2010 

50 

0102030405060708090100HR, 2010HR, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 4.10: Croatia -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators  and HNB Banks Bulletin.-10-50510152025HR, 2010HR, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 4.11: Croatia -Selected banking sector soundness indicators%Source: ECB, HNB, EC calculations.Table 4.5:Croatia - Market integration201020112012201320142015Trade openness 1) (%)40.242.943.944.847.451.1Trade with EA in goods & services 2)+3) (%)21.121.322.123.826.929.2Export performance (% change) 4)-3.8-2.90.31.74.05.4World Bank's Ease of Doing Business Index rankings 5)798084893940WEF's Global Competitiveness Index rankings 6)777681757777Internal Market Transposition Deficit 7) (%)n.a.n.a.n.a.0.60.10.1Real house price index 8)100.097.993.388.086.984.9Residential investment 9) (%)n.a.n.a.n.a.n.a.n.a.n.a. 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in  2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 4 - Croatia 

level  by  the  end  of  2015.  At  the  same  time,  bank 
lending  to  households  for  house  purchase  also 
declined  while  construction  activity  appears  to 
have remained relatively subdued. 

The financial system in Croatia is smaller relative 
to  GDP  than  that  of  the  euro  area.  Outstanding 
bank  credit to  Croatian  non-financial  corporations 
and households amounted to 63% of GDP in 2015, 
compared  to  92%  in  the  euro  area,  with  the 
majority  of  loans  denominated  in  euro.  The  stock 
of  quoted  shares  issued  by  Croatian  enterprises 
stood  at  below  40%  of  GDP  in  2015  while  it 
reached  60%  of  GDP  in  the  euro  area.  The  debt 
market,  amounting  to  62%  of  GDP  in  2015  and 
largely  dominated  by  government  securities,  is 
also  not  very  developed  relative  to  the  euro  area, 
where  it  exceeds  150%  of  GDP.  After  having 
declined  between  2010  and  2013,  the  GDP  share 
of consolidated private sector debt increased again 
to  just  above  120%  in  2014,  remaining  below  the 
euro-area average of 138%. 

51 

020406080100120140160180HR, 2010HR, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 4.12: Croatia -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services, HNB, Zagreb Stock Exchange.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
5.  HUNGARY 

5.1. 

LEGAL COMPATIBILITY 

5.1.1.  Introduction 

The  main  rules  governing  the  National  Bank  of 
Hungary (Magyar Nemzeti Bank, hereafter: MNB) 
are laid down in Article 41 of the new Hungarian 
Fundamental  Law  and  Act  CXXXIX  2013  on  the 
MNB  (hereafter:  MNB  Act).  The  MNB  Act  has 
been  subject  to  frequent  changes  including  some 
recasts over recent years. The currently applicable 
MNB  Act 
took  effect  on  1  October  2013, 
providing for the MNB to become responsible for 
macro-prudential  policy  and, 
the 
dissolution of the Hungarian Financial Supervisory 
Authority,  micro-prudential  supervision  of  the 
Hungarian  financial  sector.  Since  the  most  recent 
convergence  exercise  of  2014,  the  MNB  Act  was 
amended at several occasions (33). 

further 

to 

5.1.2.  Central Bank independence 

Frequent amendments to the Central Bank Act of a 
Member State  can create instability  in the Central 
Bank's  operations.  Therefore,  a  stable 
legal 
framework that provides a solid basis for a Central 
Bank  to  function  is  essential  for  ensuring  central 
bank independence. 

Pursuant to Section 176 of the MNB Act, the MNB 
has become the legal successor of the liabilities of 
former  Hungarian  Financial  Supervisory 
the 
Authority  (HFSA),  which  ceased  to  exist  on  1 
October  2013.  This  legal  succession  also  implies 
the transfer of all employees from the HFSA to the 
MNB  pursuant  to  Section  183  of  the  MNB  Act. 
The  principle  of  central  bank 
independence 
pursuant  to  Article  130  of  the  TFEU  implies  that 
the  MNB  must  have  sufficient  financial  resources 
to  perform  its  ESCB  and  ECB-related  tasks,  in 
addition to its national tasks. The tasks transferred 
from  the  HFSA  to  the  MNB  must  not  affect  its 

(33)  The  changes  relate  inter  alia  to  the  MNB's  resolution 
powers,  the  legal  framework  regarding  the  Financial 
Stability  Board  and  financial  stability  measures,  rules 
regarding  the  distribution  and  reproduction  of  forint  and 
euro  coins  and  forint  and  euro  medals,  the  possibility  to 
provide  emergency  liquidity  assistance  to  the  Investor 
Protection  Fund,  payment  transactions,  the  promotion  of 
the development and security of the financial intermediary 
system,  out-of-court  dispute  settlement  for  financial 
disputes. 

53 

ability to carry out these tasks from an operational 
and financial point of view. 

any  HFSA 

Further to this principle, the MNB should be fully 
insulated  from  all  financial  obligations  resulting 
from 
activities.  Contractual 
relationships in the period prior to 1 October 2013 
including,  amongst  others,  all  employment 
relations between any new MNB staff member and 
the  former  HFSA  can  be  continued  only  with  the 
proviso that the continuation does not impinge on 
the  MNB's  independence  and  its  power  to  fully 
carry out its duties under the Treaties. Against this 
background, Section 176 and 183 of the MNB Act 
have to be aligned to the principle of central bank 
independence  as  enshrined  in  Article  130  of  the 
TFEU. 

According  to  Section  9  (7)  of  the  MNB  Act,  the 
Governor and the Deputy Governors shall take an 
oath before the President of the Republic and other 
members  of  the  Monetary  Council  before  the 
Parliament  upon  taking  office  with  the  words 
required  by  Law  XXVII  of  2008  as  amended  on 
the  oath  and  solemn  promise  of  certain  public 
officials.  The  Law  requires  making  an  oath  with 
words  "I,  (name  of  the  person  taking  the  oath), 
hereby make an oath to be faithful to Hungary and 
to its Fundamental Law,  to comply with its laws, 
and  make  sure  others  citizens  comply  with  them 
too; I will fulfil the duties arising from my position 
as  a  (name  of  the  position)  for  the  benefit  of  the 
Hungarian nation […]". The oath does not contain 
a  reference  to  the  principle  of  central  bank 
independence  enshrined  in  Article  130  TFEU. 
What is more, the Fundamental Law contains only 
an  indirect  reference  to  EU  law.  Since  the 
Governor  and  the  Deputy-Governors  as  members 
of  the  Monetary  Council  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. 
Therefore,  the  oath  is  an  imperfection  as  regards 
the institutional independence of the MNB and the 
wording of the oath should be adapted to be fully 
in line with Article 130 of the TFEU.  

In  addition,  Section  156(7)  read  in  conjunction 
with Section 152(1)  of  the MNB Act,  extends  the 
application  of  conflict  of  interests  provisions  to 
to  six  months 
Monetary  Council  members 
their  employment 
following 

termination  of 

 
                                                           
relationship  with 
the  MNB.  However,  an 
exemption  is  granted  as  regards  organisations 
covered by acts enumerated in Section 39 in which 
the  Hungarian  State  or  the  MNB  has  a  majority 
stake.  Such  an  exemption  could  create  situations 
where the privileged position of Monetary Council 
members  could  give  them  an  unfair  advantage  in 
obtaining  nominations  or  posts 
in  other 
organisations, putting them in a position of conflict 
of interest while still in employment at the MNB.   

to  close 

 Moreover, Section 157 of the MNB Act provides 
for  an  obligation  for  members  of  the  Monetary 
Council,  including  the  Governor  and  the  Deputy 
Governor,  to  file  declarations  of  wealth  in  the 
same manner as Members of Parliament, pursuant 
to the provisions of Section 90 of the Law XXXVI 
of  2012  on  the  Parliament.  According  to  Section 
157(1)  of  the  MNB  Act  and  Section  90(2)  of  the 
Law  XXXVI  of  2012,  the  obligation  to  submit  a 
wealth  declaration  extends 
family 
members (spouse, domestic partner, and children). 
Pursuant  to  Section  90(3)  of  the  Law  XXXVI  of 
2012,  members  of  the  Monetary  Council  who fail 
to submit a wealth declaration will not be allowed 
to  exercise  their  functions  and  will  receive  no 
remuneration until compliance with the obligation. 
This  provision  allows  for  the  temporary  removal 
from office of inter alia the Governor which seems 
to  automatically fall  into  place  once  the failure  to 
submit  a  wealth  declaration  as  required  by  the 
above provisions is established by the Parliament. 
Such  an  automatism  may  lead  to  situations  where 
the  removal  from  office  would  result  from  an 
unintentional action that could not be qualified as a 
serious  misconduct  under  Article  14.2  of  the 
Statute of the ESCB. In order to preserve fully the 
independence, 
principle  of  central  bank 
this 
incompatibility 
removed  by  an 
should  be 
amendment of Section 157 of the MNB Act which 
would  provide  for  an  exception  for  such  kind  of 
unintentional omission. 

5.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Pursuant  to  Section  36  of  the  MNB  Act  and 
subject to the prohibition of monetary financing set 
out under Section 146 of the MNB Act, the MNB 
can  provide  an  emergency 
to  credit 
institutions  in  the  event  of  any  circumstance 
arising in which the operation of a credit institution 
jeopardizes the stability of the financial system. In 
order to comply with the prohibition on monetary 
financing of Article 123 of the TFEU, it should be 

loan 

Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

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 Section 37, as amended (34), the MNB 
may grant loans to the National Deposit Insurance 
Fund  and  Investor  Protection  Fund  in  emergency 
cases, subject to prohibition of monetary financing 
under  Section  146  of  the  Act.  Though  the  Act 
adequately  reflects  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 
cash 
to 
contributions,  government  securities,  etc.) 
secure  the  repayment  of  the  loan.  Therefore, 
Section 37 is incompatible with the prohibition on 
monetary financing as laid down in Article 123 of 
the TFEU. 

claim  on 

future 

(e.g. 

a 

of 

the 

insulate 

from  all 

the  bank 

expenses.  Therefore, 

Article  177(6)  of  the  MNB Act  provides  for  state 
compensation to the MNB of all expenses resulting 
from obligations which exceed the assets the MNB 
has  taken  over  from  the  HFSA.  The  law  does  not 
contain  any  provisions  on  the  procedure  and 
deadlines  on  how  the  state  shall  reimburse  the 
the 
MNB 
reimbursement  under  Article  177(6)  of  the  MNB 
Act  is  not  accompanied  by  measures  that  would 
fully 
financial 
obligations  resulting  from  any  activities  and 
contractual  relationships  of  the  HFSA  originating 
from  prior  to  the  transfer  of  tasks.  In  case  of  a 
substantial  time  gap  between  the  costs  arising  to 
the  MNB  and  the  reimbursement  by  the  state 
pursuant  to  Article  177(6)  of  the  MNB  Act,  the 
reimbursement  would 
in  an  ex-post 
financing scheme. Should the expenses incurred at 
the  MNB  exceed  the  value  of  assets  taken  over 
from the HFSA, such a scenario would constitute a 
breach  of  the  prohibition  of  monetary  financing 
laid down in Article 123 of the TFEU. In order to 
comply  with 
the  prohibition  of  monetary 
financing,  Sections  176  and  183  of  the  MNB  Act 
should  be  amended  in  order  to  insulate  the  MNB 
by  appropriated  means 
financial 
obligations  resulting  from 
the  HFSA's  prior 
activities  or  legal  relationships  and  obligations 
including those deriving from the automatic further 
employment of HFSA staff by the MNB. 

from  all 

result 

(34)  Article  37  was  amended,  as  from  July  2015,  by  Act 
the 

LXXXV  on  Amendments  of  Acts 
Development of the Financial Intermediary System. 

to  promote 

54 

 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

secondary  objective  of  the  ESCB  enshrined  in 
Article  127  (1)  of  the  TFEU  and  Article  2  the 
Statute  of  the  ESCB  in  order  to  embrace  the 
support  of  the  general  economic  policies  in  the 
entire EU rather than in Hungary only. 

Tasks 

The  MNB  Act 
of 
incompatibilities  with  regard  to  the  following 
ESCB/ECB tasks: 

contains 

series 

a 

•  definition  of  monetary  policy  and  the  monetary 
functions, operations and instruments of the ESCB 
(Sections 1 (2) and (3), 4, 16 – 21, 159 and 171 of 
the MNB Act); 

• conduct of foreign exchange operations (Sections 
1(2), 4(3), (4) and (12), 9 and 159(2) of the MNB 
Act) and the definition of foreign exchange policy 
(Sections  1(2),  4(4)  and  (12),  22  and  147  of  the 
MNB Act); 

• competences  of  the  ECB  and of  the  Council for 
banknotes and coins (Article K of the Fundamental 
Law and Sections 1(2), 4(2) and (12), 9, 23, 26 and 
171(1) of the MNB Act); 

There are also some imperfections in the MNB Act 
regarding the: 

• non-accurate reflection of the principle of central 
bank independence in the MNB Act (section 1 (2) 
and (3) of the MNB Act)  

•  non-recognition  of  the  role  of  the  ECB  in  the 
functioning of the payment systems (Sections 1(2), 
4(5) and (12), 9, 27-28, and 159(2), 171 (2) and (3) 
of the MNB Act); 

• non-recognition of the role of the ECB and of the 
EU  in  the  collection  of  statistics  (Section  1(2), 
30(1) and 171(1) of the MNB Act); 

•  non-recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Section 135 (5) 
of the MNB Act)); 

•  absence  of  an  obligation  to  comply  with  the 
Eurosystem's regime for the financial reporting of 
NCB  operations  (Section  12(4)(b)  and  Law  C  of 
2000/95  (IX.21.)  in  conjunction  with Government 
Decree 221/2000 (XII.19.)); 

On 26 April 2016 the Hungarian legislator adopted 
an  amendment  to  Section  162  of  the  MNB  Act 
which remedied a law which was previously found 
unconstitutional  by  the  Hungarian  Constitutional 
Court (35).  The  new  amendment  to  the  MNB  Act 
introduces  provisions  on 
the  conditions  of 
disclosure  of  data  by  a  company  related  to  the 
MNB (36).  Furthermore,  the  amendment  provides 
for  supervision  of  the  State  Audit  Office  of  the 
operations  of  foundations  established  by 
the 
MNB (37).  

Notwithstanding  the  limitations  regarding  access 
to  data  of  MNB  companies,  it  is  noted  that 
pursuant  to  the  principle  of  sincere  cooperation 
(Article 4 TEU) a Member State is required, in full 
mutual  respect,  to  assist  the  Commission  and  the 
European Central Bank in carrying out tasks which 
flow  from  the  Treaties,  such  as  providing  the 
the 
information 
application of EU law. 

for  monitoring 

necessary 

5.1.4.  Integration in the ESCB 

Objectives 

Article  3(2)  of  the  MNB  Act  determines  that, 
without prejudice to the primary objective of price 
stability,  the  MNB  shall  uphold  to  maintain  the 
stability  of  the  financial  intermediary  system,  to 
increase  its  resilience,  to  ensure  its  sustainable 
contribution  to  economic  growth  and  support  the 
economic policy of the government. The objective 
laid  down  in  Article  3(2)  of  the  MNB  Act  is 
reduced  to  supporting  the  economic  policy  in 
Hungary.  The  Article  has  to  be  aligned  to  the 

(35)  Decision  Hungarian  Constitutional  Court  –  No  8/2016  of 

31 March 2016. 

(36)  Data  relating  to  any  task  of  the  MNB  and  processed  by 
company  mostly  or  entirely  owned  by  the  MNB  shall  not 
be public until published by the company, but at  most ten 
years  from  the  time  it  was  generated,  if  such  disclosure 
would  compromise  the  central  economic  or  monetary 
policy. Furthermore, data relating to business activities and 
processed  by  companies  mostly  or  entirely  owned  by  the 
MNB or a company directly or indirectly managed by such 
a  company  shall  not  be  disclosed  if  it  would  cause 
disproportionate  harm  to  the  company's  business  activity. 
Disproportionate  harm  is  defined  as  providing  an  undue 
advantage to any competitor of such MNB company. 
(37)  The original amendment to the MNB Act which was found 
unconstitutional 
regarding 
inter  alia  provided 
foundations  established  by  the  MNB  only  data  relating  to 
the  founder  including  the  charter  as  well  as  information 
regarding  the  financial  contribution  required  for  the 
foundation’s  purpose  as  set  out  in  the  charter,  should  be 
public;  any  other  data  managed  by  the  foundation  should 
be  accessible  exclusively  in  accordance  with  the  law  on 
civil associations instead of laws on access to information 
of public interest. This provision was repealed. 

that 

55 

 
                                                           
•  non-recognition  of  the  role  of  the  ECB  and  the 
Council  in  the  appointment  of  external  auditors 
(Sections 6 (1) (b), 15 and 144 of the MNB Act). 

5.1.5.  Assessment of compatibility 

As regards central bank independence of the MNB, 
the  prohibition  on  monetary  financing  and  the 
integration of the MNB into the ESCB at the time 
of euro adoption, existing Hungarian legislation is 
not  fully  compatible  with  the  Treaties  and  the 
Statute  of  the  ESCB  and  the  ECB  pursuant  to 
Article 131 of the TFEU. 

5.2. 

PRICE STABILITY 

5.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  below  the 
reference value at the time of the last convergence 
assessment  of  Hungary  in  2014.  Average  annual 
inflation  fell  to  -0.3%  by  March  2015,  before 
starting to gradually rise again. In April 2016, the 
reference  value  was  0.7%,  calculated  as  the 
average of the 12-month average inflation rates in 
Bulgaria,  Slovenia  and  Spain  plus  1.5  percentage 
points.  The  average  inflation  rate  in  Hungary 
during the 12 months to April 2016 was 0.4%, i.e. 
0.3  percentage  points  below  the  reference  value. 
The 12-month average inflation rate is projected to 
remain  below  the  reference  value  in  the  months 
ahead. 

5.2.2.  Recent inflation developments 

Annual  HICP  inflation  in  Hungary  over  the  last 
two  years  reflected  mainly  global  trends  and  was 
mostly driven by the fall in oil prices. The annual 
changes  of  consumer  prices  were  negative  in 

Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

low 

context  of  historically 

several  months,  but  there  was  no  real  threat  of 
deflation, as core inflation remained around 1-2%. 
Headline  inflation  hovered  around  zero  in  2014, 
amid deep price decreases of unprocessed food and 
energy. Although GDP growth was high, domestic 
demand  generated  no  inflationary  pressure  yet,  in 
inflation 
the 
expectations.  By  January  2015,  the  decline  in 
market  energy  and  food  prices  pushed  headline 
-1.4%.  The  oil  price  decrease 
to 
inflation 
the  forint 
in  2015,  and  although 
continued 
depreciated and the output gap closed according to 
the  Commission  services'  methodology,  the  pass-
through to consumer prices was slow and limited. 
Nevertheless,  HICP  inflation  rose  to  1%  by  end-
2015,  partly  due  to  unprocessed  food  prices.  In 
early  2016  inflation  fell  again,  mainly  due  to  a 
VAT cut on some meat products and a further drop 
in the oil price.  

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  was  less 
volatile  than  HICP  inflation  over  the  past  two 
years.  Core  inflation  declined  from  around  2%  in 
mid-2014  to  0.8%  by  end-2014.  It  increased  in 
early  2015  and  remained  around  1.5%  from  April 
2015. Processed food inflation fell from above 3% 
in  mid-2014  to  zero  by  early  2015,  supported  by 
lower  unprocessed  food  prices.  It  then  gradually 
increased  to  around  1%  by  end-2015,  before 
decreasing  again  in  early  2016.  Prices  of  non-
energy industrial goods started rising in 2015, after 
having  remained  at  an  unchanged  level  in  2014, 
reflecting  the  impact  of  the  weakening  exchange 
rate and strengthening  domestic  demand.  Services 
inflation  was  rather  stable  at  around  2%  over  the 
past  two  years,  with  no  significant  wage  pressure 
appearing,  despite  the  tightening  labour  market. 
Industrial  producer  price  inflation  turned  negative 
in early 2014 and was still negative in early 2016, 

56 

-10123456Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16HungaryReference valueGraph 5.1: Hungary -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-202468201020112012201320142015HungaryEuro areaGraph 5.2: Hungary -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

suggesting  that  pipeline  price  pressures  remain 
contained.  

5.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

After reaching the rate of 3.7% in 2014, real GDP 
growth  in  Hungary  declined  to  2.9%  in  2015. 
Private  consumption  and  the  external  sector  both 
picked  up  and  contributed  to  growth.  The  former 
grew by 3% in 2015, supported by household real 
disposable 
income,  which  was  also  growing 
strongly  thanks  to  low  inflation  and  high  nominal 
wage  growth.  Households  have  also  benefited 
from one-off measures including a reimbursement 
from  banks  for  so-called  illegitimate  interest  and 
exchange  rate  changes.  The  1  pp.  cut  in  the  flat 
personal  income  tax  rate  introduced  in  January 
2016  had  a  similar  effect.  The  good  performance 
of  the  labour  market  also  supported  consumption. 
Based  on  the  Commission  services'  Spring  2016 
Forecast,  real  GDP  growth  is  expected  to  reach 
2.5% in 2016 and 2.8% in 2017. The output gap is 
estimated to have closed in 2015. 

The  fiscal  policy  stance,  as  measured  by  the 
change in the structural balance, was significantly 
loosened in 2014 (by some 0.7 pp. of GDP) mostly 
on  account  of  dynamic  growth  of  cyclically-
adjusted  government  expenditure  in  the  election 
year.  There  was  some  tightening  in  2015,  but  the 
Commission  services'  Spring  2016  Forecast 
projects a renewed loosening in 2016, followed by 
a partial reversal of this effect in 2017. 

Monetary  policy,  conducted  within  an  inflation 
targeting framework (38), has been further loosened 
since  2014,  in  view  of  below-target  inflation. 
Starting  from  7%  in  August  2012,  the  base  rate 
was  gradually  reduced  to  2.1%  by  July  2014.  In 
March  2015,  the  MNB  restarted  the  rate-cutting 
cycle,  lowering  the  policy  rate  in  five  equal  steps 
to 1.35% by July 2015. The MNB resumed policy 
rate  reduction  in  March  2016  (by  15  basis  points 
steps), with the policy rate reaching 1.05% by end-
April. In addition to policy rate cuts, the MNB also 
loosened  its  policy  via  unconventional  measures, 
in  particular  through  the  Funding  for  Growth 
Scheme  (FGS)  and  from  2016 
the  Growth 
Supporting Programme (GFP) which aim to foster 
to  SMEs.  General  credit  conditions 
lending 
remained  tight  in  the  last two  years, despite some 
gradual  easing.  Net  lending  to  corporates  turned 
positive  in  2014  thanks  to  the  FGS,  but  it  was 
negative  again  in  2015,  partly  due  to  one-off 
factors. 

Wages and labour costs 

The  improvement  of  the  labour  market  continued 
in 2014-2015. Employment grew by around 5% in 
2014  and  3%  in  2015,  not  only  due  to  the 
government’s  public  works  scheme,  but  also 
because  of  job  creation  in  the  private  sector.  The 
unemployment rate reached an all-time low, falling 
below  7%  in  2015.    Accordingly,  nominal  wage 
growth  was  around  4%  in  2015,  with  no  sign  of 
moderation, despite the low-inflation environment. 

(38)  Since  August  2005,  the  MNB  pursues  a  continuous 
medium-term  inflation  target  of  3%  with  a  permissible 
fluctuation  band  of  +/-  1  percentage  point  (which  was 
changed from 'ex post' to 'ex ante' in March 2015). 

57 

Table 5.1:weights  Hungary - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP4.73.95.71.70.00.10.41000Non-energy industrial goods1.91.32.60.30.00.81.1217Energy11.89.38.6-6.1-6.6-7.4-6.2154Unprocessed food 5.92.86.26.9-1.93.64.380Processed food4.06.19.04.82.40.50.7217Services3.92.14.13.62.32.22.1332HICP excl. energy and unproc. food3.33.05.03.01.61.31.4766HICP at constant taxes2.53.73.51.20.00.00.41000Administered prices HICP6.74.85.1-4.8-6.1-0.70.11511) 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.Sources: Eurostat, Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

inflation  is  accentuated  by  their  relatively  high 
weight  in  the  HICP  basket.  Growth  of  import 
prices (measured by the imports of goods deflator), 
had almost no inflationary effect in 2014, while the 
disinflationary impact started to dominate in 2015 
(the  deflator  turned  negative  again)  and  this  is 
expected to fade over the forecast horizon.  

Import  price  dynamics  have  been  significantly 
influenced  by  exchange  rate  fluctuations.  The 
forint's nominal effective exchange rate (measured 
against  a  group  of  36  trading  partners)  weakened 
on average by 3.2% in 2014 and by further 2.1% in 
2015.  The  change  of 
the  nominal  effective 
exchange rate would suggest inflationary pressure, 
rate 
but 
depreciation  to  consumer  prices  appears  much 
smaller than in the past. Looking ahead, the change 
of  import  prices  is  expected  to  remain  supportive 
of  a  low-inflation  environment  in  2016,  pending 
only moderate weakening of the exchange rate. 

the  pass-through  of 

the  exchange 

Administered prices and taxes 

The  share  of  administered  prices (39)  in  the  HICP 
basket  is  relatively  high  in  Hungary  at  around 

(39)  According to the Eurostat definition, administered prices in 
Hungary  include  inter  alia  water  supply,  refuse  and 
sewerage  collection,  electricity,  gas,  heat  energy, 
pharmaceutical  products,  certain  categories  of  passenger 
transport 
see 
http://ec.europa.eu/eurostat/documents/272892/272989/HI

services.  For 

details, 

postal 

and 

58 

Labour  productivity  growth  was  negative  in  2014 
and  zero  in  2015,  but  it  is  expected  to  gradually 
increase  over  the  forecast  horizon.  Compensation 
per employee growth was also below 1% in 2014, 
but  its  pick-up  in  2015  contributed  to  an  increase 
in  unit  labour  costs  by  around  2%.  The  ULC 
growth is to remain broadly stable in 2016 and it is 
projected to decrease in 2017 with the increase in 
labour productivity growth. 

External factors 

the  high  degree  of  openness  of 

the 
Given 
Hungarian  economy,  developments 
import 
prices  play  an  important  role  in  domestic  price 
formation.  The  impact  of  lower  energy  and 
commodity  prices  on  headline 
agricultural 

in 

-404820102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 5.3:Hungary -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast.Table 5.2:Hungary - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationHungary4.73.95.71.70.00.10.42.3Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorHungary3.73.76.32.11.00.10.82.3Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeHungary-0.33.12.11.80.93.34.64.3Euro area2.22.21.81.71.31.21.51.9Labour productivityHungary1.01.7-1.80.9-1.10.11.62.7Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsHungary-1.31.44.00.92.03.22.91.5Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorHungary1.75.04.3-0.60.1-1.1-0.50.3Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
 
 
                                                           
 
 
 
 
 
16%,  compared  to  the  euro  area  average  (13%). 
Administered  prices  declined  by  4.8%  in  2013, 
chiefly  on  account  of  three  waves  of  cuts  in 
regulated energy and other utility prices introduced 
as of January, July and November. These measures 
had an overall effect on the inflation rate of over -1 
pp. for 2013 and entail − as a full-year effect − an 
additional reduction in the inflation rate of around 
1 pp. for 2014. A further round of utility price cuts 
happened  in  April,  September  and  October  2014 
(with  smaller  items  like  the  price  of  chimney 
sweeping  and  school  textbooks),  which  decreased 
annual HICP by an additional 0.2 pp. in 2014 and 
2015.  Overall,  administered  prices 
lowered 
headline inflation by about 1.2 pp. in 2014 and 0.1 
pp. in 2015 

Changes  in  taxation  had  a  very  limited  effect  on 
inflation  in  2014-2015.  There  were  no  major 
indirect tax changes in these two years, only some 
excise  duty  increases  on  alcoholic  beverages  and 
tobacco. The harmonised index of consumer prices 
at constant tax rates reflects the lack of significant 
changes  in  the  tax  system  in  2014  and  2015. 
Starting  from  2016,  the  VAT  on  some  meat 
products  was  reduced  to  5  percent,  which  would 
have  a  downward  effect  on  headline  inflation  of 
about 0.2 pp., assuming full pass through.  

Medium-term prospects 

The historically low inflation figures over the past 
years have been driven to a large extent by the fall 
in  oil  prices.  Core  inflation  stood  at  a  moderate 
level,  close  to  1%  in  early  2016,  although  the 
output  gap  closed.  Therefore  once  the  effects  of 
low  oil  prices  fade,  domestic  demand  is  expected 
to  push  inflation  to  converge  towards  the  central 
bank's  3%  target.  Accordingly,  the  Commission 
services'  Spring  2016  Forecast  projects  HICP 
inflation  to  average  0.4%  in  2016  and  2.3%  in 
2017. 

Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

The level of consumer prices in Hungary stood at 
about 57% of the euro area average in 2014, with 
the  relative  price  gap  larger  for  services  than  for 
goods. This suggests that there is scope for further 
price  level  convergence  in  the  long  term,  as 
income  levels  (around  64%  of  the  euro  area 
average in PPS in 2014) rise towards the euro area 
average. 

Medium-term 
inflation  prospects  will  depend 
strongly  on  wage  and  productivity  developments, 
notably  on  efforts 
to  avoid  excessive  wage 
increases  in  the  non-tradable  sector  and  on  the 
success  with  anchoring  inflation  expectations  at 
the central bank's 3% target. 

5.3. 

PUBLIC FINANCES 

5.3.1.  Recent fiscal developments 

On 21 June 2013, the Council decided to abrogate 
the  decision  on  the  existence  of  an  excessive 
deficit  according  to  Article  126  (12)  TFEU, 
thereby closing the excessive deficit procedure for 
Hungary (40).  Since  then,  the  general  government 
deficit  has  been  kept  firmly  below  3%  of  GDP. 
The  deficit  decreased  to  2.3%  of  GDP  in  2014 
from 2.6% in the previous year, and then declined 
further  reaching  2.0%  GDP 
in  2015.  Both 
government  revenues  and  expenditure  increased 
during this period relative to GDP, but the latter to 
a  smaller  extent,  resulting  in  an  improved  fiscal 
balance.  The  revenue-to-GDP  ratio  went  up  from 
47% in 2013 to 47.5% in 2014, and then further to 
48.9%  in  2015.  This  development  reflected  an 
elevated  level  of  EU  funds  absorption  by  the 
general government and an upward trend in the tax 
burden,  primarily  due  to  improvements  in  tax 
administration  and  a 
the 
the 
economic  recovery.  At 
expenditure ratio went up by more than 1 pp. over 
the two years surpassing 50% of GDP.  

tax-rich  nature  of 
time, 

the  same 

Risks to the inflation outlook appear to be broadly 
balanced.  Upside  risks  to  the  projection  relate 
mainly to a stronger-than-expected recovery and a 
possible  weakening  of  the  exchange  rate.  At  the 
same  time,  if  the  global  inflation  environment 
into 
weakens 
continuing low inflation. 

this  could 

translate 

further, 

in 

target  set 

The  2015  budgetary  outturn  overachieved  the 
deficit 
the  2015  Convergence 
Programme  by  0.4  pp.  of  GDP.  Tax  and  social 
security 
the 
receipts 
interest  expenditure 
budgeted  numbers,  while 
turned  out  to  be  lower.  The  resulting  deficit-
improving  impact  was  partially  absorbed  by  extra 
the  higher-than-
expenditure,  most  notably 

significantly  exceeded 

CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b 

(40)  An  overview  of  all  excessive  deficit  procedures  can  be 

found at: http://ec.europa.eu/economy_finance/economic_ 

governance/sgp/deficit/index_en.htm 

59 

 
                                                                                   
                                                           
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

effect  of  foreign-exchange-denominated  debt,  as 
well as delays in the reimbursement of EU funds. 

5.3.2.  Medium-term prospects 

The  2016  budget  was  adopted  by  the  Hungarian 
Parliament  on  23  June  2015,  well  ahead  of  the 
standard mid-December date. It targets a deficit of 
2%  of  GDP,  while  incorporating  considerable  tax 
cuts  and  some  new  spending  commitments. 
Revenue-side  measures,  amounting  to  0.7%  of 
GDP, include the halving of the bank levy, a 1 pp. 
decrease of the flat rate personal income tax and an 
increase  of  the  family  tax  allowance  after  two 
children as well as the cutting of the VAT rate on 
unprocessed  pork  meat.  On  the  expenditure  side, 
the  budget  extends  career  path  schemes  to  civil 
servants  in  central  government  and  entails  extra 
appropriations  for  the  public  works  scheme  and 
capital  expenditure  from  domestic  sources.  The 
deficit-increasing  effect  of  these  new  measures  is 
planned  to  be  more  than  counterbalanced  by 
declining  interest  outlays,  savings  in  spending  on 
social  transfers  and  the  domestic  co-financing  of 
EU  funded  projects  as  well  as  by  contained 
expenditure  on  operating  costs.  In  addition,  the 
budget  counts  on  substantial  one-off  revenues 
(around 0.4% of GDP) from agricultural land sales 

60 

expected  spending  from  the  domestic  sources  on 
EU co-financed projects. The cyclical upturn seen 
since  2013  has  facilitated  the  containment  of  the 
general  government  deficit  with  strong  revenue 
dynamics  and  a  favourable  denominator  effect  on 
the  expenditure-to-GDP 
the 
structural  balance  deteriorated 
considerably, 
decreasing  by  0.7  pp.  to  below  -2%  of  GDP  in 
2014  and  improving  only  slightly  to  -2%  in  2015 
despite the better-than-expected headline deficit.  

ratio.  However, 

Following  the  selling  of  the  previously  acquired 
second-pillar  pension  fund  assets,  the  government 
debt-to-GDP  ratio  remained  on  a  declining  path, 
but  the  pace  of  debt-reduction  slowed  down 
somewhat. It decreased by around 1½ pp. over two 
years  to  close  to  75%  by  the  end  of  2015,  helped 
by a relatively low budget deficit and high nominal 
GDP growth (41). The reduction of the public debt 
was  hampered  by  adverse  stock-flow  adjustment 
developments including the financial costs of state 
acquisitions  of  corporate  assets,  the  revaluation 

(41)  Eurostat  has  expressed  a  reservation  on  the  quality  of 
government finance data reported by Hungary in the April 
2016 notification. This relates to the sector classification of 
Eximbank  and  would  result 
the 
government debt level for all years. 

increase  of 

in  an 

Table 5.3:Hungary - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1) 2)20102011201220132014201520162017General government balance-4.5-5.5-2.3-2.6-2.3-2.0-2.0-2.0- Total revenues45.044.346.347.047.548.746.446.1- Total expenditure49.649.748.649.649.850.748.448.1   of which: - Interest expenditure4.14.24.64.54.03.63.13.0p.m.: Tax burden37.536.938.638.238.639.238.738.3Primary balance-0.4-1.32.31.91.71.61.11.0Cyclically-adjusted balance-2.9-4.7-0.7-1.4-1.9-2.1-2.2-2.5One-off and temporary measures0.7-0.20.70.10.30.00.70.0Structural balance 3)-3.6-4.5-1.4-1.5-2.2-2.0-2.9-2.5Government gross debt80.680.878.376.876.275.374.373.0p.m: Real GDP growth (%)0.71.8-1.71.93.72.92.52.8p.m: Output gap-3.3-1.5-3.3-2.4-0.70.10.51.0Convergence programme2016201720182019General government balance-1.9-2.4-1.8-1.5Structural balance 3) 4)-2.6-2.5-2.1-2.0Government gross debt74.573.672.468.4p.m. Real GDP (% change)2.53.13.43.11) Commission services’ Spring 2016 Forecast.2) Excluding Eximbank.3) Cyclically-adjusted balance excluding one-off and other temporary measures.4) Commission services’ calculations on the basis of the information in the programme. One-off and other temporary measures Sources: Commission services, the 2016 Convergence Programme of Hungary.taken from the programme  (0.7 % of GDP in 2016, deficit-reducing; zero afterwards). 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

In 

late  2016, 

Investment  Fund. 
enacted 

to cover the costs of investment projects of the so-
called 
the 
further  measures  with 
Parliament 
significant  budgetary  effects  (estimated  at  some 
0.3%  of  GDP)  aimed  at  boosting  the  construction 
of  residential  houses,  introducing  a  new  generous 
housing  grant  scheme  for  families  with  children 
and cutting the VAT rate on newly built flats.  

The  Commission  services'  Spring  2016  Forecast 
projects  the  current  year's  deficit  at  2%  of  GDP, 
i.e.  identical  with  the  official  target.  The  forecast 
counts  on  a  considerably  increased  budgetary 
breathing  space  even  compared  to  the  initial 
budgeted numbers. This is the result of favourable 
base  effects,  lower-than-expected  interest  outlays, 
higher-than-planned receipts from agricultural land 
sales  and  a  sizeable  windfall  in  corporate  income 
tax  expected  to  be  paid  under  a  corporate  income 
tax credit arrangement in 2016 and 2017. Based on 
updated government plans, however, these deficit-
improving effects are estimated to be absorbed by  
expenditure  increasing  measures.  Based  on  a  no-
policy-change  assumption,  the  deficit  is  projected 
to  remain  at  2%  of  GDP  in  2017 (42).  While  the 
headline  deficit  is  forecast  to  remain  stable,  the 
structural budget balance is expected to deteriorate 
sharply to around -3% of GDP in 2016 and then to 
reverse to around -2.5% in 2017. This reflects the 
cyclical upturn of the economy and a one-off effect 
in  2016.  At  the  same  time,  the  debt  ratio  is 
expected  to  decline  further  to  73%  by  the  end  of 
2017,  even  though  delays  in  the  receipt  of  EU 
funds are assumed to have a debt-increasing effect 
throughout the forecast horizon.  

The  2016  Convergence  Programme,  covering  the 
period  of  2016-2020,  was  submitted  by 
the 
Hungarian  authorities  on  30  April  2016.  It  plans 
the headline deficit to increase to 2.4% of GDP by 
2017  and  then  to  decrease  gradually  to  1.2%  of 
GDP  by  2020.  The  government  plans  a  gradual 
improvement  of  the  structural  balance  in  order  to 
reach its medium-term objective, a deficit of 1.5% 
of  GDP  in  structural  terms  as  of  2017.  However, 
using  the  commonly  agreed  methodology,  the 
recalculated structural deficit would remain higher 
than  the  MTO  throughout  the  programme  period. 
Based  on  its  assessment  of  the  convergence 
programme 
the 
Commission  services'  Spring  2016  Forecast,  the 

account 

taking 

into 

and 

Commission  is  of  the  opinion  that  there  is  a  high 
risk  that  Hungary  will  not  comply  with  the 
provisions of the Stability and Growth Pact, as it is 
expected 
the 
preventive  arm  requirements.  Further  details  can 
be 
the  2016 
Convergence Programme for Hungary (43).  

significantly  deviate 

the  Assessment  of 

found 

from 

to 

in 

As  far  as  the  fiscal  framework  is  concerned  – 
which  refers  to  numerical  fiscal  rules,  medium-
term  budgetary  frameworks,  independent  fiscal 
institutions,  and  budgetary  procedures  – 
the 
process  of  re-regulation  started  with  the  adoption 
of  the  new  Fundamental  Law  in  2011  has  led  to 
mixed results. The ongoing revamp has weakened 
some  aspects  of  the  efficiency  of  its  operation 
(most  notably  by  replacing  the  forward-looking 
real  debt  rule  with  a  pro-cyclical  debt  ceiling), 
while  strengthening  others  (inter  alia,  providing  a 
constitutional  basis  for  the  new  set-up).  The 
progressively introduced set of national numerical 
rules  has  been  all  complied  with  over  the  last 
couple  of  years.  Despite 
the  recent  gradual 
reinforcements,  the  Fiscal  Council  is  not  yet  a 
body  with  a  strong  analytical  basis,  in  contrast 
with  its  veto  power  over  the  annual  budget  bill. 
The  medium-term  budgetary  framework  was 
revamped in late 2013, but its implementation was 
repeatedly  delayed  and 
in 
genuinely  lengthening  the  planning  horizon  is  yet 
to be established. 

its  effectiveness 

5.4. 

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%. On 26 
February  2008,  the  exchange  rate  band  was 
abolished and a free-floating exchange rate regime 
was  adopted  that  however  allows  for  foreign 
exchange interventions by MNB. In March 2015, a  
+/-1  percentage  point  ex  ante  tolerance  band  was 
designated  around  the  continuous  medium-term 
inflation target  of  3 percent (that is  in place  since 
2005),  representing  that  inflation  may  fluctuate 
around the point target as an effect of shocks.  

In the context of improving imbalances in Hungary 
being  more  than  counterweighted  by  relatively 

(42)  Following  the  cut-off  date  of  the  Spring  Forecast,  the 
government released the new 2017 draft budget increasing 
the  deficit  target  to  2.4%  of  GDP.  The  new  measures 
include  VAT  cuts  for  specific  goods,  which  could  not  be 
incorporated yet in the Commission forecast. 

(43)

http://ec.europa.eu/economy_finance/economic_gov

ernance/sgp/convergence/index_en.htm 

61 

 
                                                           
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

loan-related 

looser monetary policy and rising geopolitical risks 
(mainly  related  to  the  conflict  in  Ukraine),  the 
forint  depreciated  against  the  euro  by  about  4% 
between May 2012 and May 2014. The forint fell 
further in summer 2014, but regained those losses 
in  the  autumn,  as  the  rate-cutting  cycle  ended  in 
Hungary  and  the  MNB  provided  FX  liquidity  for 
housing  mortgage 
currency 
conversions  to  the  banking  sector.  The  forint  was 
again  weaker  in  January  2015  (HUF/EUR  316.5), 
following  the  SNB's  decision  to  let  the  CHF 
appreciate,  but  then  strenghtened  in  the  wake  of 
further  monetary  easing  in  the  euro  area.  Since 
June  2015,  the  forint  has  been  broadly  stable 
against  the  euro,  trading  mostly  between  310  and 
315.  Overall,  during  the  two  years  before  this 
assessment, the forint depreciated against the euro 
by  about  1%.  Inter-day  exchange  rate  volatility 
during this period was highest in March 2015 and 
declined since then. 

around 200 basis points thereafter till March 2015. 
The  MNB  then  restarted  the  rate-cutting  cycle 
lowering the policy rate over five month by overall 
75  basis  points  to  1.35%,  which  also  mostly 
showed up in a narrowing interest rate differential. 
From  September  2015,  the  MNB  changed  its  key 
policy  instrument  from  the  two-week  deposit  to  a 
three-month  deposit  instrument.  However,  short-
term interest rate differentials widened again from 
late  2015,  due  to  the  impact  of  the  ECB's  asset 
purchase programmes on euro-area money market 
interest  rates.  The  MNB  resumed  policy  rate 
reduction  in  March  2016,  cutting  by  15  basis 
points in both March and April. At the cut-off date 
of  this  report,  the  3-month  spread  vis-à-vis  the 
euro area reached around 140 basis points. 

5.5. 

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 around 9 years.  

level  of 

International  reserves  hovered  generally  around 
EUR 35bn between early 2012 and mid-2015, at a 
level two times higher than that of the 2006-2008 
pre-crisis  period.  The 
international 
reserves was mainly influenced by  sovereign  debt 
management  decisions  (e.g.  no  international  bond 
issuance  in  2015),  MNB  measures  (e.g.  the  Self-
Financing  Programme  and  its  FX  swaps  with  the 
banking  sector  for  the  conversion  of  household 
foreign  exchange  loans)  and  the  uneven  payment 
of  EU  funds.  Accordingly,  international  reserves 
fell  to  around  EUR  30bn  by  end-2015,  which 
corresponded  to  about  28%  of  GDP.  Hungary 
repaid  the  last  tranches  of  its  2008  EU-IMF 
financial assistance in November 2014 (EUR 2bn) 
and April 2016 (EUR 1.5bn) to the EU. 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  decreased  till  August  2014  in  parallel 
with  the  MNB's  policy  rate  reductions  and  stayed 

62 

2202402602803003203402010201120122013201420152016Graph 5.4:Hungary -HUF/EUR exchange rate (monthly averages)Source: ECB.02004006008002010201120122013201420152016Graph 5.5:Hungary -3-M Bubor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Hungary. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

The  Hungarian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  below  the  reference  value  at 
the  time  of  the  2014  convergence  assessment  of 
Hungary.  It  then  fell  from  5.8%  to  3.4%  by  late 
2015  and  has  remained  broadly  stable  since  then. 
In April 2016, the latest month for which data are 
available, the reference value, given by the average 
of  long-term  interest  rates  in  Bulgaria,  Slovenia 
and Spain plus 2 percentage points, stood at 4.0%. 
In that month, the 12-month moving average of the 
yield  on  the  Hungarian  benchmark  bond  stood  at 
3.4%, 
the 
reference value. 

i.e.  0.6  percentage  points  below 

The  long-term  interest  rate  of  Hungary  decreased 
between  early  2012  and  early  2015  by  about  650 
basis  points,  approaching  3%.  This  reflected 
improving financial market confidence and falling 
domestic  inflation,  against  the  background  of  a 
global  search  for  yields.  Long-term  interest  rates 
increased  with  rising  US  and  euro-area  yields 
between  February  and  June  2015.  Afterwards, 
Hungarian  long-term  yields  fell  somewhat  further 
in 2015, facilitated by low inflation until the Fed's 
rate  hike  and  stayed  broadly  around  3.3%  since 
then.  Long-term  spreads  vis-à-vis  the  German 
benchmark bond stood at some 290 basis points in 
April 2016. 

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 
financial 
developments,  product, 
market integration – gives an important indication 
of  a  Member  State's  ability  to  integrate  into  the 
euro area without difficulties.  

labour  and 

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (44) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Hungary  exceeded  the 
indicative  threshold  in  three  out  of  fourteen 
indicators,  two  in  the  area  of  external  imbalances 
(i.e.  the  net  international  investment  position  and 
export market share) and one in the area of internal 
imbalances (i.e. general government gross debt). In 
line with the conclusion of the AMR 2016 (i.e. that 
imbalances had been identified for Hungary in the 
previous  MIP  round),  Hungary  was  subject  to  an 
in-depth  review  which  found  that  Hungary  is  not 
experiencing macroeconomic imbalances.  

5.6.1.  Developments  of 

the  balance  of 

payments 

(i.e. 

The  external  balance  of  Hungary 
the 
combined  current  and  capital  account)  gradually 
increased  to  7.6%  of  GDP  by  2013.  The  external 
surplus  reached  around  6%  of  GDP  in  2014  and 
rose 
in  2015.  The 
improvement reflected higher surpluses in both the 

to  nearly  9%  of  GDP 

(44)

http://ec.europa.eu/europe2020/pdf/2016/ags2016_al

ert_mechanism_report.pdf 

63 

024681012Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16HungaryReference valueGraph 5.6:Hungary -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.02468102010201120122013201420152016HungaryGermanyGraph 5.7:Hungary -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

current  and  capital  accounts.  The  current  account 
surplus  increased  from  2%  of  GDP  in  2014  to 
around  4%  of  GDP  in  2015,  mainly  due  to  an 
increase in the trade in goods balance. The primary 
income balance also improved from 2014 to 2015. 
The  growing  capital  account  surplus  reflected 
higher absorption of EU funds.  

corresponding  indicator  doubled  (from  1.6%  in 
2014  to  3.4%  in  2015).  Overall  investment  as  a 
share  of  GDP  has  increased  between  2013  and 
2015, reflecting positive real growth in gross fixed 
capital 
remained  at 
relatively  low  levels  compared  to  the  pre-crisis 
years, despite the record high inflow of EU funds. 

formation.  However, 

it 

Hungary's savings-investment surplus decreased in 
2014 and increased in 2015. Accordingly, the high 
savings rate in the economy declined slightly from 
2013  to  2014  but  increased  further  by  2.5  pp.  in 
2015.  The  savings  rate  of  the  household  sector 
increased  further,  the  enterprise  sector's  savings 
rate  decreased  while  the  government  sector's 

Despite  some  minor  volatility,  price  and  cost 
competitiveness 
indicators  of  Hungary  have 
generally  improved  over  the  last  two  years.  The 
weakening of the  nominal effective  exchange  rate 
of the forint in 2014 and 2015 was reflected in the 

64 

0102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 5.8:Hungary -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.8090100110120201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 5.9:Hungary -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100)Table 5.4:Hungary - Balance of payments(percentage of GDP)201020112012201320142015Current account0.30.81.83.92.04.2of which: Balance of trade in goods2.72.92.93.42.43.9                 Balance of trade in services2.73.33.83.94.74.7                 Primary income balance -4.7-4.8-4.2-2.8-4.5-3.7                 Secondary income balance-0.4-0.6-0.8-0.5-0.7-0.7Capital account1.82.32.63.63.74.5External balance 1)2.13.14.37.65.78.7Financial account 2)1.10.74.76.24.67.5of which: Direct investment-2.9-1.4-2.2-0.1-2.8-1.0                Portfolio investment0.3-6.3-1.5-3.03.05.2                Other investment 3)0.74.511.88.13.67.8                Of which International financial assistance0.0-2.0-3.9-5.0-1.90.0                Change in reserves3.13.9-3.31.10.7-4.5Financial account without reserves-2.0-3.28.15.13.912.0Errors and omissions-1.0-2.50.4-1.4-1.1-1.2Gross capital formation20.720.519.520.622.222.0Gross saving21.021.321.124.624.426.9Gross external debt160.5161.5158.3145.5145.0133.7International investment position-108.9-106.4-94.2-83.5-75.5-69.91) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, Magyar Nemzeti Bank. 
 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

real-effective  exchange  rate  deflated  by  HICP, 
while  the  ULC-based  measure  remained  broadly 
stable.  Hungary's  export  performance  improved 
markedly both in 2014 and 2015. 

remain  at  around  8%  of  GDP  in  both  2016  and 
2017.  

5.6.2.  Market integration 

the  new  methodology.  Direct 

Mirroring  a  continuous  external  surplus, 
the 
financial account has also been positive according 
to 
investment 
registered  a  net  inflow  of  2.8%  of  GDP  in  2014 
and 1% of GDP in 2015. Portfolio investment net 
outflows reached 3.0% of GDP in 2014 and rose to 
5.2%  in  2015,  partly  reflecting  the  withdrawal  of 
foreign 
forint-denominated 
from 
government securities. Other investment continued 
to  register  large  outflows  in  2014-15,  while 
international reserves fell in 2015. The decrease of 
external  debt,  which  is  ongoing  since  2011, 
proceeded slowly in 2014, but accelerated in 2015. 
The net international investment position improved 
to 
-109%  of  GDP 
from  around 
around -70% of GDP by end-2015. 

in  2010 

investors 

The  EU-IMF  international  financial  assistance 
granted to Hungary in autumn 2008 expired in late 
2010. The  remaining programme-related IMF debt 
was  repaid  early  in  summer  2013.  Of  the  EUR 
5.5bn disbursed by the EU, EUR 2bn was repaid in 
November  2014  and  EUR  1.5bn  in  April  2016. 
The  EU's  post-programme  surveillance  was 
discontinued in January 2015. 

According  to  the  Commission  services'  Spring 
2016  Forecast,  the  external  surplus  is  expected  to 

65 

through 

trade  and 

the  Hungarian  economy 

The Hungarian economy is highly integrated with 
investment 
the  euro  area 
linkages.  Trade  openness  increased  from  84%  in 
2010  to  95%  in  2015,  reflecting  the  deeper 
integration  of 
into 
continental  and  global  supply  chains.  Flows  with 
the  euro  area  dominate  trade,  accounting  for 
around  55%  of  the  total  trade  in  goods  and 
services.  Outside  the  euro  area,  the  main  goods 
trading  partners  in  2015  were  Poland,  the  Czech 
Republic and Romania.  

The  stock  of  FDI  in  Hungary  amounted  to  some 
80% of GDP in 2014 (excluding SPEs), with FDI 
mainly originating from Germany, the Netherlands 
Luxembourg  and  Austria.  The  main  recipient 
sectors of FDI were services (mostly 'professional, 
scientific  and 
financial 
intermediation and trade) and manufacturing (25% 
of 
total),  suggesting  that  FDI  plays  an 
important  role  in  enhancing  Hungary’s  export 
capacity and contributes significantly to economic 
integration with the euro area. 

technical  activities', 

the 

Concerning  the  business  environment,  Hungary 
performs  in  general  worse  than  most  euro  area 
rankings. 
Member  States 
According  to  the  May  2015  Internal  Market 
Scoreboard,  Hungary's  transposition  deficit  of  EU 

international 

in 

Table 5.5:Hungary - Market integration201020112012201320142015Trade openness 1) (%)84.190.992.592.093.394.9Trade with EA in goods & services 2)+3) (%)45.549.250.751.053.454.7Export performance (% change) 4)0.30.4-3.14.93.84.2World Bank's Ease of Doing Business Index rankings 5)465154544042WEF's Global Competitiveness Index rankings 6)524860636063Internal Market Transposition Deficit 7) (%)1.41.40.50.60.60.8Real house price index 8)100.093.184.480.583.092.7Residential investment 9) (%)3.12.22.01.41.6n.a. 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 5 - Hungary 

the  2008  financial  crisis  and 

Real  house  prices  bottomed  in  Hungary  in  2013 
following 
the 
recession.  The  housing  market 
subsequent 
recovery  was  initially  slow,  but  it  accelerated  in 
2015,  with  the  real  house  price  index  reaching 
93%  of  its  2010  level.  Residential  investment  fell 
to  an  almost  unprecendently  low  level  of  around 
1.5%  of  GDP  in  2013-2014,  while  the  stock  of 
housing loans declined in net terms. 

The financial system in Hungary is smaller relative 
to GDP than that of the euro area. Domestic bank 
credit  stood  near  34%  of  GDP  at  end-2015,  split 
evenly  between  households  and  non-financial 
corporations.  Most  household  FX  loans  were 
redenominated  to  forint  loans  by  law  effective 
from  early  2015.  The  total  capitalization  of  the 
Budapest  Stock  Exchange  amounted  to  less  than 
15%  of  GDP  in  2015,  well  below  the  euro-area 
average  of  60%.  The  debt  securities  market 
remains  small  in  comparison  with  the  euro  area 
average (76% against 158% of GDP) and is mainly 
used for re-financing public debt. The consolidated 
stock of private sector debt at around 86% of GDP 
in  2015  was  significantly  below  the  euro-area 
average.  

Directives  was  at  0.8%  which  is  above  the  target 
(0.5%)  proposed  by  the  European  Commission  in 
the Single Market Act (2011). 

indicator 

The Hungarian labour market can be considered as 
rather  flexible  in  terms  of  employment  protection  
(as  measured  by  the  2013  OECD  employment 
protection 
for  permanent  workers). 
Policies  on  social  transfers,  early  retirement  and 
increasing  statutory  retirement  age  strengthened 
labour  supply.  Both  domestic  and  international 
labour mobility is rather low in Hungary, although 
the latter has increased since the financial crisis.  

Hungary's financial sector remains well integrated 
into  the  EU's  financial  system.  This  integration  is 
noticeable  in  ownership  and  other  cross-border 
linkages of the banking system. The share of bank 
assets  owned  by  foreign  lenders  has  declined  (to 
39.3%  in  2014  from  52.8%  in  2010)  as  foreign 
groups  deleveraged  and  Hungarian 
investors, 
including  the  Hungarian  State  acquired  several 
financial 
recent  years.  Bank 
in 
concentration, as measured by the market share of 
the  largest  five  credit  institutions  in  total  assets, 
decreased  to  52.5%,  still  above  the  euro-area 
average of 48.4%. 

institutions 

The  Hungarian  banking  system  remains  well-
capitalized,  with  a  capital  adequacy  ratio  above 
17%  at  end-September  2015.  Banks'  profitability 
has been suppressed by the legacy of the pre-crisis 
credit  boom,  low  economic  growth  and  the  heavy 
tax  burden  imposed  on  the  financial  sector.  In 
2014, the banking sector booked a large loss due to 
the  settlement  of  household 
provisioning  for 
foreign  currency  denominated  (mainly  in  Swiss 
franc)  mortgage 
loans,  part  of  which  was 
unwinded  in  2015.  The  deterioration  of  the  loan 
portfolio quality had finally ended in 2014 and the 
NPL ratio reached 12.4% in September 2015. 

66 

0102030405060HU, 2010HU, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 5.10: Hungary -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators.-202468101214161820HU, 2010HU, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 5.11: Hungary -Selected banking sector soundness indicators%Source: ECB, EC calculations.020406080100120140160180HU, 2010HU, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 5.12: Hungary -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
 
 
 
 
6. 

POLAND 

6.1. 

LEGAL COMPATIBILITY 

6.1.1.  Introduction 

The  Act  on  the  Narodowy  Bank  Polski  (the  NBP 
Act)  was  adopted  on  29  August  1997.  The 
consolidated version that includes all amendments 
to the NBP Act was published in Dziennik Ustaw 
of  2013,  item  908.  The  NBP  Act  has  not  been 
amended  since  the  2014  Convergence  Report. 
Therefore,  the  comments  provided  in  the  2014 
Convergence  Report  are  largely  repeated  in  this 
year's assessment. 

6.1.2.  Central Bank independence 

The  Polish  Constitution  and  NBP  Act  do  not 
explicitly  prohibit  the  NBP  and  members  of  its 
decision-making  bodies  from  seeking  or  taking 
outside  instructions;  they  also  do  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.  The  absence 
of such a reference to article 130 of the TFEU and 
article  7  of  the  ESCB/ECB  Statute  or  its  content 
constitutes an incompatibility. However, the Polish 
Constitutional Court has recognised that the central 
bank's independence is based on article 227 (1) of 
the Constitution. In this respect, it is noted that at 
the  occasion  of  a  future  amendment  to  the  Polish 
Constitution the Polish authorities should seize the 
opportunity  to  clarify  in  the  Constitution  that  the 
principle  of  central  bank 
independence  as 
enshrined in article 130 of the TFEU and article 7 
of the ESCB/ECB Statute applies. Alternatively, or 
in addition the NBP Act could also be amended to 
ensure full compatibility.   

Article 23(1)(2) provides that the NBP's Governor 
has,  inter  alia,  to  provide  draft  monetary  policy 
guidelines  to  the  Council  of  Ministers  and  the 
Minister  of  Finance.  This  procedure  provides  for 
the  opportunity  for  the  Government  to  exert 
influence  on  the  monetary  and  financial  policy  of 
the NBP and thus, constitutes an incompatibility in 
the  area  of  independence,  with  Article  130  of  the 
TFEU and Article 7 of the ESCB/ECB Statute.  

Article  9(3)  of  the  NBP  Act  foresees  that  the 
Governor  of  the  NBP  shall  assume  his/her  duties 

67 

laws, 

after  taking  an  oath  before  the  Parliament.  This 
oath  refers  to  the  observation of  the provisions of 
the  Polish  Constitution  and  other 
the 
economic  development  of  Poland  and  the  well-
being of its citizens. The Governor 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  NBP  Act 
needs  to  be  adapted  to  reflect  the  status  and  the 
obligations and duties of the Governor of the NBP 
as member of the relevant decision-making bodies 
of the ECB. Moreover, the oath does not contain a 
reference 
independence  as 
enshrined in Article 130 of the TFEU. The oath as 
it  stands  now  is  an  imperfection  and  should  be 
adapted to be fully in line with the TFEU and the 
ESCB/ECB Statute. 

to  central  bank 

The  wording  of  the  grounds  for  dismissal  of  the 
NBP's  Governor  as  enumerated  in  Article  9(5)  of 
the NBP Act could be interpreted as going slightly 
beyond  those  of  Article  14.2  of  the  ESCB/ECB 
Statute.  This  imperfection  should  be  removed  to 
bring  Article  9(5)  of  the  Act  fully  in  line  with 
Article 130 of the TFEU. 

The  Law  on  the  State  Tribunal  provides  for 
suspension  of  the  Governor  from  his  duties 
following  a procedure  which is incompatible  with 
the  principle  of  central  bank  independence  and 
Article 14.2 of the ESCB/ECB Statute. Pursuant to 
the second sentence of Article 11(1) of the Law on 
the State Tribunal read in conjunction with Article 
3  and  Article  1  (1)(3)  of  the  very  law,  the 
Governor of the NBP can be suspended as a result 
of an indictment by the Parliament even before the 
State  Tribunal  has  delivered  its  judgment  on  the 
removal  from  the  office.  The  procedure  violates 
the  principle  of  central  bank  independence  and 
Article  14.2  of  the  ESCB/ECB  Statute  given  that 
the  latter  has  to  be  understood  as  allowing  for 
removal on grounds of serious misconduct only if 
the  Governor  has  been  guilty  as  established  by  a 
court  decision  ('guilty').  A  suspension  from  office 
on  grounds  of  serious  misconduct  and  further  to 
parliamentary indictment deprives the Governor of 
the  possibility  to  continue  exercising  the  duties 
until  a  court  has  found  the  Governor  guilty  of 
serious misconduct pursuant to Article 14.2 of the 
ESCB/ECB  Statute.  Therefore,  this  procedure 
breaches the Statute and Article 130 of the TFEU. 

 
the 

to  Article  203(1)  of  Poland’s 
According 
Constitution, 
Supreme  Audit  Office 
(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  for  legal  certainty  reasons  be  clearly 
defined  so  as  to  respect  Article  130  of  the  TFEU 
the  ESCB/ECB  Statute. 
and  Article  7  of 
Furthermore,  the  provision's  relationship  with 
article  69.1  of  the  NBP  Act  is  also  unclear.  The 
relevant provision of the Constitution is therefore, 
incompatible  and  needs  to  be  adapted  in  order  to 
comply with Article 130 of the TFEU and Article 
7 of the ESCB/ECB Statute.  

6.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

  Limitation  of  the  NPB's  activities  on  the 
territory of  the  Republic of  Poland  (article  2.3 
of the NBP Act); 

  definition  and  implementation  of  monetary 
policy 
the 
Constitution,  Articles,  3(2)(5),  12,  23,  38-50a, 
and 53 of the NBP Act); 

(Articles  227(1)  and 

(5)  of 

  holding  of  foreign  reserves;  management  of 
foreign  exchange  and  the  definition  of  foreign 
exchange  policy  (Articles  3(2)(2),      3(2)(3),  
17(4)(2), 24 and 52 of the NBP Act); 

  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 
NBP  Act).  The  NBP  shall  exercise 
its 
responsibility for  issuing  the national  currency 
as part of the ESCB. 

bank 

Article  42  in  conjunction  with  Article  3(2)(5)  of 
the NBP Act allow the NBP to extend refinancing 
loans  to  banks  in  order  to  replenish  their  funding 
and  also  extend  refinancing  to  banks  for  the 
implementation 
rehabilitation 
of 
programmes,  subject 
to  conditionality  under 
Article  42(4)  of  the  same  Act.  Against  this 
background,  the  current  wording  of  Article  42(3) 
and (4) can be interpreted as allowing an extension 
of 
to  banks  experiencing 
rehabilitation  proceedings  which  however  could 
end 
the  banks  concerned. 
Effective  preventive  measures  and  more  explicit 
safeguards  should  be  provided  in  the  NBP  Act  to 
clarify compatibility with Article 123 of the TFEU. 

insolvency  of 

refinancing 

loans 

in 

6.1.4.  Integration in the ESCB 

Objectives 

Article 3(1) of the NBP Act sets the objectives of 
the  NBP. It  refers  to  the  economic  policies  of  the 
Government while it should 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 
ESCB/ECB Statute. 

the  TFEU  and  Article  2  of 

Tasks 

The  incompatibilities  in  the  NBP  Act  and  in  the 
Polish  Constitution  in  this  area  are  linked  to  the 
following ESCB/ECB/EU tasks: 

  appointment  of  independent  auditors  -  Article 
69(1)  of  the  NBP  Act  foresees  that  NBP 
accounts  are  examined  by  external  auditors. 
The  NBP  Act  does  not  take  into  account  that 
the auditing of a central bank has to be carried 
out 
auditors 
recommended  by  the  Governing  Council  and 
approved  by  the  Council.  It  is  incompatible 
with Article 27.1 of the ESCB/ECB Statute.  

independent 

external 

by 

There are also some imperfections regarding: 

  non-recognition  of  the  role  of  the  ECB  in  the 
functioning  of  the  payment  systems  (Articles 
3(2)(1) of the NBP Act); 

  non-recognition  of  the  role  of  the  ECB  and  of 
the  EU  in  the  collection  of  statistics  (Article 
3(2)(7) and 23 of the NBP Act); 

  non-recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Article  5(1) 
and 11(3) of the NBP Act); 

6.1.5.  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 NBP Act and the Constitution of the 
Republic  of  Poland  are  not  fully  compatible  with 
the  compliance  duty  under  Article  131  of  the 
TFEU. 

68 

 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

6.2. 

PRICE STABILITY 

6.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  below  the 
reference value at the time of the last convergence 
assessment  of  Poland  in  2014.  It  subsequently 
followed a gradually declining path and fell below 
zero  in  early  2015  reaching  -0.7%  at  the  end  of 
2015. In April 2016, the reference value was 0.7%, 
calculated as the average of the 12-month average 
inflation rates in Bulgaria, Slovenia and Spain plus 
1.5 percentage points. The corresponding inflation 
rate in Poland was -0.5%, i.e. 1.2 percentage points 
below  the  reference  value.  The  12-month  average 
inflation  rate  is  projected  to  remain  below  the 
reference value in the months ahead. 

6.2.2.  Recent inflation developments 

Annual  HICP  inflation  fell  from  a  local  high  of 
0.7% in February 2014 to zero in July 2014, before 
turning negative in the next month. It then fell to a 
minimum  of  -1.3%  in  February  2015,  recovering 
gradually  to  around  -0.4%  in  early  2016.  Falling 
global  oil  prices  were  the  main  driver  of  these 
changes.  Food  price  deflation  was  determined  by 
declining  global  prices  of  agricultural  products,  a 
good  harvest  in  autumn  2014  in  Poland  and  the 
Russian embargo on imports of agri-food products 
introduced in August 2014. Relative stability of the 
zloty  exchange  rate  in  2014  coupled  with  slow 
price growth in Poland's trade partners has dented 
import  prices.  Falling  producer  prices  in  industry 
reflected a lack of cost pressure.  

In  early  2014,  core  inflation  (measured  as  HICP 
inflation  excluding  energy  and  unprocessed  food) 
stayed broadly at the same level as HICP inflation. 
It then fell slightly to 0.4% in July 2014 and since 
then has remained relatively low, fluctuating in the 
narrow corridor between 0.1% and 0.4%. Whereas 
non-energy  industrial  goods  prices  continued  to 

69 

-1012345Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16PolandReference valueGraph 6.1: Poland -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-20246201020112012201320142015PolandEuro areaGraph 6.2: Poland -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 6.1:weights  Poland - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP2.63.93.70.80.1-0.7-0.51000Non-energy industrial goods0.01.00.9-0.3-0.9-0.8-1.0300Energy6.39.28.0-1.7-1.2-4.9-4.8135Unprocessed food 3.12.74.23.3-1.7-1.70.974Processed food4.06.24.42.11.6-0.3-0.2177Services2.53.03.51.61.31.71.7315HICP excl. energy and unproc. food2.03.12.81.00.60.30.2792HICP at constant taxes2.53.13.40.5-0.3-0.7-0.51000Administered prices HICP3.95.35.31.71.20.91.11501) 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.Sources: Eurostat, Commission services. 
 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

The fiscal stance, as measured by the change in the 
structural  balance,  was  tightened  in  2014  and 
slightly  tightened  in  2015.  However,  significant 
pro-cyclical  expansion  is  expected  in  2016  to  be 
followed  by  a  more  limited  fiscal  expansion  in 
2017 as supplementary spending plans will not be 
fully compensated by additional revenue measures. 

framework (45),  was  eased  as 

Monetary  policy,  conducted  within  an  inflation 
targeting 
the 
Monetary  Policy  Council  (MPC)  cut  its  main 
policy rate steadily from 4.75% in November 2012 
to  2.5%  in  July  2013  in  line  with  the  subsequent 
disinflation trend. The MPC again lowered the key 
rate in October  2014  to 2.0%  and further to  1.5% 
in March 2015 as inflation decelerated and moved 
into negative territory in 2015. The MPC then kept 
the policy rate unchanged during the second half of 
2015 and in early 2016.  

Wages and labour costs 

Employment  has  been  consistently  on  the  rise 
since  mid-2013  reaching  the  highest  values  since 
comparable  data  are  available  at  the  end  of  2015 
(both  in  terms  of  absolute  numbers  as  well  as  the 
the 
employment 

line  with 

rate). 

this, 

In 

(45)  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. 

70 

decline throughout 2014 and 2015, reflecting weak 
inflationary pressures at global markets, processed 
food  prices  only  declined  in  2015,  in  line  with 
falling  prices  of  unprocessed  food.  On  the  other 
hand,  services  price  inflation  remained  positive, 
given  strong  domestic  demand  growth.  In  the 
absence of cost pressures, producer price inflation 
in industry has remained negative since late 2012, 
averaging -2.2% in 2015. 

6.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Real GDP increased to 3.3% in 2014 and 3.6% in 
2015,  slightly  above  estimates  of  potential  output 
growth  of  around  3%  and  well  above  the  EU 
average.  Growth  was  mainly  driven  by  private 
consumption,  benefiting  from  favourable  labour 
market  conditions  and  comparatively  low  lending 
rates,  and  to  a  lesser  extent  by  investment.  The 
negative  output  gap  is  thus  estimated  to  have 
narrowed  considerably.  Real  GDP  growth 
is 
projected to stay robust at 3.7% in 2016 and 3.6% 
in  2017,  supported  by  solid  real  wage  growth, 
further employment gains and recently announced 
fiscal  measures,  with  the  output  gap  closing  in 
2016 and turning positive in 2017.  

Table 6.2:Poland - Other inflation and cost indicators(annual percentage change)2010201120122013201420151)20162)20172)HICP inflationPoland 2.63.93.70.80.1-0.70.01.6Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorPoland 3.24.93.40.4-0.3-1.20.01.6Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeePoland 10.15.33.61.71.63.13.84.3Euro area2.22.21.81.71.31.21.51.9Labour productivityPoland 6.64.41.41.31.52.23.03.0Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsPoland 3.30.92.10.30.10.90.81.3Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorPoland 1.89.55.8-1.2-2.2-1.30.02.0Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Nominal compensation per employee and nominal unit labour costs for 2015 are estimates.2) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

administered prices was 1.2% in 2014 and 1.1% in 
2015.  The  positive  annual  rate  of  growth  of 
administered prices was mainly related to hikes in 
electricity  prices  in  January  2014  and  January 
2015.  Administered  prices  are  set  to  decrease  in 
2016  following  decreases  in  natural  gas  and 
electricity prices. 

The  impact  of  tax  measures  on  overall  consumer 
price  developments  was  marginal  in  2014  and 
2015  as  constant  tax  inflation  lingered  only  some 
0.4 pp. below headline inflation in 2014 while both 
inflation measures were identical in 2015. In 2014 
a  marginally  positive  inflation  contribution  was 
provided  by  higher  excise  duties  on  alcohol  and 
tobacco.   

Medium-term prospects 

low  global 

Looking  ahead,  inflation  is  expected  to  increase 
only  gradually.  The 
inflation 
environment  and  subdued  commodity  prices 
should  counteract  positive  impulses  from  the 
expected  gradual  acceleration  of  wages.  The 
Commission  services'  Spring  2016  Forecast 
projects annual HICP inflation to average 0.0% in 
2016 and 1.6% in 2017.  

Risks to the inflation outlook appear to be broadly 
balanced. On the one hand, possible exchange rate 
depreciation,  for  instance  due  to  increased  capital 
outflows,  could  result  in  higher  consumer  price 
growth. On  the  other hand,  the  outlook for  global 
growth,  commodity  prices  and  related  price 
pressures remains fragile.  

further  price 

The  level  of  consumer  prices  in  Poland  was  at 
around 55% of the euro-area average in 2014. This 
suggests  potential 
level 
for 
convergence  in  the  long  term,  as  income  levels 
(about  64%  of  the  euro-area  average  in  PPS  in 
2014)  increase  towards  the  euro-area  average.  On 
the other hand, in the last decade the relatively fast 
convergence 
level  was  actually 
associated  with  divergence  in  comparative  price 
levels.  

income 

in 

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 
to  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. As 

unemployment  rate  has  declined  steadily  since 
2013 returning to pre-crisis (2008) level of around 
7% by the end of 2015. 

Following  a  period  of  sluggish  growth,  labour 
productivity  accelerated  in  2014  and  especially  in 
2015.  Compensation  per  employee  followed  a 
similar  trend,  with  somewhat  stronger  growth  in 
2015  translating  into  nominal  ULC  growing  by 
0.9%, up from zero in the previous year (46). With 
unemployment  at  record  lows  and  expectations of 
a further reduction, wage pressures are expected to 
strengthen with ULC growth of over 1% in 2017.  

External factors 

Although external trade represents a lower share of 
GDP  in  Poland  than  in  regional  peers,  prices  of 
imported goods and services play an important role 
in  domestic  price  formation.  Imported  inflation 
(measured  by  the  imports  of  goods  deflator)  has 
stayed  slightly  negative  since  2013.  This  was 
driven  by  very  low  inflation  globally,  relative 
stability  of  the  zloty  exchange  rate  and  since  late 
2014  also  the fall  in  global oil prices.  The  import 
deflator is forecast to increase in 2016 compared to 
previous year and turn positive in 2017. 

Administered prices and taxes 

Increases in administered prices (47), with a weight 
of  around  15%  in  the  HICP  basket  (compared  to 
13% in the euro area), exceeded HICP inflation in 
recent  years.  The  average  annual  increase  in 

(46)  Please  note  that  recent  quarterly  figures  would  suggest  a 

different estimate for 2015. 

(47)  According to the Eurostat definition, administered prices in 
Poland include inter alia water supply, refuse and sewerage 
collection,  electricity,  gas,  heat  energy  and  certain 
categories  of  passenger 
transport.  For  details,  see 
http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b 

71 

-303691220102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 6.3:Poland -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast. 
 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

to  product  markets,  there  is  scope  to  enhance  the 
competitive environment, especially in the services 
and  energy  sectors.  At  the  macro  level,  a  prudent 
fiscal 
to  contain 
inflationary pressures. 

stance  will  be  essential 

6.3. 

PUBLIC FINANCES 

6.3.1.  Recent fiscal developments 

In June 2015, the Council decided to abrogate the 
decision  on  the  existence  of  an  excessive  deficit 
according 
thereby 
to  Article  126(12)  TFEU, 
closing  the  excessive deficit  procedure for  Poland 
(48).  While  the  general  government  deficit  was 
slightly  above  3%  of  GDP  in  2014,  Poland  was 
eligible  for  abrogation  under  the  Stability  and 
Growth  Pact  provisions  concerning  systemic 
pension reforms - Article 2(7) of Regulation (EC) 
1467/97. In particular, the total net costs in 2014 of 
the  1999  systemic  pension  reform  were  estimated 
at  0.4% of  GDP.  The  Council  considered them  to 
be  sufficient  to  explain  the  excess  of  the  deficit 
over the 3% of GDP reference value in 2014.  

(48)  An  overview  of  all  excessive  deficit  procedures  can  be 

found at: http://ec.europa.eu/economy_finance/economic_ 

governance/sgp/deficit/index_en.htm 

The  general  government  deficit  declined  from 
3.3%  of  GDP  in  2014  to  2.6%  in  2015.  In 
structural  terms,  the  deficit  also  improved  by  0.3 
pp.  to  2.3%  of  GDP  in  2015.  The  ratio  of  total 
government  expenditure  to  GDP  has  followed  a 
downward  trend  since  2010.  The  ratio  fell  from 
42.2%  of  GDP  in  2014  to  41.5%  in  2015.  Debt 
servicing costs decreased visibly, while investment 
expenditure  was  on  the  rise.  Total  government 
revenue remained at 38.9% of GDP in 2014 and in 
2015. 

income 

In  2014,  the  deficit  reduction  was  driven  by  both 
an  improvement  in  revenues  and  a  small  fall  in 
government  expenditures.  On  the  revenue  side 
VAT  collection  improved  after  the  particularly 
weak  performance  in  the  previous  year,  while  a 
better  labour  market  situation  supported  stronger 
personal 
tax  collection.  Government 
revenues  from  social  contributions  also  increased, 
due  to  re-direction  from  the  second  to  the  first 
pension pillar, in the context of the reversal of the 
1999 pension system reform made in 2013. On the 
expenditure side, the improvement was mostly due 
to  the  substantial  fall  in  the  costs  of  public  debt 
servicing.  Moreover,  the  government  maintained 
the  freeze  in  the  wage  fund  of  public  sector 
employees. 

72 

Table 6.3:Poland - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance-7.5-4.9-3.7-4.0-3.3-2.6-2.6-3.1- Total revenues38.138.838.938.438.938.939.139.1- Total expenditure45.643.642.642.442.241.541.742.2   of which: - Interest expenditure2.52.52.72.51.91.81.71.5p.m.: Tax burden32.032.532.832.833.033.333.733.5Primary balance-5.0-2.3-1.0-1.5-1.4-0.8-0.9-1.5Cyclically-adjusted balance-8.2-6.0-3.9-3.4-2.8-2.4-2.6-3.3One-off and temporary measures0.00.00.10.0-0.20.00.40.0Structural balance 2)-8.2-6.0-4.0-3.4-2.6-2.3-3.0-3.3Government gross debt53.354.454.056.050.551.352.052.7p.m: Real GDP growth (%)3.75.01.61.33.33.63.73.6p.m: Output gap1.42.30.4-1.2-1.0-0.50.00.4Convergence programme2016201720182019General government balance-2.6-2.9-2.0-1.3Structural balance 2) 3)-2.9-2.7-2.1-1.6Government gross debt52.052.552.050.4p.m. Real GDP (% change)3.83.94.04.11) Commission services’ Spring 2016 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.Sources: Commission services, the 2016 Convergence Programme of Poland. 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

to deteriorate from 2¼% of GDP in 2015 to 3¼% 
of GDP in 2017. 

The  general  government  debt-to-GDP  ratio  is 
forecast  to  increase  to  52.7%  in  2017.  The 
projected  debt  figures  are,  however,  subject  to 
in  view  of  possible 
considerable  uncertainty 
valuation 
debt 
sovereign 
the 
denominated  in  foreign  currency  due  to  exchange 
rate fluctuations. 

effects 

of 

The 2016 Convergence Programme was submitted 
on  28  April  2016.  It  foresees  an  increase  in  the 
structural budget balance to 3.1% of GDP in 2016 
and  its  gradual  decrease  in  subsequent  years.  The 
Medium  Term  Objective  of  a  structural  deficit  of 
not  more  than  1%  of  GDP  is  not  expected  to  be 
reached within the programme period (2019). The 
nominal  balance  is  expected  in  the  Programme  to 
be in a deficit of 2.6% of GDP in 2016, widening 
to  2.9%  of  GDP  in  2017  and  gradually  declining 
thereafter.  These  projections  are  in  line  with  the 
Commission  services'  Spring  2016  Forecast  as 
regards  2016  and  more  favourable  thereafter,  in 
to  a  slightly  more  optimistic 
particular  due 
macroeconomic 
these 
budgetary projections. Based on the Commission's 
assessment  of  the  2016  Convergence  Programme, 
there is a risk that Poland will not comply with the 
provisions  of  the  Stability  and  Growth  Pact,  as 
there  is  a  risk  of  a  significant  deviation  from  the 
recommended adjustment both in 2016 and, under 
unchanged  policies,  in  2017.  Therefore  further 
measures  will  be  needed  to  ensure  compliance  in 
2016 and 2017. Further details can be found in the 
Assessment  of  the  2016  Convergence  Programme 
for Poland (49). 

scenario  underpinning 

fares 

the  national  fiscal  framework 

relatively  well,  but 
fiscal 

As  far  as 
is 
concerned – which refers to numerical fiscal rules, 
medium-term  budgetary  frameworks,  independent 
fiscal  institutions,  and  budgetary  procedures  – 
Poland 
lacks  an 
independent 
council.  Medium-term 
budgetary  planning  is  based  on  the  Multiannual 
State  Financial  Plan  which  covers  four  years  and 
constitutes  a  basis  for  the  preparation  of  annual 
budgets.  There  is  a  constitutional  debt  threshold 
for the general government and a separate debt rule 
for 
stabilising 
expenditure rule covering almost the entire general 
government was introduced at the end of 2013. In 

local  governments.  A  new 

(49)

http://ec.europa.eu/economy_finance/economic_gov

ernance/sgp/convergence/index_en.htm 

In  2015,  the  further decrease  in  the budget deficit 
was  driven  by  falling  expenditures.  In  particular, 
expenditures  on  compensation  of  employees 
increased  much  below  the  rate  suggested  by 
private  sector  wage  dynamics  helped  by  a 
continued  freeze  of  the wage  bill  for  most central 
government  institutions.  In  addition,  public  debt 
servicing  costs  continued  to  fall  benefitting  from 
low  interest  rates.  On  the  revenue  side,  social 
contributions 
increased  dynamically  following 
acceleration  of  wage  and  employment  growth, 
while  both  taxes  on  production  and  imports  and 
current  taxes  on  income  and  wealth  stayed  at  the 
2014 level in relation to nominal GDP. 

The significant fall of the general government debt 
in  2014,  down  by  more  than  5  pp.  to  50.4%  of 
GDP,  is  mainly  explained  by  a  large  one-off 
transfer  of  private  pension  fund  assets.  In  2015, 
government debt increased to 51.3% of GDP. 

6.3.2.  Medium-term prospects 

following 

the  elections 

The  2016  budget  was  adopted  only  on  3  March 
2016,  as 
the  new 
government amended the draft budget submitted to 
the  Parliament  by  the  outgoing  government.  The 
key  amendment  on  the  expenditure  side  was  an 
increase  of  around  0.9%  of  GDP  to  finance  the 
new  child  benefit.  Revenues  were  also  adjusted 
upwards.  One-off  revenue  (around  0.5%  of  GDP) 
from  the  sale  of  mobile  internet  frequencies  was 
moved  to  the  2016  budget,  from  the  2015  budget 
(which  was  also  amended  in  December  2015).  In 
addition,  revenues  from  two  new  taxes  (on  assets 
of  financial  institutions  and  the  retail  sector) 
amounting 
to  around  0.4%  of  GDP  were 
incorporated  in  the planned revenue. Only the  tax 
on assets of financial institutions was implemented 
from  February  2016,  while  the  other  remained  in 
the  stage  of  consultations  as  of  April.  The 
Commission  services'  Spring  2016  Forecast 
projects  a  general  government  deficit  of  2.6%  of 
GDP  in  2016,  broadly  in  line  with  the  level 
specified  in  the  budget  law,  while  assuming  no 
revenue from the planned retail sector tax.  

The  general  government  deficit  is  projected  to 
widen  to  3.1%  of  GDP  in  2017  under  the  no-
policy-change  scenario.  The 
the 
projected deficit is mainly explained by additional 
costs  of  the  child  benefit  (in  2016  it  entered  into 
force  only  in  the  second  quarter),  legislated 
decrease  in  VAT  rates  and  lack  of  other  one-off 
revenues in 2017. The structural deficit is expected 

increase  of 

73 

 
                                                           
 
spite  of  the  existence  of  these  important  elements 
of  the  framework,  its  credibility  is  compromised 
by frequent changes to the rules. Moreover, Poland 
is currently the only EU Member State without an 
independent  fiscal  council  or  plans  to  create  one. 
Typically  remits  of  such  fiscal  councils  cover 
carrying  out  ex  ante  and  ex  post  monitoring  of 
compliance  with  fiscal  rules,  assessment  of 
macroeconomic and budgetary forecasts as well as 
analysis  of  the  long-term  sustainability  of  public 
finances. 

6.4. 

EXCHANGE RATE STABILITY 

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 (50).  

along 

regional  peers. 

The  zloty  broadly  stabilised  and  predominantly 
traded  in  the  range  of  4.1-4.2  PLN/EUR  during 
2013  and  until  end  of  2014.  Zloty  volatility 
increased thereafter. It weakened rather sharply in 
December  2014 
It 
appreciated rather steeply in the beginning of 2015 
following the Swiss National Bank's decision to let 
the  CHF  appreciate,  touching  below  4  PLN/EUR 
in  April  supported  by  accelerating  economic 
growth,  ECB  easing  and  the  end  of  the  monetary 
easing cycle in Poland. The zloty then depreciated 
gradually  in  the  second  half  of  2015,  affected  by 
domestic  political  uncertainty,  and  then  rather 
sharply in January 2016 following the S&P credit 
rating  downgrade, 
reaching  4.5  PLN/EUR. 
Exchange  rate  volatility  in  early  2016  was  driven 

(50)  As from beginning of 2004, the inflation target of the NBP 
is set as annual consumer price index growth of 2.5% (with 
a permissible fluctuation band of ± 1 percentage point). 

Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

by  factors  such  as  a  credit  rating  downgrade, 
benign  global  risks  and  compression  of  risk 
premia.  Inter-day  exchange  rate  volatility  during 
this  period  was  highest  in  February  2016  and 
declined  since  then.  Poland  has  benefited  from  a 
Flexible  Credit  Line  arrangement  with  the  IMF 
since 2009. Compared to April 2014, the exchange 
rate of the zloty against the euro was around 2.9% 
weaker in April 2016.  

International  reserves  held  by  the  NBP  increased 
gradually  from  around  EUR  77  billion  by  end-
2013 
to  EUR  82  billion  by  end-2014  and 
fluctuated around EUR 90 billion during 2015 and 
at  beginning  of  2016.  The  reserve-to-GDP  ratio 
was  at  around  20%  by  end-2015.  The  level  of 
international  reserves  was  mainly  influenced  by 
sovereign  debt  management  decisions,  inflows  of 
EU funds and FX fluctuations.  

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  remained  in  the  range  between  200  and 
250  basis  points  during  2014.  They  started  to 
decline at the end-2014 hitting a low of 165 basis 
in  early  2015,  reflecting  considerable 
points 
the  NBP,  which 
monetary  policy  easing  by 
gradually  cut  its  key  reference  rate  by  325  basis 
points  between  November  2012  and  March  2015. 
Interest  rate  differentials  have  been  widening 
gradually  since  then,  reflecting  mainly  additional 
monetary  policy  easing  by  the  ECB  as  well  as 
domestic political uncertainties. At the cut-off date 
of  this  report,  the  3-month  spread  vis-à-vis  the 
euro area stood at around 190 basis points.  

6.5. 

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 

74 

3.03.54.04.55.02010201120122013201420152016Graph 6.4: Poland -PLN/EUR exchange rate(monthly averages)Source: ECB.01002003004005002010201120122013201420152016Graph 6.5: Poland -3-M Wibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

with  a  residual  maturity  of  close  to  but  below  10 
years.  

The  Polish  12-month  average  long-term  interest 
rate  relevant  for  the  assessment  of  the  Treaty 
criterion  was  2  percentage  points  below  the 
reference value at the time of the last convergence 
assessment in 2014. It declined further from above 
4%  at  the  beginning  of  2014  to  below  4%  at  the 
end of 2014 due to improving market confidence. 

beginning  of  2015,  reflecting  improved  investor 
sentiment  towards  the  country,  strong  economic 
growth  as  well  as  a  substantial  fall  in  domestic 
inflation.  Long-term  interest  rates  increased  again 
during  2015  and  fluctuated  around  3%  as  risk 
appetite in global financial markets dwindled while 
perceptions of domestic political risks increased.  

As  a  result,  long-term  interest  rate  spreads  vis-à-
vis  the  German  benchmark  bond  increased  to 
around 280 basis points in early 2016 (51). 

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  –  gives  an  important  indication  of  a 
Member  State's  ability  to  integrate  into  the  euro 
area without difficulties.  

It went further down to around 3% in early 2015. It 
stayed  around  2.7%  during  2015  but  increased 
slightly  at  the  beginning  of  2016  due  to  changing 
investors'  risk  perceptions,  following  S&P  credit 
rating downgrade. In April 2016, the latest month 
for  which  data  are  available,  the  reference  value, 
given by the average of long-term interest rates in 
Bulgaria,  Slovenia  and  Spain  plus  2  percentage 
points, stood at 4.0%. In that month, the 12-month 
moving  average  of  the  yield  on  the  Polish 
benchmark bond stood at 2.9%, i.e. 1.1 percentage 
points below the reference value. 

In  November  2015,  the  Commission  published  its 
third  Alert  Mechanism  Report  (AMR  2016) (52) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Poland  exceeded  the 
indicative  threshold  for  one  out  of  fourteen 
investment 
indicators, 
position. In line with the conclusions of the AMRs 
2012-2016, Poland has not been subject to in-depth 
reviews in the context of the MIP. 

international 

i.e. 

the 

6.6.1.  Developments  of 

the  balance  of 

payments 

a 

reflecting 

2013,  mainly 

Poland’s  external  balance  (i.e. 
the  combined 
current  and  capital  account)  has  been  positive 
since 
further 
improvement  in  the  trade  balance,  which  shifted 
into  surplus.  Although  export  growth  remained 
solid, the trade in goods deficit widened somewhat 
in  2014  primarily  due  to  strengthening  imports 
reflecting  a  rebound  in  domestic  demand.  Lower 
prices of imported energy commodities helped the 
trade balance turn positive in 2015. The narrowing 
of  the  current  account  deficit  was  also  supported 

Long-term  interest  rates  declined  from  around 
4.1%  in  early  2014  to  just  above  2%  at  the 

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

(52)

http://ec.europa.eu/europe2020/pdf/2016/ags2016_al

ert_mechanism_report.pdf  

75 

024681012Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16PolandReference valueGraph 6.6: Poland -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.024682010201120122013201420152016PolandGermanyGraph 6.7: Poland -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

by  consistently  strong  performance  of  services 
exports.  At  the  same  time,  the  negative  primary 
in 
income  balance 
2013-2015  while  the  secondary  income  balance 
was close to zero. 

remained  broadly  stable 

been an important factor. Since the second half of 
2014, both the nominal and real effective exchange 
rate  have  followed  a  depreciation  trend,  with  a 
temporary reversal in the first quarter of 2015 and 
then again in early 2016. 

the  saving-investment  balance 

is 
As  far  as 
concerned,  gross  national  saving  (as  a  percentage 
of  GDP)  kept  increasing  after  2013.  In  2014,  the 
increase  was  driven  by  rising  gross  saving  of  the 
corporate  sector,  which  was  partially  offset  by 
lower  saving  by  households  and  the  government. 
In 2015, gross national saving increased further as 
households started to increase their savings again. 
At the same time, gross fixed capital formation (as 
a  percentage  of  GDP)  increased  in  2014  and 
remained  relatively  stable  in  2015,  after  a  fall  in 
2013.  This  was  driven  by  both  public  and  private 
sectors investment spending. However, the private 
sector  investment-to-GDP  ratio  in  Poland  remains 
below the level observed among its regional peers. 

Poland's  external  competitiveness  appears  to  have 
remained  solid.  Poland's  export  performance  was 
very  strong  over  the  past  two  years  with  gains  in 
market  shares.  Strong  cost-competitiveness  has 

On  the  financing  account  of  the  balance  of 
payments, direct investment recorded a net inflow 
of  2.0%  of  GDP  in  2014  and  0.7%  of  GDP  in 
2015.  The  portfolio 
investment  showed  net 
outflows  in  2014  and  2015,  primarily  due  to 
increased residents’ holdings of portfolio debt and 
equity  abroad  and  marginal  inflows  of  non-
residents'  financing  at  the  sovereign  debt  market. 

76 

0102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 6.8: Poland -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.Table 6.4:Poland - Balance of payments(percentage of GDP)201020112012201320142015Current account-5.4-5.2-3.7-1.3-2.0-0.2of which: Balance of trade in goods-3.0-3.5-2.1-0.1-0.80.5                 Balance of trade in services0.91.41.51.92.12.3                 Primary income balance -3.3-3.2-3.1-3.0-3.2-2.8                 Secondary income balance0.00.20.0-0.1-0.1-0.2Capital account1.81.92.22.32.42.4External balance 1)-3.6-3.3-1.51.00.42.1Financial account 2)-6.4-5.2-2.3-1.1-0.81.8of which: Direct investment-1.8-2.6-1.2-0.8-2.0-0.7                Portfolio investment-6.1-3.2-3.90.00.40.7                Other investment 3)-1.8-0.60.6-0.50.71.6                Change in reserves3.21.22.20.20.10.2Financial account without reserves-9.6-6.4-4.5-1.3-0.91.6Errors and omissions-2.8-1.9-0.8-2.1-1.2-0.4Gross capital formation21.322.421.019.020.420.5Gross saving16.517.717.718.519.120.6Gross external debt65.865.472.170.671.070.3International investment position-65.1-62.4-65.4-69.0-68.5-61.91) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Poland. 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

The  other  investment  also  registered  net  outflows 
in 2014 and 2015. 

According  to  the  Commission  services'  Spring 
2016 Forecast, the external balance is expected to 
gradually deteriorate to 0.9% of GDP in 2016 and 
0.4%  of  GDP  2017  as  imports  are  foreseen  to 
outpace exports. 

6.6.2.  Market integration 

in 

increased 

trade  openness 

Poland's economy is well integrated with the euro 
area  through  both  trade  and  investment  linkages. 
Following  a  decrease  in  2008-2009  as  a  result  of 
the  crisis, 
the 
following  years,  reaching  some  49%  of  GDP  in 
2015.  The  share  of  trade  with  euro-area  partners 
expressed 
in  percentage  of  GDP  has  been 
increasing  in  recent  years,  reaching  28%  in  2015. 
Within  the  euro  area,  Poland  mainly  trades  with 
Germany, the Netherlands, Italy and France, while 
outside the euro area its main trading partners are, 
the  Czech  Republic,  Russia  and 
the  United 
Kingdom. 

the  Netherlands, 

FDI  inflows  to  Poland  have  mainly  originated  in 
Germany, 
and 
Luxembourg,  which  together  provided  over  50% 
of the FDI stock at the end of 2014. The significant 
size and growth of the domestic market as well as 
good  access 
large  regional  markets  have 
supported the attractiveness of the country for FDI. 

France 

to 

Concerning  the  business  environment,  Poland 
performs  in  general  worse  than  most  euro-area 

international 

Total gross external debt increased somewhat from 
70.6% of GDP in 2013 to 71% of GDP in 2014 but 
decreased  to  70.3%  of  GDP  in  2015,  while  the 
negative  net 
investment  position 
(NIIP) narrowed significantly from 69% of GDP in 
2013  to  61.9%  of  GDP  in  2015.  Although  this  is 
well beyond the indicative threshold set in the MIP 
(-35% of GDP), a major part of the NIIP consists 
of 
the  accumulated  stock  of  foreign  direct 
investments.  Since  May  2009,  the  stability  of  the 
balance  of  payments  has  been  supported  by 
precautionary  access  to  the  IMF's  Flexible  Credit 
Line  (FCL)  arrangement.  As  a  step  towards  a 
gradual exit from the arrangement, in January 2015 
and then again in January 2016 the size of the FCL 
was  lowered  due  to  strong  fundamentals  and 
abating external risks. 

77 

8090100110120201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 6.9: Poland -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100)Table 6.5:Poland - Market integration201020112012201320142015Trade openness 1) (%)42.244.845.946.948.449.4Trade with EA in goods & services 2)+3) (%)24.125.225.125.627.027.8Export performance (% change) 4)1.31.62.94.63.33.5World Bank's Ease of Doing Business Index rankings 5)596255452825WEF's Global Competitiveness Index rankings 6)394141424341Internal Market Transposition Deficit 7) (%)1.72.11.81.20.71.5Real house price index 8)100.095.489.084.885.888.1Residential investment 9) (%)2.62.52.62.62.42.5 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
 
in 

international 

Member  States 
rankings. 
Moreover,  according  to  the  May  2015  Internal 
Market  Scoreboard,  Poland's  transposition  deficit 
of  EU  Directives  was  at  1.5%  which 
is 
substantially  above  the  target  (0.5%)  proposed  by 
the  European  Commission  in  the  Single  Market 
Act (2011).  

in 

rather 

flexible 

The  current  segmentation  with  a  substantial  share 
of  temporary  employment  of  the  Polish  labour 
market  affects  productivity  and  the  accumulation 
of human capital in the longer term. Shortcomings 
in the education system and in the design of active 
labour market policies lead to mismatches between 
labour  demand  and  supply.    Poland  has  recently 
taken  some  measures  to  tackle  labour  market 
segmentation.  The  Polish  labour  market  can  be 
considered  as 
terms  of 
employment  protection  (as  measured  by  the  2013 
OECD  employment  protection  indicator,  while 
collective  bargaining  has  a  stronger  impact  on 
wage  formation  in  sectors  dominated  by  state 
enterprises,  such  as  mining.  Preferential  sector-
in 
specific  social  security  arrangements  — 
particular  the  highly  subsidised  pension  systems 
for  farmers  and  miners  —  also  reduce  labour 
mobility  and  have  high  budgetary  costs.  Outward 
migration  flows,  especially  after  EU  accession  in 
2004,  were  substantial,  while  domestic  labour 
mobility  is  hampered  by  factors  such  as  housing 
policies,  transport  infrastructure,  access  to  child 
care and skills mismatches.  

by 

foreign 

Poland's  financial  sector  is  well  integrated  within 
the  overall  EU  financial  system.  In  2015,  around 
64%  of  the  Polish  banking  sector's  assets  were 
owned 
institutions, 
predominantly 
from  EU  Member  States. 
Concentration  in  the  Polish  banking  sector  has 
remained close to the euro-area average. The share 
of  total  assets  owned  by  the  five  largest  lenders 
amounted to 48%. 

financial 

Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

The  capitalisation  of  banks  continued  to  improve 
reaching a capital adequacy ratio (CAR) of 14.9% 
in 2014. Profitability remained high in 2014, with 
return on equity (ROE) at around 10%, however, it 
decreased to 7% in Q3 2015, mainly due to record 
low  interest  rates  and  higher  contributions  to  the 
Bank  Guarantee  Fund.  The  new  tax  on  financial 
sector  assets 
the 
profitability  of  the  banking  sector,  which  could 
also be negatively affected by pending proposals to 
convert  foreign-currency  denominated  loans.  The 
non-performing  loans  ratio  broadly  followed  the 
euro-area trend and deteriorated during the crisis to 
about  6½%  in  2009-2010, up  from  3.9%  in  2007, 
before dropping to 5.3% in Q3 2015. 

to  weigh  on 

is  expected 

According to Eurostat, real house prices in Poland 
declined  by  over  28%  between  2008  and  2013. 
House  prices  started  to  recover  in  2014  and 
in 
increased  by  2.3% 
dwellings has remained relatively stable at around 
2.5% of GDP.  

in  2015.  Investment 

The  financial  system  in  Poland  is  smaller  relative 
to  GDP  than  that  of  the  euro  area.  Credit  to  the 
private  economy  (households  and  non-financial 
corporations)  has  increased  to  49%  of  GDP  in 
2014  from  39%  in  2007.  The  share  of  foreign-
currency  denominated  loans  remains  significant 
(around  30%  of  the  total  loan  stock),  particularly 
in  the  mortgage  loan  segment  where  around  40% 
of  housing  loans  are  denominated  either  in  Swiss 
franc  or  euro.  Nevertheless,  the  share  of  foreign-
currency  denominated  loans  has  been  gradually 
declining,  as  most  banks  do  not  offer  them  since 
2009.  

78 

010203040506070PL, 2010PL, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 6.10: Poland -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators. 024681012141618PL, 2010PL, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 6.11: Poland -Selected banking sector soundness indicators%Source: ECB, EC calculations. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 6 - Poland 

The  total  capitalisation  of  the  Warsaw  Stock 
Exchange represented 28% of GDP in 2015, down 
from  a  pre-crisis  record  high  of  45%  of  GDP  in 
2007,  following  the  decrease  in  private  pension 
funds involvement in the capital market. The debt 
securities  market  is  one  of  most  liquid  in  the 
region  but  remains  small  in  comparison  with  the 
euro area (54% against 158% of GDP). The market 
is  dominated  by  government  bonds  (over  90% 
share)  while  corporate  bonds  account  for  only 
about 
amounts. 
Consolidated  private  sector  debt  went  up  from 
around  70%  to  close  to  79%  of  GDP  in  2015, 
significantly below the euro-area average. 

outstanding 

7% 

the 

of 

79 

020406080100120140160180PL, 2010PL, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 6.12: Poland -Recent development of the  financial systemrelative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
 
 
 
7. 

ROMANIA 

7.1. 

LEGAL COMPATIBILITY 

7.1.1.  Introduction 

The  Banca  Naţională  a  României  (BNR) 
is 
governed  by  Law  No.  312  on  the  Statute  of  the 
Bank of Romania of 28 June 2004 (hereinafter 'the 
BNR  Law')  which  entered  into  force  on  30  July 
2004. 

The  BNR  law  has  not  been  amended  since  the 
Convergence  Report  2014.  Therefore, 
the 
comments  provided  in  the  Convergence  Report 
2014 are largely repeated in this year's assessment.  

7.1.2.  Central Bank independence 

As regards central bank independence, a number of 
incompatibilities  and  imperfections  have  been 
identified  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's  decision-
making  in  areas  for  which  its  independence  is 
protected by the Treaty. The active participation of 
the Minister and one of the State Secretaries, even 
without  voting  right,  in  discussions  of  the  BNR 
Board  where  BNR  policy  is  set  could  structurally 
offer 
to 
influence  the  central  bank  when  taking  its  key 
decisions. Against this background, Article 33(10) 
of the BNR Law is incompatible with Article 130 
of the TFEU.  

the  Government 

the  possibility 

to 

Article 3(1) of the BNR Law needs to be amended 
with  a  view  to  ensuring  full  compatibility  with 
Article  130  of  the  TFEU  and  Article  7  of  the 
ESCB/ECB Statute. Pursuant to Article 3(1) of the 
BNR  Law,  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.  First,  for  legal  certainty 
reasons,  it  should  be  clarified  that  the  BNR's 

81 

institutional  independence  is  also  protected  vis-à-
vis  national,  foreign  and  EU  institutions,  bodies, 
offices  or  agencies.  Moreover,  Article  3  should 
expressly  oblige  the  government  not  to  seek  to 
influence  the  members  of  the  BNR's  decision-
making bodies in the performance of their tasks. 

The  BNR  Law  should  be  supplemented  by  rules 
and procedures ensuring a smooth and continuous 
functioning  of  the  BNR  in  case  of  the  Governor's 
termination of office (e.g. due to expiration of the 
term  of  office,  resignation  or  dismissal).  So  far, 
Article 33(5) of the BNR Law provides that in case 
the  Board  of  BNR  becomes  incomplete,  the 
vacancies  shall  be  filled  following  the  procedure 
for  the  appointment  of  the  members  of  the  Board 
of  BNR.  Article  35(5)  of  the  BNR Law  stipulates 
that in case the Governor is absent or incapacitated 
to  act,  the  Senior  Deputy  Governor  shall  replace 
the Governor.  

Pursuant  to  Article  33(9)  of  the  BNR  Law,  the 
decision  to  recall  a  member  of  the  BNR  Board 
(including  the  Governor)  from  office  may  be 
appealed to the Romanian High Court of Cassation 
and  Justice.  However,  Article  33(9)  of  the  BNR 
Law remains silent on the right of judicial review 
by  the  Court  of  Justice  of  the  European  Union  in 
the  event  of  the  Governor's  dismissal  provided  in 
Article  14.2  of  the  ESCB/ECB  Statute.  This 
imperfection should be corrected. 

on 

161/2003 

certain  measures 

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  in  Article  33(6)  of  this  Law. 
for 
Law 
transparency  in  the  exercise  of  public  dignities, 
public functions and business relationships and for 
the  prevention  and  sanctioning  of  corruption  and 
the  Law  176/2010  on  the  integrity  in  the  exercise 
of  public  functions  and  dignities  define 
the 
conflicts of interest incompatibilities applicable to 
the  Governor  and  other  members  of  the  Board  of 
the  BNR  and  require  them  to  report  on  their 
interests  and  wealth.  For 
legal 
certainty,  it  is  recommended  to  remove  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 
to those contained in Article 33 of the BNR Law. 

the  sake  of 

 
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 
Auditors 
the 
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  as  regards 
article  27.1  of  the  ESCB/ECB  Statutes  and  thus, 
for  legal  certainty  reasons,  it  is  recommended  to 
define clearly in the Law that the scope of audit by 
the  Court  of  Auditors,  is  without  prejudice  to  the 
activities  of  the  BNR’s  independent  external 
auditors. 

it  has 

insufficient 

Article 43 of the BNR 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 could, in certain circumstances, be seen 
as  an  intra-year  credit,  which  negatively  impacts 
on  the  financial  independence  of  the  BNR.  A 
Member  State  may  not  put  its  central  bank  in  a 
position  where 
financial 
resources to carry out its ESCB tasks, and also its 
own  national 
its 
tasks,  such  as 
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  BNR  Law  is  incompatible  with 
Article 130 of the TFEU and Article 7 of the ECB/ 
ESCB Statute and should, therefore, be adapted, to 
ensure 
the  above  arrangements  do  not 
undermine  the  ability  of  the  BNR  to  carry  out  its 
tasks in an independent manner.  

financing 

that 

Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

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  prohibit 
the  direct  purchases  by  the  BNR  in  the  primary 
market  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)  of  the  BNR  Law  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  BNR  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)  of  the  BNR  Law  extends 
this prohibition to other bodies governed by public 
law  and  public  undertakings  of  Member  States. 
These  provisions  do  not  fully  mirror  the  entities 
listed in Article 123 of the TFEU (amongst others, 
a  reference  to  Union  institutions  is  missing)  and, 
therefore, have to be amended.  

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 under Article 7(2) 
of the BNR Law 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  BNR  Law  is 
incompatible 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”, and should be aligned. 

7.1.3.  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 collateralise the 
monetary or foreign exchange policy operations of 
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 

As  noted  above  in  point  8.1.2.,  Article  43  of  the 
BNR Law provides that the BNR shall transfer to 
the  State  on  a  monthly  basis  80%  of  its  net 
revenues  left  after  deduction  of  the  expenses 
related to the financial year and the uncovered loss 
of the previous financial years. 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. The adjustment would be made by the 
State  only  after  the  closure  of  the  financial  year 

82 

 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

  non-recognition  of  the  role  of  the  ECB  and  of 
the  Council  in  the  appointment  of  an  external 
auditor (Article 36(1) of the BNR Law);  

  absence  of  an  obligation  to  comply  with  the 
ESCB/ECB  regime  for  the  financial  reporting 
of  NCB  operations  (Articles  37(3)  and  40  of 
the BNR Law); 

  non-recognition  of  the  ECB's  right  to  impose 

sanctions (Article 57 of the BNR Law). 

7.1.5.  Assessment of compatibility 

As  regards  the  independence  of  the  BNR,  the 
prohibition  on  monetary  financing  and  the  BNR's 
integration  into  the  ESCB  at  the  time  of  euro 
adoption,  the  legislation  in  Romania,  in  particular 
the  BNR  Law,  is  not  fully  compatible  with  the 
compliance duty under Article 131 of the TFEU.  

7.2. 

PRICE STABILITY 

7.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  above  the 
reference value at the time of the last convergence 
assessment  of  Romania  in  2014.  Average  annual 
inflation  has  declined  steadily  since  then,  moving 
into  negative  territory  since  October  2015  and 
gradually  falling  to  -1%  in  early  2016.  In  April 
2016, the reference value was 0.7%, calculated as 
the average of the 12-month average inflation rates 
in  Bulgaria,  Slovenia  and  Spain  plus  1.5 
percentage  points.  The  average  inflation  rate  in 
Romania  during  the  12  months  to  April  2016 
was  -1.3%,  i.e.  2.0  percentage  points  below  the 
reference  value.  It  is  projected  to  remain  well 
below the reference value in the months ahead. 

and  would  thus  imply  an  intra-year  credit  to  the 
State,  which  would  breach  the  prohibition  on 
monetary  financing.  This  provision  is,  therefore, 
also  incompatible  with  the  Article  123  of  the 
TFEU and has to be amended.  

7.1.4.  Integration in the ESCB 

Objectives 

Pursuant  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) of the 
BNR  Law  contains  an  imperfection  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. 

Tasks 

The  incompatibilities  in  the  BNR  Law  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) of the BNR Law); 

  conduct of foreign exchange operations and the 
definition of  foreign  exchange policy  (Articles 
2(2)(a)  and  (d),  9  and  33(1)(a)  of  the  BNR 
Law); 

  holding  and  management  of  foreign  reserves 
(Articles 2(2)(e), 9(2)(c), 30 and 31 of the BNR 
Law); 

 

right to authorise the issue of banknotes and the 
volume  of  coins  (Articles  2(2)(c),  12  to  18  of 
the BNR Law); 

  non-recognition  of  the  role  of  the  ECB  and  of 
the  Council  in  regulating,  monitoring  and 
controlling 
transactions 
(Articles 10 and 11 of the BNR Law); 

currency 

foreign 

 

lack  of  reference  to  the  role  of  the  ECB  in 
payment  systems  (Articles  2(2)(b),  22  and 
33(1)(b) of the BNR Law). 

There are also imperfections regarding the:  

  non-recognition of the role of the ECB and the 
EU in the collection of statistics (Article 49 of 
the BNR Law);  

83 

-202468Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16RomaniaReference valueGraph 7.1: Romania -Inflation criterion since 2010(percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast. 
 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  declined 
sharply by almost 2 pp. in the second half of 2013 
and  stabilised  around  1.6%  in  the  first  half  of 
2014. The main drivers were slowing inflation for 
services and processed food. Annual core inflation 
increased slightly to 2% in the last quarter of 2014 
as the impact of the VAT cut for flour and bakery 
products  wore  out.  In  the  second  half  of  2015, 
following  the  cut  of  the  VAT  rate  for  the 
remaining  food  products,  core  inflation  dropped 
below  zero,  but  started  a  modest  recovery  as  of 
November  2015.  It  again  turned  negative  in  early 
2016, following the cut in the standard VAT rate. 
Annual  average  producer  price  inflation  for  total 
industry has been negative since the last quarter of 
2014.   

84 

7.2.2.  Recent inflation developments 

rapidly 

from  around  4.5%  at 

Annual  HICP  inflation  has  been  on  a  downward 
path  over  the  past  two  years,  mainly  driven  by 
successive  VAT  cuts  and  low  global  oil  prices, 
though  underlying  price  pressures  have  been 
building  amid  strong  domestic  demand  supported 
by  fiscal  stimulus  and  high  wage  growth.  It 
dropped 
the 
beginning of 2013 to just above 1% in September 
2013 and fluctuated between 1% and 2% for most 
of  2014.  The  considerable  decline  in  2014  was 
attributable  to  several  factors:  (i)  the  15  pp. 
reduction  of  the  VAT  rate  for  flour  and  bakery 
products  from  September  2013,  (ii)  the  abundant 
harvest  in 2014, (iii) falling global energy and oil 
prices  and  (iv)  disinflationary pressures  stemming 
from  a  persistently  negative  output  gap.  Inflation 
developments  in  2015  and  over  the  forecast 
horizon  (2016-2017)  are  markedly  influenced  by 
fiscal  policy,  in  particular  by  the  successive 
reductions  of 
for  different 
categories  of  products.  After  falling  to  below  1% 
in  the  first  months  of  2015,  inflation  moved  into 
negative  territory  in  June  2015  (-0.9%)  following 
the  cut  of  the  VAT  rate  for  the  remaining  food 
products from 24% to 9%.  

the  VAT 

rates 

The  annual  HICP  inflation  rate  has  been  negative 
since  then,  reaching  a  historical  low  of  -2.6%  in 
April 2016. The main reasons for the steep fall in 
early 2016 were the reduction of the standard VAT 
rate  by  4  pp.  from  January  2016  and  persistently 
low global oil prices.  

-30369201020112012201320142015RomaniaEuro areaGraph 7.2:Romania -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 7.1:weights  Romania - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP6.15.83.43.21.4-0.4-1.31000Non-energy industrial goods3.53.32.42.01.61.00.3252Energy7.69.36.94.12.3-2.7-3.3119Unprocessed food 2.95.40.66.4-0.7-3.4-5.2154Processed food10.47.53.52.30.2-1.6-3.2213Services4.13.54.22.63.12.22.0262HICP excl. energy and unproc. food6.45.03.32.31.70.7-0.1727HICP at constant taxes1.83.83.23.01.11.22.01000Administered prices HICP5.47.65.36.02.01.60.71381) 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.Sources: Eurostat, Commission services. 
 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

7.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Economic  growth  has  been  strong  over  the  past 
two years. Romania's economy expanded by 3.0% 
in 2014, the drivers of growth switching gradually 
from  net  exports  to  domestic  demand.  Real  GDP 
growth accelerated further to 3.8% in 2015, on the 
back  of  surging  domestic  demand,  while  net 
exports  contributed  negatively  to  growth.  Private 
consumption was strong, particularly supported by 
a  cut  of  the  VAT  for  food.  Investment  also 
bounced  back  and  returned  to  almost  pre-crisis 
growth rates in 2015. GDP growth is set to remain 
above potential at 4.2% in 2016 and 3.7% in 2017, 
supported by additional fiscal stimulus. The output 
gap  is  estimated  to  close  in  2016  and  to  turn 
positive in 2017. 

The fiscal stance, as measured by the change in the 
structural  balance,  tightened  in  2014  compared 
with  2013,  but  loosened  somewhat  in  2015.  The 
structural  budget  balance was  estimated  at  around 
¼%  of  GDP  in  2014  and  ½%  in  2015.  The  fiscal 
stance is projected to become highly expansionary 
deficit 
and 
deteriorating to 2¾% of GDP in 2016 and 3½% of 
GDP in 2017. 

pro-cyclical,  with 

structural 

85 

The  BNR,  operating  within  an  inflation  targeting 
framework (53), cut the key policy rate by a total of 
350 basis points between July 2013 and May 2015 
in order to stimulate lending and domestic demand, 
on  the  back  of  an  improved  inflation  outlook.  It 
also  reduced  minimum  reserve  requirements  with 
the medium-term goal to align them gradually with 
the  EU. 
the 
ratios  prevailing 
Nevertheless,  credit  growth  remained  negative  in 
2014  but  picked  up  in  2015  due  to  very  strong 
lending in domestic currency. 

rest  of 

in 

Wages and labour costs 

In  2014  employment  registered  a  positive  growth 
rate for the first time since the crisis, supported by 
strong  economic  growth.  Despite  a  drop  in  total 
employment  in  2015  on  account  of  a  significant 
reduction of the number of self-employed persons, 
employment  is  expected  to  remain  broadly  stable 
in 2016 and 2017. Employment levels in Romania 
remain,  nonetheless,  low  compared  to  most  other 
EU  Member  States.  The  unemployment  rate  has 
decreased  to below 7%  and  is expected  to  remain 
at the same level.  

Strong  economic  growth  and  successive  increases 
of  both  public  sector  and  minimum  wages  have 
been  driving  nominal  wages  upwards  since  2013, 

(53)  As  from  2013,  the  BNR  follows  a  flat  multi-annual 

inflation target of 2.5% (± 1pp.). 

Table 7.2:Romania - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationRomania6.15.83.43.21.4-0.4-0.62.5Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorRomania7.24.24.52.61.21.20.21.8Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeRomania1.9-4.19.43.85.33.26.96.2Euro area2.22.21.81.71.31.21.51.9Labour productivityRomania-0.51.95.74.42.14.74.23.8Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsRomania2.4-5.83.5-0.63.1-1.42.52.3Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorRomania5.76.07.5-6.2-1.8-2.3-3.41.2Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
per 

is  expected 

compensation 

and  most  notably  in  2015.  Labour  productivity 
growth  slowed  somewhat  in  2014  but  picked  up 
again  in  2015  when  it  exceeded  the  increase  in 
employee. 
nominal 
Compensation  per  employee 
to 
increase further by around 7% in 2016 and slightly 
above  6%  in  2017.  Wage  growth  has  been 
accelerating  considerably  (growing 
in  double 
digits  in  early  2016)  and  is  forecast  to  outpace 
productivity growth in 2016 and 2017, resulting in 
significant  increases  in  nominal  unit  labour  costs 
which  are  likely  to  weigh  on  competitiveness  and 
job creation.     

External factors 

Due  to  the  openness  of  the  Romanian  economy 
and its deep integration into the world and the EU 
economy,  developments  in  import  prices  play  a 
significant  role  in  domestic  price  formation.  In 
particular, energy and food commodity prices have 
been  a  significant  determinant  of  import  price 
inflation  in  Romania,  given  the  large  weight  of 
these  categories  in  the  Romanian  HICP.  Import 
price  inflation  (measured  by  the  imports  of  goods 
deflator)  was  negative  and  significantly  below 
consumer  price  inflation  in  both  2014  and  2015. 
Going  forward,  import  price  inflation  is  projected 
to remain negative in 2016 and to pick up and turn 
positive in 2017, remaining below consumer price 
inflation. 

Fluctuations  of  the  leu  have  only  moderately 
influenced  import  price  dynamics  in  recent  years. 
The  nominal  effective  exchange  rate  (measured 
against a group of 37 trading partners) appreciated 
somewhat in the first half of 2014, but depreciated 
slightly  between  mid-2014 
and  mid-2015, 
reflecting  mainly  monetary  policy  easing.  It 
recovered  again  in  the  third  quarter  of  2015  and 
has been on a slight upward path since then. 

Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

Administered prices and taxes 

in 

influenced 

considerably 

Changes  in  administered  prices  and  indirect  taxes 
inflation 
have 
developments 
recent  years.  Administered 
prices (54)  have  a  slightly  larger  weight  in  the 
Romanian  HICP  basket  than  in  the  euro  area 
(13.7%  compared  to  12.9%).  The  average  annual 
increase in administered prices plunged from 6.0% 
in 2013 to 2.0% in 2014 and 1.6% in 2015 due to 
limited  growth  of  electricity  and  gas  prices, 
although  remaining  substantially  above  average 
headline  inflation.  The  liberalisation  of  gas  and 
electricity prices in Romania had a rather moderate 
impact  on  inflation,  as  the  expected  upward 
pressure  on  energy  and  therefore  on  administered 
prices  was  counterbalanced  by 
low  global 
commodity prices. 

in 

fuel  excise  duties  contributed 
Increases 
moderately  to  inflation  in  Romania  in  2014  and 
2015.  HICP  inflation  measured  at  constant  taxes 
was  above  HICP  inflation  in  the  first  quarter  of 
2014 due to the effect of the VAT cut on bread and 
flour. Starting from the second quarter of 2014 this 
trend  was  reversed  and  constant-tax  inflation 
remained  below  HICP  inflation  until  the  second 
quarter of 2015. With the cut of the VAT rate for 
indicators  diverged 
two 
food  products, 
significantly from each other. The gap between the 
two increased to 3 pp. in June 2015 and has been 
around 3 pp. until the end of 2015. HICP inflation 
was  pushed  down  further  by  a  reduction  of  the 
standard  VAT  rate  by  4  pp.  from  January  2016. 
These several VAT cuts decreased annual inflation 
by  5  pp.  in  January  2016,  as  measured  by  the 
constant-tax index (HICP-CT).  

the 

These  measures  had  an  overall  effect  on  inflation 
rate of over [X%] for 2015 and entail an additional 
reduction in the inflation rate of around [X pp.] for 
2016.  

Medium-term prospects 

According  to  the  Commission  services'  Spring 
2016  Forecast,  annual  HICP  inflation  is  projected 
to  remain  slightly  negative  at  -0.6%  in  2016 
mainly  on  account  of  the  4  pp.  reduction  of  the 

(54)  According to the Eurostat definition, administered prices in 
Romania  include  inter  alia  regulated  electricity  and  gas 
prices,  regulated  utility  prices,  medical  products,  postal 
services  and  cultural services  and  part of  public  transport. 
For 
see: 
details, 
http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP+classification+2015-02/023e5b4d-6300-47dc-
b7aa-27d1e5013f3b  

86 

-8-40481220102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 7.3:Romania -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2016 Forecast. 
 
                                                           
standard  VAT  and  continuously  low  global  oil 
prices.  However,  as  the  transitory  impact  of  the 
VAT  rate  cut  for  food  products  fades  out,  the 
output  gap  closes  and  domestic  pressures  are 
mounting (a further 19% increase in the minimum 
wage  from  May  2016  and  strengthening  domestic 
demand),  inflation  is  set  to  return  to  positive 
territory  in  the  second  half  of  2016.  Despite  the 
additional  cut  in  the  standard  VAT  rate  by  1pp. 
VAT cut announced for January 2017, inflation is 
target  band 
expected 
(2.5% ±1 pp.)  and  to  reach  an  annual  average  of 
2.5% in 2017.  

to  re-enter 

the  NBR's 

consumption 

the  relatively 
the 
in 

Risks to the inflation outlook are broadly balanced. 
Downside  risks  are  related  to  persistently  low 
global  commodity  prices,  with  the  overall  impact 
large  weight  of 
amplified  by 
commodities 
basket. 
Inflationary  pressures  from  the  closing  of  the 
output  gap  in  2016  may  be  higher  than  currently 
expected.  A  gradual  withdrawal  of  monetary 
stimulus in the US and associated capital outflows 
some 
from  emerging  markets  might  exert 
downward  pressure  on  the  exchange  rate  which 
would  feed  into  higher  inflation.  Upside  risks  to 
the  projection  relate  mainly  to  a  stronger-than-
expected build-up of domestic price pressures and 
acceleration of wage growth. 

Over  the  long  run,  there  is  potential  for  further 
significant price level convergence in line with the 
expected  catching-up  of  the  Romanian  economy 
(with  income  levels  in purchasing power  standard 
at  about  51%  of  the  euro-area  average  in  2014). 
The  level  of  consumer  prices  in  Romania  was 
around 52% of the euro-area average in 2014, with 
the relative price gap widest for services.  

Medium-term 
inflation  prospects  will  depend 
strongly  on  productivity  and  wage  developments, 
notably  on  efforts 
to  avoid  excessive  wage 
increases and on the success of anchoring inflation 
expectations  at  the  central  bank's  2.5%  target.  A 
prudent  fiscal  policy  and  the  continuation  of 
structural  reforms  will  be  essential  to  contain 
inflationary  pressures  and  support  sustainable 
convergence going forward. Tax policy is expected 
to have some impact on inflation in 2017 due to a 
cut of the standard VAT rate by 1pp. from January 
2017 and cuts in excise duties on fuel. 

Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

7.3. 

PUBLIC FINANCES 

7.3.1.  Recent fiscal developments 

three 

Romania  benefited 
consecutive 
from 
EU/IMF financial assistance programmes between 
2009  and  2015.  Fiscal  policy  targets  of  the  2013-
2015  precautionary  programme  included  reaching 
the  medium-term  budgetary  objective  by  2015,  as 
recommended by the Council (55), improving fiscal 
governance  and  public  debt  management,  and 
implementing  additional  structural  reforms 
to 
improve 
expenditure 
revenue 
management.  On  21  June  2013,  the  Council 
decided  to  abrogate  the  decision  on  the  existence 
of  an  excessive  deficit  according  to  Article  126 
(12)  TFEU,  thereby  closing  the  excessive  deficit 
procedure for Romania (56). 

public 

and 

The  headline  general  government  deficit  declined 
further from 2.1% of GDP in 2013 to 0.9% of GDP 
in  2014.  In  structural  terms,  the  deficit  improved 
by  0.8  pp.  to  ¼%  of  GDP.  The  2015  general 
government  deficit  of  0.7%  of  GDP  was  better 
than  the  -1.2%  of  GDP  targeted  in  the  2015 
Convergence  Programme.  The  structural  balance 
deteriorated 
the  enacted 
measures.  

somewhat  due 

to 

The adjustment over 2013-2015 was mainly driven 
by  measures  on  the  revenue  side.  The  measures 
adopted in 2014 included an increase in excises on 
fuel,  an  introduction  of  inflation  indexation  of 
excise duties, broadening of the property tax base, 
and  an  increase  in  royalties  on  mineral  resources 
other  than  oil  and  gas.  In  2015,  fiscal  easing 
measures, namely a cut by 5 pp. in social security 
contributions,  a  cut  of  the  VAT  rate  on  food  and 
the  doubling  of  child  benefits  (from  mid-2015) 
were  compensated  by  higher  tax  revenues  on  the 
tax 
back  of  strong  economic  growth,  better 
compliance  and  lower-than-budgeted  expenditure 
on some public investment items (e.g. co-financing 
of  EU-funded  projects).  The  general  government 
revenue-to-GDP  ratio  increased  from  33.1%  in 
2013  to  34.8%  in  2015,  while  total  government 
expenditure  increased  from  35.2%  to  35.5%  of 
GDP over the same period. 

(55)  For  the  Country-Specific  Recommendations  addressed  to 
Romania 
see: 
http://ec.europa.eu/europe2020/pdf/csr2015/csr2015_counc
il_romania_en.pdf. 

2015, 

in 

(56)  An  overview  of  all  excessive  deficit  procedures  can  be 

found at: http://ec.europa.eu/economy_finance/economic_ 

governance/sgp/deficit/index_en.htm 

87 

 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

the  2016  general  government  balance  will 
deteriorate from -0.7% of GDP in 2015 to -2.8% of 
GDP  in  2016  and  to  -3.4%  of  GDP  in  2017.  The 
structural  deficit  is  forecast  to  widen  by  nearly 
3 pp. to 3.4% of GDP in 2017 as a consequence of 
the  fiscal  easing  and  closing  of  the  output  gap  in 
2016-2017, reflecting strongly expansionary fiscal 
stance. The general government debt-to-GDP ratio 
is projected to rise from 38.4% of GDP in 2015 to 
40.1% of GDP in 2017. 

submitted 

programme 

Romania 
the  2016  Convergence 
Programme  on  28  April  2016.  The  Programme 
departs from the MTO, which has been achieved in 
2014-2015, and does not aim to return to it within 
the 
period.  The  Convergence 
Programme targets a deficit of 2.9% of GDP both 
in 2016 and 2017, 2.3% in 2018 and 1.6% in 2019. 
The  Commission  services'  Spring  2016  Forecast  
expects  the  deficit  to  amount  to  2.8%  of  GDP  in 
2016  and  to  further  increase  to  3.4%  of  GDP  in 
2017  under  a  no-policy-change  assumption.  The 
Programme has a more favourable macroeconomic 
scenario 
the  macro 
projections  in  the  Commission  services'  Spring 
  Based  on  the  Commission's 
2016  Forecast. 
assessment  of  the  2016  Convergence  Programme, 
there  is  a  risk  that  Romania  will  not  comply  with 

in  2017  compared 

to 

88 

General government debt fell from 39.8% of GDP 
in 2014 to 38.4% of GDP in 2015, thanks to strong 
GDP  growth  and  a 
low  general 
government deficit. 

relatively 

7.3.2.  Medium-term prospects 

The  budget  for  2016  was  adopted  by 
the 
Parliament  on  16  December  2015  targeting  a 
deficit of 2.95% of GDP. On the revenue side, the 
fiscal  stance  has  been  loosened  by  a  new  Fiscal 
Code,  which reduced  the standard  VAT  rate  from 
24% to 20% from January 2016 and further to 19% 
from  January  2017.  The  dividend  tax  was  also 
reduced  from  16%  to  5%.  The  new  Fiscal  Code 
also eliminates the special construction tax and the 
extra  excise  duty  on  fuel  from  2017.  On  the 
expenditure  side,  public  sector  wages  were 
increased  in  several  steps  in  2015,  including 
specific increases in selected sectors and a general 
wage  hike  by  10%  as  of  December  2015.  The 
minimum  wage,  which  also affected  public  sector 
workers, was raised by 12.5% in 2014 and 17% in 
2015. An additional 19% increase of the minimum 
wage was enacted from May 2016.  

Taking  these  measures  into  account,  according  to 
the  Commission  services'  Spring  2016  Forecast, 

Table 7.3:Romania - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance-6.9-5.4-3.7-2.1-0.9-0.7-2.8-3.4- Total revenues32.733.733.433.133.534.831.831.5- Total expenditure39.639.137.135.234.335.534.634.9   of which: - Interest expenditure1.51.61.81.71.71.61.71.7p.m.: Tax burden26.928.028.027.527.728.226.625.8Primary balance-5.4-3.8-1.9-0.40.80.9-1.1-1.6Cyclically-adjusted balance-5.6-4.1-2.0-1.1-0.2-0.4-2.8-3.4One-off and temporary measures0.0-1.10.50.00.00.30.10.0Structural balance 2)-5.6-3.0-2.6-1.1-0.2-0.6-2.8-3.4Government gross debt29.934.237.438.039.838.438.740.1p.m: Real GDP growth (%)-0.81.10.63.53.03.84.23.7p.m: Output gap-3.9-3.8-4.9-3.1-2.1-1.10.00.3Convergence programme2016201720182019General government balance-2.9-2.9-2.3-1.6Structural balance 2) 3)-2.7-2.9-1.9-1.3Government gross debt39.139.839.939.3p.m. Real GDP (% change)4.24.34.54.71) Commission services’ Spring 2016 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.  Sources: Commission services, the 2016 Convergence Programme of Romania.There are no one-off and other temporary measures in the programme. 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

The  leu's  exchange  rate  against  the  euro  showed 
relatively  limited  fluctuation between  spring  2014 
and  beginning  of  2016  also  in  comparison  with 
other  regional  peers  operating  under  floating 
exchange  rate  regimes.  The  leu  predominantly 
traded  in  the  range  of  4.4-4.5  RON/EUR  since 
2013.  The  leu  fluctuated  little  during  2014,  but 
weakened  somewhat  in  December  2014  mainly 
due  to  an  increase  in  risk  aversion  at  the  global 
level.  The  leu  strengthened  moderately  at  the 
beginning  of  2015,  supported  by  the  additional 
monetary  easing 
leu 
weakened again at the end of 2015 due to domestic 
political uncertainties but recovered in early 2016. 
The lower short-term volatility of the leu reflected 
the  positive  effects  associated  with  the  EU-IMF 
international  financial  assistance  to  Romania  until 
end-2015, favourable global market conditions and 
also  operations  by  the  BNR  in  the  interbank  and 
foreign  exchange  markets.  Compared  to  April 
2014, the exchange rate of the leu against the euro 
was basically unchanged in April 2016. 

the  euro  area.  The 

in 

the provisions of the Stability and Growth Pact, as 
there  is  a  risk  of  a  significant  deviation  both  in 
2016  and,  under  unchanged  policies,  2017. 
Therefore  further  measures  will  be  needed  to 
ensure  compliance  in  2016  and  2017.  Further 
details can be found in the Assessment of the 2016 
Convergence Programme for Romania (57). 

the  national  fiscal  framework 

As  far  as 
is 
concerned – which refers to numerical fiscal rules, 
medium-term  budgetary  frameworks,  independent 
fiscal  institutions,  and  budgetary  procedures  – 
Romania  has  conducted  a  series  of  reforms  since 
2010,  aiming  to  ensure  fiscal  discipline  and 
prevent  the  budgetary  slippages.  Romania  has 
declared its intention to apply the provisions of the 
Fiscal  Compact.  Overall,  Romania  has  a  sound 
fiscal framework in terms of principles and rules in 
legislation,  but  the  framework  is  not  effectively 
implemented  in  practice.  Fiscal  measures  adopted 
are  often  not  in  full  compliance  with  the  Fiscal 
Responsibility  Law  and  ad  hoc  government  acts 
providing derogations from the law are weakening 
the  fiscal  rules.  The  medium-term  fiscal  plans  are 
not  adequately  guiding  budgetary  process.  The 
Fiscal  Council  is  often  given  very  little  time  to 
react  to  budgetary  proposals  and  its  opinions  and 
recommendations  are  not  sufficiently  taken  into 
account. 

7.4. 

EXCHANGE RATE STABILITY 

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 (58).  De 
facto,  the  exchange  rate  regime  moved  gradually 
from a strongly managed float – including through 
the use of administrative measures until 1997 – to 
a more flexible one. In 2005, Romania shifted to a 
direct  inflation  targeting  framework  combined 
with  a  floating  exchange  rate  regime.  The  BNR 
has, 
currency 
remains  available  as  a  policy 
intervention 
instrument.  

nonetheless, 

stressed 

that 

(57)

http://ec.europa.eu/economy_finance/economic_gov

ernance/sgp/convergence/index_en.htm 

(58)  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. 

89 

The  NBR's  gross  international  reserves  declined 
from  on  average  around  EUR  35bn  in  2012-2013 
to  around  EUR  33.6bn  in  April  2016,  mainly  due 
to substantial repayments of international financial 
assistance  to  IMF  and  EU  during  2014-2016. 
Short-term  fluctuations  in  recent  years  have  also 
reflected  changes  in  the  foreign  exchange  reserve 
requirements  of  credit  institutions (59)  as  well  as 
foreign  exchange  operations  by  the  government. 
The  reserve  level  was  at  around  22%  of  GDP  by 
end-2015, covering above 100% of short-term debt 
and around 6 months of imports. 

(59)  MRR  ratio  on  foreign  currency-denominated  liabilities 
were cut from 20% to 18% in January, to 16% in July, and 
to 14% in November 2014, and further to 12% in January 
2016. 

3.03.54.04.55.02010201120122013201420152016Graph 7.4: Romania -RON/EUR exchangerate(monthly averages)Source: ECB. 
                                                           
 
 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  declined  gradually  from  around  270 
basis points at the beginning of 2014 to below 200 
basis  points  by  end-2014.  They  continued  to 
decline  substantially  during  2015  and  at  the 
beginning  of  2016.  These  developments  reflect 
considerable  monetary  policy  easing  by  the  BNR 
from  July  2013  to  May  2015,  when  the  key  rate 
was by reducing the key policy rate from 5.25% to 
1.75%.  At  the  cut-off  date  of  this  report,  the  3-
month  spread  vis-à-vis  the  euro  area  stood  at 
around 100 basis points.  

7.5. 

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 nine years.  

The  Romanian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  below  the  reference  value  at 
the  time  of  the  last  convergence  assessment  of 
Romania in 2014. Since then, it declined further to 
below  5%  mid-2014  and  further  to  below  4%  in 
early  2015  and  floated  around  3.5%  over  most  of 
2015.  It  went  slightly  up  again  in  early  2016.  In 
April  2016,  the  latest  month  for  which  data  are 
available, the reference value, given by the average 
of  long-term  interest  rates  in  Bulgaria,  Slovenia 
and Spain plus 2 percentage points, stood at 4.0%. 
In that month, the 12-month moving average of the 
yield  on  the  Romanian  benchmark  bond  stood  at 
3.6%, 
the 
reference value. 

i.e.  0.4  percentage  points  below 

interbank 

rates  and 

Long-term  interest  rates  declined  gradually  from 
above 5% in spring 2014 to below 4% at the end of 
2014,  reflecting  a  reduced  country  risk  premium 
backed by a solid fiscal consolidation track record 
as  well  as  a  gradual  downward  adjustment  of  the 
expected  path  of 
the 
precautionary  EU-IMF  programme.  They  then 
gradually  declined  further,  temporarily  moving  to 
below  3%  in  February  2015.  It  went  up  again  in 
mid-2015 touching 4% and fluctuated around 3.5% 
thereafter. At the same time, the long-term spread 
vis-à-vis  the  German  benchmark  bond  declined 
from above 500 basis points in late 2012 to around 
250  basis  points  in  January  2015  and  stood  at 
around 330 basis points in April 2016 (60).  

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 

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

90 

025050075010002010201120122013201420152016Graph 7.5: Romania -3-M Robor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Romania.024681012Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16RomaniaReference valueGraph 7.6: Romania -Long-terminterest rate criterion(percent, 12-month moving average)Source: Commission services.02468102010201120122013201420152016RomaniaGermanyGraph 7.7: Romania -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
 
                                                           
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

additional factors – including balance of payments 
developments,  product, 
financial 
market integration – gives an important indication 
of  a  Member  State's  ability  to  integrate  into  the 
euro area without difficulties.  

labour  and 

threshold 

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (61) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Romania  exceeded  the 
indicative 
in  one  out  of  fourteen 
indicators,  i.e.  the  net  international  investment 
position.  Romania  benefited  from  a  precautionary 
EU-IMF  financial  assistance  programme  totalling 
up  to  about  EUR  5  billion  which  ended  end 
September 2015. Close surveillance related to this 
arrangement implied that Romania was not subject 
to  in-depth  reviews  in  the  context  of  the  MIP  in 
order  to  avoid  the  duplication  of  surveillance 
procedures  until  2014  (62).  In  line  with  the 
conclusions of the AMR 2016 (i.e. that imbalances 
had  been  identified  for  Romania  in  the  previous 

(61)

http://ec.europa.eu/europe2020/pdf/2016/ags2016_al

ert_mechanism_report.pdf 

(62)  http://eur-lex.europa.eu/LexUriServ/ 

LexUriServ.do?uri=OJ:L:2013:140:0001:0010:EN:PDF 

MIP  round),  Romania  was  subject  to  an  in-depth 
review,  which 
is  not 
that  Romania 
found 
experiencing macroeconomic imbalances. 

7.6.1.  Developments  of 

the  balance  of 

payments 

Romania's  external  balance  (i.e.  the  combined 
current  and  capital  account)  has  adjusted 
significantly in the wake of the global crisis. After 
having recorded a deficit of around 5% of GDP in 
2010  it  narrowed  and  then  shifted  into  a  surplus 
starting in 2013 which more than doubled in 2014. 
Although  positive  at  around  1.3%  of  GDP,  the 
external  surplus  modestly  deteriorated  in  2015. 
The overall improvement in the external balance in 
the last three years reflected a significant decline in 
the  trade  deficit,  on  the  back  of  strong  export 
performance resulting in a decrease in the balance 
of goods deficit and a rising surplus in the services 
balance.  With  the  exception  of  2013,  the  primary 
income  balance  deficit  has  widened  while  the 
secondary  income  balance  surplus  has  decreased. 
Finally, the capital account recorded an increasing 
surplus  in  2013-2015  due  to,  inter  alia,  improved 
absorption of EU funds.  

91 

Table 7.4:Romania - Balance of payments(percentage of GDP)201020112012201320142015Current account-5.1-4.9-4.8-1.1-0.5-1.1of which: Balance of trade in goods-7.6-7.0-6.9-4.0-4.2-4.9                 Balance of trade in services1.21.21.93.33.94.3                 Primary income balance -1.2-1.3-1.7-2.2-1.3-2.4                 Secondary income balance2.52.12.01.91.11.8Capital account0.20.51.42.12.62.4External balance 1)-4.9-4.4-3.41.02.21.3Financial account 2)-4.5-3.5-2.51.11.91.8of which: Direct investment-1.8-1.3-1.9-2.0-1.8-1.7                Portfolio investment-0.7-1.3-2.6-3.8-1.90.5                Other investment 3)-4.6-1.73.15.56.63.4                Of which International financial assistance6.31.8-1.1-3.3-3.0-0.9                Change in reserves2.60.7-1.11.4-0.9-0.4Financial account without reserves-7.1-4.3-1.4-0.32.92.2Errors and omissions0.40.90.90.1-0.20.5Gross capital formation26.827.926.825.625.225.6Gross saving22.323.522.624.925.424.7Gross external debt74.374.975.368.263.156.2International investment position-63.4-65.4-67.4-62.6-57.4-51.11) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Romania. 
                                                           
 
 
 
 
 
 
The  current  account  adjustment  was  supported  by 
corrections  of  the  savings-investment  balance. 
Romania's  saving-investment  balance  narrowed 
from -4.5% in 2010 to close to balance in 2014 and 
widened slightly to around  -0.9% in 2015 as both 
private  and  public  sectors  continued  to  adjust  in 
parallel  with  improving  financial  conditions.  The 
decline  in  investment  up  to  2014,  contributed  to 
the  adjustment  of  the  current  account  balance.  In 
2015,  investment  increased  slightly,  while  saving 
decreased,  resulting  in  a  deterioration  of  the 
current account balance.  

Improvements  in  cost  competitiveness  sustained 
export  performance 
fuelled  by  a  moderate 
depreciation in 2014-2015 of the nominal (NEER) 
and  the  real  effective  exchange  rate  (REER). 
Romania's  improved  competitiveness  contributed 
to one of the highest growth rates in export market 
shares in the EU in 2010-2014. Romania was able 
to  gain  market  shares  in  the  EU  market  and  also 
benefited  from  the  dynamism  of  markets  outside 
the EU.  

Romania  was  a  beneficiary  of 
international 
financial assistance between 2009 and 2011, when 
it  benefitted 
from  EU  balance-of-payments 
assistance  programme  and  an  IMF  stand-by 
arrangement.  The  success  of 
this  EU-IMF 
programme and two successor programmes (2011-
2013  and  2013-2015)  enabled  Romania  to  regain 
full  market  access  since  mid-2011.  The  latter  two 
programmes were on a precautionary basis and no 
drawings  were  made.  Romania  has  repaid  all 
liabilities  to  the  IMF  and  part  of  liabilities  to  the 
EU (EUR 1.6bn in 2015). Given the disbursements 
made under the first programme, Romania will be 
under  post-programme  surveillance  until  spring 
2018,  when  70 %  of  the  financial  assistance  from 
the European Union has been repaid.  

External financing pressures eased further in 2013-
2015  amid  the  improvement  in  the  external 

Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

benchmark 

in  2013,  mainly 

balance  and  a  recovery  in  global  risk  appetite. 
After  net  FDI  inflows  had  fallen  sharply  in 
2009-2010,  they  stabilised  broadly  in  2013-2015, 
averaging  around  2.0%  of  GDP.  Net  portfolio 
inflows increased gradually to reach nearly 4% of 
GDP 
reflecting  significant 
portfolio  investment  into  government  securities 
following the inclusion of Romania in a number of 
international 
indices.  However, 
portfolio inflows declined in 2014 and turned into 
outflows in 2015 in part due to the amortisation of 
government  bonds.  Gross  external  debt  peaked  at 
above 75% of GDP in 2012 reflecting the increase 
of  public  external  debt.  It  declined  to  56.2%  of 
GDP  in  2015,  due  to  falling  public  and  private 
sector  debt.  The  net  international  investment 
position  bottomed  out  at  around  -67%  of  GDP  in 
2012 and has improved since then to around -51% 
of GDP in 2015, on the back of narrowing current 
account deficits and strong nominal growth.  

According  to  the  Commission  services'  Spring 
2016 Forecast, the external balance is expected to 
remain  in  balance  in  2016  and  to  widen  to  -0.7% 
of  GDP  in  2017  as  domestic  demand  accelerates, 
but 
to  remain  contained.  Romania's  external 
position  benefited  from  higher  absorption  of  EU 
funds  up  to  2015.  It  is  expected  to  deteriorate  in 
2016 due to lower EU funds' absorption related to 
the  end  of  the  2007-2013  programming  period 
while 
the  2014-2020 
programmes has just started. 

implementation  of 

the 

7.6.2.  Market integration 

Romania's  economy  is  well  integrated  with  the 
euro  area  through  both  trade  and  investment.  The 
trade  openness  of  Romania  has 
increased 
significantly  in  the  aftermath  of  the  crisis,  but  is 
still  relatively  low.  Trade  openness  in  2015  stood 
at  around  45%  of  GDP.  Romania's  main  trading 

92 

0102030201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 7.8: Romania -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.8090100110120201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 7.9: Romania -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100) 
 
 
Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

collective  bargaining  at  sector  and  undertaking 
level. A recent revision of the social dialogue law 
improving  collective  bargaining  by 
aims  at 
establishing  a  representation  cascade  for  trade 
unions at higher level when no representative trade 
union  exists  in  the  undertaking.  Strong  outward 
migration, including of the highly-skilled workers, 
presents  a  challenge  to  support  a  competitive 
economy. 

The Romanian financial sector is highly integrated 
into  the  EU  financial  sector,  in  particular  through 
the  strong  presence  of  foreign  banks  in  Romania. 
The  share  of  foreign-owned  banks,  mainly  euro 
area  parent  banks,  in  the  total  assets  of  the 
Romanian  banking  sector  reached  68%  in  2014. 
Concentration  in  the  banking  sector,  as  measured 
by  the  market  share  of  the  largest  five  credit 
institutions  at  54%,  remained  above  the  euro  area 
average.  

partners  within  the  euro  area  are  Germany,  Italy 
and  France,  while  outside  the  euro  area  it  mainly 
trades  with  Hungary,  Poland,  Turkey  and  the 
United Kingdom. The share of trade with the euro 
area  expressed  in  percentage  of  GDP  has  been 
increasing in recent years, reaching 25% in 2015. 

Due to wage competitiveness, favourable corporate 
tax  rates  and  a  relatively  large  domestic  market, 
Romania  attracted  substantial  FDI  inflows.  The 
FDI stock reached 56% of GDP in 2014, with main 
FDI  inflows  originating  from  euro-area  Member 
States, with the Netherlands, Austria and Germany 
accounting for  more  than half  of  the  FDI  stock  at 
the end of 2014.  

in 

Concerning  the  business  environment,  Romania 
performs,  in  general,  worse  than  most  euro-area 
Member  States 
international  rankings.  In 
particular, Romania has low ranks in trading across 
borders  and  in  registering  property.  According  to 
the  May  2015 
Internal  Market  Scoreboard, 
Romania's  transposition  deficit  of  EU  Directives 
was at 1.2% which is substantially above the target 
(0.5%)  proposed  by  the  European  Commission  in 
the Single Market Act (2011).  

In terms of resilience during the crisis, the capacity 
of the Romanian labour market to adjust has been 
improved. The social dialogue law enacted in 2011 
promoted 
collective 
decentralisation 
bargaining.  However,  a  combination  of  factors, 
including  representativeness  criteria  for 
trade 
unions and employers' associations, has hampered 

of 

a 

93 

01020304050607080RO, 2010RO, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 7.10: Romania -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators Table 7.5:Romania - Market integration201020112012201320142015Trade openness 1) (%)38.843.543.844.045.145.1Trade with EA in goods & services 2)+3) (%)20.422.622.724.024.725.1Export performance (% change) 4)4.66.20.317.95.21.9World Bank's Ease of Doing Business Index rankings 5)657272733737WEF's Global Competitiveness Index rankings 6)677778765953Internal Market Transposition Deficit 7) (%)0.51.20.41.01.01.2Real house price index 8)100.084.276.574.372.073.2Residential investment 9) (%)2.92.73.12.4n.a.n.a. 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
The  Romanian  banking  sector  has  remained 
resilient and well-capitalised as capital adequacy at 
system  level  stood  at  roughly  17.1%  in  Q3  2015, 
substantially  above  the  euro  area  average.  The 
deterioration  in  asset  quality  and  the  increase  in 
loan-loss  provisions  necessary  to  support  the 
cleaning  up  of  bank  balance  sheets  have  put  a 
strain  on  banking  sector  profitability  until  2014, 
with  return  on  equity  declining  from  22.5%  in 
2007  to  -15.2%  in  2014.  The  banking  system 
returned to profit in 2015 (12% in Q3 2015). Non-
performing loans (90 days overdue) have increased 
significantly  in  the  post-crisis  period  (i.e.  from 
below  2%  in  2007)  and  peaked  at  nearly  20%  in 
2013.  In  2014,  measures  were  implemented  to 
resolve  non-performing  loans  which  led  to  their 
decline  to  12.4%  in  Q3  2015,  although  remaining 
considerably above the average of the euro area.  

 After  the  pre-crisis  boom,  house  prices  have 
followed a negative trend from 2008 (the first year 
with  available  data)  to  2014.  In  2015,  real  house 
prices  went  up  slightly  and  reached  73%  of  their 
2010  level.  Investment  in  dwellings  has  been 
fluctuating  at  around  2.5-3%  of  GDP  in  the  past 
five years.  

Romania  still  lags  considerably  behind  the  euro 
area  as  regards  bank  credit  to  the  private  non-
financial sector (around 31% of GDP), around half 
of it in foreign currency (47% of total). The share 

Convergence Report 2016 - Technical annex 

Chapter 7 - Romania 

lending 

foreign-currency 

of  foreign-currency  loans  to  the  private  sector 
decreased from a peak of around 67% of the total 
loans  in  2012,  inter  alia  due  to  the  measures 
introduced  by  the  National  Bank  of  Romania  to 
curb 
to  unhedged 
households  and  corporates,  in  particular  SMEs, 
and  restricting  the  state  guaranteed  mortgage 
scheme to lending in domestic currency. However, 
recent legislative initiatives, including the recently 
enacted  Law  on  debt  discharge,  raise  concerns  in 
impact  on  financial 
their  potential 
terms  of 
stability and the economy. 

Equity  and  debt  markets 
in  Romania  have 
remained  comparatively  underdeveloped.  Stock 
market  capitalisation  (9.5%  of  GDP  in  2015)  has 
remained  very  low  compared  to  the  euro  area 
average  of  60%.  The  debt  securities  market 
remained  small  in  comparison  with  the  euro  area 
average  (28%  vs.  158%  of  GDP)  and  has  been 
dominated  by  issuances  of  government  debt  (T-
bills  and  bonds  denominated  in  both  RON  and 
foreign  currency),  whereas 
issuance  of 
corporate  and  municipal  bonds  has  remained 
limited.  Consolidated  private  sector  debt  declined 
from 74% of GDP in 2010 to below 60% in 2015 
and was significantly below the euro-area average. 

the 

94 

024681012141618RO, 2010RO, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 7.11: Romania -Selected banking sector soundness indicators%Source: ECB, EC calculations, NBR.020406080100120140160180RO, 2010RO, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 7.12: Romania -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives. 
 
 
 
 
 
 
8. 

SWEDEN 

8.1. 

LEGAL COMPATIBILITY  

8.1.1.  Introduction 

(as  part  of 

The  legal  rules  governing  the  Swedish  Central 
Bank  (Riksbank)  are  laid  down  in  the  Instrument 
the  Swedish 
of  Government 
Constitution) and the Riksbank Act from 1988, as 
amended. No amendments to these legal acts were 
passed with regard to the incompatibilities and the 
imperfections mentioned in the 2014 Convergence 
Report. 

8.1.2.  Central Bank independence 

Article 3 of Chapter 6 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.  A  dialogue  between  a  central 
bank and third parties is not prohibited as such, but 
regular  upfront 
information  of  government 
representatives  about  monetary  policy  decisions, 
especially when the Riksbank would consider them 
as of major importance, could structurally offer to 
the government an incentive and the possibility to 
influence the Riksbank when taking key decisions. 
Therefore,  the  obligation  to  inform  the  minister 
about  a  monetary  policy  decision  of  major 
importance  prior  to  its  approval  by  the  Riksbank 
limits 
to 
the 
independently 
possibility for the Government to seek to influence 
them.  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.  Article  3  of 
Chapter 6 should be revised in order to ensure that 
monetary policy decisions of major importance are 
communicated to the minister, if ever, only after its 
approval  by  the  Riksbank  and  for  information 
purposes only. 

the  Riksbank 
take  decisions  and  offers 

the  possibility 

for 

Pursuant to Article 2 of Chapter 3 of the Riksbank 
Act and Article 13 of Chapter 9 of the Instrument 
of Government, the prohibition on the members of 
the  Executive  Board  to  seek  or  take  instructions 
only covers monetary policy issues. The provisions 
do  not  provide  for  their  independence  in  the 
performance  of  ESCB-related 
tasks  directly 
entrusted  by  the  Treaties.  By  means  of  broad 

95 

to 

interpretation through reference to the explanatory 
memorandum 
the  Law  (the  memorandum 
extends the coverage to all ESCB tasks), one could 
consider these tasks as tacitly encompassed by the 
principle  of  central  bank  independence.  However, 
the  principle  of 
institutional 
independence  cannot  be  considered  as  fully 
respected from a legal certainty perspective as long 
as  the  legal  text  itself  does  not  contain  a  clear 
reference  to  them.  Both  provisions  are  therefore 
considered as incompatible with Article 130 of the 
TFEU and Article 7 of the ESCB/ECB Statute. 

the  Riksbank's 

Pursuant  to  Article  4  of  Chapter  10  of  the 
Riksbank  Act,  the  Swedish  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 
Parliament  must  not  be  involved  in  the  relevant 
decision-making  process.  Its  right  should  be 
limited  to  approving  the  Central  Bank's  decision 
on  the  profit  allocation.  Legislative  proposals  to 
tackle  the  flaw  have  been  submitted  by  the 
Swedish  legislator  but  still  provide  for  a  decisive 
role  of  the  Parliament  in  profit  distribution  and 
budget allocation, which are incompatible with the 
principle of financial independence as enshrined in 
Article 130 of the TFEU. 

Article  4  of  Chapter  1  of  the  Riksbank  Act 
provides  for  the  replacement  of  the  Governor,  in 
case  of  absence  or  incapacity,  by  the  Vice-
Governors nominated by the General Council. It is 
unclear  whether  the  notion  "absence"  in  Article  4 
also refers to cases such as the expiry of the term 
of  office,  resignation,  dismissal  or  other  cause  of 
termination  of  office.  To  ensure  the  smooth  and 
the 
continuous  functioning  of 
some 
Riksbank  Act  would  benefit 
improvement  and  should  provide 
for  clear 
procedures  and  rules  regarding  the  succession  of 
the  Governor  in  case  the  notion  "absence"  also 
refers to instances of termination of office as well 
as in case the Governor is incapacitated. 

the  Riksbank, 

from 

8.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Under Article 8 of Chapter 6 of the Riksbank Act, 
the  Riksbank  may,  in  exceptional  circumstances, 

 
to  banking 

grant  credits  or  provide  guarantees  on  special 
terms 
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  the  debtor's  default. 
Although  the  Swedish  Parliament  inserted  a  new 
article  8a  in  Chapter  6  of  the  Riksbank  Act 
obliging  the  Riksbank  to  provide  information  to 
the  Government  and  a  number  of  relevant  public 
authorities  on  implemented  liquidity  support,  the 
occasion  was  not  seized  to  amend  Article  8  as 
to 
suggested  above.  Therefore, 
constitute  an  incompatibility  with  the  prohibition 
on  monetary  financing  under  Article  123  of  the 
TFEU. 

it  continues 

Pursuant  to  Article  1(3)  of  Chapter  8  of  the 
Riksbank  Act,  the  Riksbank  shall  not  extend 
credits or purchase debt instruments "directly from 
the State, another public body or institution of the 
European Union". The Article does not enumerate 
the entities covered by the prohibition of monetary 
financing  correctly.  Therefore,  Article  1 
is 
incompatible with the wording of Article 123(1) of 
the TFEU and 21(1) of the ESCB/ECB Statute. 

According  to  the  Article  1(4)  of  Chapter  8  of  the 
Riksbank  Act,  the  Riksbank  may  grant  credit  to 
and  purchase  debt  instruments  from  financial 
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 because the 
exemption only covers publicly owned institutions. 
For  the  sake  of  legal  certainty  it  should  be  added 
that,  in  the  context  of  the  supply  of  reserves  by 
these  publicly  owned  credit 
central  banks, 
institutions should be given the same treatment as 
private credit institutions.  

of 

profit 

the  Riksbank’s 

The  provisions  of  Article  4  of  Chapter  10  on  the 
allocation 
are 
supplemented by non-statutory guidelines on profit 
distribution,  according  to  which  the  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 
contingency  and  balancing  funds.  Although  these 
guidelines are not legally binding but accepted as a 
practice  by  Parliament  for  calculating  profit 

Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

allocation  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  the 
reserve  capital  of  Riksbank  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. 

8.1.4.  Integration in the ESCB 

Objectives 

Chapter  1,  Article  2  of  the  Riksbank  Act  should 
include  a  reference  to  the  secondary  objective  of 
the  ESCB,  while  the  promotion  of  a  safe  and 
efficient  payment  system  as  a  task  should  be 
the  primary  and  secondary 
subordinated 
objectives of the ESCB. 

to 

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 
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, Article13 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). 

96 

 
are 

There 
regarding the: 

furthermore 

some 

imperfections 

  non-recognition  of  the  role  of  the  ECB  and  of 
the EU in the collection of statistics (Chapter 6, 
Articles 4(2) and Article 9, 10 and 11); 

  non-recognition  of  the  role  of  the  ECB  in  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  in  the  appointment  of  an  external 
auditor; 

  non-recognition  of  the  role  of  the  ECB  in  the 
field  of  international  cooperation  (Chapter  7, 
Article 6). 

8.1.5.  Assessment of compatibility 

As regards the prohibition on monetary financing, 
the  independence  of  the  Riksbank  as  well  as  its 
integration  into  the  ESCB  at  the  time  of  euro 
adoption,  the  legislation  in  Sweden,  in  particular 
the  Riksbank  Act  and 
Instrument  of 
Government as part of the Swedish Constitution, is 
not  fully  compatible  with  the  compliance  duty 
under Article 131 of the TFEU. 

the 

8.2. 

PRICE STABILITY 

8.2.1.  Respect of the reference value 

Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

Bulgaria,  Slovenia  and  Spain,  plus  1.5  percentage 
points. The corresponding inflation rate in Sweden 
was 0.9%, i.e. above the reference value. Sweden's 
12-month  average  inflation  rate  is  likely  to  return 
below the reference value in the months ahead. 

8.2.2.  Recent inflation developments  

HICP  inflation  in  Sweden  bottomed  out  in  late-
2014.  The  depreciation  of  the  krona,  tax  hikes  as 
well  as  expanding domestic  demand  supported by 
an  accommodative  monetary  policy  resulted  in  an 
average  inflation  rate  of  0.7%  in  2015,  compared 
with  0.2%  the  year  before.  On  average,  Swedish 
HICP  inflation  reached  about  1%  in  the  first 
quarter of 2016. 

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  followed 
a  similar  pattern  as  headline  inflation,  increasing 
from  0.5%  in  2014  to  1.1%  in  2015.  The  pick-up 
was  induced  by  all  of  its  three  main  components. 
Inflation in the service sector increased from 0.9% 
in  2014  to  1.3%  in  2015  while  processed  food 
prices  increased  by  2.1%  in  2015,  after  1.0%  in 
2014,  reflecting  international  price  developments 
over  that  period.  Non-energy  industrial  goods 
prices  also  started  rising  again  in  2015,  after 
having  declined  for  four  years.  Producer  price 
inflation  was  almost  flat  in  2014  before  turning 
negative (averaging -1.9%) in 2015. Positive rates 
for  the  first  half  of  the  year  were  outweighed  by 
negative ones during the second half due to falling 
energy and commodity prices. 

The 12-month average inflation rate, which is used 
for  the  convergence  evaluation,  was  below  the 
reference value at the time of the last convergence 
assessment of Sweden in 2014. In April 2016, the 
reference  value  was  0.7%,  calculated  as  the 
average of the 12-month average inflation rates in 

97 

012345Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16SwedenReference valueGraph 8.1: Sweden -Inflation criterion since 2010 (percent, 12-month moving average)Note: The dots  in December 2016 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2016 Forecast.-2024201020112012201320142015SwedenEuro areaGraph 8.2: Sweden -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

export price growth abroad. In February 2015, the 
Riksbank  also  announced  an  asset  purchase 
programme  which  –  having  been  extended  in 
several  steps  –  aims  at  purchasing  a  total  of  SEK 
245  billion  in  government  bonds  by  the  end  of 
2016 (SEK 200 billion until end-June and a further 
SEK 45billion during the second half of this year).  

Wages and labour costs 

Employment  recovered  quickly  following 
the 
financial crisis and has been expanding at a strong 
pace, growing by 1.4% in 2014 and 1.5% in 2015. 
This rise was driven primarily by services and the 
public sector, while the manufacturing and energy 
sectors saw a decrease in the number of employed 
persons.  Continued  building  activity  should  also 
strengthen  the  contribution  of  the  construction 
sector in creating jobs over the coming years.  

In  spite  of  steadily  growing  employment,  the 
unemployment rate still hovers around roughly 7% 
due to increases in the labour force. Migrants enter 
the labour force only gradually. Also, employment 
is likely to be affected with a lag, as it could take 
several  years  for  newly  arrived  migrants  to  find 
jobs.  

The  annual  growth  of  nominal  compensation  per 
employee  fell  from  above  3%  in  2012  to  1.9%  in 
2013,  but  has  subsequently  increased  again.  In 
2015, 
the 
it  stood  at  3.6%  according 
Commission services' Spring 2016 Forecast but is 
likely  to  fall  back  somewhat  in  2016  (3.1%)  and 
2017 (3.2%). 

to 

Growth  in  labour  productivity  was  moderate  in 
2013 and 2104, with 0.3% and 0.9%, respectively, 
but  experienced  a  rebound  last  year  at  2.6%.  It  is 
likely  to  become  more  subdued  again  in  the  next 

98 

8.2.3.  Underlying  factors  and  sustainability  of 

inflation  

Macroeconomic  policy  mix  and  cyclical 
stance 

Sweden's  economic  growth  has  accelerated  and  is 
expected  to  remain  robust  in  the  coming  years. 
Real GDP expanded by 2.3% in 2014 and 4.1% in 
2015, making Sweden one of the currently fastest-
growing  economies  in  the  EU.  Steady  growth  in 
domestic  demand,  supported  by  expansionary 
monetary  policy,  helped  to  sustain  economic 
growth  against  the  impact  of  a  weak  external 
environment.  In  2015,  strong  investment  growth, 
rebounding  exports  and  increasing  government 
consumption also provided a significant impetus to 
growth.  Annual  real  GDP  growth  rates  are 
projected  to  slow  down  slightly  to  3.4%  in  2016 
and  2.9%  in  2017.  The  output  gap  has  been 
negative over the past years, but is expected to turn 
positive in 2016 and to remain so in 2017.  

The  fiscal  stance,  as  measured  by  changes  in 
structural  balance,  was  expansionary  in  2014  and 
rather  restrictive  in  2015.  It  is  expected  to  be 
slightly expansionary in 2016 and 2017. 

was 

framework (63), 

Monetary  policy,  conducted  within  an  inflation 
targeting 
loosened 
significantly since December 2011. In response to 
low  inflationary  pressures  and  sluggish  economic 
growth, the Riksbank gradually cut its main policy 
rate  from  2%  in  autumn  2011  to  minus  0.5%  in 
February  2016.  Nevertheless,  inflation  has  been 
below the target of 2% since 2011, due to the weak 
international  economic  activity  and  dampened 

(63)  Since  1995,  the  Riksbank  has  targeted  increases  in  the 
domestic CPI with the aim of keeping inflation at 2%. 

Table 8.1:weights  Sweden - Components of inflation(percentage change)1)in total   201020112012201320142015Apr-162016HICP1.91.40.90.40.20.70.91000Non-energy industrial goods0.9-0.5-1.0-0.8-0.40.30.9286Energy5.54.80.5-1.4-2.0-4.7-4.287Unprocessed food 0.9-1.81.63.50.04.14.663Processed food1.82.72.41.31.02.11.6141Services1.81.71.81.10.91.31.3424HICP excl. energy and unproc. food1.51.11.00.50.51.11.2851HICP at constant taxes 1.91.41.30.40.20.50.71000Administered prices HICP1.71.93.11.91.71.21.11411) 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.Sources: Eurostat, Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

External factors 

the 

Given the high openness of the Swedish economy, 
developments  in  import  prices  play  an  important 
role  in  domestic  price  formation.  Import  price 
growth  (measured  by 
imports  of  goods 
deflator)  has  fluctuated  significantly  over  the  past 
years.  Developments  can  be  largely  explained  by, 
on  the  one  hand,  falling  international  commodity 
price 
the 
weakening  krona.  Looking  ahead,  the  import 
deflator is expected to be negative this year, but is 
likely  to  return  to  a  positive  growth  path  as  from 
2017,  thus  dampening  external  disinflationary 
pressures. 

inflation,  and  on 

the  other  hand 

The real effective exchange rate (measured against 
a  group of 36 trading  partners)  has depreciated  in 
2014  and  2015  due  to  the  weak  krona,  while 
domestic prices continue to grow more slowly than 
in the main trading partners. Overall, Swedish cost 
developments  do  not  pose  major  challenges  in 
terms of competitiveness.  

couple of years, while remaining above 1% both in 
2016  and  2017.  Accordingly,  growth  in  nominal 
unit  labour  costs  (ULC),  which  stood  at  1.3%  in 
2014  and  fell  to  1.0%  in  2015,  is  projected  to 
increase  to  1.3%  and  1.8%  in  2016  and  2017 
respectively.  These  developments  point 
to 
relatively limited price pressures from labour costs 
in the years ahead. 

In  fact,  the  current  low  inflation  expectations  can 
be  said  to  have  influenced  wage  negotiations  this 
year.  While  some  sectors  have  challenged  the 
agreed benchmark, wage increases are likely to be 
relatively  modest,  overall  in  line  with  the  2.2% 
one-year agreement with industry. 

99 

-404820102011201220132014201520162017Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 8.3:Sweden -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services'Spring 2016 Forecast.Table 8.2:Sweden - Other inflation and cost indicators(annual percentage change)20102011201220132014201520161)20171)HICP inflationSweden1.91.40.90.40.20.70.91.2Euro area1.62.72.51.30.40.00.21.4Private consumption deflatorSweden1.51.70.50.70.71.01.11.3Euro area1.62.31.91.10.50.20.41.3Nominal compensation per employeeSweden2.23.23.11.92.23.63.13.2Euro area2.22.21.81.71.31.21.51.9Labour productivitySweden5.00.5-1.00.30.92.61.81.4Euro area2.81.5-0.10.60.30.60.50.8Nominal unit labour costsSweden-2.62.64.11.71.31.01.31.8Euro area-0.60.61.91.11.00.70.91.1Imports of goods deflatorSweden0.3-0.3-1.9-3.71.1-0.7-2.91.2Euro area6.07.02.6-2.0-2.6-3.6-2.71.11) Commission services' Spring 2016 Forecast.Source: Eurostat, Commission services. 
 
 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

Administered prices and taxes 

The  share  of  administered  prices  (64)  in  the 
Swedish  HICP  basket  amounts  to  14%  and  it  is 
thus  close  to  the  euro-area  average  of  13%. 
Although  not  very  large,  it  still  contributed  to 
driving  inflation  upwards  over  the  last  two  years, 
as  it  stood  at  1.7%  in  2014  and  1.2%  in  2015, 
largely  explained  by  increases  in  rental  prices, 
which rose by  1.3%  over  the  period 2014/15  –the 
smallest increase since 2007. 

Tax  changes  also  added  somewhat  to  higher 
headline  inflation  as  emphasised  by  the  slower 
pace with which HICP at constant taxes increased 
over the past two years. 

Medium-term prospects 

HICP  inflation  is  likely  to  increase  moderately  in 
the course of 2016 on the back of currently strong 
growth  and  tax  hikes.  At  the  same  time  low  oil 
prices  have  the  opposite  effect.  No  particular 
upward  pressure  is  foreseen  from  any  HICP 
component  and  wage  developments  are  projected 
to remain moderate. Accordingly, the Commission 
services'  Spring  2016  Forecast  projects  annual 
average  inflation  at  0.9%  in  2016  and  1.2%  in 
2017. 

Risks to the inflation outlook appear to be broadly 
balanced. An appreciating krona could dampen the 
currently projected rising inflation trajectory, even 
though the Riksbank has announced its intention to 
directly intervene on  the  foreign  exchange  market 
if  necessary.  At  the  same  time,  the  Riksbank's 
loose monetary conditions could prevail, leading to 
faster inflation acceleration. 

The level of consumer prices in Sweden relative to 
the  euro  area  gradually  increased  since  Sweden 
joined the EU in 1995. In 2014, the Swedish price 
level was at some 124% of the euro-area average, 
down  from  129%  in  2013.  At  the  same  time,  the 
income  level  in  Sweden  remained  rather  stable 
over the past ten years, reaching 115% of the euro-
area average in PPS in 2014.  

(64)  According  to  the  Eurostat  definition,  fully  administered 
prices  in  Sweden  inter  alia  include  water  supply,  refuse 
and  sewerage  collection,  hospital  services  and  combined 
passenger  transport.  Mainly  administered  prices  inter  alia 
include  actual  rents  for housing  and medical  services.  For 
details, see 

http://ec.europa.eu/eurostat/web/hicp/methodology/hicp-

administered-prices 

In  the  medium  term,  inflation  is  likely  to  pick  up 
given  the  projected  closure  of  the  output  gap  and 
further  decreases  in  unemployment.  With  the 
expected  robust  domestic  demand,  companies  are 
projected to raise prices and cautiously compensate 
for the subdued price levels over the past years. On 
the  other  hand,  moderate  wage  developments, 
spare  capacity  still  lingering  in  the  Swedish 
economy and strong international competition will 
weigh  on  consumer  price  developments  in  the 
short run.  

8.3. 

PUBLIC FINANCES  

8.3.1.  Recent fiscal developments 

Sweden’s  general  government  deficit  improved 
significantly  last year from  1.6% of GDP  in  2014 
to 0.0% of GDP in 2015. This was mainly due to a 
strong  rise  in  tax  revenues,  supported  by  strong 
private consumption and tax increases (principally 
increased  social  fees  for  young  people,  higher 
income taxes for high-income-earners, energy and 
fuel taxes and some excise duties) and a temporary 
high corporate tax payment in the fourth quarter of 
2015.  

The structural balance improved, from a deficit of 
0.3% of GDP in 2014 to a surplus of 0.3% in 2015. 
The higher expenditure related to the large refugee 
and  migrant  inflows  into  Sweden  over  the  last 
couple of years has been so far compensated with 
strong  economic  growth  and  tax  hikes.  The 
expenditure-to-GDP ratio decreased from 51.7% of 
GDP  in  2014  to  50.4%  in  2015,  while  the 
revenues-to-GDP  ratio  increased  by  0.2  pp.  to 
50.4% of GDP. 

Overall,  Swedish  public  finances  remain  robust. 
The  budgetary  outcome  in  2015  was  substantially 
better than the deficit of 1.4% of GDP targeted in 
the  2015  Convergence  Programme,  generally  on 
the back of stronger-than-expected growth in 2015. 

The  government  debt-to-GDP  ratio  rose  to  44.8% 
in  2014,  i.e.  up  by  5  pp.  compared  to  2013.  This 
was  due  largely  to  statistical  factors  linked  to 
the 
changing  accounting  standards.  In  2015, 
government  gross  debt  came  down  to  43.4%  of 
GDP. 

100 

 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

migration  and  integration,  there  is  also  a  risk  for 
the budget related to sickness leave benefits, where 
the expenditure has been on the rise over the past 
years. Since 1 February 2016, the 2.5-year-cap on 
the  sickness  insurance  has  been  lifted,  which  will 
most 
increasing  effect  on 
expenditure.  

likely  have  an 

The  budget  balance  is  foreseen  to  deteriorate  in 
2016  and  2017,  as  tax  increases  are  likely  to  be 
outweighed  by  costs  related  to  the  recent  large 
inflow  of  refugees  and  migrants  and  increasing 
sickness  insurance  expenses.  The  Spring  Budget 
Bill 
involving  expenditure 
amounting  to  SEK  31  billion  to  address  the 
challenges linked to migration and integration.  

includes  measures 

According  to  the  Commission  services'  Spring 
2016 Forecast, the general government deficit will 
reach 0.4% of GDP in 2016 and 0.7% in 2017 and 
the  structural  deficit  is  also  set  to  deteriorate  to 
0.9%  until  2017.  The  revenue-to-GDP  ratio  is 
expected to remain rather stable at around 50% of 
GDP,  while  the  expenditures  are  likely  to  remain 
at around 51% of GDP. 

Gross  government  debt  is  well  below  the  60%  of 
GDP  Treaty  reference  value  and  is  expected  to 

8.3.2.  Medium-term prospects 

Partly  as  a  consequence  of  the  migration  and 
integration  challenges,  the  2016  Budget  Bill, 
which  was  adopted  on  17  December  2015, 
includes  measures 
labour  market 
integration  of  vulnerable  groups  and  education 
investments  amounting  to  SEK  24  billion  (EUR 
2.55 billion). 

to  promote 

By  raising  income  tax  rates  for  high-income 
earners  and  increased  social  fees  for  young 
employees and those older than 65, the budget also 
contributes to a limited tax shift back to labour. It 
also reduces deductions applicable to certain types 
of  services,  for  instance  for  house  repair  and 
maintenance and for domestic services. Further tax 
increases  in  2016  relate  predominately  to  labour 
taxes  (by  8.6%  due  to  the  combined  effect  of  a 
sharp increase in the tax bases and rate hikes (65)) 
and  to  local  government  taxes.  In  addition  to  the 
inherent  uncertainty  linked  to  expenditure  on 

(65)  Mainly  explained  by  legislated  measures  involving  the 
gradual  reduction  of  earned 
tax  credit,  an 
unchanged lower threshold for central government income 
tax, abolished reduction of social security contributions for 
young  people, 
level  of  subsidy  for  home 
renovation  services  (ROT)  and  higher  tax  on  petrol  and 
diesel. 

lowered 

income 

101 

Table 8.3:Sweden - Budgetary developments and projections(as % of GDP unless indicated otherwise)Outturn and forecast 1)20102011201220132014201520162017General government balance0.0-0.1-0.9-1.4-1.60.0-0.4-0.7- Total revenues51.150.550.751.050.250.449.849.7- Total expenditure51.250.551.752.451.750.450.150.4   of which: - Interest expenditure1.11.10.90.80.70.50.50.5p.m.: Tax burden44.143.543.543.843.844.143.843.9Primary balance1.01.00.0-0.6-0.90.50.1-0.2Cyclically-adjusted balance0.80.10.20.0-0.30.3-0.5-0.9One-off and temporary measures0.00.00.00.00.00.00.00.0Structural balance 2)0.80.10.20.0-0.30.3-0.5-0.9Government gross debt37.636.937.239.844.843.441.340.1p.m: Real GDP growth (%)6.02.7-0.31.22.34.13.42.9p.m: Output gap-1.4-0.2-1.9-2.4-2.1-0.50.20.4Convergence programme2016201720182019General government balance-0.4-0.7-0.40.1Structural balance 2) 3)-0.8-0.8-0.4-0.1Government gross debt42.541.140.339.1p.m. Real GDP (% change)3.82.21.82.11) Commission services’ Spring 2016 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.Sources: Commission services, the 2016 Convergence Programme of Sweden.There are no one-off and other temporary measures in the programme. 
                                                           
 
 
 
 
 
gradually  decline  in  the  coming  years,  reaching 
41.3%  of  GDP  in  2016  and  40.1%  of  GDP  in 
2017,  mainly  supported  by  strong  economic 
growth and falling debt servicing costs due to low 
interest rates.  

submitted 

the  2016  Convergence 
Sweden 
Programme on 28 April 2016. The main aim of the 
presented  fiscal  strategy  is  to  remain  at  the 
medium-term  budgetary  objective  (MTO),  i.e.  a 
structural  balance  of  -1%  of  potential  GDP.  The 
Convergence  Programme  foresees  a  deficit  of 
0.4% of GDP in 2016 and 0.7% of GDP in 2017, 
which  is  fully  in  line  with  the  Commission 
services'  Spring  2016  Forecast.  Based  on  the 
Commission's  assessment  of  the  Convergence 
the 
Programme 
taking 
Commission  services'  Spring  2016 
forecast, 
Sweden is expected to comply with the provisions 
of  the  Stability  and  Growth  Pact.  Further  details 
can  be  found  in  the  Assessment  of  the  2016 
Convergence Programme for Sweden. (66) 

account 

into 

and 

As  far  as  the  fiscal  framework  is  concerned  – 
which  refers  to  numerical  fiscal  rules,  medium-
term  budgetary  frameworks,  independent  fiscal 
institutions,  and  budgetary  procedures  –Sweden 
has  a  strong  domestic  system  since  the  1990s, 
which is also reflected in its extensive track record 
of  fiscal  soundness.  The  main  pillars  of  the 
framework  are  (i)  the  numerical  target  defined 
over  the  cycle  for  general  government;  (ii)  a 
balanced-budget  rule  for  local  authorities;  (iii)  an 
effective  medium-term  budgetary 
framework 
leading to binding three-year expenditure ceilings; 
independent  fiscal 
and  (iv) 
institutions,  with  a  monitoring  and  analytical  role 
for the Fiscal Policy Council. The authorities have 
recently started to re-examine the adequacy of the 
current  1%  of  GDP  surplus  target  (in  place  since 
2007).  Irrespective  of  the  stipulated  level  of  the 
numerical rule, the method applied to monitor the 
fulfilment  of 
clarified 
target 
unambiguously  (currently,  multiple  indicators  are 
in use by the government to assess compliance). In 
its  annual  reports,  the  Fiscal  Policy  Council  has 
signalled  the  issue  of  non-compliance  for  several 
years, including in 2016. 

the  working  of 

is  not 

the 

Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

8.4. 

EXCHANGE RATE STABILITY 

The Swedish krona does not participate in ERM II. 
The  Riksbank  pursues  inflation  targeting  under  a 
floating exchange rate regime.  

Following  the  sharp  depreciation  of  the  krona 
against  the  euro  in  2008,  i.e.  at  the  onset  of  the 
financial  crisis,  the  krona  recovered  at  a  similarly 
rapid  pace  and  by  mid-2012  even  reached  a 
twelve-year  high  of  8.3  SEK/EUR.  While  this 
appreciation  was  arguably  a  correction  of  the 
krona's  previous  weakening,  safe-haven  flows, 
resulting  from  the  intensification  of  the  euro-area 
sovereign  debt  crisis,  significantly  contributed  to 
it. Between early-2013 and the beginning of 2015, 
the  krona  was  on  a  depreciation  trend,  falling 
overall by almost 14% against the euro. During the 
two  years  before  this  assessment,  the  krona 
depreciated  against  the  euro  by  some  1.6%, 
fluctuating around on average 9.30 SEK/EUR.  

Since August 2012, i.e. when the Riksbank started 
cutting  its  repo  rate,  short-term  interest  rate 
spreads vis-à-vis the euro area have declined. The 
interest rate spread even turned negative (euro-area 
short-term interest rates being higher than Swedish 
ones)  in  February  2015,  when  the  Riksbank  was 
among 
to 
introduce  a  negative  policy  rate,  cutting  its  repo 
rate  to  minus  0.1%.  Three  additional  cuts  to  the 
repo 
the 
Riksbank's  February  2016  Executive  Board 
meeting,  widened 
the  3-months  STIBOR-
EURIBOR spread further to about on average  -20 
basis points during the first four months of 2016. 

the  first  European  central  banks 

reaching  minus  0.5%  after 

rate, 

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

economic_governance/sgp/convergence/index_en.htm 

In  December  2012,  the  Riksbank  decided  to 
increase its foreign currency reserves by SEK 100 
billion  to  reflect  higher  risks  to  the  Swedish 
financial  system  from  an  uncertain  economic 

102 

8.08.59.09.510.010.52010201120122013201420152016Graph 8.4:Sweden -SEK/EUR exchange rate (monthly averages)Source: ECB. 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

Long-term  interest  rates  declined  more  than  230 
basis  points  between  mid-2013  and  April  2015, 
reaching an all-time low of 0.3%. In particular the 
loosening of monetary policy as a response to the 
low domestic inflation environment, the launch of 
the  Riksbank's  asset  purchase  programme,  and 
safe-haven flows into Swedish government bonds, 
fuelled  the  compression  of  Swedish  long-term 
the  German 
interest  rates,  closely  following 
benchmark bond. The announcement of the ECB's 
expanded  asset  purchase  programme  (EAPP)  in 
January  2015  and  its  subsequent  launch  in  March 
2015 have led to a gradual re-pricing of investors' 
risks  perceptions  and  triggered  an  abatement  of 
flows  into  safe-haven  assets,  e.g.  German  or 
Swedish  government  bonds.  Yields 
increased 
somewhat  but  with  an  average  of  0.8%  in  early 
2016 remain very low by historic standards.  

Very  low  long-term  interest  spreads  vis-à-vis  the 
German  benchmark  bond  widened  between  end-
2012  and  autumn  2013  before  narrowing  again 

situation  abroad  and  the  increase  in  commitments 
to  the  IMF.  Subsequently  international  reserves 
rose and peaked at about SEK 520 billion in May 
2015,  an  increase  by  more  than  20%  since  mid-
2014.  Early-2016  international  reserves  averaged 
slightly less than SEK 500 billion (a decline of 5% 
from the previous' year's peak), representing some 
12%  of  GDP.  In  December  2015,  the  Riksbank 
introduced the operational framework to intervene 
on foreign exchange markets in a timely manner if 
needed  in  order  to  prevent  a  de-anchoring  of 
inflation expectations due to a strengthening krona. 
Judging  by 
statistics 
Riksbank  interventions  have  not  taken  place  thus 
far, though.  

international 

reserve 

8.5. 

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 around nine years. 

The Swedish 12-month average long-term interest 
rate,  relevant  for  the  assessment  of  the  Treaty 
criterion was well below the reference value at the 
time  of  the  2014  convergence  assessment  of 
Sweden.  Following  a  slight  increase  to  2.3%  by 
May 2014, the relevant Swedish 12-month moving 
average long-term interest rate has declined again. 
In April 2016, the latest month for which data are 
available, the reference value, given by the average 
of  long-term  interest  rates  in  Bulgaria,  Slovenia 
and Spain plus 2 percentage points, stood at 4%. In 
that  month,  the  12-month  average  of  the  yield  on 
the  Swedish  benchmark  bond  stood  at  0.8%,  i.e. 
3.2 percentage points below the reference value. 

103 

-500501001502002010201120122013201420152016Graph 8.5:Sweden -3-M Stibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat.024681012Jan-10Jan-11Jan-12Jan-13Jan-14Jan-15Jan-16SwedenReference valueGraph 8.6:Sweden -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.012342010201120122013201420152016SwedenGermanyGraph 8.7:Sweden -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

since  early  2014.  They  stood  at  some  68  basis 
points at the end of April 2016 (67).  

reflecting  Sweden's  foreign  aid  and  positive  net 
contributions to international organisations, as well 
as  remittances  transferred  by  foreign  workers  in 
Sweden to their home countries. 

8.6.  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  –  gives  an  important  indication  of  a 
Member  State's  ability  to  integrate  into  the  euro 
area without difficulties.  

threshold 
two 
i.e. 

In  November  2015,  the  Commission  published  its 
fifth  Alert  Mechanism  Report  (AMR  2016) (68) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5).  The  AMR  2016 
scoreboard  showed  that  Sweden  exceeded  the 
in  four  out  of  fourteen 
indicative 
indicators, 
the  area  of  external 
in 
imbalances (the surplus on the current account, the 
change in the export market share) and two in the 
area  of  internal  imbalances  (the  annual  change  in 
the  house  price  index,  the  consolidated  private 
sector  debt  in  %  of  GDP).  In  line  with  the 
conclusions of the AMR 2016 (i.e. that imbalances 
had  been  identified  for  Sweden  in  the  previous 
MIP  round),  Sweden  was  identified  as  warranting 
a  further  in-depth  review,  which  found  that 
Sweden  continued  to  experience  macroeconomic 
imbalances.  

8.6.1.  Developments  of 

the  balance  of 

payments 

Sweden's  current  account 
surplus  gradually 
declined from its peak of 8.6% of GDP in 2008 to 
around  6%  over  the  last  years  (5.9%  in  2015). 
While the contribution of services and net primary 
income  to  the  current  account  balance  has  been 
increasing,  the  trade  surplus  in  goods  diminished, 
resulting  in  a  relatively  stable  current  account 
surplus.  The  goods  trade  surplus  has  remained 
slightly  above  3%  of  GDP  since  2010  and 
Sweden's net international investment position has 
been  improving  successively  and  is  expected  to 
turn positive in the coming years. Current transfers 
have delivered a relatively steady negative impact, 

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

(68)  http://ec.europa.eu/europe2020/pdf/2016/ags2016_alert 

_mechanism_report.pdf 

large 

savings-investment 

Sweden's 
surplus 
persisted  in  2014  and  2015,  reflecting  high  net 
savings  by  the  private  sector,  a  limited  fiscal 
deficit  and  a  low  level  of  residential  investment. 
As  regards  the  latter,  despite  a  recent  rebound  in 
housing investment, the number of new dwellings 
built  still  does  not  meet  surging  housing  demand. 
Gross  national  savings  reached  almost  30%  of 
GDP in 2014 and 2015, similar to previous years. 
While  households  have  increased  precautionary 
savings  following  the  financial  crisis,  corporate 
and household saving had also risen as a result of 
reforms  introduced  in  the  1990s,  such  as  the 
introduction  of  a  pension  plan  with  defined 
formation 
contributions.  Gross 
cautiously took up again in 2014, but the uncertain 
economic environment is still affecting investment 
levels. 

fixed  capital 

A  gradual  recovery  in  Sweden's  main  trading 
partners  and  a  relatively  weak  krona  have  been 
positively  impacting  Swedish  export  performance 
since  2015.  This  is  projected  to  improve  the 
outlook  for  export-oriented  industrial  production 
and  manufacturing 
investment.  Swedish  cost 
developments  do  not  point  to  major  challenges  in 
terms of competitiveness. Unit labour costs (ULC) 
have  been  growing  in  line  with  Sweden's  main 
trading  partners,  while  the  accumulated  ULC 
growth  was  broadly  stable  between  the  period  of 
2001  and  2014.  The  real  effective  exchange  rate 
has depreciated in 2014 and 2015 due to the weak 
krona,  while  domestic  prices  continue  growing 
more slowly than in the main trading partners. The 
share 
decrease 
continued  in  2014  as  goods  exports  lost  further 
ground  to  international  competitors.  There  has 
been  a  contraction  of  9.8%  in  the  previous  five 

in  Sweden's  export  market 

104 

010203040201020112012201320142015Gross national savingGross capital formation at current prices; total economyGraph 8.8:Sweden -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services. 
                                                           
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

years,  continuing  a  long-term  trend  that  started 
already  in  the  1970s.  However,  a  reversal  was 
noted  in  2015  when  Sweden  actually  gained 
market shares. 

Sweden's  financial  account  shows  relatively  large 
fluctuations over time but seems to have stabilised 
around  3.2%  in  2014  and  2015.  However,  the 
financial  account  balance  consistently  reflects 
Sweden's role as a net FDI investor abroad. 

According  to  the  Commission  services'  Spring 
2016  Forecast,  net  exports  are  expected 
to 
to  real  GDP 
contribute  somewhat  positively 
growth  in  2016  and  2017,  while  the  current 
account surplus is expected to remain stable during 
this period. 

External reserves increased somewhat in 2014 and 
2015,  following  the  marked  surge  in  2013,  when 
the  Riksbank  increased  foreign  currency  reserves 
by  SEK  100  billion  to  re-align  them  with  the 
exposure  of  Swedish  banks  to  foreign  capital 
markets.  External  debt  increased  from  184.3%  of 
GDP in 2013 to 190.3% of GDP in 2014, i.e. by 6 
percentage points. Again, this development largely 
mirrors  the  increase  in  the  gross  government  debt 
that  was  due  largely  to  technical  factors  linked  to 
changing  accounting  standards.  Sweden's  net 
international 
improved 
significantly in 2014 and 2015. 

investment 

position 

105 

8.6.2.  Market integration 

Sweden  is  integrated  with  the  euro  area  through 
trade  and  investment  linkages.  Trade  openness  of 
the  Swedish  economy  remained  rather  stable  at 

90100110120130201020112012201320142015NEERREER, HICP deflatedREER, ULC deflatedGraph 8.9:Sweden -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2010 = 100)Table 8.4:Sweden - Balance of payments(percentage of GDP)201020112012201320142015Current account6.06.15.96.05.45.9of which: Balance of trade in goods3.93.63.73.63.32.9                 Balance of trade in services1.41.81.82.11.82.6                 Primary income balance 2.02.02.21.91.92.1                 Secondary income balance-1.3-1.3-1.8-1.7-1.7-1.6Capital account-0.1-0.2-0.2-0.2-0.1-0.2External balance 1)5.95.95.75.85.25.7Financial account 2)7.58.01.53.33.23.2of which: Direct investment4.23.02.34.40.92.3                Portfolio investment-3.9-5.1-3.1-8.44.2-2.1                Other investment 3)7.49.92.24.7-1.82.8                Change in reserves-0.10.10.12.60.00.3Financial account without reserves7.77.91.40.73.22.9Errors and omissions1.72.2-4.2-2.5-2.0-2.5Gross capital formation22.923.822.622.523.824.5Gross saving29.629.929.128.028.029.4Gross external debt198.1192.9187.0184.6190.6181.5International investment position-8.4-10.2-16.6-14.6-2.5-1.61) The combined current and capital account.2) The data is presented under BPM6 methodology, where the signs of financial account items are the opposite as under BPM5       (that was used in earlier Convergence Reports).3) Including financial derivatives.Sources: Eurostat, Statistics Sweden, Commission services. 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

about  41%  of  GDP  in  2014.  The  main  euro-area 
trading partners are Germany, the Netherlands and 
Finland,  while  Norway,  Denmark  and  the  UK  are 
the biggest non-euro-area partners.  

Sweden  has  attracted  a  high  share  of  FDI  in  the 
tradable sector thanks to good infrastructure and a 
highly  educated  labour  force.  In  2014,  more  than 
80% of the total FDI stock emanated from the EU, 
with  biggest 
the 
Netherlands, Luxembourg and the UK. 

investments  originating 

in 

Regarding 
the  business  environment,  Sweden 
regularly  scores  top  positions  in  international 
rankings,  well  above  most  euro-area  Member 
States.  Following  a  slight  dip  between  2010  and 
2013,  rankings  have  improved  again  over  the  last 
two years. Sweden's deficit in the transposition of 
EU  directives  was  very  low  (0.4%  in  2015),  thus 
meeting  the  0.5%  target  as  proposed  by  the 
European  Commission  in  the  Single  Market  Act 
(2011). 

The  Swedish  labour  market,  to  a  large  extent 
governed  by  negotiations  between  social  partners 
at  sectorial  level,  is  characterised  by  positive 
labour  market  outcomes  with  high  employment 
lowest  wage 
rates.  Sweden  has  one  of 
dispersions  in  the  EU,  with  high  entry  wages  and 
little wage progression. Employment protection of 
permanent  workers  is  rather  high  (slightly  below 
the euro-area-OECD countries' average, according 
to 
the  2013  OECD  employment  protection 
indicator) compared to that of temporary workers . 
Adjustment by labour mobility is adequate, with a 

the 

of 

low 

dispersion 

relatively 
regional 
unemployment  rates.  The  integration  of  low-
skilled  and  foreign-born  workers  remains  the  key 
challenge  for  the  Swedish  labour  market,  though, 
as 
is 
the  employment  rate  of  both  groups 
significantly below the overall employment rate.  

Sweden's  financial  sector  (accounting  for  more 
than 400% of GDP) is well integrated into the EU 
financial sector, especially through interlinkages in 
the  Nordic-Baltic  financial  cluster.  Subsidiaries 
and branches of the Swedish banking groups hold 
the  majority  of  the  market  in  Lithuania,  Latvia, 
Estonia  and  Finland.  They  also  have  substantial 
market shares in Denmark and Norway.  

Foreign ownership in the Swedish financial market 
is significantly below the euro-area average (about 
9%  in  2014)  but  has  increased  marginally  since 
2010.  At  almost  60%,  bank  concentration 
measured  by  the  market  share  of  the  largest  five 

106 

010203040506070SE, 2010SE, 2014EA, 2010EA, 2014Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 8.10: Sweden -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators .Table 8.5:Sweden - Market integration201020112012201320142015Trade openness 1) (%)41.842.942.039.941.041.5Trade with EA in goods & services 2)+3) (%)17.818.617.917.417.617.7Export performance (% change) 4)2.01.0-0.7-2.70.33.3World Bank's Ease of Doing Business Index rankings 5)914131498WEF's Global Competitiveness Index rankings 6)2346109Internal Market Transposition Deficit 7) (%)0.90.60.10.10.20.4Real house price index 8)100.0100.8101.5106.3115.4129.3Residential investment 9) (%)3.63.93.43.54.14.6 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total. (Nov. data, May in 2013 and 2015). 8) Deflated house price index (2010=100), Eurostat. 9) Gross capital formation in residential buildings (in % of GDP), Eurostat.Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
Convergence Report 2016 - Technical annex 

Chapter 8 - Sweden 

credit  institutions  in  total  assets  has  remained 
above the euro-area average for the past years.  

The  capital  adequacy  of  Swedish  banks  measured 
by  standard  regulatory  ratios  is  relatively  high  at 
23%  in  Q3  2015,  compared  to  the  euro-area 
average (16% in Q3 2015). Moreover, the ratio of 
non-performing loans (1.0% in Q3 2015) is only a 
fraction  of  the  euro-area  average,  which  between 
2010  and  Q3  2015  increased  by  about  2½ 
percentage  points,  reaching  more  than  6%.  High 
asset 
and  market 
cost-efficiency 
concentration  support  the  profitability  of  Swedish 
banks, which is among the highest in Europe. The 
sector's  average  return  on  equity  (ROE)  in  Q3 
2015 stood at almost 9%.  

quality, 

(plus  13  percentage  points  since  2010),  while  the 
euro-area average decreased to 158% of GDP over 
the  same  period.  Outstanding  bank  credit  to  non-
financial  companies  and  households 
reached 
almost  130%  of  GDP  (an  increase  of  about  2 
percentage points since 2010), compared to 92% in 
the  euro  area.  The  consolidated  stock  of  private 
sector debt increased from 190% of GDP in 2010 
to almost 194% of GDP in 2014. This is the sixth-
highest consolidated private sector debt level in the 
EU  and  remains  significantly  above  the  euro-area 
average of 138%. 

House prices in Sweden have been growing almost 
uninterruptedly  over  the  last  20  years:  real  house 
prices  doubled  during  this  period  and  surged  by 
almost  40%  since  2008.  The  growth  has  been 
accelerating  since  late  2011.  While  real  house 
prices grew at an average rate of 4.7% in 2013 and 
8.5%  in 2014,  their  increase  accelerated  to  13.7% 
in  Q3  2015  compared  to  the  previous  year. 
Residential 
investment  has  picked  up  only 
marginally from 3.6% of GDP in 2010 to 4.1% of 
GDP in 2014. Overvalued house prices entail risks 
of  a  disorderly  and  harmful  correction,  with  a 
potential impact on the banking sector and the real 
economy.  The  overall  shortage  of  housing  supply 
is  further 
can  hamper 
exacerbated by the large inflow of refugees in need 
of affordable housing. 

labour  mobility  and 

in  Sweden  are  very  well 
Capital  markets 
developed compared to the euro area. The stock of 
quoted  shares 
issued  by  Swedish  enterprises 
increased to about 136% of GDP by end-2015 (up 
from  about  119%  of  GDP  in  2010).  It  thus 
exceeded  by  far  the  2015  euro-area  average  of 
60% of GDP. The total amount of outstanding debt 
securities also increased to 172% of GDP in 2015 

107 

0510152025SE, 2010SE, Q3-15EA, 2010EA, Q3-15Return on equityCapital adequacyNon performing loansGraph 8.11: Sweden -Selected banking sector soundness indicators%Source: ECB, EC calculations.020406080100120140160180200SE, 2010SE, 2015EA, 2010EA, 2015Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 8.12: Sweden -Recent development of the  financial systemrelative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives.