COMMISSION STAFF WORKING DOCUMENT Convergence Report 2018 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2018 (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union)
Date: 2018-05-23
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Sweden, convergence criteria, euro, euro area

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 23.5.2018 SWD(2018) 350 final  COMMISSION STAFF WORKING DOCUMENT Convergence Report 2018 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2018  (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union) {COM(2018) 370 final}  
 
 
European Commission 

Directorate-General for Economic and Financial Affairs 

Convergence Report 2018 

EUROPEAN ECONOMY 

x/2018 

 
 
 
 
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 
CZK 
Czech koruna 
HRK  Croatian kuna 
HUF  Hungarian forint 
PLN 
RON  Romanian leu (ROL until 30 June 2005) 
SEK 
USD  United States dollar 

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 
Central and Eastern Europe 
CEE 
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 
EDP 
Excessive Deficit Procedure 
EMU  Economic and monetary union 
ERM II  Exchange rate mechanism II 

ii 

 
 
 
 
European Union 

In-Depth Review 

European System of Accounts 

Foreign direct investment 
Funding for Growth Scheme 
Financial Supervisory Authority 

ESA 
ESCB  European System of Central Banks 
EU 
Eurostat Statistical Office of the European Union 
FDI 
FGS 
FSA 
GDP  Gross domestic product 
HICP  Harmonised index of consumer prices 
HFSA  Hungarian Financial Supervisory Authority 
IDR 
MFI  Monetary Financial Institution  
MIP  Macroeconomic Imbalance Procedure 
MTO  Medium-term objective 
NCBs  National central banks 
NEER  Nominal effective exchange rate 
Najwyższa Izba Kontroli (Poland's Supreme Chamber of Control) 
NIK 
Non-performing loans 
NPL 
Official Journal 
OJ 
Official Journal Lex 
OJL 
Personal Income Tax 
PIT 
PPS 
Purchasing Power Standard 
REER  Real effective exchange rate 
TFEU  Treaty on the Functioning of the European Union 
ULC   Unit labour costs 
VAT  Value added tax 

iii 

 
 
 
ACKNOWLEDGEMENTS 

The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic 
and  Financial  Affairs.  The  main  contributors  were  Maja  Ferjančič,  Balázs  Forgó,  Anton  Jevčák  and 
Matteo Salto. 

Other contributors were Wojciech Balcerowicz, Laura Bardone, Cristiana Belu Manescu, Nicolae-Dragoș 
Bîea,  Stefan  Ciobanu,  Karl  Croonenborghs,  Iván  Csaba,  Patrick  D'Souza,  Mateja  Gabrijelčič,  Juan 
González  Fernández,  Julien  Hartley,  Michal  Havlát,  László  Jankovics,  Isabelle  Justo,  Robert  Kuenzel, 
Ivan  Kusen,  Wojciech  Paczynski,  Mona  Papadakou,  Gábor  Pellényi,  Leonardo  Pérez-Aranda,  Arian 
Perić,  Mario  Pletikosa,  Marc  Puig,  Diana  Radu,  Maximilian  Reßing,  Ralph  Schmitt-Nelson,  Outi 
Slotboom,  Michael  Stierle,  Márton  Szili,  Maja  Šamanović,  Geert  Vermeulen,  Bartlomiej  Wiczewski, 
Rafał Wielądek, Ana Xavier and Marcin Zogala.  

Statistical assistance was provided by Eric Mc Coy, Gerda Symens and André Verbanck, administrative 
assistance by Erdemia Malagrida and Sien Vangompel.  

The  report  was  coordinated  by  Balázs  Forgó  under  the  supervision  of  Eric  Ruscher,  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 2018 

Convergence Report 2018 - 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.  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 

3.6.  ADDITIONAL FACTORS 

v 

1 

3 

5 

5 

6 

7 

7 

10 

10 

13 

13 

17 

17 

17 

17 

18 

18 

19 

19 

19 

20 

22 

22 

23 

24 

25 

25 

26 

27 

31 

31 

31 

31 

31 

32 

32 

32 

32 

33 

33 

36 

36 

36 

37 

37 

38 

 
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.  Recent fiscal developments 

4.3.2.  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 

6.2.2.  Recent inflation developments 

6.2.3.  Underlying factors and sustainability of inflation 

38 

40 

43 

43 

43 

43 

43 

43 

43 

43 

43 

44 

44 

46 

46 

47 

48 

48 

49 

49 

51 

53 

53 

53 

53 

54 

56 

56 

56 

56 

57 

57 

60 

60 

61 

62 

63 

63 

64 

65 

69 

69 

69 

69 

70 

70 

71 

71 

71 

71 

73 

vi 

 
 
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 

LIST OF TABLES 

2.1.  Bulgaria - Components of inflation 

2.2.  Bulgaria - Other inflation and cost indicators 

vii 

74 

74 

75 

76 

76 

77 

78 

79 

83 

83 

83 

83 

84 

85 

85 

85 

85 

86 

86 

89 

89 

90 

90 

91 

92 

92 

94 

97 

97 

97 

97 

98 

98 

99 

99 

99 

99 

100 

102 

102 

103 

104 

105 

105 

106 

107 

20 

22 

 
 
 
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 

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 

3.2.  Czech Republic - HICP inflation 

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 

22 

26 

28 

33 

34 

35 

38 

40 

43 

44 

47 

50 

52 

57 

57 

61 

64 

64 

70 

71 

75 

77 

79 

85 

86 

88 

92 

93 

100 

100 

103 

106 

106 

19 

19 

21 

24 

24 

25 

25 

27 

27 

29 

29 

29 

33 

33 

34 

37 

37 

38 

viii 

 
 
 
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 

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 

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 

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 

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 

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. 

Sweden - Inflation criterion 

38 

39 

39 

40 

41 

41 

44 

44 

46 

48 

48 

49 

49 

50 

50 

51 

52 

52 

57 

57 

59 

62 

62 

63 

63 

65 

65 

66 

66 

67 

71 

72 

73 

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76 

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80 

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95 

99 

ix 

 
 
8.2. 

8.3. 

8.4. 

8.5. 

8.6. 

8.7. 

8.8. 

8.9. 

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) 

99 

101 

104 

104 

105 

105 

107 

107 

108 

109 

109 

5 

8 

11 

13 

14 

x 

 
 
 
 
 
 
 
Convergence Report 2018 

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

 
 
Convergence Report 2018 

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

2 

 
 
Convergence Report 2018 

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 (2).  

they  wish 

indicate 

that 

In  2016,  the  Commission  and  the  ECB  adopted 
their latest regular Convergence Reports (3). None 
of the Member States assessed in those reports was 
deemed  to  meet  the  necessary  conditions  for 
adopting the euro.  

In 2018, 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, 
Romania  and  Sweden.  This  Commission  Staff 
Working  Document  is  a  Technical  Annex  to  the 
Convergence  Report  2018  and  includes  a  detailed 

(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)  The  United  Kingdom  has  decided  to  withdraw  from  the 

EU. 

assessment  of  the  progress  with  convergence,  as 
required by Article 140(1) of the Treaty. 

The  financial  and  economic  crisis,  along  with  the 
euro-area  sovereign  debt  crisis,  has  exposed  gaps 
in 
the 
the  economic  governance  system  of 
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 
strengthened 
surveillance  of  macroeconomic 
imbalances (see sub-section 1.2.6.).  

President  Juncker  said  in  his  2017  State  of  the 
Union address: "The euro is meant to be the single 
currency  of  the  European  Union  as  a  whole.  All 
but  two  of  our  Member  States  are  required  and 
entitled  to  join  the  euro  once  they  fulfil  all 
conditions.  Member  States  that  want  to  join  the 
euro  must  be  able  to  do  so."  The  Commission 
proposed in its 6 December 2017 "EMU Package" 
to  set  up  a  dedicated  work  stream  (as  part  of  its 
technical  assistance  activities)  to  offer  targeted 
support  to  Member  States  on  their  way  to  joining 
the  euro (4).  The  technical  support  will  be  offered 
upon  request  and  will  cover  all  policies  that  can 
help achieve a high degree of convergence, such as 
support for reforms in the areas of public financial 
management, 
the 
financial  sector,  labour  and  product  markets,  and 
the  public  administration.  This  technical  support 
will  be  funded  through  the  Structural  Reform 
Support  Programme.  The  Commission  also 
announced  that  for  the  period  post-2020,  it  will 
propose a dedicated convergence facility, as part of 
the  follow-up  to  the  Structural  Reform  Support 
Programme, in order to support Member States in 
smooth 
their 
participation  in  the  euro  area.  This  is  however 
irrespective  of  the  formal  process  towards  euro 
adoption,  which  is  part  of  a  specific  monitoring 
process through the Convergence Reports. 

the  business  environment, 

concrete  preparation 

for 

a 

(3)  European  Commission,  Convergence  Report  2016, 
COM(2016)  191  final,  7  June  2016;  European  Central 
Bank, Convergence Report 2016, June 2016. 

(4)  European Commission, Communication on new budgetary 
instruments  for  a  stable  euro  area  within  the  Union 
framework, COM(2017) 0822 final, 6 December 2017 

5 

 
                                                           
                                                           
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

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  fulfilment  of  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 23 April 
2018. 

1.2.  APPLICATION OF THE CRITERIA 

In  accordance  with  Article  140(1)  of  the  Treaty, 
the  Convergence  Reports  shall  examine 
the 
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 

to 

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 2018 - Technical annex 

Chapter 1 - Introduction 

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”.  

they  do  not  constitute 

Since  national  consumer  price  indices  (CPIs) 
diverge substantially in terms of concepts, methods 
the 
and  practices, 
appropriate means to meet the Treaty requirement 
that  inflation  must  be  measured  on  a  comparable 
basis.  To  this  end,  the  Council  adopted  on  23 
October  1995  a  framework  regulation (5)  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.  

legal  basis  for 

in 

inflation 

the  percentage  change 

As has been the case in past convergence reports, a 
Member  State’s  average  rate  of 
is 
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 (see Box 1.2). 

(5)  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. 

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

1.2.1.  Compatibility of legislation 

In  accordance  with  Article  140(1)  of  the  Treaty, 
the  legal  examination  includes  an  assessment  of 
a  Member  State’s 
compatibility 
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.  

financing 

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

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

7 

 
                                                           
Convergence Report 2018 - 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), 2014 (Greece, Bulgaria and Cyprus) and 2016 (Cyprus and Romania), as their inflation rates deviated by a wide margin from the euro-area average, driven by country-specific factors that limited their scope to act as meaningful benchmarks for other Member States. Table 1 lists the reference value in the Convergence Reports issued since 1998.    
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

Accordingly, the reference value is currently 1.9%, 
based  on  the  data  of  Cyprus  (0.2%),  Ireland 
(0.3%),  and  Finland  (0.8%)  over  the  12-month 
period covering April 2017-March 2018. 

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 

9 

in 

developments  in  unit  labour  costs  as  a  result  of 
trends 
labour  productivity  and  nominal 
compensation  per  head,  developments  in  import 
prices  to  assess  how  external  price  developments 
have impacted on domestic inflation. Similarly, the 
impact of administered prices and indirect taxes on 
headline inflation is also considered. 

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 (6).  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 

(6)  Based  on  the  Commission  services'  Spring  2018  Forecast, 
the inflation reference value is forecast to stand at 2.2% in 
December 2018. 

  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, Spain0.70.12018March 2018Cyprus, Ireland, Finland1.91.41) 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 2018 - Technical annex 

Chapter 1 - Introduction 

1.2.3.  Public finances 

1.2.4.  Exchange rate stability 

the 
The  convergence  criterion  dealing  with 
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 which sets out the way 
in  which  government  deficit  and  debt  levels  are 
assessed to determine 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 (7). 

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 (8). 

in 

(7)  The definitions of the government deficit and debt used in 
this  report  are  in  accordance  with  the  excessive  deficit 
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 
at: 
since 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm. 

found 

2002 

can 

be 

(8)  A  directive  on  minimum  requirements  for  national 
on 

frameworks, 

regulations 

budgetary 

new 

two 

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” (9). Based on the Council Resolution 
on  the  establishment  of  the  ERM  II  (10),  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 
exchange 
measures, 
interventions, and international financial assistance 
wherever  relevant,  in  maintaining  exchange  rate 
stability.  

including 

foreign 

and 

surveillance 

the  Stability 

three 
and  Growth  Pact 

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 
the  country-specific 
assessment  of  progress 
medium-term budgetary objective. 

the  amendments 

towards 

(9)  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. 

(10)  97/C 236/03 of 16 June 1997, OJ C 236, 2.8.1997, p.5. 

10 

 
                                                           
                                                                                   
 
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

11 

(Continued on the next page) 

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, the debt criterion in Article 126(2) of the Treaty was operationalised.  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 when assessing compliance on the basis of the debt criterion. When assessing compliance on the basis of the                                                            (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 2018 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

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 24 April 2016 to 23 April 2018. 

12 

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 075, March 2018: https://ec.europa.eu/info/sites/info/files/economy-finance/ip075_en.pdf  
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

the  assessment  of 

the 
For 
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 

The  reference  value  for  March  2018  is  calculated 
as  the  simple  average  of  the  average  long-term 
interest rates in Cyprus (2.2%), Ireland (0.8%) and 
Finland (0.6%), plus 2 percentage points, yielding 
a reference value of 3.2%. 

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 

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 
into 
bonds  or  comparable  securities, 
account  differences  in  national  definitions”  (see 
Box 1.4).    

taking 

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 10-year benchmark bond yields 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 ten Member States, the residual maturity of the benchmark bond is at least 9.5 years. For seventeen Member States, the residual maturity of the benchmark bond is below 9.5 years, in particular for Lithuania with a residual maturity below 7 years. All yields are calculated on the basis of secondary market rates, where available. 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) and in a dedicated page in the ECB website with additional information: http://www.ecb.europa.eu/stats/financial_markets_and_interest_rates/long_term_interest_rates/html/index.en.html.  
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

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 

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 was that the economic governance framework in the EMU needed to be further strengthened to better support macroeconomic stability, including in aspects beyond fiscal policy. The Macroeconomic Imbalance Procedure (MIP) responds to that need by aiming at the detection, prevention and correction of macroeconomic imbalances that could harm economic stability in an EU country, the euro area, or the EU as a whole. It was a key element of the legislative package (the "Six-Pack") to enhance the governance structures in EMU adopted in 2011.  No simple and mechanistic criteria are available for the identification of macroeconomic imbalances because drivers of macroeconomic instability are multi-dimensional phenomena whose severity needs to be assessed along several aspects and taking into account also country-specific features, notably linked to the adjustment capacity of the economy. Instead, the MIP relies on a two-step approach for the identification of imbalances. In a first step for the identification of imbalances under the MIP, the Alert Mechanism Report (AMR) identifies the Member States that require more in-depth investigation on whether they may be affected by macroeconomic imbalances. The AMR builds on an economic reading of a scoreboard of economic and financial indicators with indicative thresholds. The scoreboard aims at covering the different challenges facing the Member States and comprises fourteen indicators of external imbalances and competitiveness developments, internal imbalances and the employment situation (1). The scoreboard encompasses variables that the economic literature and recent experiences suggest anticipating or associated with crisis episodes. The scoreboard is a starting point for the analysis in the AMR, which also takes into account additional information and assessment tools and previous in-depth assessments at country level. In a second step, the analysis carried out in the in-depth reviews (IDRs) for the selected Member States provides the basis for the identification of imbalances by the Commission. IDR analysis makes use of updated and specific information and analytical tools developed by the Commission services and is integrated in the Country Reports published in the European Semester context on annual basis. If imbalances have been identified, a difference is made between "imbalances" and "excessive imbalances", both implying possible recommendations by the Council upon Commission proposal, which have so far been integrated in the single package of Country-Specific Recommendations (CSRs) under the European Semester. The identification of "excessive imbalances" implies a stronger surveillance process, possibly leading to the launch of the Excessive Imbalance Procedure. The latter provides a framework underpinned by an articulated corrective action plan designed by the concerned Member State, endorsed by the Commission and the Council and monitored by the Commission, and including the possibility of sanctions for euro-area Member States in case of reiterated lack of compliance. The Excessive Imbalance Procedure has never been launched for countries with excessive imbalances, but the Commission has issued prescriptive recommendations and put in place a system of specific monitoring to assess the implementation of policy commitments in these countries. The 2018 Alert Mechanism Report (AMR) and In-Depth Reviews (IDR) The Commission published its seventh AMR in November 2017 concluding that IDRs were warranted for 12 Member States, which coincided with the ones that had already been identified with imbalances or excessive imbalances in the previous annual round of application of the MIP. Three of the Member States for which IDRs were prepared are covered in this Convergence Report (Bulgaria, Croatia and Sweden). On the basis of this year's IDRs, in March 2018, the Commission concluded that Bulgaria is experiencing imbalances thereby revising the previous conclusion of excessive imbalances, while Croatia and Sweden continue to experience, respectively, excessive imbalances and imbalances.                                                            (1) The variables are: current account, net international investment position, real effective exchange rates, unit labour cost, and export market shares; private sector debt, general government debt, private sector credit flow, change in total financial sector liabilities, house prices; unemployment rate, activity rate, long-term and youth unemployment.  
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 1 - Introduction 

the 

integration 

functioning  of 

the  situation  and  development  of  the  external 
balance  (11).  Market 
is  assessed 
through  trade,  foreign  direct  investment  and  a 
smooth 
internal  market. 
Moreover,  progress  in  financial  integration  is 
examined,  together  with  the  main  characteristics, 
structures and trends of the financial sector. Given 
that  Member  States  which  adopt  the  euro  also 
participate  in  the  banking  union,  developments  in 
national banking sectors are specifically looked at 
as well. 

Starting  with  the  2012  Convergence  Report,  the 
convergence assessment is aligned with the  

integrated 

broader  European  Semester  approach  which  takes 
the  economic  policy 
an 
challenges 
fiscal 
sustainability,  competitiveness,  financial  market 
stability and economic growth (12).  

look  at 
facing  EMU 

in  ensuring 

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). 

(11)  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. 

(12)  The cut-off date of this Convergence Report does not allow 
to  include  the  assessment  of  the  2018  updates  of  the 
Convergence  Programmes 
this  Staff  Working 
Document. 

in 

15 

 
 
                                                           
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  2016 
Convergence  Report.  However,  no  amendments 
have  been  made  as  regards  the  incompatibilities 
2016 
highlighted 
Convergence  Report.  Therefore,  the  comments 
provided in the latter report are largely repeated in 
this year's assessment. 

Commission's 

the 

in 

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 

Interest  Prevention 

The  Conflict  of 
and 
Ascertainment  Act  of  2008,  which  regarding  the 
possibility to dismiss the Governor of the BNB had 
to  be  brought  in  line  with  Article  14.2  of  the 
ESCB/ECB  Statute,  was  fully  repealed  and 
replaced  by  the  Act  on  Corruption  Counteraction 
and  Eviction  of  Illegally  Acquired  Property  of 
2018 (13).  However,  similar  to  the  repealed  Act, 

(13)  State Gazette No. 7/19.01.2018. 

17 

Article  80(1)  in  conjunction  with  Article  6(1)(12) 
of the new Act provides that the ascertainment of a 
conflict of interest is a ground for dismissal of the 
Governor  of  the  BNB.  Thus,  an  incompatibility 
remains and 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  ascertainment  of  a  conflict  of  interest 
corresponds 
the 
conditions  required  for  the  performance  of  the 
Governor's duties or a serious misconduct of which 
the Governor has been guilty. 

lack  of  fulfilment  of 

to  a 

Pursuant  to  Article  12(1)  of  the  BNB  Law,  the 
Governor  shall  be  elected  by 
the  National 
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 
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 

that 

 
                                                           
suspended 

this  might 

been 
an 
incompatibility  in  the  area  of  independence,  with 
Article  130  of  the  TFEU  and  Article  7  of  the 
ESCB/ECB. 

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. 

Objectives 

The  objectives  of  the  BNB  (Article  2(2)  of  the 
BNB  Law)  are  compatible  with  the  Treaty  on  the 
Functioning of the European Union. 

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 

Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

ESCB (Articles 2(1) and (3), 16(4) and (5), 28, 
29,  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,  29,  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 (Article 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). 

2.1.4.  Assessment of compatibility 

The  BNB  Law  and 
the  Act  on  Corruption 
Counteraction  and  Eviction  of  Illegally  Acquired 
Property 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.  

The Commission has understood that the Bulgarian 
authorities  have  the  intention  to  amend  the  BNB 
Law  in  the  course  of  2018.  In  this  context, 
Bulgarian  authorities  are  invited  to  consult  the 
ECB on the draft law amending the BNB Law and 
other  related  laws,  as  provided  for  by  Articles 

18 

 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

127(4) and 282(5) of the TFEU and to remedy the 
abovementioned incompatibilities. 

1.9% in March. In October 2017, the inflation rate 
surpassed that of the euro area by 0.12 percentage 
points and it has remained above it since then.  

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  below  the 
reference value at the time of the last convergence 
assessment  of  Bulgaria  in  2016.  It  started  to 
increase  steadily  soon  after,  moved  into  positive 
territory  in  June  2017  and  has  been  further 
increasing afterwards, reaching 1.2% in December 
2017.  In  March  2018,  the  reference  value  was 
1.9%,  calculated  as  the  average  of  the  12-month 
average  inflation  rates  in  Cyprus,  Ireland  and 
Finland  plus  1.5  percentage  points.  The 
corresponding inflation rate in Bulgaria was 1.4%, 
i.e.  0.5  percentage  points  below  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected  to  remain  below  the  reference  value  in 
the months ahead. 

2.2.2.  Recent inflation developments 

factors, 

The  annual  HICP  inflation  rate  in  Bulgaria  was 
negative between mid-2013 and early-2017 due to 
a  combination  of  several 
including 
declining  imported  commodity  prices,  subdued 
domestic  demand  and  reductions  in  administered 
prices.  With  the  reversal  of  these  trends,  the 
inflation rate started to gradually increase again in 
the  second  half  of  2016,  after  having  reached  its 
trough  at  -2.5%  in  May.  It  entered  positive 
territory at the beginning of 2017 and maintained a 
predominantly  growing 
then, 
the  year  despite  slight 
reaching  1.2% 
downwards fluctuations between April and July. In 
2018,  inflation  continued  picking  up  reaching 

trajectory  since 

for 

inflation  (measured  as  HICP 

Core 
inflation 
excluding energy and unprocessed food) fell from 
0.4% in October 2015 to -0.8% in May 2016. After 
that,  it  started  to  gradually  pick  up,  entering 
positive  figures  in  the  second  half  of  2017  and 
reaching  1.0%  by  December  2017.  This  trend 
continued  in  2018,  with  core  inflation  standing  at 
1.9%  in  March.  Services  and  processed  food 
the  main  contributors 
inflation  were 
this 
increase.  Core 
inflation  was  above  headline 
inflation  during  2015  and  most  of  2016, 
highlighting  the  effect  of  plunging  energy  and 
unprocessed  food  prices.  As  prices  in  these  two 
categories  started  to  increase  rapidly  in  the  final 
months  of  2016,  the  headline  inflation  increased 
above the core inflation in December 2016.  

to 

The  components  of  core  inflation  have  been 
mostly negative in 2016. Processed food inflation, 
which was the first to turn around already the year 
before,  partly  due  to  rising  unprocessed  food 
prices,  continued  trending  up  throughout  2016. 
Despite some fluctuations over the year, it reached 
2.5%  in  December  2017  and  fell  slightly  to  2.3% 
in  March  2018.  Services  inflation  has  been  pretty 
volatile  over  the  last  years.  After  starting  2016  in 
the positive territory, it fell to -1.1% in May 2016. 
It had recovered by August 2016, only to be falling 
again  until  March  2017,  when  it  bottomed  at  -
1.3%.  It  resumed  growth  in  the  ensuing  months 
reaching  1.2%  in  December  2017  and  peaking  at 
3.7% in March 2018. This increase is in line with 
the  wage  increases  and  positive  developments  in 
the  labour  market  that  are  strengthening  domestic 
demand. Non-energy industrial goods inflation was 
deeply  negative  in  2016  reflecting  both  lower 
import  prices  and  weak  domestic  demand  for  a 

19 

-2-101234Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18BulgariaReference valueGraph 2.1: Bulgaria -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.-4-20242012201320142015201620172018BulgariaEuro areaGraph 2.2: Bulgaria -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

and 3.7% for 2019. The output gap turned positive 
in 2017 and it is set to remain positive in 2018 and 
2019. 

The fiscal stance, as measured by the change in the 
structural  balance,  remains 
tight.  The  fiscal 
adjustment which started in 2015, continued in the 
recent  years  and  the  structural  fiscal  surplus 
already  achieved  in  2016  has  widened  further  in 
2017.  According  to  the  Commission  services' 
Spring  2018  Forecast,  the  structural  surplus  is 
projected to be slightly reduced in 2018 and 2019, 
indicating a small fiscal expansion owed mostly to 
a projected higher public investment. 

In  the  context  of  its  currency  board  arrangement 
with  lev  (BGN)  pegged  to  the  euro,  the  most 
standard  monetary  policy  instruments  are  not 
to 
to  Bulgaria.  In  response 
available 
these 
limitations, 
relatively 
the  BNB  has  kept 
conservative  liquidity  and  capital  requirements  on 
the  banking  sector.  Bank  interest  rates  have 
decreased  further  over  the  past  two  years  in  line 
with  monetary  policy  developments  in  the  euro 
area. Lending to the private sector has been on the 
recovery  path  since  mid-2016.  However,  it  has 
remained  subdued  due  to  an  ongoing  corporate 
deleveraging.  The  domestic  banking  crisis  which 
largely  quickly 
erupted 
soundness 
overcome, 
has 
risks  have  abated. 
improved  and  contagion 
Nevertheless  vulnerabilities 
remain  as  non-
financial  corporations'  debt,  and  non-performing 
loans  are  still  higher  than  in peer countries,  albeit 
decreasing.  The  action  plan  drawn  to  deal  with 
identified  shortcomings  in  banks'  management 
practices  and  supervision  is  being  implemented.  
The  collateral  valuation  practices  need  to  be 
enhanced in line with EU standards. 

in  2014  has  been 
sector 

financial 

20 

long  time.  Non-energy  industrial  goods  inflation 
started to recover only in 2017 fuelled by stronger 
domestic  demand  and  higher  import  prices,  but  it 
remained  in  negative  territory,  reaching  -0.5%  in 
December 2017 and -0.4% in March 2018.   

index  rose  by  4.1% 

The  producer  price 
in 
December  2017  compared  to  the  same  month  of 
2016,  mostly  as  a  result  of  price  increases  in  the 
electricity,  gas,  steam  and  air  conditioning  supply 
and the mining and quarrying industry.   

2.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Bulgaria’s  economy  is  growing  steadily,  with  the 
drivers of growth having shifted from the external 
sector  to  domestic  demand  in  2017.  Real  GDP 
growth  was  estimated  at  3.6%  in  2017,  0.3 
percentage points lower than in 2016. Increases in 
wages and improved household expectations had a 
positive  impact  on  private  consumption  over  the 
course  of  2017.  Public  consumption  growth  was 
also  stronger  than  in  previous  years,  reflecting 
mainly 
increasing  public  wages  and  higher 
spending on intermediate consumption. Investment 
is  slowly  recovering  from  its  drop  in  2016,  as 
confidence  is  improving  in  the  business  sector. 
However,  the  public  investment  decreased  further 
in 2017 mainly because the implementation of EU 
funded  projects  has  been  slower  than  expected. 
Following a very strong performance in 2016, net 
exports'  contribution 
turned 
negative,  as  imports  driven  by  strong  domestic 
demand  grew  faster  in  2017  and  export  growth 
slowed down. The GDP growth rate is expected to 
remain  robust  with  projections  of  3.8%  for  2018 

to  GDP  growth 

Table 2.1:(cid:9)weights  Bulgaria - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP2.40.4-1.6-1.1-1.31.21.41000Non-energy industrial goods-0.8-1.5-2.2-1.6-1.6-1.0-0.8260Energy7.9-1.7-3.8-6.7-7.05.85.3134Unprocessed food 4.44.4-0.80.6-1.15.12.982Processed food1.51.3-0.40.61.22.12.3209Services2.41.1-1.30.1-0.6-0.10.9315HICP excl. energy and unproc. food1.20.3-1.3-0.3-0.40.20.7784HICP at constant tax rates 2.40.4-1.6-1.1-1.51.01.21000Administered prices HICP4.9-1.1-1.01.50.11.72.31661) 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. 
 
 
 
 
 
Wages and labour costs 

The  labour  market  continued  to  improve  over 
2016-17. Activity and employment rates increased 
substantially  in  this  period  which,  combined  with 
the  improved  economic  outlook,  further  reduced 
the unemployment rate from 7.6% in 2016 to 6.2% 
in  2017.  Nominal  compensation  per  employee 
increased  by  5.8%  in  2016  and  7.5%  in  2017, 
merely  as  a  response 
to  wage  convergence 
pressures, and skills shortages and mismatches. 

Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

international  oil  prices  and  the  stronger  nominal 
effective  exchange  rate  of  the  lev.  However,  this 
trend  was  reversed  in  2017  with  import  prices 
increasing by 3%. This growth in import prices is 
assumed  to  continue  in  2018,  mainly  due  to  the 
expected  movements  of  global  oil  prices,  pushing 
upwards energy prices, though at a declining rate.  

The  nominal  effective  exchange  rate  of  the  lev 
(measured  against  a  group  of  36  trading  partners) 
has appreciated by over 5% since the start of 2016 
as  the  currencies  of  Bulgaria's  major  trading 
partners  depreciated  against  the  euro  (the  US 
dollar,  the  pound  sterling,  the  Swiss  franc,  the 
Turkish lira, the Russian rouble, the Romanian leu, 
the Chinese yuan). Almost half of this appreciation 
was  realized  in  the  second  half  of  2017.  While 
stronger  nominal  effective  exchange  rate  also 
contributed 
the 
assessment  period,  the  appreciation  of  the  euro 
(and  hence  of  the  lev)  against  the  US  dollar  also 
cushioned  somewhat  the  inflationary  pressures  of 
higher oil prices. 

import  prices  over 

lower 

to 

Labour productivity growth continued to increase, 
but  it  is  estimated  to  have  flattened  from  3.4%  in 
2016  to  1.7%  in  2017.  Over  2018-2019,  labour 
productivity  is  forecast  to  continue  growing  as  a 
result  of  the  improvements  in  the  labour  market 
and  the  ongoing  recovery  of  investment.  Nominal 
unit labour cost (ULC) growth remained at 2.3% in 
2016,  but  exhibited  a  strong  growth  of  5.7%  in 
2017,  which  is  in  line  with  the  tightening  of  the 
labour market in the private sector and increases in 
public sector wages. According to the Commission 
services'  Spring  2018  Forecast,  ULC  growth  is 
expected  to  continue  to  be  strong  in  2018.  For 
2019, ULC growth is forecast to slow down in line 
with  the  evolution  of  nominal  compensation  per 
employee,  while  remaining  well  above  ULC 
growth in the euro area. 

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  due  to  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 until recently, bottoming out 
at  -6%  in  2016.  This  reflected  mainly  lower 

Administered prices and taxes 

The  growth  rate  of  administered  prices (14) was 
above  headline  consumer  price  inflation  over  the 
past two years. The share of administered prices in 
the HICP basket is relatively high at around 16%, 
compared  to  13%  in  the  euro  area.  The  annual 
change  of  a  growth  rate  of  administered  prices 
increased  from  0.1%  in  2016  to  1.7%  in  2017. 
Overall, the contribution of administered prices to 
headline  inflation  was  neutral  in  2016  and  about 
0.3  percentage  points  in  2017  (or  22.4%  of  total 
HICP growth).  

Indirect tax changes had an insignificant effect on 
inflation  over  2016-2017  despite  tobacco  excise 
tax  increases  since  2016.  Annual  constant-tax 
HICP  was  broadly  at  the  same  level  as  headline 
inflation during the assessment period. 

(14)  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 

21 

-40481220122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflation(y-o-y percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast.Graph 2.3: Bulgaria -Inflation, productivity and wage trends 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

expected  to  have  only  a  limited  impact  on 
inflation. 

2.3. 

PUBLIC FINANCES 

2.3.1.  Recent fiscal developments 

The  general  government  budget 
registered 
surpluses  in  2016  and  2017.  The  expenditure-to-
GDP  ratio  decreased  by  5.5  percentage  points 
between  2015  and  2017,  to  35.2%.  The  reduction 
in  expenditure  reflects  the  lower  spending  in 
investment  and  other  expenditure  related  to  the 
implementation  of  EU  funded  programmes.  The 
transition between the two financing periods of EU 
structural and investment funds had also an impact 
on the revenue side. Between 2015 and 2017, total 
revenues  decreased  by  2.9  percentage  points  to 
36.1%  of  GDP.  This  decrease  can  almost  entirely 
be  attributed  to  lower  transfers  from  EU  funds. 
However, the negative developments on the side of 
transfers  was  partly  moderated  by  higher  tax 
revenue, which increased by 1 percentage point of 
GDP between 2015 and 2017. 

target  of  -0.6%  of  GDP 

The general government balance in 2017 overshot 
the 
the  2017 
Convergence  Programme.  The  better  outcome  is 
mainly  owed  to  a  significantly  lower  public 
investment relative to the initial target and a better 

in 

22 

Medium-term prospects 

fuelled  by  positive 

Annual HICP inflation is expected to rise further in 
2018 and 2019. Core inflation is set to continue to 
rise  in  2018  as  growth  in  household  disposable 
incomes, 
labour  market 
developments, boosts private demand. At the same 
time,  global  oil  prices  are  expected  to  continue 
pushing  energy  prices  upwards.  Accordingly,  the 
Commission  services'  Spring  2018  Forecast 
projects  HICP  inflation  to  average  1.8%  in  2018 
and 2019.  

Risks  to  the  inflation  outlook  appear  broadly 
balanced. The most significant risks are related to 
global energy and food price developments, given 
their relatively large share in the consumer basket. 
Additional inflation risk factors are supported also 
by domestic developments, including administered 
prices changes and higher wage growth. 

In  2016,  the  level  of  consumer  prices  in  Bulgaria 
was  about  47%  of  the  euro  area  average  and  the 
GDP  per  capita  was  about  46%  of  the  euro  area 
average in PPS terms. In line with the catching-up 
of  the  Bulgarian  economy,  further  price  level 
convergence is expected. 

Medium-term  inflation  prospects  will  depend  on 
wage and productivity developments, as well as on 
global  commodity  price  trends.  The  tax  policy  is 

Table 2.2:(cid:9)Bulgaria - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationBulgaria2.40.4-1.6-1.1-1.31.21.81.8Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorBulgaria3.6-2.60.01.2-0.11.11.81.8Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeBulgaria7.78.85.65.65.87.57.67.0Euro area1.81.61.41.41.21.62.41.9Labour productivityBulgaria2.61.31.03.33.41.72.73.3Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsBulgaria5.07.44.62.32.35.74.83.6Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorBulgaria3.8-2.8-2.9-2.9-6.06.61.71.4Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

performance  on  the  revenue  side.  In  structural 
terms,  the  adjustment  achieved  since  2015  is  2 
percentage  points  of  GDP.  The  structural  surplus 
improved  further  from  0.3%  of  GDP  in  2016  to 
0.9% in 2017, while the output gap almost closed 
in  2017,  after  being  in  a  negative  territory  for 
years. 

cash terms provides for reductions of the deficit by 
0.5 percentage points per annum until 2020, when 
it  is  planned  to  be  balanced.  In  ESA  terms,  the 
surplus that has been achieved already since 2016 
is  forecast  by  the  government  to  get  to  zero  in 
2018  and  again  return  and  remain  positive  in  the 
medium term.  

The general government gross debt peaked in 2016 
at the level of 29% of GDP. The positive primary 
budget  balance  and  the  repayment  of  debt  of 
around  1.5  percentage  points  of  GDP  out  of 
accumulated  fiscal  reserves  together  with  high 
nominal growth led to a reduction by more than 4 
percentage points of GDP in 2017, to 25.4%.   

2.3.2.  Medium-term prospects 

The  2018  budget  was  adopted  by  Parliament  in 
December  2017.  It  aims  at  a  general  government 
deficit of 1% of GDP in cash terms, corresponding 
to  a  balanced  budget  in  ESA  terms.  On  the 
revenues' side, the main measures planned include 
a  further  increase  of  the  excise  duty  on  cigarettes 
in  order  to  reach  the  EU  minimum  level,  an 
increase  of  social  security  contributions  by 
1 percentage  point,  adjustments  of  the  minimum 
income  for  which  contributions  have  to  be  paid 
and an adjustment of the minimum wage, which is 
expected  to  have  a  positive  impact  also  on  direct 
taxes.  On  the  expenditures'  side,  the  government 
has decided to increase wages for some categories 
of  teaching  staff  and  security  personnel.  The 
medium  term  plan  of  the  government  budget  in 

23 

Given  the  over-achievement  of  the  consolidation 
targets  in  the  last  few  years,  the  Commission 
services  updated  their  forecast  of  the  budget 
balance  upwards.  The  Commission  services 
forecast  the  general  government  budget  in  ESA 
terms  to  remain  in  a  surplus  of  0.6%  of  GDP  in 
both 2018 and 2019. Taking into account estimated 
positive  output  gap  from  2018  onwards,  the 
structural  surplus  is projected  to  be  slightly  lower 
than the headline one at 0.5% of GDP in both 2018 
and 2019. The public-debt-to-GDP ratio is forecast 
to  continue  to  decrease  to  23.3%  in  2018  and 
21.4% in 2019.                                                                      

The 2018 Convergence Programme was submitted 
by  the  Bulgarian  authorities  on  19  April  2018.  It 
plans  to  reduce  the  headline  surplus  to  zero  in 
2018 and return to surpluses in 2019 remaining in 
positive balance until 2021. In structural terms, the 
government  plan  targets  at  balanced  to  positive 
budgetary outcomes, well above the medium-term 
objective for the entire period 2018-2021.                                                                                                               

The  various  components  of  the  Bulgarian  fiscal 
framework have gradually been strengthened over 
the last few years. Bulgaria is bound by the Fiscal 

Table 2.3:(cid:9)Bulgaria - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-0.3-0.4-5.5-1.60.20.90.60.6- Total revenues34.137.236.639.135.236.136.436.4- Total expenditure34.537.642.140.735.035.235.835.8   of which: - Interest expenditure0.80.70.90.90.90.80.70.7p.m.: Tax burden26.728.228.429.129.230.130.230.0Primary balance0.50.4-4.6-0.71.11.71.31.3Cyclically-adjusted balance-0.2-0.1-4.9-1.20.30.90.50.5One-off and temporary measures0.00.0-3.2-0.10.00.00.00.0Structural balance 2)-0.2-0.1-1.7-1.10.30.90.50.5Government gross debt16.717.027.026.029.025.423.321.4p.m: Real GDP growth (%)0.00.91.33.63.93.63.83.7p.m: Output gap-0.4-0.8-1.8-1.3-0.30.10.40.51) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
 
 
 
 
 
Compact (15)  based  on  its  own  declaration  of 
intention and has transposed its provisions into the 
national  legal order.  The  most recent  steps of  this 
reform  drive  were  adopted  in  autumn  2017  with, 
inter  alia,  improvements  in  the  design  of  rules 
governing  expenditure  developments  and  as  well 
as  in  multi-annual  budget  planning  through  the 
legislated  systematic  use  of  no-policy-change 
scenarios.  The  Fiscal  Council  became  operational 
in the first half of 2016, and has started to roll out 
faces  significant 
its  activities.  However, 
challenges in performing its relatively wide remit, 
mainly due to the limited analytical resources and 
financial  autonomy. 
the 
Parliament  decided  to  increase  the  size  of  the 
Fiscal  Council's  support  staff  from  three  to  five 
experts. 

In  February  2018, 

it 

2.4. 

EXCHANGE RATE STABILITY 

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

liabilities  and  euro  at 

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

in 

Coordination  and  Governance 
Monetary Union. 

Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

Over  the  past  two  years,  the  CBA  operated  in  an 
environment  of  strong  nominal  GDP  growth  and 
solid  labour  market  recovery,  with  improving 
soundness of the financial sector, recovering credit 
flows and the abating of the contagion risks in the 
banking  sector  which  had  been  observed  in  the 
previous  years.  Furthermore,  strong  exports,  a 
favourable 
funding 
position  of  the  banking  sector  and  sizable  reserve 
buffers  have  underpinned  the  resilience  of  the 
CBA. 

(mainly  deposit  driven) 

Bulgaria's  international  reserves  increased  from 
around EUR 20.2 billion to over EUR 23.5 billion 
between  end-2015  and  end-2017.  International 
reserves were boosted by some EUR 4 billion due 
to  the  issuance  of  long-term,  foreign-currency 
government  debt,  inflows  of  EU  funds  and  an 
increase of the BNB liabilities towards commercial 
banks  in  2016.  International  reserves  covered 
around 155% of the monetary base, 55% of broad 
money  (M3)  and  47%  of  GDP  at  the  end-2017. 
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 
euro area were quite stable over the past two years. 
The  3-month  spread  hovered  around  45  basis 
points by the end-2016 and further declined to 33 
basis points in March 2018.  

24 

1.81.92.02.12012201320142015201620172018Graph 2.4: Bulgaria -BGN/EUR exchange rate(monthly averages)Source: ECB.01002003002012201320142015201620172018Graph 2.5: Bulgaria -3-M Sofibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
 
 
                                                           
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

expectations  of  loose  monetary  policy  in  the  euro 
area for an extended period of time. 

Spreads  to  the  Bund  increased  by  some  50  basis 
points in the first half of 2016, reaching about 250 
basis points at the peak in July 2016, but has been 
on decreasing path since then. At the end of 2017, 
the  spread  has  reached  72  basis  points,  and  it  has 
been further decreasing to about 40 basis points in 
early 2018.  

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

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP – see also Box 1.5), which concluded that an 
in-depth review (IDR) was warranted for Bulgaria. 
In  March  2018,  the  Commission  published  its 
annual  country  report  on  Bulgaria (16),  including 
an IDR. The analysis concluded that Bulgaria was 
experiencing  macroeconomic  imbalances,  linked 
to  vulnerabilities  in  the  financial  sector  coupled 
with  high  indebtedness  and  non-performing  loans 
in the corporate sector. The authorities have made 
progress  in  implementing  the  recommendations 
addressed after the asset quality and balance sheet 
reviews,  but  the  legacy  issues  linked  to  weak 

(16)  https://ec.europa.eu/info/sites/info/files/2018-european-

semester-country-report-bulgaria-en.pdf 

2.5. 

LONG-TERM INTEREST RATES 

the  development  of 

long-term 
For  Bulgaria, 
interest  rates  over  the  current  reference  period  is 
assessed  on  the  basis  of  secondary  market  yields 
on  a  single  benchmark  government  bond  with  a 
residual maturity of around 9 years.  

The  Bulgarian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  below  the  reference  value  in 
the  2016  convergence  assessment  of  Bulgaria.  It 
further declined from around 2.5% in mid-2016 to 
around 1.6% by the end-2017. In March 2018, the 
latest  month  for  which  data  are  available,  the 
reference value, given by the average of long-term 
interest rates in Cyprus, Ireland and Finland plus 2 
percentage  points,  stood  at  3.2%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Bulgarian benchmark  bond  stood  at  1.4%, i.e.  1.8 
percentage points below the reference value. 

The long-term interest rate of Bulgaria has been on 
a  decreasing  path  since  early  2016,  going  from 
2.44% in January 2016 to 0.90% in January 2018. 
These  developments  partly  reflect  the  efforts  in 
implementing measures to strengthen the financial 
system,  but  also  re-balancing  of 
their  asset 
portfolios towards government long-term bonds by 
domestic banks, due to low inflation risk and lack 
of alternative profitable investment.   

Bulgarian benchmark bond yields continued to fall 
throughout  2016-17  mainly  due  to  internal,  but 
also  due  to  external  factors.  Primarily,  they  were 
supported  by  developments  on  the  secondary 
market characterised by continuing strong demand 
for  government  securities  while 
their  supply 
remained subdued. Falling long-term interest rates 
i.e. 
were  supported  also  by  external  forces, 

25 

0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18BulgariaReference valueGraph 2.6: Bulgaria -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-202462012201320142015201620172018BulgariaGermanyGraph 2.7: Bulgaria -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

transportation  and  business  process  outsourcing 
sectors.  The  capital  account  surplus  decreased  in 
the  last  couple  of  years,  from  3.1%  of  GDP  in 
2015  to  1.0%  of  GDP  in  2017,  mainly  due  to  the 
fluctuations  of  inflow  of  EU  funds.  The  negative 
primary  income  balance,  has  improved  in  2017 
reflecting  a 
international 
less  negative  net 
investment  position  due  to  dividends  payments. 
There were no significant changes in the secondary 
income balance. 

The  saving-investment  gap  of 
the  Bulgarian 
economy  has  increased  over  the  last  two  years. 
Investment has decreased by 2 percentage points in 
2016  and  increased  by  1.7  percentage  points  to 
20.9%  in  2017.  Savings  were  24.5%  of  GDP  in 
2016  and  decreased  to  23.9%  of  GDP  in  2017. 
This  dynamics  of  the  saving-investment  gap  was 
mostly driven by the public sector. On average, the 
public  sector  contributed  1.9  percentage  points  of 
GDP  to  the  fall  of  investment  and  2.2  percentage 
points  to  the  rise  in  savings  between  2015  and 
2017. Public investment decreased sharply in 2016 
and  it  continued  decreasing  in  2017  due  to  slow 
uptake of the implementation of the EU structural 
and  investment  funds.  These  developments  led  to 
the accumulation of the advanced payments on the 
saving  side.  The  movement  in  the  private  sector 

26 

governance, asset quality and supervision have not 
yet  been  fully  dealt  with.  The  robust  growth  has 
supported  continuous  private-sector  deleveraging 
and  further  decreases  in  non-performing  loan 
ratios,  but  stocks  are  still  high,  especially  in  the 
corporate  sector.  Labour  market  improvement  has 
continued despite persistent structural issues. Some 
measures  have  been  taken  to  tackle  the  main 
sources  of  imbalances,  but  further  progress  is 
needed  to  address  remaining  vulnerabilities  in  the 
financial  sector  and  completing  the  reform  of  the 
insolvency framework. 

2.6.1.  Developments  of 

the  balance  of 

payments 

Bulgaria's  external  balance  (i.e.  the  combined 
current  and  capital  account)  has  further  improved 
over  the  last  two  years.  The  external  surplus 
further  expanded  to  4.5%  in  2016  and  5.5%  of 
GDP  in  2017,  mainly  on  acconut  of  improved 
primary  income  balance.  The  trade  balance  of 
goods  as  a  percentage  of  GDP  remained  negative 
but  improved  by  almost  4  percentage  points  in 
2016 
about 
2 percentage  points  in  2017.  The  trade  balance  in 
services  remained  about  6.0%  of  GDP  in  both 
tourism, 
to  stable  growth 
years  owing 

before  worsening 

again 

by 

in 

Table 2.4:(cid:9)Bulgaria - Balance of payments(percentage of GDP)201220132014201520162017Current account-0.91.30.10.02.34.5of which: Balance of trade in goods-9.5-7.0-6.5-5.8-2.0-4.1                 Balance of trade in services6.26.35.96.66.16.0                 Primary income balance -2.5-3.8-3.1-4.5-5.1-1.1                 Secondary income balance5.05.73.83.63.33.7Capital account1.31.12.23.12.21.0External balance 1)0.42.42.33.14.55.5Financial account2.32.1-0.76.68.44.4of which: Direct investment-2.5-3.0-2.1-5.1-1.5-1.4                Portfolio investment2.10.3-2.8-1.3-1.35.2                Other investment 2)-2.46.00.04.84.00.7                Change in reserves5.1-1.34.28.27.2-0.2Financial account without reserves-2.83.4-4.9-1.61.24.6Errors and omissions1.8-0.3-3.03.54.0-1.1Gross capital formation21.921.321.421.219.120.9Gross saving21.823.421.621.824.523.9Gross external debt92.690.997.481.379.374.2International investment position-77.9-73.3-75.2-61.2-46.2-40.51) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Bulgarian National Bank. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

macroeconomic 

was the opposite, but of a smaller magnitude. The 
positive 
environment 
accompanied  by  low  interest  rate  underpinned 
confidence  and  increased  investment  in  2016,  a 
trend that continued in 2017 but at a slower pace. 

improved  also  the  net  international  investment 
position,  from  around  46%  of  GDP  in  2016  to 
around 40% of GDP in 2017. 

Competitiveness  seems  to  have  been  preserved  in 
the  past  two  years,  although  relevant  indicators 
continue  to  show  a  somewhat  mixed  picture.  The 
real  effective  exchange  rate,  deflated  by  ULC, 
stabilized  in  2016.  This  period  of  stabilization 
helped  external  competitiveness,  which  was 
reflected  in  stronger  exports'  growth.  In  2017,  a 
significant  real  appreciation  worsened  the  cost 
competitiveness  of  Bulgaria  but  the  pressures 
induced by the real exchange rate movements were 
partly  offset  by  non-cost  related  improvements 
(such as quality). The real effective exchange rate, 
deflated  by  HICP,  on  the  contrary,  depreciated  in 
2016 and started to slowly appreciate in 2017. The 
price  competitiveness  of  Bulgarian  exporters 
remains high, although their relative advantage has 
been  gradually  reduced  by  narrowing  differences 
in inflation with trading partners. 

Robust  financial  account  outflows  have  continued 
since 2015. Net FDI inflows have remained at low 
levels  by  pre-crisis  standards,  reaching  around 
0.7% of GDP in 2016 and 1.4% of GDP in 2017. 
In  2015  and  2016,  there  was  a  net  inflow  of 
portfolio  investment,  mainly  due  to  government 
borrowing.  This  was  reversed  in  2017  due  to 
government  and  corporate  deleveraging  and  the 
build-up  of  foreign  assets  by  both  financial  and 
non-financial  institutions.  At  the  same  time,  the 
maturity  structure  of  debt  securities  has  changed 
lower 
from  short 
uncertainty  in  the  borrowing  markets.  Although 
still high, gross external debt has improved further 
in the past two years, from about 80% of GDP in 
2016  to  around  74%  of  GDP  in  2017.  This 
reduction,  accompanied  by  current  account 
surpluses  and  lower  level  of  investment  inflows, 

indicating 

term, 

long 

to 

According  to  the  Commission  services’  Spring 
2018  Forecast,  the  external  surplus  is projected  at 
3.2% of GDP in 2018 and at 2.7% of GDP in 2019. 

2.6.2.  Market integration 

The economy is well integrated with the euro area 
through trade and investment linkages. As a small 
open economy, Bulgaria is characterised by a high 
ratio of trade openness, which stood at around 65% 
and  69%  of  GDP  in  2016  and  2017,  respectively. 
Trade  with  the  euro  area  was  about  31%  of  total 
trade  in  2017.  Outside  the  EU,  Bulgaria's  main 
trading  partners  are  Russia  and  China  (especially 
for imports). 

FDI  inflows  decreased  from  about  3%  of  GDP  in 
2013  to  1.4%  of  GDP  in  2017.  The  stock  of  FDI 
amounted  to  some  78%  of  GDP  in  2016  and 
around  75%  in  2017,  with  FDI  mainly  coming 
from the Netherlands, Austria, Germany, Italy and 
Greece.  Half  of  all  FDI 
to 
and 
manufacturing 
communications  technology  (ICT),  with  another 
25% going into trade, transport and tourism. 

is  directed 

information 

and 

Concerning  the  business  environment,  Bulgaria 
performs  relatively  worse  than  most  euro-area 
Member  States  in  international  rankings  (WEF's 
Global  Competitiveness  Index,  the  World  Bank's 
Ease  of  Doing  Business).  The  major  challenges 
relate  to  the  institutional  framework,  including 
fighting  corruption,  improving  the  functioning  of 
the  judicial  system,  reducing  the  administrative 
burden on corporations, and improving the quality 
of  public  services.  Public  administration  as  a 
whole  scores  relatively  poorly  according  to  the 

27 

0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 2.8: Bulgaria -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.90100110120130201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 2.9: Bulgaria -Effective exchange rates(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100)Source: Commission services. 
 
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

World  Bank's  Worldwide  Governance  Indicators. 
Bulgaria's  transposition  deficit  of  EU  Directives, 
on  the  other  hand,  was  1.7%  in  2016,  above  the 
EU average (1.5%) and the target (0.5%) proposed 
by the European Commission in the Single Market 
Act  (2011),  according  to  the  December  2016 
Internal  Market  Scoreboard.  The  4th  Anti-Money 
Laundering Directive imposed transposition by 26 
June  2017.  Bulgaria  communicated 
the 
Commission  the  measures  it  adopted  to  transpose 
the directive on 3 April 2018, only after a reasoned 
opinion  was  addressed  by  the  Commission  to 
Bulgaria on 8 December 2017 due to an absence of 
an  appropriate  response  to  the  letter  of  formal 
notice  from  19  July  2017.  The  Commission  is 
analysing  the  communicated  measures  to  assess 
their  completeness  and  conformity  with 
the 
directive. 

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 
conditions. 
flexible  wage-setting 
generally 
Activity and employment rates returned to the pre-
crisis  level  (close  to  70%)  only  in  2017.  The 
positive  cyclical  factors  also  largely  explain  the 
fall  of  unemployment  below  7%  in  2017.  In  a 
context of economic growth and declining working 
age population, the unemployment rate is expected 
to continue to decrease. Structural weaknesses that 
continue  to  hinder  the  labour  market  include  the 
high  share  of  long-term  unemployment  in  total 
unemployment,  the  shrinking  working  population, 
the high inactivity rate especially from discouraged 

workers, skills and qualifications mismatches, and 
wide disparities between urban and rural areas and 
between regions. At the same time, in a context of 
worsening  demographics,  the  labour  force  is 
suffering  from  high  emigration  and  brain  drain. 
Widespread  low  skills  and  relatively  high  social 
exclusion remain worrisome. 

The impact of the ongoing positive labour market 
developments  is  not  equally  spread  through  the 
population.  The  loss  of  jobs  during  the  crisis  was 
concentrated  in  specific  groups,  in  particular  the 
low  skilled,  young,  those  on  pre-retirement  and 
older women. Those without a job for more than a 
year,  inactive  youth,  Roma,  and  those  living  in 
rural  areas  continue  to  face  significant  difficulties 
in  entering  employment.  The 
labour  market 
structural  challenges  described  above  have  an 
impact  on  income  inequality  and  poverty  levels 
which are among the highest in the EU, while the 
redistribution mechanisms are very limited.  

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 
total  bank  assets  increased  slightly  to  73.8%  in 
2016.  Bank  concentration,  as  measured  by  the 
market  share  of  the  five  largest  credit  institutions 
in 
increased  to  58%,  some  10 
percentage  points  above  the  euro  area  average  in 
2016 

total  assets, 

28 

Table 2.5:Bulgaria - Market integration201220132014201520162017Trade openness 1) (%)65.968.169.166.465.068.6Trade with EA in goods & services 2)+3) (%)28.629.730.730.329.931.4Export performance (% change) 4)1.36.3-0.53.34.4-2.2World Bank's Ease of Doing Business Index rankings 5)665838383950WEF's Global Competitiveness Index rankings 6)625754545049Internal Market Transposition Deficit 7) (%)0.90.60.70.90.61.7Real house price index 8)96.697.098.5100.0107.1115.2Residential investment 9) (%)1.71.71.61.42.72.8 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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 2 - Bulgaria 

in 

to  address 

banking sector and a broader definition of ‘related 
parties’  in  the  non-banking  sector  in  line  with 
international  standards  have  been  adopted.  Other 
actions  are  still  due 
remaining 
vulnerabilities 
the  financial  sector.  These 
include  the  way  both  the  banking  and  the  non-
banking  sectors  deal  with  exposures  to  hard-to-
value  assets,  as  well  as  the  treatment  of  specific 
reinsurance  contracts  and  inadequate  group  level 
supervision in the insurance sector. In the pension 
funds  sector,  the  concentration  of  assets  on  the 
relatively  illiquid  traded  and  non-traded  domestic 
market,  and  complex  ownership  and  cross-
ownership structures require further monitoring.  

After  the  pre-2009  boom,  real  house  prices  in 
Bulgaria had been falling till 2012. Thereafter, the 
recovery was initially slow, but has accelerated in 
the  last  few  years.  House  prices  increased  by 
15.7%  in  real  terms  between  June  2015  and  June 
2017  and  by  7.2%  in  the  second  quarter  of  2017 
alone.  Residential  investment  reached  2.7%  of 
GDP in 2016 and is estimated at the same level in 
2017.  The  stock  of  loans  for  house  purchases 
increased in 2016-2017 by 8.7%. 

Relative to GDP, the financial system is smaller in 
Bulgaria  than  in  the  euro  area.  Domestic  bank 
credit  stood  at  around  52%  of  GDP  in  2016 
compared to almost 90% of GDP in the euro area. 
The capitalization of the stock market fell to 8.7% 
of GDP in 2016, well below the euro-area average 
of  61.5%.  The  debt  securities  market  remains 
small  in  comparison  with  the  euro  area  average 
(28.3%  vs.  154.2%  of  GDP).  The  consolidated 
stock  of  private  sector  debt  at  104.9%  of  GDP  in 
2016 was below the euro-area average of 137.2%.  

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 
slightly  above  22%  in  the  second  quarter  of  2017 
compared to almost 18% in the euro area. The ratio 
of NPLs to the loan portfolio held by the banking 
sector  has  fallen  substantially  over  the  last  two 
years, but at 10.6% in the second quarter of 2017, 
was still well above the euro-area average of 4.3%. 
The  profitability  of  the  domestic  banking  sector 
remained  above  the  euro-area  level,  with  an 
average return on equity (RoE) close to 6% in the 
second quarter of 2017.  

in 

reviews 

The  2016  asset  quality  review  and  stress  tests  in 
the  banking  sector  showed  robust  results  on 
aggregate  but  pockets  of  vulnerabilities  were 
identified.  The 
the 
independent 
insurance  and  pension  fund  sectors  also  showed 
that  these  sectors  are  overall  stable  but  some 
capital  shortfalls  were  identified,  as  well  as 
instances  of  unsound  business  practices.  A 
substantial  effort  has  been  made  to  improve 
banking  and  non-banking  supervision,  however, 
vulnerabilities  remain.  The  implementation  of  an 
action  plan  for  banking  supervision  and  the 
implementation  of  the  action  plan  for  the  non-
banking sector adopted in September 2017 are still 
to  be  completed.  A  somewhat 
risk 
management  of  related-party  exposures  in  the 

tighter 

29 

01020304050607080BG, 2012BG, 2016EA, 2012EA, 2016Concentration 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.-50510152025BG, 2012BG, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 2.11: Bulgaria -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180BG, 2012BG, 2017EA, 2012EA, 2017Debt 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 

The  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 2016, the ČNB 
Law  was  only  slightly  amended (17).  However, 
since  there  have  been  no  amendments  as  regards 
the 
the 
the 
Commission's  2016  Convergence  Report, 
comments  made  in  the  latter  report  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.  

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 
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 
possibility  to  seek  legal  redress  by  the  Governor 
before the Court of Justice of the European Union, 
as  enshrined  in  Article  14.2  of  the  ESCB/ECB 
Statute,  would  apply.  However,  the  ČNB  Law 
would benefit from a more explicit clarification.   

the  Commission  understands 

that 

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,  in  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 

(17)  Act  258/2016  Coll.  and  Act  No.  183/2017  Coll.  In 
particular, Act 258/2016 Coll. places further entities under 
the supervision of the ČNB regarding consumer credits. 

Article 34a(1) first half-sentence of the ČNB Law 
the  ČNB  from  providing  overdraft 
prohibits 

31 

 
                                                           
institutions  or  other  entities  of 

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(2)  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. 

Tasks 

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

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

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

Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

  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 
monetary 
to 
the 
determine 
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  partial  absence  of  reference  to  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). 

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.  The  Czech  authorities  are 
abovementioned 
invited 
incompatibilities. 

remedy 

the 

to 

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

3.2. 

PRICE STABILITY 

  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); 

3.2.1.  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 

32 

 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

producer  prices  increased  in  2017  after  having 
declined for three years.  

assessment  of  the  Czech  Republic  in  2016.  It 
declined  to  0.2%  in  mid-2016  and  then  increased 
gradually over the next 18 months to 2.4% by end-
2017.  In  March  2018,  the  reference  value  was 
1.9%,  calculated  as  the  average  of  the  12-month 
average  inflation  rates  in  Cyprus,  Ireland  and 
Finland  plus  1.5  percentage  points.  The 
corresponding inflation rate in the Czech Republic 
was  2.2%,  i.e.  0.3  percentage  points  above  the 
reference  value.  The  12-month  average  inflation 
rate  is  projected  to  decline  below  the  reference 
value in the months ahead. 

3.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

in 

by 

2017, 

supported 

formation  made 

The  Czech  Republic  is  experiencing  an  economic 
upswing.  Real  GDP  expanded  by  4.4%  in  2017, 
considerably  faster  than  in  2016  (2.6%).  Private 
consumption  was  again  the  main  driver  of  GDP 
falling 
growth 
unemployment  as  well  as  vigorous  wage  growth. 
Following  a  strong  decline  in  2016,  gross  fixed 
capital 
large  positive 
contribution  to  GDP  growth  in  2017  owing  to 
revived  private  investment  and  increasing  support 
from  EU  funds.  According  to  the  Commission 
services'  Spring  2018  Forecast,  domestic  demand 
growth  should  keep  GDP  growth  at  above  3%  in 
both  2018  and  2019.  The  Czech  economy  is 
estimated 
its 
potential  since  early  2017  amid  increasingly  tight 
labour market conditions. The positive output gap 
is estimated to widen slightly in 2018 and 2019. 

to  have  been  operating  above 

a 

The fiscal stance, as measured by the change in the 
structural  balance,  tightened  considerably  in  2016 
and  then  remained  broadly  unchanged  in  2017. 
Specifically,  the  structural  balance  recorded  a 
surplus of 1% and 1.2% of GDP in 2016 and 2017 
respectively.  It  is  expected  to  moderate  over  the 
forecast period to around 0.2% of GDP in 2019. 

The  ČNB  conducts  monetary  policy  within  an 
inflation  targeting  framework. In  November  2013 
it  started  using  the  exchange  rate  as  an  additional 
instrument  for  easing  monetary  conditions  given 
that its key policy rate (i.e. the 2-week repo rate), 

3.2.2.  Recent inflation developments 

The annual HICP inflation rate dropped from 0.5% 
in  early  2016  to  -0.1%  in  June  2016  before 
increasing  to  above  2%  by  end-2016.  It  then 
floated between 2 and 3% during 2017. The annual 
HICP  inflation  rate  thus  averaged  0.6%  in  2016 
and 2.4% in 2017. The pick-up in annual inflation 
in  2017  reflected  larger  inflation  contributions 
from energy and food prices as well as higher price 
increases  in  the  service  sector.  The  annual  HICP 
inflation rate dropped to 1.7% in the first quarter of 
2018,  amid  strong  base  effects  and  decelerating 
food prices. 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  has 
mostly  exceeded  headline  inflation  since  early 
2014. This was mainly the result of muted energy 
price  developments  which  made  a  negative 
contribution  to  HICP  inflation  in  2014-2016  and 
only  a  modestly  positive  contribution  in  2017. 
Core inflation accelerated in tandem with headline 
inflation  in  the  second  half  of  2016,  increasing 
from below 1% in June 2016 to above 2% in late 
2016.  It  then  oscillated  around  2.6%  in  2017  as 
prices of processed food and services increased at 
their highest rates since 2012. Domestic industrial 

33 

01234Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18Czech RepublicReference valueGraph 3.1: Czech Republic -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.-202462012201320142015201620172018Czech RepublicEuro areaGraph 3.2: Czech Republic -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

set at 0.05%, was considered to be at its effective 
lower  bound.  The  use  of  the  exchange  rate  as  an 
additional  monetary  policy 
instrument  was 
discontinued  in  April  2017.  The  decision  was 
supported by macroeconomic data and forecasting 
scenarios indicating a sustainable fulfilment of the 
2%  inflation  target  over  the  forecast  horizon. 
Subsequently,  the  ČNB  started  in  August 2017  to 
gradually  hike  its  main  policy  rate  as  annual 
inflation remained above its 2% inflation target. Its 
2-week repo rate was raised in three steps to 0.75% 
in February 2018. 

Wages and labour costs 

The  labour  market  has  performed  well  since  the 
economy emerged from recession in late 2013. The 
unemployment rate declined from 4.0% in 2016 to 
2.9%  in  2017,  i.e.  the  lowest  level  in  the  EU.  At 
the  same  time,  the  number  of  employed  persons 
increased  by  1.3%  in  2016  and  by  1.6%  in  2017 
despite  the  decline  in  working-age  population. 
Nominal wage growth accelerated sharply in 2016 
and 2017, reaching 4.6% and 6.7% respectively.  

Labour  productivity  accelerated  significantly  in 
2017  following  more  muted  growth  in  2016. 
However,  with  compensation  per  employee 
outstripping productivity growth in both years, and 
indeed  recording  the  highest  growth  rates  since 
2010,  nominal  unit  labour  costs  rose  by  3.3%  in 
2016  and  by  3.8%  in  2017.  Nominal  unit  labour 
costs  are  expected 
increase 
markedly in 2018 and in 2019.  

to  continue 

to 

External factors 

the  size  and  openness  of 

the  Czech 
Given 
economy,  import  prices  have  a  sizeable  effect  on 
domestic  price  formation.  After  having  fallen  in 
2015  and  2016,  mainly  thanks  to  a  decline  in 
primary  commodity  prices,  the  imports  of  goods 
deflator stabilised in 2017.  

Overall, the appreciation of the koruna since April 
2017  has  tempered  import  price  growth.  After 
having  remained  broadly  stable  throughout  2016 
and in early 2017, the nominal effective exchange 
rate  (measured  against  a  group  of  36  trading 
partners) appreciated by about 7% between March 
and  December  2017.  As  a  result,  Czech  import 
prices  remained  broadly  unchanged 
in  2017 
despite the recovery in primary commodity prices. 

Administered prices and taxes 

The  share  of  administered  prices  in  the  HICP 
basket has stabilised at around 10-11% since 2011, 
after  a  sharp  decline  over  the  course  of  the 
previous decade. With a weight of 10.3% in 2017, 
administered  prices  in  the  Czech  Republic (18) 

(18)  According to the Eurostat definition, administered prices in 
the  Czech  Republic  include  inter  alia  heat  energy,  public 
transport, pharmaceuticals, medical and social services. For 
see: 
details, 

34 

-3036920122013201420152016201720182019Productivity (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 percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast.Table 3.1:(cid:9)weights  Czech Republic - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP3.51.40.40.30.62.42.21000Non-energy industrial goods-0.5-0.50.40.50.80.70.7255Energy7.70.6-3.8-3.0-2.51.20.6128Unprocessed food 7.67.21.20.70.53.12.679Processed food5.03.02.71.11.24.34.1208Services3.11.00.60.91.52.82.7330HICP excl. energy and unproc. food2.51.01.10.81.22.62.5793HICP at constant tax rates 2.20.40.30.10.42.62.31000Administered prices HICP8.33.50.40.51.41.11.31021) 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 2018 - Technical annex 

Chapter 3 - Czech Republic 

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 higher inflationary pressures. 

The  level  of  consumer  prices  in  the  Czech 
Republic  increased  to  about  64%  of  the  euro-area 
average in 2016, with the relative price gap widest 
for  services.  This  suggests  that  there  is  potential 
for  further  price  level  convergence  in  the  long 
term.  After  having  stagnated  at  around  78% 
between 2008 until 2013, Czech GDP per capita in 
purchasing power standards gradually increased to 
almost 83% of the euro-area average by 2016. 

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.  

in 

reverted 

the  euro  area  (13.4%).  Changes 

accounted  for  a  smaller  share  of  the  HICP  basket 
than 
in 
administered  prices  were  a  significant  driver  of 
inflation  in  2016  as  they  increased  by  1.4%,  i.e. 
more  than  double  of  the  headline  HICP  inflation 
rate.  The  situation 
in  2017  when 
administered prices increased by 1.1%, i.e. around 
half  of  the  headline  inflation  rate.  Declines  in 
prices  for  household  heating  contributed  to  weak 
growth in administered prices in 2017 while other 
categories  such  as  dental  services 
increased 
tax  rates  was 
noticeably.  HICP  at  constant 
somewhat  lower  than  headline  inflation  in  2016 
and somewhat higher in 2017.   

Medium-term prospects 

Annual  HICP  inflation  is  expected  to  decline  in 
2018, mainly because the inflation contribution of 
food prices (both processed and unprocessed food) 
should  decrease.  At  the  same  time,  prices  of 
energy  and  services  are  expected  to  exert  a 
stronger  inflation  contribution  than  in  previous 
years.  According  to  the  Commission  services' 
Spring  2018  Forecast,  annual  HICP  inflation  is 
thus  projected  to  average  2.1%  in  2018  and  1.8% 
in 2019.  

http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP-national-classification-December-2017/a9439235-
7b46-4736-984a-0134ca2cd10b 

35 

Table 3.2:(cid:9)Czech Republic - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationCzech Republic3.51.40.40.30.62.42.11.8Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorCzech Republic2.20.80.60.10.52.52.11.8Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeCzech Republic1.7-0.32.63.04.66.76.86.2Euro area1.81.61.41.41.21.62.41.9Labour productivityCzech Republic-1.2-0.82.23.81.32.82.62.9Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsCzech Republic3.00.50.4-0.83.33.84.13.2Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorCzech Republic3.80.02.0-1.9-3.90.1-3.10.9Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
                                                                                   
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

3.3. 

PUBLIC FINANCES 

3.3.1.  Recent fiscal developments 

The  Council  decided  to  abrogate  the  decision  on 
the  existence  of  an  excessive  deficit  according  to 
Article  126  (12)  TFEU  in  2014,  thereby  closing 
the  excessive  deficit  procedure  for  the  Czech 
Republic (19).  Since  then,  the  general  government 
balance  improved  substantially,  from  -2.1%  of 
GDP in 2014 to a surplus of 1.6% of GDP in 2017. 
In  terms  of  expenditure  and  revenues  shares,  the 
total expenditure-to-GDP ratio stood at 38.8% and 
the revenue-to-GDP ratio at 40.4% in 2017. Public 
investment levels surged to 5.1% of GDP in 2015 
due to the EU funds cycle then dropped sharply in 
2016  to  3.3%  of  GDP  and  grew  in  line  with 
nominal GDP in 2017.  

The  2017  general  government  surplus  of  1.6%  of 
GDP  was  significantly  better  than  the  0.4%  of 
GDP  surplus  target  in  the  2017  Convergence 
Programme.  This  reflected  tax-rich  growth  on  the 
back of strong labour market boosting direct taxes 
and social security contributions. At the same time, 
investment  growth 
short  of  previous 
fell 
expectations. Other notable developments were the 
marked 
increase  of  wage  scales  for  public 
employees and falling debt service payments. The 
structural  balance  remained  in  surplus  at  around 

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

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

governance/sgp/deficit/index_en.htm 

1.2%  of  GDP  in  2017  as  the  output  gap  is 
estimated to have turned positive.  

The general government debt declined to 34.6% of 
GDP  in  2017,  remaining  well  below  the  60% 
threshold. 

3.3.2.  Medium-term prospects 

The  2018  Budget  was  adopted  by  the  Parliament 
on 19 December 2017. A headline surplus of 1.3% 
of  GDP  was  envisaged  for  2018  at  that  time. 
Revised  fiscal  data  for  2017  indicate  a  higher 
surplus  for  2018.  The  budget  includes  increased 
social  expenditure,  reflecting  measures  such  as 
higher  pension  indexation  and  higher  outlays  on 
family policies. The wage bill is set to increase by 
10%  for  public  employees.  On  the  revenue  side, 
revenues,  particularly 
additional  discretionary 
from  reducing tax  evasion,  have  a  lower revenue-
yielding  effect  than  in  previous  years.  Public 
investment is forecast to grow appreciably, in part 
due  to  the  maturing  of  the  current  EU  funds 
Interest  payments  are 
programming  period. 
forecast to stabilise after three consecutive years of 
decline. 

According  to  the  Commission  services'  Spring 
2018  Forecast,  the  headline  general  government 
balance is projected to decline slightly to 1.4% of 
GDP in 2018, largely as a result of revived public 
investment  activity  and  a  minor  slowdown  in  tax 
revenue  growth.  The  revenue-to-GDP  ratio  is 
expected  to  decline  slightly  to  40.3%  while  the 

36 

Table 3.3:(cid:9)Czech Republic - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-3.9-1.2-2.1-0.60.71.61.40.8- Total revenues40.541.440.341.140.240.440.340.4- Total expenditure44.542.642.441.739.438.838.939.5   of which: - Interest expenditure1.41.31.31.10.90.70.70.7p.m.: Tax burden34.334.833.934.134.935.435.435.5Primary balance-2.50.1-0.80.51.62.32.11.6Cyclically-adjusted balance-3.20.1-1.0-0.50.91.20.90.2One-off and temporary measures-1.7-0.1-0.30.0-0.10.00.00.0Structural balance 2)-1.40.2-0.7-0.51.01.20.90.2Government gross debt44.544.942.240.036.834.632.731.8p.m: Real GDP growth (%)-0.8-0.52.75.32.64.43.43.1p.m: Output gap-1.8-3.1-2.6-0.3-0.40.91.21.41) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

expenditure-to-GDP  ratio  is  forecast  to  increase 
marginally  to  38.9%.  Based  on  the  no-policy-
is 
change  assumption, 
expected to worsen to 0.8% of GDP in 2019. The 
structural  surplus  is  set  to  continue  shrinking  to 
around 0.2% of GDP by 2019.   

the  headline  balance 

precluded  further  exchange  rate  appreciation.  
Following  the  expiry  of  the  ČNB's  exchange  rate 
commitment in April 2017, the koruna followed a 
gradual  appreciation 
the  euro, 
strengthening  from  above  27  CZK/EUR  in  early 
April 2017 to below 25.5 CZK/EUR in early 2018. 

trend  against 

International  reserves  held  by  the  ČNB  increased 
from below EUR 60 billion by end-2015 to above 
EUR 120 billion (64% of GDP) in the first quarter 
of 2017, largely as a result of its foreign exchange 
market  interventions. They  then  remained broadly 
stable up to early 2018. 

The 3-month interest rate differential vis-à-vis the 
euro  area  remained  close  to  60  basis  points 
between mid-2016 and mid-2017 as the ČNB and 
the ECB kept their policy rates unchanged. It then 
widened over the second half of 2017 and in early 
2018 as a result of policy rate hikes by the ČNB. It 
thus exceeded 120 basis points in early 2018. 

The  debt-to-GDP  ratio  is  expected  to  decline 
below  32%  of  GDP  in  2019.  This  implies  a 
reduction  of  around  13  percentage  points from  its 
liquidity  management, 
peak 
favourable 
fiscal 
conditions 
surpluses  in  recent  years  played  a  key  role  in  the 
favourable debt dynamics. 

in  2013.  Better 

financing 

and 

to  strengthen 

the  Czech 
Important  measures 
national  fiscal  framework  have  been  taken  since 
mid-2016,  but  their  effectiveness  will  depend  on 
the implementation of the new rules. In particular, 
the  Fiscal  Responsibility  Law  adopted  in  early 
2017  introduced  two  numerical  rules  for  the 
general government, namely an expenditure ceiling 
set  on  the  basis  of  cyclically-adjusted  revenue 
projections and a public debt rule. Moreover, local 
authorities  are  subject  to  more  stringent  rules  on 
debt  management.  The  National  Budgetary 
Council,  tasked  with  monitoring  compliance  with 
fiscal  rules,  has  been  set  up  and  its  members 
appointed  in  early  2018.  The  Committee  on 
Budgetary  Forecast  assessing  the  macroeconomic 
and fiscal projections produced by the Ministry of 
Finance is expected to be established in the course 
of 2018. Finally, a draft law on independent audits 
aims  to  address  the  outstanding  full  transposition 
of 
the  Council  Directive  2011/85/EU  on 
requirements for national budgetary frameworks. 

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 
with a floating exchange rate regime, allowing for 
foreign  exchange  market  interventions  by  the 
central  bank.  Between  November  2013  and  April 
2017,  the  ČNB  used  the  exchange  rate  as  an 
additional 
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.  

instrument 

for 

The koruna traded marginally above 27 CZK/EUR 
throughout  2016  and  in  early  2017  as  foreign 
the  ČNB 
exchange  market 

interventions  by 

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

3.5. 

LONG-TERM INTEREST RATES 

37 

2022242628302012201320142015201620172018Graph 3.4: Czech Republic -CZK/EUR exchange rate(monthly averages)Source: ECB.-500501001502012201320142015201620172018Graph 3.5: Czech Republic -3-M Pribor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
 
 
secondary  market  yields  on  a  basket  of 
government  bonds  with 
the  average  residual 
maturity of close to, but below, 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 in 2016. It 
declined to 0.4% in late 2016 and then followed a 
gradual upward trend throughout 2017. It exceeded 
1% in early 2018. In March 2018, the latest month 
for  which  data  are  available,  the  reference  value, 
given by the average of long-term interest rates in 
Cyprus,  Ireland  and  Finland  plus  2  percentage 
points, stood at 3.2%. In that month, the 12-month 
moving  average  of  the  yield  on  the  Czech 
benchmark bond stood at 1.3%, i.e. 1.9 percentage 
points below the reference value. 

The long-term interest rate of the Czech Republic 
oscillated  around  0.4%  in  2016.  It  then  slowly 
increased  to  about 1.5% by end-2017  as  the  ČNB 
gradually  tightened  its  monetary  policy  stance. 
Consequently, the spread against the German long-
term  benchmark  bond  (20)  widened  to  some  120 
basis  points.  In  early  2018,  the  long-term  interest 
rate increased to about 1.8% with the spread vis-à-
vis 
the  German  benchmark  bond  fluctuating 
around 120 basis points.  

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

Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

3.6.  ADDITIONAL FACTORS 

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

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5),  which  concluded  that 
since  issues  related  to  possible  internal  risks 
remained  contained,  no  In-Depth  Review  (IDR) 
was warranted for the Czech Republic. Risks relate 
to the increase in nominal unit labour costs, largely 
driven  by  strong  wage  growth  which  is  projected 
to accelerate further in the context of a tightening 
labour market, and to the acceleration in real house 
price  growth.  The  feedback  spiral  between  house 
prices and mortgage volumes accelerated while the 
private sector debt level slightly increased in 2016, 
but remains at a moderate level. 

3.6.1.  Developments  of 

the  balance  of 

payments 

According to balance of payments data, the Czech 
Republic's  external  balance  (i.e.  the  combined 
current  and  capital  account)  has  remained  in 
surplus since 2013. It, nevertheless, declined to 2% 
of  GDP  in  2017  from  2.7%  of  GDP  in  2016, 
largely  as  a  result  of  a  lower  current  account 
surplus.  This  reflected  both  a  somewhat  lower 
trade  surplus  as  well  as  a  more  negative  income 
balance.  The  capital  account  balance  remained  in 

38 

0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18Czech RepublicReference valueGraph 3.6: Czech Republic -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-20242012201320142015201620172018Czech RepublicGermanyGraph 3.7: Czech Republic -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
                                                           
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

Measured  by  the  export  market  share,  the  trade 
performance improved just marginally in 2016 and 
2017.  External  price  and  cost  competitiveness,  as 
real 
measured  by  ULC-  and  HICP-deflated 
roughly 
rates, 
effective  exchange 
unchanged  in  2016  but  clearly  worsened  in  2017. 
The  deterioration  was  largely  induced  by  the 
nominal effective exchange rate appreciation. 

remained 

surplus  for  the  13th  consecutive  year  at  close  to 
1% of GDP in 2017 as a result of the drawdown of 
funds from the EU budget. 

According  to  national  accounts  data,  the  savings-
investment  balance  was  negative  in  the  Czech 
Republic  up  to  2016.  Investment  by  the  general 
government  and 
the  non-financial  corporate 
sectors  tend  to  exceed  their  savings,  while  the 
household  and  financial  corporate  sectors  tend  to 
save  more  than  they  invest.  The  strong  decline  of 
public  investment  in  2016  shrank  the  savings-
investment  gap  to  -0.1%  of  GDP.  The  savings-
investment gap then turned positive in 2017 as the 
gross national saving rate picked up. 

The  financial  account  balance  of  the  Czech 
Republic  remained  positive  in  2016  and  2017.  It 
was  mostly  affected  by  rising  official  reserves 
since  the  pace  of  external  asset  accumulation  by 
the  ČNB  further  accelerated  in  the  second  half  of 

39 

0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 3.8: Czech Republic -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 3.9: Czech Republic -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100)Table 3.4:(cid:9)Czech Republic - Balance of payments(percentage of GDP)201220132014201520162017Current account-1.6-0.50.20.21.61.0of which: Balance of trade in goods3.04.15.14.15.14.7                 Balance of trade in services1.91.71.31.72.32.4                 Primary income balance -5.9-6.1-6.0-5.6-5.3-5.2                 Secondary income balance-0.7-0.3-0.20.0-0.6-0.9Capital account1.32.00.82.21.10.9External balance 1)-0.31.50.92.42.72.0Financial account 0.31.71.53.82.42.3of which: Direct investment-3.00.2-1.91.1-3.9-2.7                Portfolio investment-1.4-2.32.1-3.6-3.6-5.1                Other investment 2)2.6-0.7-0.4-1.4-1.9-14.0                Change in reserves2.04.51.77.711.824.1Financial account without reserves-1.7-2.8-0.2-3.9-9.4-21.8Errors and omissions0.50.20.51.4-0.20.3Gross capital formation26.224.725.928.026.326.4Gross saving23.923.624.626.426.226.9Gross external debt60.063.267.868.573.389.2International investment position-45.9-41.4-36.6-32.9-26.9-26.41) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Czech National Bank. 
 
 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

2016.  The  increase  in  official  reserves  was, 
however, to a large extent offset by increasing net 
external  liabilities,  in  particular  other  investment 
liabilities,  as  foreign  investors  used  the  liquidity 
injected  by  the  ČNB  to  acquire  Czech  financial 
assets. As a result, gross external debt also jumped 
up  substantially  whereas  the  net  international 
investment position continued to improve. 

According  to  the  Commission  services'  Spring 
2018 Forecast based on national accounts data, the 
external  balance  is  expected  to  deteriorate  over 
2018 and 2019. 

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  at  close  to  90%  of  GDP.  The  share  of 
trade with the euro area seems to have stabilised in 
recent  years  at  around  55%  of  GDP  as 
neighbouring  euro-area  countries  are  among  its 
largest trade partners.  

(as  measured  by 

Protection  of  permanent  employees  against 
collective  and  individual  dismissals  is  relatively 
the  2013  OECD 
strict 
employment  protection  indicator)  whereas  the 
duration  of  unemployment  benefits  is  below  the 
EU  average.  Cross-border  migration  flows  have 
the 
remained 
tightening  labour  market  has  started  to  attract 
workers from both EU and non-EU countries. 

relatively 

subdued, 

although 

financial  sector 

remains  highly 
The  Czech 
integrated  into  the  EU  financial  sector.  The  main 
channel of integration is through a high degree of 
foreign ownership of financial intermediaries with 
more  than  90%  of  banking  sector's  assets  held  in 
local 
2016  by  foreign 
branches  and  subsidiaries.  Concentration  in  the 
banking sector, as measured by the market share of 
the  largest  five  credit  institutions  in  total  assets, 
increased  to  almost  65%  in  2016  and  thus 
continued to exceed the euro-area average of 48%. 

institutions  via 

their 

in 

to 

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

The Czech banking sector is well capitalised with 
the  average  capital  adequacy  ratio  above  17%  in 
the third quarter of 2017, i.e. close to the euro-area 
average of about 18%. Moreover, it has performed 
relatively  well  in  terms  of  profitability  as  the 
average  annual  return  on  equity  (RoE)  reached 
13%  in  the  third  quarter  of  2017,  compared  to 
4.5% in the euro area. At the same time, the share 
of  non-performing  loans  declined  close  to  2%  in 
while it was at 4% in the euro area. 

As  far  as  the  business  environment  is  concerned, 
the  Czech  Republic's  position  in  international 
rankings seems to have stabilised below the euro-
area  average  in  recent  years.  In  the  World  Bank's 
Ease  of  Doing  Business,  the  Czech  Republic's 
worst  rankings  concern  dealing  with  construction 
permits  and  enforcing  contracts.  According  to  the 
World  Bank's  Worldwide  Governance  Indicators 
the  Czech  Republic  performs  relatively  worse  in 
terms of corruption control and regulatory quality. 
At  the  same  time,  the  Czech  Republic's  deficit  in 
the  transposition  of  EU  internal  market  directives 
increased  to  1.5%  in  2017.  The  4th  Anti-Money 
Laundering Directive imposed transposition by 26 
June  2017  and  the  Czech  Republic  notified  the 
Commission  of  the  transposition  measures  within 
that  deadline.  The  Commission  is  analysing  these 
measures  to  assess  their  conformity  with  the 
directive. 

40 

0102030405060708090100CZ, 2012CZ, 2016EA, 2012EA, 2016Concentration 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.  
 
Convergence Report 2018 - Technical annex 

Chapter 3 - Czech Republic 

around  70%  of  its  GDP  between  2010  and  2016, 
the  euro-area 
remaining  significantly  below 
average of 137%. 

trend 

The  real  house  price  index  has  followed  an 
since  2013  and 
accelerating  upward 
exceeded  116%  of  its  2015  level  in  2017.  At  the 
same time, the GDP share of residential investment 
remained  broadly  stable  at  below  4%  of  GDP  in 
to 
recent  years  even 
households for house purchase expanded by almost 
25% between end-2015 and end-2017. 

though  bank 

lending 

The  financial  system  in  the  Czech  Republic  is 
smaller relative to GDP than that of the euro area. 
In  2017,  outstanding  bank  credit  to  non-financial 
companies and households reached 52% of GDP in 
the  Czech  Republic,  compared  to  almost  90%  in 
the  euro  area.  The  valuation  of  quoted  shares 
issued  by  Czech  enterprises  amounted  to  14%  of 
GDP while it exceeded 67% in the euro area. The 
total  amount  of  outstanding  debt  securities  was 
below  90%  of  GDP,  i.e.  far  below  the  euro-area 
average  of  149%.  The  consolidated  stock  of 
private  sector  debt  in  the  Czech  Republic  floated 

41 

-505101520CZ, 2012CZ, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 3.11: Czech Republic -Selected banking sector soundness indicators%Source: ECB, IMF,  EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180CZ, 2012CZ, 2017EA, 2012EA, 2017Debt 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.Table 3.5:(cid:9)Czech Republic - Market integration201220132014201520162017Trade openness 1) (%)82.783.790.691.589.590.1Trade with EA in goods & services 2)+3) (%)50.651.255.756.055.555.5Export performance (% change) 4)3.8-2.44.71.90.70.8World Bank's Ease of Doing Business Index rankings 5)657544362730WEF's Global Competitiveness Index rankings 6)394637313131Internal Market Transposition Deficit 7) (%)1.90.20.30.30.81.5Real house price index 8)95.394.696.3100.0106.7116.2Residential investment 9) (%)3.73.23.43.63.73.9 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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
 
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 (21)  and  the  Act  on  the 
Croatian  National  Bank  (the  HNB  Act) (22).  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. 

4.1.4.  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  and  IX  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  any  potential 
amendments to the HNB Act on the basis of a draft 
law which is pending in the Croatian Parliament at 
the  moment  of  writing  the  2018  Convergence 
Report.   

4.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

4.2. 

PRICE STABILITY 

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. 

(21)  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, 5/2014. 

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

54/2013. 

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  2016 
the 
convergence  assessment  of  Croatia.  It  remained 
negative throughout 2016, bottoming out at -0.8% 
in  September  2016.  It  returned  into  positive 
territory  in  May  2017  and  then  continued  to 
gradually  increase  up  to  January  2018  when  it 
exceeded  1.3%.  In  March  2018,  the  reference 
value  was  1.9%,  calculated  as  the  average  of  the 

43 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

prices  of  services  which  remained  on  average 
unchanged in 2016. Core inflation increased again 
and equalled HICP inflation at 1.3% in 2017. The 
larger 
pickup  mainly 
inflation  contribution  of  processed  food  and 
services.  Domestic 
industrial  producer  prices 
remained  roughly  unchanged  in  2016  and  then 
increased by about 2% in 2017.   

substantially 

reflected 

4.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

After  six  years  of  contraction,  economic  activity 
started  to  recover  in  2015.  The  pace  of  real  GDP 
growth accelerated to 3.2% in 2016 and moderated 
to 2.8% in 2017. The output gap is thus estimated 
to have turned positive in 2017. The recovery was 
mainly  driven  by  revived  private  consumption.  A 
marked  recovery  in  private  investment  started  in 
2016,  but  the  momentum  was  curbed  in  2017 
amidst  the  crisis  in  the  distressed  food-to-retail 
giant  Agrokor  and  a  substantial  decline  in  the 
uptake  of  EU  funding,  particularly  in  the  public 

44 

12-month average inflation rates in Cyprus, Ireland 
and  Finland  plus  1.5  percentage  points.  The 
corresponding  inflation  rate  in  Croatia  was  1.3%, 
i.e.  0.6  percentage  points  below  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected  to  remain  below  the  reference  value  in 
the months ahead. 

4.2.2.  Recent inflation developments 

inflation 

remained  negative 
Annual  HICP 
throughout most of 2016 due to falling energy and 
unprocessed food prices. It averaged -0.6% for the 
year  as  a  whole.  Annual  inflation  rates  turned 
positive  in  late  2016  and  then  increased  to  above 
1%  in  early  2017  thanks  to  larger  inflation 
contributions  from  all 
its  main  components. 
Annual  inflation  rates  thereafter  oscillated  around 
1.3%  up  to  January  2018.  Annual  HICP  inflation 
declined  to  below  1%  in  February  2018  and  then 
recovered to 1.2% in March 2018.  

inflation  (measured  as  HICP 

Core 
inflation 
food) 
and 
excluding 
decelerated  in  2016,  but  remained  in  positive 
territory at 0.2%. The slowdown was largely due to 

unprocessed 

energy 

-2-1012345Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18CroatiaReference valueGraph 4.1: Croatia -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.-202462012201320142015201620172018CroatiaEuro areaGraph 4.2: Croatia -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 4.1:(cid:9)weights  Croatia - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP3.42.30.2-0.3-0.61.31.31000Non-energy industrial goods1.2-0.1-1.10.10.60.80.6245Energy10.81.80.7-5.9-5.7-0.10.3122Unprocessed food 5.54.5-3.60.8-0.93.72.172Processed food2.75.30.90.60.22.32.2202Services0.71.61.71.40.01.11.4358HICP excl. energy and unproc. food1.62.10.60.80.21.31.4805HICP at constant tax rates 2.51.9-0.6-0.6-0.81.21.21000Administered prices HICP7.63.41.70.4-1.3-0.10.71101) 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 2018 - Technical annex 

Chapter 4 - Croatia 

Wages and labour costs 

The  labour  market  situation  continued  improving 
in  2016  and  2017,  although  both  the  activity  and 
employment rates remain among the lowest in the 
EU.  From  its  peak  of  almost  18%  in  2013,  the 
unemployment  rate  dropped  to  an  estimated  11% 
in  2017,  though  in  part  due  to  sizeable  outbound 
migration.  Total  employment  has  been  increasing 
moderately but steadily in recent years, with some 
signs of labour market tightening in some sectors. 
This, coupled with wage hikes in the public sector, 
resulted  in  a  rebound  in  wage  growth  in  2017  (as 
evidenced  by  administrative  data),  after 
the 
contraction 
in  previous  years  and 
stabilisation in 2016. 

recorded 

Nominal  unit  labour  costs  (ULC)  continued  to 
decline in 2016 and 2017 as nominal compensation 
(based  on  national 
per  employee  decreased 
accounts 
productivity 
labour 
data),  while 
recovered  somewhat.  Going  forward,  positive 
trends  in  employment  are  expected  to  support 
further  wage  growth,  at  roughly  the  same  pace  as 

at  an  interest  rate  competitive  to  interest  rates  on  other 
banks’  kuna  liquidity  sources,  with  debt  securities  of 
issuers  from  Croatia  maturing  after  the  repurchase  date 
accepted as collateral under the condition that the issuer or 
the  issue  has  been  assigned  a  credit  rating  that  is  at  least 
equal to the rating of the Republic of Croatia. 

sector. Exports performed strongly on the back of 
further  gains  in  goods  export  market  shares  and 
continued  expansion  of  inbound  tourism.  Going 
forward,  real  GDP  growth  rates  are  expected  to 
remain  roughly  unchanged  at  around  2¾  in  2018 
and 2019. Growth should continue to be driven by 
private  consumption,  but  also  investment,  both 
thanks  to  an  expected  improvement  in  absorption 
of  EU  funds  and  a  recovery 
in  corporate 
investment. 

The fiscal stance, as measured by the change in the 
structural  balance,  was  considerably  tightened  in 
2015-2017,  on  the  back  of  a  general  containment 
of  expenditure  growth  combined  with  buoyant 
revenues.  The  structural  balance  thus  improved 
from -3.4% of GDP in 2014 to 0.4% in 2017. It is 
expected to deteriorate somewhat in 2018-2019.  

in 

the 

banking 

The HNB has continued to pursue accommodative 
monetary  policy  by  preserving  high  levels  of 
liquidity 
system  while 
simultaneously  maintaining  a  broadly  stable 
exchange rate of the kuna against the euro. In early 
2016 the monetary policy toolkit was expanded by 
the  introduction  of  structural  repo  operations 
which have been used to provide banks with long-
term kuna liquidity (23).   

(23)  According  to  the  HNB,  these  operations  are  aimed  at 
providing banks with longer-term sources of kuna liquidity 

45 

Table 4.2:(cid:9)Croatia - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationCroatia3.42.30.2-0.3-0.61.31.41.5Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorCroatia3.21.9-0.5-0.5-1.21.01.41.5Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeCroatia0.4-0.9-5.20.4-0.2-1.11.11.4Euro area1.81.61.41.41.21.62.41.9Labour productivityCroatia1.42.0-2.71.12.90.61.11.1Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsCroatia-1.0-2.9-2.6-0.7-3.0-1.70.00.3Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorCroatia2.9-0.4-0.9-1.2-2.42.51.21.6Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
                                                           
                                                                                   
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

productivity.  As  a  result,  nominal  ULC  should 
broadly stabilise.  

rate  of  13%  as  of  January  2017  and  excises  on 
motor vehicles were lowered as of January 2018. 

Medium-term prospects 

According  to  the  Commission  services'  Spring 
2018  Forecast,  annual  HICP  inflation  is  projected 
to  remain  broadly  stable  as  recovering  energy 
prices  are  likely  to  offset  the  lower  inflation 
contribution of unprocessed food. Core inflation is 
expected to slightly accelerate in 2019 in line with 
the  continued  economic  expansion.  Annual  HICP 
inflation  is  thus  forecast  to  average  1.4%  in  2018 
and 1.5% in 2019. 

External factors 

Import  prices  (measured  by  the  imports  of  goods 
deflator)  rebounded  by  2.5%  in  2017  after  four 
years  of  declines.  This  mainly  reflected  oil  price 
developments.  

The exchange rate exerted a dampening impact on 
domestic price developments in 2016 and 2017, as 
the  nominal  effective  exchange  rate  (measured 
against  a  group  of  36  trading  partners)  has 
appreciated rather steadily since the end of 2015. 

Administered prices and taxes 

The weight of administered prices in the Croatian 
HICP  basket  (24)  amounted  to  11%  in  2018, 
compared  to  13%  in  the  euro  area.  In  2016, 
administered  prices  turned  from  growing  faster 
than  other  components  to  having  a  cushioning 
effect  on  overall  inflation.  The  big  drop  in 
administered prices in April 2016 was induced by 
the  government's  decision  to  reduce  gas  prices. 
Since  then,  administered  prices  have  been  slowly 
recovering largely on the back of increasing global 
energy prices.   

Tax  changes  had  overall  only  marginal  impact  on 
headline inflation over the past two years. Whereas 
excise  taxes  on  tobacco  were  raised  in  December 
2016 and December 2017, VAT on electricity was 
moved  from  the  general  rate  (25%)  to  a  reduced 

(24)  According to the Eurostat definition, administered prices in 
Croatia  include  inter  alia  gas  and  heat  energy,  water 
supply,  refuse  and  sewerage  collection  as  well  as  dental, 
hospital 
see: 
http://ec.europa.eu/eurostat/documents/272892/272989/HI
CP-AP-national-classification-December-2017/a9439235-
7b46-4736-984a-0134ca2cd10b 

services.  For  details, 

cultural 

and 

tightening 

the  one  hand, 

Risks to the inflation outlook are broadly balanced. 
On 
labour  market 
conditions  and  related  wage  pressures  could 
contribute positively to inflation developments. On 
the  other  hand,  a  slower-than-expected  GDP 
expansion,  constrained  by  the  economy's  low 
potential  growth,  could  alleviate  some  of  the 
inflationary pressures. 

The  relative  level  of  consumer  prices  in  Croatia 
continued  to  follow  a  downward  trend,  falling  to 
below 65% of the euro-area average in 2016. As a 
result, there is potential for price level convergence 
in  the  long  term.  However,  Croatian  GDP  per 
capita in purchasing power standards has stagnated 
at  around  56%  of  the  euro-area  average  in  recent 
years. 

Medium-term  inflation  prospects  will  be  affected 
by wage and productivity developments against the 
backdrop  of  declining  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  the  economy  continuing  on  its 
recovery path,  it  will  be  increasingly  important  to 
ensure  that  wage  growth  remains  in  line  with 
productivity growth. 

4.3. 

PUBLIC FINANCES 

4.3.1.  Recent fiscal developments 

the  Commission's 
In  June  2017,  based  on 
recommendation, 
the 
excessive  deficit  procedure  for  Croatia (25).  The 

the  Council  abrogated 

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

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

governance/sgp/deficit/index_en.htm 

46 

-8-404820122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 4.3: Croatia -Inflation, productivity and wage trends(y-o-y percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast. 
 
                                                           
                                                           
Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

The  decrease  in  the  deficit  and  the  pick-up  in 
nominal  GDP  growth  put  the  general  government 
debt ratio on a declining path: from 83.8% of GDP 
in 2015 to 78% of GDP in 2017. 

4.3.2.  Medium-term prospects 

The 2018 budget was adopted by the Parliament on 
30 November 2017. Based on an expected general 
government  deficit  of  1.3%  of  GDP  in  2017,  the 
budget foresees a deficit of 0.5% of GDP in 2018. 
It  incorporates  the  full-year  effect  of  the  2017 
gradual increase in public sector wages as well as 
expenditure-increasing measures in defence, social 
and  population  policies.  While  there  is  a  risk  that 
the  budgetary  impact  of  some  of  these  measures 
may  be  underestimated,  the  revenue  side  was 
projected conservatively, with tax revenue growing 
from  an 
well  below  nominal  GDP  and 
underestimated 2017 base.  

The  Commission  services'  Spring  2018  Forecast 
projects the general government balance to remain 
in surplus in both 2018 and, on a no-policy-change 
basis,  in  2019,  at  0.7%  and  0.8%  of  GDP, 
respectively.  The  general  government  debt  is 
forecast to decline to around 70% of GDP by 2019. 

The fiscal framework in Croatia remains relatively 
weak,  following  repeated  delays  with  the  planned 
and  long  overdue  adoption  of  the  new  Fiscal 
Responsibility  Act  and  the  amendments  to  the 
Budget  Act.  In  particular,  the  domestic  medium-
term  budgetary  framework  is  only  indicative  for 

decision was based on the reduction of the general 
government deficit to 0.9% of GDP in 2016 – well 
below both the 3% Treaty threshold and the 2.7% 
EDP  recommendation  –  and  on  compliance  with 
the forward-looking element of the debt reduction 
benchmark.  The  improvement  was  facilitated  by 
the  strong  cyclical  contribution  as  economic 
growth supported tax revenue, but also by restraint 
of expenditure growth. While expenditure grew in 
nominal terms, as a ratio to GDP it decreased from 
48.4%  in  2015  to  47.2%  in  2016.  Savings  were 
made in social transfers and interest payments, but 
the  remaining  categories  of  expenditure  grew 
slower 
nominal  GDP.  Meanwhile, 
government  revenue  rose  sharply  from  44.9%  to 
46.3%  of  GDP,  supported  mostly  by  taxes  on 
products and on income.  

than 

in  January  2017.  At 

The  general  government  balance  turned  into  a 
surplus of 0.8% of GDP in 2017, compared to the 
deficit  of  1.3%  of  GDP  planned  in  the  2017 
convergence  programme.  The  improvement  was 
achieved  on  the  back  of  buoyant  revenue,  driven 
by a strong tourist season, rising consumption and 
employment, in spite of the tax cuts that came into 
force 
time, 
expenditure  slightly  declined  in  nominal  terms, 
benefitting  from  decreasing  interest  costs  and 
lower  public  investment,  but  also  growth  of  other 
expenditure,  most  notably  social  spending,  below 
the  rate  of  nominal  GDP  growth.  Only  the  public 
sector wage bill recorded a significant increase. In 
structural  terms,  the  balance  improved  further  to 
0.4% of GDP in 2017 from -0.7% of GDP in 2016. 

the  same 

47 

Table 4.3:(cid:9)Croatia - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-5.2-5.3-5.1-3.4-0.90.80.70.8- Total revenues42.142.443.044.946.346.045.845.4- Total expenditure47.347.748.148.447.245.345.144.6   of which: - Interest expenditure3.13.23.43.53.12.72.52.4p.m.: Tax burden35.936.336.737.338.038.038.137.8Primary balance-2.1-2.1-1.70.02.23.43.33.2Cyclically-adjusted balance-3.5-3.5-3.2-2.3-0.60.3-0.3-0.6One-off and temporary measures0.0-0.20.20.00.1-0.10.00.0Structural balance 2)-3.5-3.2-3.4-2.4-0.70.4-0.3-0.6Government gross debt69.480.584.083.880.678.073.769.7p.m: Real GDP growth (%)-2.2-0.6-0.12.33.22.82.82.7p.m: Output gap-3.7-3.9-4.2-2.4-0.70.92.33.11) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
 
 
 
 
 
annual  fiscal  planning  and  the  role  of  the  Fiscal 
Policy  Commission  remains  weak.  In  early  2018 
the  Parliament  approved  Croatia's  adhesion  to  the 
intergovernmental 
Stability, 
Treaty 
Coordination and Governance in the Economic and 
Monetary  Union,  without,  however,  the  intention 
to  be  bound  by  its  Fiscal  Compact (26)  provisions 
before accession to the euro area.  

on 

4.4. 

EXCHANGE RATE STABILITY 

The Croatian kuna does not participate in ERM II. 
The  HNB  operates  a  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, 
its  foreign  exchange 
transactions, it aims to prevent excessive exchange 
rate  fluctuations.  Between  early  2016  and  early 
2018  kuna 
appreciation 
pressures  which  necessitated  foreign  exchange 
purchases  from  banks  by  the  HNB  aimed  at  the 
stabilisation of its exchange rate against the euro.     

experienced 

through 

some 

thanks 

in  spring 

the  euro  has 
The  kuna's  exchange  against 
to  exhibit  a  seasonal  pattern  of 
continued 
temporarily  appreciating 
to 
foreign exchange inflows generated by the tourism 
sector.  After  having  appreciated  from  above  7.6 
HRK/EUR  in  early  2016  to  about  7.5  HRK/EUR 
by mid-2016, it depreciated somewhat in late 2016 
and early 2017. It then strengthened again close to 
7.4  HRK/EUR  by  mid-2017  before  weakening 
back to above 7.5 HRK/EUR in late 2017. In early 
2018, kuna traded below 7.5 HRK/EUR. 

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

in 

Coordination  and  Governance 
Monetary Union. 

Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

After  having  remained  close  to  EUR  13  billion 
throughout 2016, international reserves held by the 
HNB increased to above EUR 16 billion in the first 
quarter  of  2017.  This  also  reflected  the  sovereign 
issuance  of  10-year  euro-bonds  for  EUR  1.25 
billion  in  March  2017  which  was  used  to  settle 
USD 1.5 billion worth of bonds maturing in April 
2017.  As  a  result,  international  reserves  declined  
to  EUR  14  billion  in  the  second  quarter  of  2017 
before  increasing  again  to  almost  EUR  16  billion 
(32%  of  GDP)  by  end-2017,  mainly  thanks  to 
foreign  exchange  purchases  from  banks  by  the 
HNB.  

Given  that  the  HNB  does  not  frequently  change 
interest  rates  on  its  lending  and  deposit  facilities, 
the  evolution  of  short-term  rates  mainly  reflects 
changes  in  kuna  liquidity  in  the  banking  system. 
The  3-month  interest  rate  differential  against  the 
euro area averaged 112 basis points in 2016 but it 
stabilised  at  below  100  basis  points  in  2017  and 
early  2018  as  short-term  money  market  rates 
declined in Croatia. 

4.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Croatia  used  for  the 
convergence  examination  reflect  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  2016  convergence  assessment  of  Croatia. 
After  peaking  at  above  3.8%  in  June  2016,  it 
declined gradually to below 2.7% in early 2018. In 
March  2018,  the  latest  month  for  which  data  are 
available, the reference value, given by the average 

48 

7.07.27.47.67.88.02012201320142015201620172018Graph 4.4: Croatia -HRK/EUR exchange rate(monthly averages)Source: ECB.-10001002003004005002012201320142015201620172018Graph 4.5: Croatia -3-M Zibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
 
                                                           
 
of  long-term  interest  rates  in  Cyprus,  Ireland  and 
Finland plus 2 percentage points, stood at 3.2%. In 
that  month,  the  12-month  moving  average  of  the 
yield  on  the  Croatian  benchmark  bond  stood  at 
2.6%, 
the 
reference value. 

i.e.  0.6  percentage  points  below 

The  long-term  interest  rate  of  Croatia  remained 
broadly  stable  from  August  2015  until  August 
2016,  floating  between  3.5%  and  4%.  It  declined 
to about 3% in late 2016 and then mostly hovered 
below 3% throughout 2017 with the spread to the 
German long-term benchmark bond (27) oscillating 
around  245  basis  points.  In  early  2018,  the 
long-term interest rate declined to below 2.4% and 
the  spread  vis-à-vis  the  German  benchmark  bond 
to  below  200  basis  points  as  Croatia  received  its 
first rating upgrade since 2004.  

Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

experiencing 

under  the  Macroeconomic  Imbalance  Procedure 
(MIP - see also Box 1.5), which concluded that an 
In-Depth Review (IDR) was warranted for Croatia. 
In  March  2018,  the  Commission  published  its 
annual country report on Croatia (28), including an 
IDR. This report led to the conclusion that Croatia 
excessive  macroeconomic 
was 
imbalances,  linked  to  still  high  levels  of  public, 
private  and  external  debt,  all  largely  denominated 
in  foreign  currency,  in  a  context  of  low  potential 
its  estimated 
growth.  Strong  growth,  above 
potential,  is  helping  to  reduce  stock  imbalances: 
public,  private  and  external  debt  ratios  are 
declining  at  a  fast  pace.  The  banking  sector  is 
increasingly profitable and solvent and the stock of 
non-performing loans continued to decline, but the 
foreign  currency  exposure  (mainly  euro)  of 
corporations  and  households  remains  a  source  of 
vulnerability.  While  the  economic  environment  is 
improving, there has been little advancement in the 
adoption  of  policy  measures  aimed  at  addressing 
macroeconomic  imbalances,  including  by  raising 
the still low growth potential. 

4.6.1.  Developments  of 

the  balance  of 

payments 

the 

in  2017.  Whereas 

the 
in  2017, 

After having declined to 2.5% of GDP in 2016, the 
current account surplus increased to almost 4% of 
trade  surplus 
GDP 
deteriorated  somewhat 
income 
balance  improved,  also  due  to  losses  incurred  by 
the  largely  foreign-owned  banking  sector  in  the 
aftermath  of  the  Agrokor  crisis (29).  The  capital 
account  balance,  however,  declined  to  0.5%  of 
GDP in 2017, from above 1% in 2016. As a result, 
Croatia's  external  surplus  (i.e. 
the  combined 
current  and  capital  account)  increased  from  3.6% 
of GDP in 2016 to 4.2% of GDP in 2017. 

and 

low 

These external balance developments reflected the 
relatively 
continued 
investment 
deleveraging  by  all  sectors.  While  bank  credit 
provision  to  both  households  and  non-financial 
corporations  started  to  increase  again  in  2016, 
investment  activity,  measured  as  percentage  of 
GDP, has so far remained broadly stable. 

4.6.  ADDITIONAL FACTORS 

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 

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

(28)  https://ec.europa.eu/info/sites/info/files/2018-european-

semester-country-report-croatia-en.pdf 

(29)  With around 30 000 employees and 2.2 % of the total gross 
value  added  in  the  economy,  the  Agrokor  group  is  the 
largest  private  employer  in  Croatia.  Having  faced  serious 
financial  distress  in  early  2017,  Agrokor  was  put  under 
extraordinary administration in April 2017. 

49 

0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18CroatiaReference valueGraph 4.6: Croatia -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-2024682012201320142015201620172018CroatiaGermanyGraph 4.7: Croatia -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
                                                           
Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

In  2016  and  2017,  exports  continued  to  perform 
strongly,  as  the  economy  further  increased  its 
export  market  shares,  although  at  a  slower  pace 
than  in  the  previous  two  years.  Based  on  national 
accounts,  external  cost  competitiveness,  as 
measured  by  the  ULC-deflated  real  effective 
exchange rate, improved somewhat over 2016 and 
2017.  On  the  other  hand,  the  HICP-based  REER 
indicates  some  deterioration  in  external  price 
competitiveness 
the  NEER 
appreciation over this time period. 

resulting 

from 

The financial account continued to display positive 
balances  in  2016  and  2017.  This  reflected  the 
positive  net  contribution  of  portfolio  as  well  as 
other  investment  flows.  At  the  same  time,  net 
foreign  liabilities  stemming  from  foreign  direct 
investment in Croatia continued to increase. While 
international  reserves  held  by  the  HNB  declined 
somewhat  in  2016,  they  increased  by  more  than 
5%  of  GDP  in  2017.  The  net  international 
investment  position 
improved 
substantially from about  -77% of GDP in 2015 to 
around  -63%  of  GDP  at  the  end  of  2017  while 
gross external debt declined to 83% of GDP. 

(NIIP) 

thus 

50 

0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 4.8: Croatia -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.Note: Data on gross national saving rate excluded due to unavailabilityof sectoral national accounts from 2013.8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 4.9: Croatia -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100)Table 4.4:(cid:9)Croatia - Balance of payments(percentage of GDP)201220132014201520162017Current account-0.11.02.04.52.53.8of which: Balance of trade in goods-14.3-15.0-15.0-15.7-15.8-16.7                 Balance of trade in services14.815.516.918.018.719.0                 Primary income balance -3.4-2.0-2.0-0.7-3.3-2.3                 Secondary income balance2.82.62.12.92.93.8Capital account0.10.10.20.71.10.5External balance 1)0.01.12.15.23.64.2Financial account-1.0-1.01.04.22.43.4of which: Direct investment-2.8-1.9-1.6-0.6-4.2-2.6                Portfolio investment-4.0-4.41.7-0.32.80.3                Other investment 2)5.71.12.23.34.40.3                Change in reserves0.14.2-1.21.7-0.65.3Financial account without reserves-1.1-5.22.32.53.0-1.9Errors and omissions-1.0-2.1-1.1-1.0-1.2-0.8Gross capital formation19.219.318.820.020.220.5Gross saving 3)19.6n.a.n.a.n.a.n.a.n.a.Gross external debt102.8105.3107.0101.989.883.1International investment position-90.6-88.5-85.4-76.5-70.0-62.81) The combined current and capital account.2) Including financial derivatives.3) Data on gross national saving missing due to unavailability of sectoral national accounts from 2013.Sources: Eurostat, Commission services, Croatian National Bank. 
 
 
 
 
 
 
 
 
 
According  to  the  Commission  services'  Spring 
2018  Forecast,  the  external  surplus  is  expected  to 
decline somewhat over 2018 and 2019. 

4.6.2.  Market integration 

The  Croatian economy  is  well  integrated  with  the 
euro  area  through  trade  and  investment  linkages. 
The  degree  of  trade  openness  has  gradually 
increased in recent years and reached 55% of GDP 
in 2017 but it still remains relatively low given the 
small size of the Croatian economy. Trade with the 
euro area amounted to almost 31% of GDP in 2017 
and  thus  constituted  over  half  of  total  trade,  with 
Germany,  Italy,  Slovenia  and  Austria  as  Croatia's 
largest  trade  partners.  There,  nevertheless,  should 
be  room  for  a  further  deepening  of 
trade 
integration with the euro area. 

inflows  originated  from  Austria, 

FDI  has  so  far  been  mainly  directed  into  the 
banking,  real  estate  and  retail  sectors,  with  the 
largest 
the 
Netherlands  and  Hungary.  On  the  other  hand, 
Croatia  failed  to  attract  significant  FDI  inflows 
into the tradable goods sector and it is thus weakly 
integrated 
supply  chains.  The 
unfavourable  business  environment  appears  to  be 
the main obstacle to attracting more FDI.     

into  global 

to 

With  regard  to  the  business  environment,  Croatia 
performs  worse  than  most  euro-area  Member 
to  several  commonly  used 
States  according 
indicators  (e.g.  the  World  Bank's  Ease  of  Doing 
Business  Index  or  the  World  Economic  Forum’s 
Global  Competitiveness  Index).  Moreover,  it  has 
not recorded  any  significant  relative  improvement 
in recent years. In the World Bank's Ease of Doing 
Business, Croatia's worst rankings concern dealing 
with  construction  permits  and  paying 
taxes. 
According 
the  World  Bank's  Worldwide 
Governance Indicators, Croatia performs relatively 
poorly  in  terms  of  regulatory  quality  as  well  as 
voice  and  accountability.  At  the  same  time, 
Croatia's deficit in the transposition of EU internal 
market  directives  increased  to  2.2%  in  2017.  The 
4th  Anti-Money  Laundering  Directive  imposed 
2017.  Croatia 
by 
June 
transposition 
communicated 
to 
it  adopted 
the  measures 
transpose the directive on 28 November 2017 after 
the  Commission  had  addressed  to  Croatia  a  letter 
of formal notice on 19 July 2017. The Commission 
is  analysing 
their 
conformity with the directive. 

these  measures 

to  assess 

26 

Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

in 

rates 

remain 

the  use  of 

Activity  and  employment 
low 
compared to the euro-area average, which is partly 
related  to  underlying  policies  in  place,  such  as 
early  retirement  schemes  and  pension  eligibility 
criteria.  The  relaxation  in  employment  protection 
legislation  in  2013-14  resulted  in  a  significant 
temporary  contracts. 
increase 
Employment  on  permanent  contracts,  however, 
picked up again in 2017. After attaining a peak of 
11 %  in  2013,  the  long-term  unemployment  rate 
has  been  steadily  decreasing  to  pre-crisis  levels 
and  stood  at  6.6%  in  2016  (still  above  the  euro-
area  average  of  5%).  Long-term  unemployment 
affects  particularly 
low  skilled  workers  who 
remain  insufficiently  targeted  by  active  labour 
market policy measures. Non-harmonised and still 
inefficient  wage  setting  frameworks  in  the  public 
sector  hampers  the  government’s  control  over  the 
public  wage  bill  and  may  weigh  on  wage 
responsiveness in the economy. 

The financial sector in Croatia is highly integrated 
into  the  EU  financial  sector,  in  particular  through 
foreign ownership of the banking sector, as around 
90%  of  its  assets  are  held  by  subsidiaries  of 
foreign banks. Concentration in its banking sector 
is  relatively  high,  with  the  largest  five  banking 
institutions  accounting  for  more  than  70%  of 
sectors'  total  assets,  compared  to  on  average  48% 
in the euro-area countries. 

The banking system in Croatia is well capitalized, 
with  capital  adequacy  ratio  exceeding  20%  in  the 
third quarter of 2017, compared to 18% in the euro 
area. However,  the  share  of non-performing  loans 
(NPLs) has remained relatively elevated at close to 
10% in the third quarter of 2017 while it declined 
to 4% in the euro area. Profitability of the banking 
sector  has  been  quite  volatile  in  recent  years  but 
the  annual  return  on  equity  (RoE)  on  average 
exceeded 5% in  the third quarter of 2017 and was 
thus  above 
the  euro-area  average  of  4.5%. 
Reflecting  the  important  role  of  the  euro  in  the 

51 

0102030405060708090100HR, 2012HR, 2016EA, 2012EA, 2016Concentration 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. 
 
Convergence Report 2018 - Technical annex 

Chapter 4 - Croatia 

banking  sector,  the  share  of  foreign  currency 
deposits amounted to about 60% by end-2017. 

securities  market  corresponding  to  61%  of  GDP 
was  largely  dominated  by  government  securities 
and thus remained far less developed that the euro-
area  market  encompassing  debt  securities  in  the 
nominal value of almost 150% of GDP. The GDP 
share  of  consolidated  private  sector  debt  declined 
gradually from 125% in 2010 to 106% in 2016 and 
thus  remained  below  the  euro-area  average  of 
137%. 

The real house price index started to increase again 
in  2016  and  reached  105%  of  its  2015  level  in 
2017.  Bank  lending  to  households  for  house 
purchase  also  picked  up  in  late  2017  while 
construction  activity  has  started  showing  signs  of 
recovery. 

The financial system in Croatia is smaller relative 
to  GDP  than  that  of  the  euro  area.  In  2017, 
outstanding  bank  credit  to  Croatian  non-financial 
corporations  and  households  amounted  to  about 
56% of GDP, compared to almost 90% in the euro 
area.    The  majority  of  bank  loans  is  denominated 
in  euro  but  lending  to  households  in  kuna  has 
followed  an  upward 
trend  since  2013.  The 
valuation  of  quoted  shares  issued  by  Croatian 
enterprises  amounted  to  less  than  40%  of  GDP 
while  it  exceeded  67%  in  the  euro  area.  The  debt 

52 

-50510152025HR, 2012HR, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 4.11: Croatia -Selected banking sector soundness indicators%Source: ECB, HNB, EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180HR, 2012HR, 2017EA, 2012EA, 2017Debt 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.Table 4.5:(cid:9)Croatia - Market integration201220132014201520162017Trade openness 1) (%)43.944.646.950.351.954.7Trade with EA in goods & services 2)+3) (%)22.023.726.728.829.430.6Export performance (% change) 4)-1.20.11.95.21.70.6World Bank's Ease of Doing Business Index rankings 5)848965404351WEF's Global Competitiveness Index rankings 6)817577777474Internal Market Transposition Deficit 7) (%)n.a.n.a.0.60.10.32.2Real house price index 8)109.9103.6102.5100.0102.12 105.1Residential 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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
 
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  past  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.  After  this  the  MNB 
Act  was  amended  at  several  occasions (30), 
including some amendments since the most recent 
convergence exercise of 2016 (31). 

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 
the 
former  Hungarian  Financial  Supervisory 
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. 
independence 
The  principle  of  central  bank 

(30)  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. 

(31)  The  amendments  concern  inter  alia  the  implementation  of 
EU  financial  legislation  when  carrying  out  supervisory 
tasks,  the  publication  of  certain  information  by  the  MNB, 
the  provisions  on  proceedings  of  the  MNB  and  the 
information  requirements  of 
the 
European Supervisory Authorities. 

the  MNB 

towards 

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 
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.  

53 

 
                                                           
involved, 

including 

Section  153(6)  of  the  MNB  Act  provides  for  the 
possibility  for  members  of  the  Monetary  Council 
(including  the  Governor)  and  MNB  employees  to 
take on roles in the management, boards of trustees 
or supervisory boards of foundations and business 
associations under majority ownership of the MNB 
established  by  the  MNB  under  Section  162(2)  of 
the MNB Act without being subject to the conflict 
of  interest  rules  provided  for  in  Section  152(1)  to 
(5)  of  the  MNB  Act,  including  any  formal 
disclosure requirement. Hence, for those activities 
the  MNB  officials 
the 
Governor,  are  fully  shielded  from  any  scrutiny. 
Moreover,  Section  153(6)  of  the  MNB  Act  also 
provides  for  an  explicit  exemption  to  the  rule  of 
Section 156(1) of the MNB Act which determines 
that  members  of  the  Monetary  Council  (including 
the  Governor)  may  only  perform  other  activities 
which  are  compatible  with  their  central  bank 
decision-making duties. Hence, under national law 
such  members  may  undertake  activities  in  the 
MNB's  foundations  and  business  associations  that 
are  incompatible  with  their  central  bank  decision-
making  duties.  The  provision  conflicts  with 
Section  162(2)  of  the  MNB  Act  which  provides 
that the MNB may only establish foundations and 
business  associations  in  line  with  its  tasks  and 
primary  objective  of  ensuring  price  stability. 
Moreover,  central  bank  decision  making  duties 
always  have  to  be  performed  in  compliance  with 
Article 130 of the TFEU. The exemption therefore 
seems to imply that the latter principles of primary 
Union law may be disregarded by members of the 
Monetary  Council  when  acting  in  the  context  of 
the  foundations  and  business  associations  under 
MNB  ownership.  Therefore,  the  incompatibility 
needs to be removed.  

termination  of 

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 
following 
their  employment 
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.   

Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

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 
Governors,  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 
ESCB/ECB  Statute.  In  order  to  preserve  fully  the 
independence, 
principle  of  central  bank 
this 
removed  by  an 
should  be 
incompatibility 
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 

loan 

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 
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  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 

54 

 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

162(5) provides for supervision of the State Audit 
Office of the operations of foundations established 
by  the  MNB.  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  information  necessary  for 
monitoring the application of EU law. 

Pursuant  to  Section  162(2)  of  the  MNB  Act,  the 
MNB  may  establish  business  associations  under 
majority  of  MNB  ownership,  or  foundations.  In 
order  to  dispel  any  concerns  from  the  perspective 
of  Article  123  of  the  TFEU,  the  provision  should 
be  amended  by  providing  for  a  clear  framework 
delimiting  the  operations  of  such  foundations  and 
the  volumes  or  resources  which  the  MNB  could 
endow them with, enabling them to purchase large 
volumes  of  Hungarian  government  securities (34). 
Moreover,  the  exemption  provided  under  Section 
153(6)  of  the  MNB  Act  to  the  rule  of  Section 
156(1)  of  the  MNB  Act  which  determines  that 
members  of  the  Monetary  Council  (including  the 
Governor) may only perform other activities which 
are  compatible  with  their  central  bank  decision-
making duties is incompatible with Article 123 of 
the TFEU. The exemption provided for in national 
law  seems  to  imply  that  the  prohibition  of 
monetary financing enshrined in Article 123 of the 
TFEU  may  be  disregarded  by  members  of  the 
Monetary  Council  (including  the  Governor)  when 
acting  in  the  context  of  the  foundations  and 
business associations under MNB ownership. This 
incompatibility needs to be removed. 

(Decision  Hungarian  Constitutional  Court  –  No  8/2016  of 
31 March 2016). The original amendment to the MNB Act 
which  was  found  unconstitutional  inter  alia  provided  that 
regarding  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, 
the 
should  be  public;  any  other  data  managed  by 
foundation  should  be  accessible  exclusively  in  accordance 
with the law on civil associations instead of laws on access 
to information of public interest. 

(34)  In  line  with  their  articles  of  association  the  MNB 
foundations  have  to  invest  their  endowment  in  low-risk 
securities  such  as  government  bonds  and  Treasury  bills, 
property,  art,  and  cash  and  then  use  the  proceeds  from 
those 
themselves  and  provide 
financing for achieving their goals. 

investments 

fund 

to 

requirement  should  be  included  to  ensure  that  the 
loans  granted  to  the  National  Deposit  Insurance 
Fund are provided against adequate collateral (e.g. 
a  claim  on  future  cash  contributions,  government 
securities,  etc.)  to  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. 

of 

the 

insulate 

from  all 

the  bank 

expenses.  Therefore, 

Section 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 
the  prohibition  of  monetary 
comply  with 
financing,  Sections  176  and  183  of  the  MNB  Act 
should  be  amended  in  order  to  insulate  the  MNB 
by  appropriated  means 
financial 
the  HFSA's  prior 
obligations  resulting  from 
activities  or  legal  relationships  and  obligations 
including those deriving from the automatic further 
employment of HFSA staff by the MNB. 

from  all 

result 

Section 162(3) and (4) of the MNB Act lay down 
the conditions of disclosure of data by a company 
related  to  the  MNB (32) (33).  Furthermore,  Section 

(32)  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. 
(33)  Section  162(3)  and  (4)  of  the  MNB  Act  were  adopted  in 
order  to  remedy  a  law  which  was  previously  found 
unconstitutional  by  the  Hungarian  Constitutional  Court 

55 

 
                                                           
                                                                                   
5.1.4.  Integration in the ESCB 

Objectives 

Section  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  Section  3(2)  of  the  MNB  Act  is 
reduced  to  supporting  the  economic  policy  in 
Hungary.  The  provision  has  to  be  aligned  to  the 
secondary  objective  of  the  ESCB  enshrined  in 
Article  127(1)  of  the  TFEU  and  Article  2  of  the 
ESCB/ECB Statute 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(1), 9, 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), 
9, 22 and 147 of the MNB Act); 

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

(Article  K  of 

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); 

Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

  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 
international  cooperation  (Section 

field  of 
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.)); 

  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 
the  TFEU.  The  Hungarian 
Article  131  of 
authorities 
the 
to 
invited 
are 
abovementioned incompatibilities. 

remedy 

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  2016.  It  fell  further  to 
0.2% by August 2016 and then increased gradually 
to 2.4% by end-2017. In March 2018, the reference 
value  was  1.9%,  calculated  as  the  average  of  the 
12-month average inflation rates in Cyprus, Ireland 
and  Finland  plus  1.5  percentage  points.  The 
corresponding inflation rate in Hungary was 2.2%, 
i.e.  0.3  percentage  points  above  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected  to  remain  above  the  reference  value  in 
the months ahead. 

56 

 
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Chapter 5 - Hungary 

5.2.2.  Recent inflation developments 

Over  the  last  two  years  Hungary  exited  from  a 
very  low  inflation  environment.  Annual  HICP 
inflation was in negative territory in mid-2016, but 
it  turned  positive  in  September  2016,  as  energy 
prices  increased.  At  end-2016,  inflation  started  to 
rise steeply, reaching 2.9% by February 2017 and 
it  slightly  moderated  thereafter,  mostly  explained 
by  energy  price  fluctuations.  Overall,  in  2016, 
headline  inflation  remained  low  at  an  average  of 
0.4%  for  the  year  as  a  whole  and  it  increased  to 
2.4% in 2017, due to rising food and energy price 
inflation.  During  the  last  two  years,  annual  HICP 
in  Hungary  was  higher  than  in  the  euro  area, 
except 
in  mid-2016  when  Hungary  recorded 
negative inflation. 

due  to  processed  food,  which  was  on  a  rising 
inflation trend, partly reflecting increases in excise 
duties  on  tobacco.  Non-energy  industrial  goods 
inflation moderated slightly in 2017 while services 
inflation remained at a moderate level despite fast 
expansion  of  disposable  income  and  wage  costs. 
While  the  inflation  of  labour  intensive  services 
rose  at  a  relatively  fast  pace,  inflation  of  other 
services, 
telecommunication  was 
negative  in  2017.  Domestic  industrial  producer 
prices 
inflation  was  over  3%  at  end-2017, 
signalling the presence of cost price pressures. 

in  particular 

5.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  was  less 
volatile  than  HICP  inflation  over  the  past  two 
years. It stood at around 1.4% throughout 2016 and 
early  2017,  before  increasing  to  around  2.5%  by 
August 2017 and remaining at around that level till 
early  2018.  The  rise  in  core  inflation  was  largely 

57 

Hungary’s real GDP increased by 4% in 2017 after 
a  temporary  lull  in  2016.  In  2017,  GDP  grew 
above  potential  helped  by  a  supportive  external 
domestic 
environment 
policies.  Consumer  confidence  strengthened  and 
private consumption was supported by rapid wage 
rises  and  continued  employment  growth.  Gross 

accommodative 

and 

-10123456Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18HungaryReference valueGraph 5.1: Hungary -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.-2024682012201320142015201620172018HungaryEuro areaGraph 5.2: Hungary -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 5.1:(cid:9)weights  Hungary - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP5.71.70.00.10.42.42.21000Non-energy industrial goods2.60.30.00.81.00.50.4224Energy8.6-6.1-6.6-7.4-3.74.21.9146Unprocessed food 6.26.9-1.93.60.01.82.477Processed food9.04.82.40.51.03.94.8209Services4.13.62.32.21.81.91.9344HICP excl. energy and unproc. food5.03.01.61.31.42.12.3776HICP at constant tax rates 3.51.20.00.00.62.92.71000Administered prices HICP5.1-4.0-5.1-0.20.91.11.21621) 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 2018 - Technical annex 

Chapter 5 - Hungary 

important  driver  of 

fixed capital formation grew by around 17% year-
on-year  in  2017.  The  resumption  of  EU  funds' 
absorption  under  the  new  multiannual  financial 
the 
framework  was  an 
acceleration.  Business  and  household  investment 
also increased dynamically as the global economic 
recovery  improved  the  prospects  for  businesses 
and  strong  demand  for  new  homes  spurred  the 
construction  of  dwellings.  Fiscal  policy  measures 
further 
and 
supported 
flows 
accelerated  in  2017  and  net  exports  contributed 
negatively  to  GDP  growth.  According  to  the 
Commission  services  Spring  2018  Forecast,  GDP 
growth is projected to 4.0% in 2018, slowing down 
to  3.2%  in  2019.  The  output  gap  is  positive  and 
widened further in 2017. 

financing  conditions 
demand.  Trade 

favourable 

domestic 

The  fiscal  policy  stance,  as  measured  by  the 
change in the structural balance, slightly tightened 
in  2016,  but  it  significantly  loosened  in  2017  (by 
some  1¼%  of  GDP).  According 
the 
Commission services' Spring 2018 Forecast, which 
is  based  on  a  no-policy  change  assumption,  the 
fiscal stance is expected to remain expansionary in 
2018, followed by a partial reversal of this effect in 
2019. 

to 

to 

the 

loosened 
limiting  access 

Monetary  policy,  conducted  within  an  inflation 
targeting  framework (35),  has  remained  highly 
accommodative. The MNB reduced its policy rate 
to  0.9%  by  May  2016  and  has  left  it  unchanged 
since  then, while  signalling  that  the  base rate  will 
stay  at  this  level  at  least  until  mid-2019.  The 
central  bank 
its  policy  further  via 
three-month 
gradually 
deposit  facility  and  injecting  additional  forint 
liquidity via  FX  swap  tenders.  The  MNB reduced 
its overnight deposit rate from minus 5 basis points 
to minus 15 basis points in September 2017. It also 
made  efforts  to  lower  long-term  rates,  including 
via  new  unconventional  measures,  such  as  the 
Mortgage  bond  purchase  programme  and  IRS 
tenders, which were both announced in November 
2017.  In  view  of  the  recovery  in  private  sector 
lending, 
its  SME-financing 
Funding  for  Growth  Scheme  in  early-2017.  Net 
lending  to  the private  sector increased  moderately 
in an environment of negative real interest rates. 

the  MNB  ended 

Wages and labour costs 

Employment  continued  to  expand  in  2016  and 
2017 
reach  new  historic  highs.  The 
improvement  in  the  labour  market  started  already 

to 

(35)  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). 

58 

Table 5.2:(cid:9)Hungary - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationHungary5.71.70.00.10.42.42.33.0Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorHungary6.21.80.9-0.2-0.22.32.33.0Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeHungary1.71.80.8-1.54.07.97.45.6Euro area1.81.61.41.41.21.62.41.9Labour productivityHungary-1.81.0-0.60.9-0.42.03.12.7Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsHungary3.60.81.4-2.44.45.84.22.8Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorHungary4.3-0.90.1-1.1-2.41.92.01.6Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
the  difference.  As  a 

in  2013,  supported  by  a  public  work  scheme.  In 
2017,  the  number  of  public  workers  decreased 
significantly  but  private  labour  demand  quickly 
absorbed 
the 
unemployment rate fell to a record low of 4.2% in 
that year. Employment growth slowed down at the 
labour  market  became 
end  of  2017  as 
increasingly 
tight.  Labour  shortage  generated 
strong  wage  growth  and  nominal  wages  rose  by 
more than 12% in 2017.  

result, 

the 

Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

Over the last two years exchange rate fluctuations 
influenced import price dynamics only marginally. 
The  forint's  nominal  effective  exchange  rate 
(measured  against  a  group  of  36  trading  partners) 
appreciated  on  average  by  0.5%  in  2016  and  by 
further  1.7%  in  2017.  The  change  of  the  nominal 
effective exchange rate would suggest deflationary 
pressures,  but  the  pass-through  of  the  exchange 
rate appreciation to consumer prices appears much 
smaller  than  in  the  past.  Looking  ahead,  rising 
import prices are expected to contribute positively, 
but moderately to inflation, as the global recovery 
continues in 2018.  

Administered prices and taxes 

The  share  of  administered  prices (36)  in  the  HICP 
basket  is  relatively  high  in  Hungary  at  around 
16%,  compared  to  the  euro  area  average  (13%). 
Administered  prices  increased  by  0.9%  in  2016 
and 1.1%  in 2017,  chiefly  on  account of dynamic 
products 
pharmaceutical 
inflation 
and 
recreational 
activities.  However, 
sport 
regulated energy and other utility prices practically 
did  not  change  in  2016  and  2017.  Overall, 
administered prices had a minor effect on headline 
inflation, contributing just 0.2 pp. in both 2016 and 
2017. 

and 

of 

Changes  in  taxation  had  an  overall  downward 
effect  on  inflation  in  2016-2017.  Excise  duty 
temporarily  increased  on  fuel  for  three  months  at 
the end of 2016. Excise duty on tobacco increased 
by 29% in three steps in 2016-2017. In 2016, VAT 
was reduced on pork carcasses and new flats from 
27%  to  5%.  In  2017  VAT  was  reduced  on  eggs 
and  poultry  from  27%  to  5%,  on  fresh  milk  from 
18%  to  5%,  on  internet  and  restaurant  services 
from  27%  to  18%.  Overall,  changes  in  taxation 
lowered headline  inflation  by  0.2  pp.  in 2016  and 
by  0.5  pp.  in  2017.  Starting  from  2018,  the  VAT 
on  internet  and  restaurant  services  was  reduced 
further as well as the VAT on fish and pork offal, 
which would have a downward effect on headline 
inflation. However, some carry over effects of the 
increase in excise duties will play a role as well in 
2018. 

(36)  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
CP-AP-classification-2001-February-2017/ 

services.  For 

details, 

postal 

and 

Labour  productivity  growth  was  negative  in  2016 
and  2%  in  2017.  Nominal  compensation  per 
employee  started  to  increase  strongly  in  2016, 
albeit from a low level. It increased sharply further 
in 2017, but less so than nominal wages, due to a 5 
pp. cut in social security contributions. As a result, 
nominal unit labour cost rose by 4.4% and 5.8% in 
both  2016  and  2017,  well  above  the  euro  area 
average.  Looking  ahead,  compensation  per 
employee growth is set to remain high in 2018, but 
it  is  to  slow  down  somewhat  in  2019.  As 
productivity is projected to increase by around 3% 
in both years, nominal ULC growth is projected to 
moderate to below 3% by 2019. 

External factors 

in 

the  high  degree  of  openness  of 

the 
Given 
Hungarian  economy,  developments 
import 
prices  play  an  important  role  in  domestic  price 
formation. Import prices are mainly influenced by 
energy  and  commodity  prices,  which  also 
represent  a  relatively  high  weight  in  the  HICP 
basket. Growth of import prices (measured by the 
imports  of  goods  deflator),  had  a 
strong 
deflationary  effect  in  2016,  while  in  2017  a 
similarly  strong  inflationary  impact  started  to 
dominate, both mostly explained by fluctuations in 
the international oil price. 

59 

-40481220122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 5.3: Hungary -Inflation, productivity and wage trends(y-o-y percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast. 
 
                                                           
Medium-term prospects 

Inflation  picked  up  in  2017  and  is  projected  to 
increase  further  as  domestic  price  pressures 
develop.  Price  growth  is  expected  to  be  broad 
based,  as  energy  prices  rise  further  and  services 
inflation  increases  on  the  back  of  strong  wage 
growth.  Inflation  can  be  foreseen  to  rise  towards 
the  central  bank’s  target  of  3%.  Accordingly,  the 
Commission  services'  Spring  2018  Forecast 
projects  HICP  inflation  to  average  2.3%  in  2018 
and 3.0% in 2019. 

Risks  to  the  inflation  outlook  appear  to  be  on  the 
upside.  These  risks  relate  mainly  to  a  stronger-
than-expected  recovery  of  wages,  as  they  are 
expected to continue to grow rapidly, affected also 
by  minimum  wage  hikes.  Households'  returning 
confidence,  rising  asset  prices  and  intensifying 
lending  could  also  strongly  increase  consumption 
and  thus  inflation.  Slower  than  expected  global 
economic  growth  represents  the  main  potential 
downside risks.  

The level of consumer prices in Hungary stood at 
about 58% of the euro area average in 2016, with 
the  relative  price  gap  larger  for  services  than  for 
goods.  This  suggests  that  there  is  a  significant 
potential for further price level convergence in the 
long term, as GDP per capita in PPS (around 63% 
of the euro area average in 2016) increases 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 (37).  Since  then,  the  general  government 
deficit  has  been  kept  below  3%  of  GDP.  Overall, 
the  headline  deficit  did  not  not  change  notably 
during  2016  and  2017.  It  decreased  to  1.7%  of 

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

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

governance/sgp/deficit/index_en.htm 

Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

GDP in 2016 from 1.9% in the previous year, and 
then  rose  to  2.0%  in  2017.  Total  government 
revenue and expenditure relative to GDP declined 
by more than 3.5 pp. between 2015 and 2017. The 
revenue-to-GDP ratio dropped from 48.2% in 2015 
to  44.9%  in  2016  and  then  further  to  45.5%  in 
2017.  To  a  considerable  extent,  this  development  
resulted  from  decreased  EU  fund  absorption. 
Despite some recovery in EU co-financed projects 
in 2017, the level of EU funds spent still remained 
some  3  pp.  below  the  level  seen  in  2015.  At  the 
same time, government revenues without EU funds 
also  decreased  over  this  period.  This  reflected 
significant  tax  cuts  (in  particular  the  reduction  of 
the  employers'  social  contribution  and  corporate 
income  tax  rates  in  2017),  which  were  partly 
compensated  by  extra  revenues  due  to  dynamic 
wage  growth  and  temporary  revenue  windfalls 
benefiting  corporate  income  tax  proceeds.  Apart 
interest 
from  decreased  EU  funds,  declining 
outlays  and  social  transfers  and  one-off  receipts 
from 
negative 
expenditure) also contributed to the moderation of 
the expenditure ratio. However, these savings were 
partially 
capital 
by 
expenditure,  public  wage  bill  and  other  current 
spending. 

(accounted 

increased 

absorbed 

sales 

land 

as 

in 

in  2016, 

target  set 

The  2017  budgetary  outturn  over-achieved  the 
deficit 
the  2017  Convergence 
Programme by 0.4 pp. of GDP. While tax receipts 
exceeded  the  plans,  spending  on  goods  and 
services  turned  out  to  be  considerably  lower  than 
expected.  These  deficit-improving  developments 
were  just  partly  offset  by  higher-than-planned 
capital  expenditure  from  domestic  sources  and 
extra  spending  on  public  wages  and  social 
temporary  economic 
transfers.  Following  a 
slowdown 
the  budgetary  position 
significantly  benefited  from  the  acceleration  of 
economic recovery in 2017. The strong growth of 
major  tax  bases  reduced  the  fiscal  impact  of  tax 
cuts,  whereas  nominal  spending  increases  were 
counterbalanced  by  a  favourable  denominator 
effect  regarding  the  expenditure-to-GDP  ratio.  At 
the  same  time,  the  structural  balance  deteriorated 
sharply reflecting the widening of the output gap in 
the  positive  territory.  While  the  fiscal  stance 
somewhat tightened in 2016, the structural balance 
declined  from  around  –1.8%  of  GDP  to  –3.0%  in 
2017, well below the country's MTO (i.e. –1.5% of 
GDP). 

60 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

considerable  deficit-increasing  effect  stemming 
from the phasing out of one-off receipts from land 
sales and a temporary extra revenue component in 
corporate  income  tax.  To  counterbalance  this, 
government  spending  overall  was  set  to  grow 
rather moderately relative to the nominal GDP, but 
still above the rate of inflation.  

The  Commission  services'  Spring  2018  Forecast 
projects  the  current  year's  general  government 
deficit  at  2.4%  of  GDP,  in  line  with  the  official 
target. The forecast estimates lower-than-budgeted 
tax  revenues  reflecting  a  more  conservative 
economic growth projection. However, the impact 
of  this  on  the  deficit  is  offset  by  the  assumed 
slower-than-planned expansion of capital spending 
due  to  expected  delays  in  implementation.  Based 
on  a  no-policy-change  assumption,  the  deficit  is 
projected to decrease to 2.1% of GDP in 2019. In 
structural  terms  the  fiscal  stance  is  estimated  to 
loosen further in 2018, with the structural balance 
deteriorating  to  around  –3  ½%,  while  some 
reversal is projected in 2019. At the same time, the 
debt ratio  is expected  to  decline  further  to [below 
71%  by  the  end  of  2019,  supported  by  sustained 
high nominal GDP growth.] 

after 

in  Hungary 
the  wide-ranging 

is  well-
The  fiscal  framework 
developed, 
revamp 
launched in 2011 has resulted in a set of rules and 
procedures to control debt accumulation. The most 
recent  steps  taken  in  autumn  2017  reinforced  the 
domestic  budget  balance  rules  by  clarifying  their 
binding  effect  for  the  entire  budget  process. 

The  government  debt-to-GDP  ratio  has  been  on  a 
gradually  declining  path  since  2011,  albeit  it  still 
remained  high  for  a  middle  income  economy.  It 
fell  from  76.7%  in  2015  to  73.6%  by  the  end  of 
2017. The debt ratio decreased by 0.7 pp. in 2016. 
Although it was helped by a high primary surplus, 
the  slowdown  of  nominal  GDP  growth  made  an 
adverse  effect.  With  the  debt  ratio  falling  by  a 
the  pace  of  debt  reduction  
further  2.4  pp., 
increased 
the 
acceleration  of  nominal  GDP  growth,  despite  the 
contraction  of  the  primary  surplus  and  a  sizeable 
debt-increasing  effect  stemming  the  pre-financing 
needs of EU funds. 

in  2017.  This  was 

thanks 

to 

5.3.2.  Medium-term prospects 

The  2018  budget  was  adopted  by  the  Hungarian 
Parliament  on  20  June  2017.  It  targets  a  headline 
deficit  of  2.4%  of  GDP,  indicating  a  continued 
fiscal 
expansion.  Revenue-side  measures, 
amounting  to  a  deficit-increasing  effect  around 
0.6% of GDP in net terms, most notably include a 
further reduction of employers' social contribution 
(38)  and  lowering  of  the  VAT  rate  on  selected 
items  such  as  restaurant  meals,  fish  food  and 
internet.  These  tax  cuts  are  expected  to  be  partly 
compensated  by  extra  tax  revenues  triggered  by 
minimum wage increases and expected yields from 
measures  aiming  at 
tax  collection 
efficiency.  The  budget  also  counts  on  a 

improved 

(38)  The  budget  initially  incorporated  2  pp.  reduction  of  the 
social  contribution  rate,  which  was  increased  to  2.5  pp  in 
late 2017. 

61 

Table 5.3:(cid:9)Hungary - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-2.4-2.6-2.6-1.9-1.7-2.0-2.4-2.1- Total revenues46.146.746.848.244.944.544.745.0- Total expenditure48.549.349.450.146.546.547.147.1   of which: - Interest expenditure4.64.54.03.53.22.82.62.5p.m.: Tax burden38.438.038.238.939.438.537.437.4Primary balance2.21.91.41.61.60.80.10.3Cyclically-adjusted balance-0.6-1.3-2.2-2.0-1.8-2.8-3.6-3.3One-off and temporary measures0.70.1-0.10.0-0.10.40.00.0Structural balance 2)-1.3-1.4-2.1-2.0-1.8-3.1-3.6-3.3Government gross debt78.477.176.676.776.073.673.371.0p.m: Real GDP growth (%)-1.62.14.23.42.24.04.03.2p.m: Output gap-3.7-2.7-0.70.30.31.62.42.31) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

Nonetheless, 
shortcomings 
some  noteworthy 
remain,  weighing  on  the  transparency  and  quality 
of  fiscal  policy-making.  Specifically,  the  role  of 
the  Fiscal  Council  in  scrutinizing  and  shaping 
fiscal policies is persistently weak, in contrast with 
its  constitutionally-enshrined  veto  power  over  the 
annual  budget  bill.  The  implementation  of  the 
recently 
budgetary 
adopted  medium-term 
framework  has  not  yet  delivered  its  desired  effect 
to  genuinely  lengthen  the  fiscal  planning  horizon 
beyond its annual focus. 

providing  FX  swap  tenders.  A  similar  forint 
appreciation of about 2 percent between April and 
August  2017  was  arrested  by  MNB's  verbal 
intervention,  hinting  at  the  introduction  of  new 
instruments,  which  were 
eventually 
announced in November 2017. Inter-day exchange 
rate volatility  was  on  a  declining  trend during  the 
past two years and the annual volatility peaks were 
the lowest among those of the last decade. In early 
2018,  the  forint's  exchange  rate  against  the  euro 
was at around 311 HUF/EUR. 

then 

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).  

the  past 

two  years.  The 

International reserves decreased from around EUR 
30bn at end-2015 to around EUR 24bn on average 
during 
level  of 
international  reserves  was  mainly  influenced  by 
sovereign  debt  management  decisions  (e.g.  the 
very  limited  international  bond  issuance  since 
2014),  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 
end-2017,  which 
around  EUR 
corresponded  to  about  19%  of  GDP.  Hungary 
repaid  the  last  tranches  of  its  2008  EU-IMF 
financial assistance in November 2014 (EUR 2bn) 
and early April 2016 (EUR 1.5bn) to the EU. 

23bn 

by 

The forint was broadly stable against the euro over 
the  past  two  years  trading  around  310  HUF/EUR. 
There were some forint appreciation pressures due 
to  loose  monetary  policy  in  the  euro  area  and 
improving economic fundamentals of Hungary, as 
indicated  e.g.  by  credit  rating  agency  upgrades. 
These  pressures  were,  however,  stopped  by  MNB 
announcements of new monetary easing measures. 
Notably, the forint strengthening between May and 
October  2016  of  about  2  percent  was  ended  with 
the  introduction  of  volume  caps  on  the  three-
month  deposit  facility  and  the  forint  liquidity 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  decreased  from  around  140  basis  points 
in April 2016 to below 40 basis points by October 
2017  and  have  remained  around  that  level  since 
then. The MNB reduced its policy rate by 15 basis 
points in May 2016 and kept it unchanged at 0.9% 
since  then.  Further  decrease  of  the  interest  rate 
differential  was  driven  by  the  gradual  capping  of 
the volume of the three-month deposit facility and 
the  injection  of  additional  forint  liquidity,  against 
the  background  of  stable  three-month  euro-area 
money  market  rates.  In  early  2018,  the  3-month 

62 

2202402602803003203402012201320142015201620172018Graph 5.4: Hungary -HUF/EUR exchange rate(monthly averages)Source: ECB.02004006008002012201320142015201620172018Graph 5.5: Hungary -3-M Bubor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Hungary. 
 
 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

spread  vis-à-vis  the  euro  area  reached  around  40 
basis points. 

5.5. 

LONG-TERM INTEREST RATES 

the  development  of 

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

3.5%  by  February  2017.  It  then  started  to  decline 
again  and  reached  2.1%  in  December  2017, 
reflecting  the  MNB's  efforts  to  extend  even  more 
its  monetary  stimulus  to  long-term  rates,  mainly 
via  mortgage  bond  purchases  and  IRS  tenders. 
Hungary's  long-term  interest  rate  increased  to 
around 2.6% by February 2018, in an environment 
of  rising  yields  in  major  advanced  economy  bond 
markets.  The 
the 
German  benchmark  bond  stood  at  around  200 
basis points in early 2018 (39). 

long-term  spread  vis-à-vis 

5.6.  ADDITIONAL FACTORS 

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

labour  and 

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  2016  convergence  assessment  of 
Hungary. It then gradually decreased from 3.4% to 
below 3% by end-2017. In March 2018, the latest 
month  for  which  data  are  available,  the  reference 
value,  given  by  the  average  of  long-term  interest 
rates  in  Cyprus,  Ireland  and  Finland  plus  2 
percentage  points,  stood  at  3.2%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Hungarian benchmark bond stood at 2.7%, i.e. 0.5 
percentage points below the reference value. 

In-Depth  Review 

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5),  which  concluded  that 
issues  related  to  the  housing  market  and  labour 
market  existed  but  since  overall  risks  remained 
(IDR)  was 
contained,  no 
warranted  for  Hungary.  There  are  signs  of 
emerging  capacity  constraints  and  price  pressures 
in  the  economy,  which  warrant  attention.  Real 
house  prices,  in  particular,  have  continued  to 
increase  rapidly,  albeit  from  undervalued  levels. 
However,  the  still  high  share  of  non-performing 
mortgage  loans  could  benefit  from  a  recovery  in 
the  housing  market 
improved 
marketability.  At  the  same  time,  while  there  have 
been gains in export market shares, supported by a 
growing  car  industry,  cost  competitiveness  has 
deteriorated as reflected in dynamic growth in unit 
labour costs. 

through 

their 

The  long-term  interest  rate  of  Hungary  decreased 
to  around  2.8%  by  August 2016,  before  it  rose  to 

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

63 

0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18HungaryReference valueGraph 5.6: Hungary -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-202468102012201320142015201620172018HungaryGermanyGraph 5.7: Hungary -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

5.6.1.  Developments  of 

the  balance  of 

payments 

According  to  balance  of  payments  data,  after 
peaking  at  8%  of  GDP  in  2015,  the  surplus  of 
Hungary's  external  balance  (i.e.  the  combined 
current and capital account) declined to around 6% 
of  GDP  in  2016  and  to  4%  of  GDP  in  2017.  The 
current account surplus also reached 6% of GDP in 
2016,  as  the  trade  in  services  and  the  income 
balances  improved.  In  2017,  it  lowered  to  around 
3%  of  GDP  as  the  surplus  on  the  trade  in  goods 
balance decreased and the income balance slipped 
the  capital  account 
back.  The  surplus  of 
disappeared  in  2016  as  absorption  of  EU  funds 
halted  temporarily  due  to  the  switch  to  the  new 
multiannual  financial  framework.  In  2017,  the 
capital  account  recorded  a  surplus  again,  as 
absorption of EU funds resumed. 

Hungary's  savings-investment  surplus  increased 
significantly 
in  2016  as  gross  fixed  capital 
formation dropped markedly. The decline was due 
to the lower absorption of EU funds at the end of 
the  2007-2013  Multiannual  Financial  Framework. 
In addition, the already high saving rate increased 
further  in  2016,  due  to  the  corporate  sector.  In 
2017, the savings-investment surplus decreased as 
investment picked up rapidly and savings started to 

decrease  on 
improving  consumer  confidence. 
Overall  investment  as  a  share  of  GDP  largely 
fluctuated  between  2015  and  2017,  reflecting  the 
stop-and-go  effect  of  EU  funds.  In  2017,  the 
investment rate remained at a somewhat low level 
compared to the pre-crisis years. 

two  years  price  and  cost 
Over 
last 
the 
competitiveness 
indicators  of  Hungary  have 
deteriorated.  The  nominal  effective  exchange  rate 
of  the  forint  and  the  real-effective  exchange  rate 
deflated by HICP appreciated slightly in 2016 and 
somewhat  more 
in  2017.  The  real-effective 
exchange rate deflated by ULC increased markedly 
both  in  2016  and  2017,  due  to  the  fast  wage 
growth  and  improving  labour  market.  Hungary's 
export  performance  slightly  deteriorated  in  2016, 
but improved in 2017. 

Mirroring  a  continuous  external  surplus, 
the 
financial  account  has  also  been  positive.  Direct 
investment registered a net inflow of 2.4% of GDP 
in  2016  and  1.7%  of  GDP  in  2017.  Portfolio 
investment  net  outflows  reached  4.3%  of  GDP  in 
2016  and  3.1%  in  2017,  partly  reflecting  the 
investors  from  forint-
withdrawal  of  foreign 
securities.  Other 
denominated 
investment  continued  to  register  large  outflows  in 
2016,  but  its  net  flows  stabilised  in  2017,  while 

government 

64 

Table 5.4:(cid:9)Hungary - Balance of payments(percentage of GDP)201220132014201520162017Current account1.73.81.53.46.02.8of which: Balance of trade in goods2.93.32.04.04.11.9                 Balance of trade in services3.83.74.44.95.95.8                 Primary income balance -4.2-2.6-4.2-4.5-2.5-4.1                 Secondary income balance-0.8-0.6-0.7-1.0-1.5-0.9Capital account2.53.63.74.60.01.2External balance 1)4.37.35.28.06.04.0Financial account4.76.24.15.93.31.9of which: Direct investment-2.20.0-2.7-2.3-2.4-1.7                Portfolio investment-1.5-3.03.05.14.33.1                Other investment 2)11.78.13.17.66.80.5                Of which International financial assistance3.95.01.90.01.30.0                Change in reserves-3.31.10.7-4.4-5.40.0Financial account without reserves8.05.13.310.48.71.9Errors and omissions0.4-1.1-1.1-2.1-2.6-2.1Gross capital formation19.521.023.321.819.822.5Gross saving21.224.824.825.225.925.5Gross external debt157.4144.7144.6130.0122.2103.0International investment position-93.6-83.1-80.3-68.4-60.0-54.81) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Magyar Nemzeti Bank. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

international  reserves  followed  a  very  similar 
pattern  to  this in  2016  and  2017.  The  decrease  of 
gross external debt proceeded in 2016 and 2017 at 
a  fast  pace,  reaching  103%  of  GDP  at  the  end  of 
this  period.  The  net 
investment 
position  improved  from  around  -94%  of  GDP  in 
2012 to around -55% of GDP by end-2017. 

international 

5.6.2.  Market integration 

through 

trade  and 

the  Hungarian  economy 

The Hungarian economy is highly integrated with 
the  euro  area 
investment 
linkages.  Trade  openness  increased  from  92%  in 
2012  to  95%  in  2017,  reflecting  the  deeper 
integration  of 
into 
continental  and  global  supply  chains.  Flows  with 
the  euro  area  dominate  trade,  accounting  for 
around  54%  of  the  total  trade  in  goods  and 
services. The main goods trading partners in 2017 
were  all  euro-area  countries,  namely  Germany, 
Austria, Slovakia and Italy.  

The  stock  of  FDI  in  Hungary  amounted  to  about 
66% of GDP in 2016 (excluding SPEs), with FDI 
mainly originating from Germany, the Netherlands 
and  Austria.  The  main  recipient  sectors  of  FDI 
were  services  (mostly  'professional,  scientific  and 
financial 
technical 

activities', 

trade 

and 

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, the last instalment was 
repaid in early April 2016. 

According  to  the  Commission  services'  Spring 
2018 Forecast, which is based on national accounts 
data,  the  external  surplus is expected  to remain  at 
around 4% of GDP in both 2018 and 2019. 

65 

0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 5.8: Hungary -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 5.9: Hungary -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100)Table 5.5:(cid:9)Hungary - Market integration201220132014201520162017Trade openness 1) (%)92.091.692.493.594.295.4Trade with EA in goods & services 2)+3) (%)50.550.753.053.854.554.2Export performance (% change) 4)-2.51.64.94.2-0.51.2World Bank's Ease of Doing Business Index rankings 5)545454424148WEF's Global Competitiveness Index rankings 6)606360636960Internal Market Transposition Deficit 7) (%)1.40.50.70.60.40.8Real house price index 8)89.385.588.3100.0113.61 120.5Residential investment 9) (%)2.01.81.92.22.4n.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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

to 

strategy 

40.2% in 2016 from 48.9% in 2012), reflecting the 
government's 
increase  domestic 
ownership  in  the  sector.  Bank  concentration,  as 
measured  by  the  market  share  of  the  largest  five 
credit  institutions  in  total  assets,  decreased  to 
53.4%, above the euro-area average of 47.6%. 

The  Hungarian  banking  system  remains  well-
capitalized, with a capital adequacy ratio of around 
17%  at  end-September  2017,  which  is  somewhat 
below that of the euro area. Banks' profitability has 
recovered over the past two years and the sector's 
return  on  equity  reached  more  than  14%  in  the 
year to end-September 2017, well above the 4.5% 
average of the euro area. Profits were boosted also 
by  the  unwinding  of  earlier  provisions  which 
makes  it  unlikely  that  this  RoE-level  will  be 
sustainable 
interest  rate 
environment  and  given  the  still  low  efficiency  of 
the  sector.  The  improvement  of  the  loan  portfolio 
quality continued and the NPL ratio reached 6.3% 
in  September  2017,  which  is  still  above  the 
average  of  the  euro  area.  Thus,  the  Hungarian 
banking system slowly leaves behind the legacy of 
the previous decade's credit bubble.  

the  current 

low 

in 

intermediation)  and  manufacturing  (30%  of  the 
total), suggesting that FDI plays an important role 
in  enhancing  Hungary’s  export  capacity  and 
contributes  significantly  to  economic  integration 
with the euro area. 

Concerning  the  business  environment,  Hungary 
performs  in  general  worse  than  most  euro  area 
Member  States  in  international  rankings.  In  the 
World  Bank's  Ease  of  Doing  Business  Hungary 
scores  particularly  poorly  with  regards  getting 
electricity and protecting minority investors. In the 
World  Bank's  Worldwide  Governance  Indicators 
Hungary  performs  relatively  worse  in  terms  of 
"voice  and  accountability"  and  control  of 
corruption,  but  they  also  point  to  problems  with 
regulatory  quality.  According  to  the  latest  data, 
Hungary's  transposition  deficit  of  EU  Directives 
was  at  0.8%  which  is  above  the  target  (0.5%) 
proposed  by  the  European  Commission  in  the 
Single  Market  Act  (2011).  The  4th  Anti-Money 
Laundering Directive imposed transposition by 26 
June  2017,  and  Hungary notified  the  Commission 
of the adopted measures within that deadline. The 
Commission is analysing these measures to assess 
their conformity with the directive. 

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 
have 
strengthened  labour  supply.  Both  domestic  and 
international  labour  mobility  is  rather  low  in 
Hungary,  although  the  latter  has  increased  since 
the financial crisis.  

retirement 

statutory 

age 

The  housing  market  recovery  that  started  in  2014 
in  2016  and  2017  with  sizeable 
continued 
increases  in  real  house  prices  in  both  years, 
supported  by  a  new  housing  support  scheme 
introduced  by 
the  government.  Residential 
investment increased from historical lows reached 
in  2013-2014, but remained  well  below  the  levels 
seen in the last decade. The stock of housing loans 
in  real  terms  broadly  stagnated  in  2017  compared 
to  2016,  but  new  lending  became  very  dynamic 
towards the end of the year. 

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 

The financial system in Hungary is smaller relative 
to GDP than that of the euro area. Domestic bank 
credit  fell  to  32%  of  GDP  by  the  end-2017,  split 
broadly  evenly  between  households  and  non-
financial  corporations.  Most  household  loans  in 

66 

0102030405060HU, 2012HU, 2016EA, 2012EA, 2016Concentration 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.-10-505101520HU, 2012HU, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 5.11: Hungary -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters. 
 
 
Convergence Report 2018 - Technical annex 

Chapter 5 - Hungary 

foreign  currency  were  redenominated  to  forint 
loans  by  law  effective  from  early  2015.  The  total 
capitalization  of  the  Budapest  Stock  Exchange 
amounted  to  about  22%  of  GDP  in  2017,  well 
below  the stock-market  capitalization  of  the  euro-
area.  The  debt  securities  market  remains  small  in 
comparison  with  the  euro  area  average  (74% 
against  149%  of  GDP)  and  is  mainly  used  for  re-
financing  public  debt.  The  consolidated  stock  of 
private sector debt fell from around 102% in 2012 
to  around  71%  of  GDP  in  2017,  which  is 
significantly  below  the  private  debt  level  of  the 
euro-area. 

67 

020406080100120140160180HU, 2012HU, 2017EA, 2012EA, 2017Debt 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 2017, item 1373. The NBP Act has been slightly 
amended  since  the  2016  Convergence  Report (40). 
In  absence  of  any  legislative  action  regarding  the 
issues mentioned in the 2016 Convergence Report, 
the  comments  provided  in  the  latter  report  are 
largely repeated in the 2018 assessment. 

6.1.2.  Central Bank independence 

content 

constitutes 

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 
in 
members  of  NBP  decision-making  bodies 
situations where this may have an impact on NBP's 
fulfilment  of  its  ESCB  related  tasks.  The  absence 
of such an explicit reference to Article 130 of the 
TFEU  and  Article  7  of  the  ESCB/ECB  Statute  or 
incompatibility. 
its 
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 
with the principle of central bank independence. 

an 

Article  23(1)(2)  of  the  NBP  Act  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 

(40)  The  amendments  stem  from  the  Law  on  the  Bank 
and 
Guarantee  Fund,  Deposit  Guarantee  Scheme 
Resolution of 10 June 2016 (Dziennik Ustaw of 2016, item 
996)  and  the  Law  on  the  amendment  of  the  Law  on  the 
payment  services  and  some  other  laws  of  30  November 
2016 (Dziennik Ustaw of 2016, item 1997). 

69 

procedure  provides  for  the  opportunity  for  the 
Government  to  exert  influence  on  the  monetary 
and  financial  policy  of 
thus 
constitutes  an  incompatibility  in  the  area  of 
independence  with  Article  130  of  the  TFEU  and 
Article 7 of the ESCB/ECB Statute.  

the  NBP  and 

laws, 

Article  9(3)  of  the  NBP  Act  foresees  that  the 
Governor  of  the  NBP  shall  assume  his/her  duties 
after  taking  an  oath  before  the  Parliament.  This 
oath  refers  to  the  observation of  the provisions of 
the 
the  Polish  Constitution  and  other 
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  the 
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 
the  office.  The  procedure  violates 
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 
the 
Governor has been guilty as established by a court 

if 

 
                                                           
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 

system 

threatening 

The Commission recalls the recent changes in the 
judicial 
judicial 
independence of the Polish Supreme Court and its 
First  President (41),  who  also  chairs  the  State 
Tribunal  pursuant  to  Article  199(2)  of  the  Polish 
Constitution.  In  this  context,  the  NBP  Act  would 
benefit  from  an  explicit  clarification  that  the 
Governor  of  the  NBP  has  the  possibility  to  seek 
legal redress against his/her dismissal by the State 
Tribunal  before  the  Court  of  Justice  of  the 
European  Union,  as  enshrined  in  Article  14.2  of 
the ESCB/ECB Statute. 

the 

According 
to  Article  203(1)  of  Poland’s 
Supreme  Audit  Office 
Constitution, 
(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 
and  Article  7  of 
the  ESCB/ECB  Statute. 
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 

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 
to  conditionality  under 
programmes,  subject 
Article  42(4)  of  the  same  Act.  Against  this 
background,  the  current  wording  of  Article  42(3) 

bank 

(41)  Cf.  Commission  Proposal  for  a  Council  Decision  on  the 
determination  of  a  clear  risk  of  a  serious  breach  by  the 
Republic  of  Poland  of  the  rule  of  law,  COM(2017)  835 
final, para. 115-122. 

Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

loans 

refinancing 

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 

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: 

 

limitation of the NPB's activities to 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 

(6)  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,  31-37  of  the  NBP 
Act). The NBP shall exercise its responsibility 
for issuing the national currency as part of the 
ESCB; 

  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 

independent 

external 

by 

70 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

approved  by  the  Council.  It  is  incompatible 
with Article 27.1 of the ESCB/ECB Statute.  

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); 

 

incomplete  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. The Polish authorities are invited to remedy 
the abovementioned incompatibilities. 

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  2016.  It  then  remained 
around  -0.5%  until  autumn  2016,  before  it  started 
to increase gradually, reaching 1.6% by end-2017. 

71 

In  March  2018,  the  reference  value  was  1.9%, 
calculated as the average of the 12-month average 
inflation rates in Cyprus, Ireland and Finland plus 
1.5 percentage points. The corresponding inflation 
rate in Poland was 1.4%, i.e. 0.5 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  stayed  negative  between 
July  2014  and  September  2016.  In  the  first  three 
quarters  of  2016  it  remained  broadly  stable 
fluctuating  between  -0.6%  and  -0.2%.  After 
turning  minimally  positive 
in  October  2016, 
inflation  increased  fast  to  a  local  high  of  1.9%  in 
February  2017  and  gradually  declined  again  to 
1.3%  in  June  2017.  The  second  half  of  2017  was 
marked  by  a  gradual  inflation  increase  before  it 
jumped to 2.0% in November and receded again to 
1.6%  in  January  2018  before  declining  sharply  to 
0.7%  in  February-March  2018.  This  somewhat 
volatile  pattern  is  explained  by  the  strong  swings 
in  the  dynamics  of  energy  and  unprocessed  food 
prices  during  the  analysed  period.  These  reflected 

-1012345Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18PolandReference valueGraph 6.1: Poland -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.Table 6.1:(cid:9)weights  Poland - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP3.70.80.1-0.7-0.21.61.41000Non-energy industrial goods0.9-0.3-0.9-0.8-1.5-0.9-0.9313Energy8.0-1.7-1.2-4.9-3.72.91.8135Unprocessed food 4.23.3-1.7-1.71.64.64.576Processed food4.42.11.6-0.30.72.52.5176Services3.51.61.31.71.82.42.3300HICP excl. energy and unproc. food2.81.00.60.30.31.11.1789HICP at constant tax rates 3.40.5-0.3-0.7-0.21.61.41000Administered prices HICP5.31.81.21.02.11.21.21461) 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 2018 - Technical annex 

Chapter 6 - Poland 

mainly  developments  in  the  global  markets  rather 
than  Poland-specific  factors.  The  relative  stability 
of  the  zloty  exchange  rate  in  2016  and  its 
appreciation  in  2017  coupled  with  slow  price 
growth  in  Poland's  trade  partners  dented  import 
prices.  Gradually  strengthening  nominal  wage 
growth  and  higher  producer  prices'  growth 
throughout most of 2017 contributed towards some 
increase  in  services  and  processed  food  prices. 
Strong  market  competition  had  a  partially 
countervailing effect on them. 

inflation  (measured  as  HICP 

Core 
inflation 
excluding energy and unprocessed food) stayed in 
a  narrow  band  of  between  0.1%  and  0.4%  in  the 
first ten months of 2016. It then increased to 1.3% 
in April 2017, to subsequently stay broadly stable 

until  January  2018  at  between  1.1%  and  1.4%.  In 
February 2018 core inflation declined significantly 
to 0.6% with a March reading at 0.4%. Non-energy 
industrial goods prices continued decreasing on an 
annual  basis,  but 
their  deflation  moderated 
somewhat from around -1.5% during most of 2016 
to  between  -1.2%  and  -0.7%  during  2017.  This 
reflected  still  rather  weak  inflationary  pressures 
and  strong  competition 
in  global  markets. 
Processed food price inflation gradually rose from 
0%  in  January  2016  to  2.3%  in  March  2017  and 
after  a  correction  in  April  2017  (1.8%)  generally 
followed  an  upward  trend  for  the  remainder  of 
2017  to  3%  in  December.  In  early  2018  it  eased 
somewhat  to  2%.  This  partly  reflected  a  trend  of 
rising  unprocessed  food  prices  during  2017  and 
subsequent  easing  in  early  2018  and  partly  other 
demand  and  supply  factors  such  as  rising  wages 
and  a  strong  increase  in  private  consumption. 
Strongly  rising  domestic  demand  and  increasing 
difficulty  in  hiring  adequately  skilled  workers 
leading  to  rising  wages  also  played  a  role  for 
services  inflation.  Its  fast  increase  in  the  first 
month  of  2017  was  also  related  to  rising  housing 
rental  costs,  costs  of  TV  subscriptions  and  postal 
services. In turn, a slowdown of services  inflation 
in  February-March  2018  was  affected  by  sector-
specific  factors,  such  as  a  decline  of  financial 
services  charges.  Domestic  industrial  producer 
price  inflation  exceeded  6%  in  early  2017,  but 
declined to around 1% in early 2018. 

72 

-202462012201320142015201620172018PolandEuro areaGraph 6.2: Poland -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 6.2:(cid:9)Poland - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationPoland 3.70.80.1-0.7-0.21.61.32.5Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorPoland 3.30.4-0.1-1.1-0.41.91.52.5Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeePoland 3.61.72.21.75.14.06.87.4Euro area1.81.61.41.41.21.62.41.9Labour productivityPoland 1.51.51.52.32.43.23.53.4Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsPoland 2.00.20.6-0.62.60.73.23.9Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorPoland 5.8-1.2-2.2-1.3-0.31.51.61.7Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

Labour  productivity  growth  rose  slightly  from 
2.3% in 2015 to 2.4% in 2016 and it strengthened 
to  3.2%  in  2017.  Compensation  per  employee 
increased  by  around  5%  in  2016,  but  its  growth 
rate moderated to 4% in 2017. This translated into 
nominal ULC growing by 2.6% in 2016 and 0.7% 
in  2015.  With 
in  2017,  after  a  decline 
unemployment  at  record  lows  and  expectations of 
a further reduction, wage pressures are expected to 
strengthen with ULC growth of over 3% in 2019.  

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) stayed 
negative between 2013 and 2016. 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. Higher oil prices translated 
into  the  deflator  turning  positive  in  2017  (1.5%), 
despite  some  appreciation  of  the  zloty  during  the 
year.  Imported  inflation  is  forecast  to  remain 
positive during 2018-2019. 

Administered prices and taxes 

The  increase  of  administered  prices (43),  with  a 
weight  of  around  15%  in  the  HICP  basket 
(compared  to  13%  in  the  euro  area),  exceeded 
HICP  inflation  in  2016,  but  was  below  HICP 
inflation  in  2017.  The  average  annual  increase  in 
administered prices was 2.1% in 2016 and 1.2% in 
2017. The faster growth of administrative prices in 

(43)  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-2001-February-2017/ 

6.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Real  GDP  increased  by  3.0%  in  2016,  a  sizeable 
slowdown  from  3.8%  in  2015.  In  2017  growth 
rebounded  to  4.6%,  well  above  estimates  of 
potential output growth of around 3-3.5% and well 
above  the  euro  area  average.  Growth  was  mainly 
driven  by  private  consumption,  benefiting  from 
favourable  labour  market  conditions,  increased 
social  benefits,  consumer  confidence  gradually 
improving to record-high levels and comparatively 
low lending interest rates. After a sharp contraction 
in 2016, investment recovered in the second half of 
2017.  The  output  gap  is  estimated  to  have  been 
closed  in  2017  and  a  positive  gap  is  expected  to 
widen  somewhat  with  projected  robust  real  GDP 
growth of 4.3% in 2018 and 3.7% in 2019. Growth 
is projected to remain driven by domestic demand, 
with  strong  private  consumption  supported  by 
rising wages and high consumer confidence, strong 
growth  of  public  and  a  more  gradual  revival  of 
private investment. 

The fiscal stance, as measured by the change in the 
structural  balance,  was  tightened  in  2015  and 
2016.  In  2017  the  fiscal  stance  as  defined  by  this 
indicator  remained  neutral.  A  limited  pro-cyclical 
expansion 
the 
is  expected 
structural balance stabilises in 2019. 

in  2018,  before 

Monetary  policy,  conducted  within  an  inflation 
targeting framework (42) remained accommodative 
over  the  past  two  years.  The  Monetary  Policy 
Council (MPC) has kept the policy rate unchanged 
at 1.5% since March 2015. The growth rate of net 
bank  credit  to  the  non-financial  private  sector 
remained  moderate,  despite  the  historically  low 
interest rates. 

Wages and labour costs 

Employment  has  been  consistently  on  the  rise 
since  mid-2013  reaching  the  highest  level  since 
comparable  data  are  available  at  the  end  of  2017 
(both  in  terms  of  absolute  numbers  and  of 
employment 
the 
unemployment  rate  has  declined  steadily  since 
2013, reaching record low levels of 4.9% in 2017. 

line  with 

rate). 

this, 

In 

(42)  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. 

73 

-3036920122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 6.3: Poland -Inflation, productivity and wage trends(y-o-y percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast. 
                                                           
 
                                                           
2016  was  mainly  related  to  hikes  in  costs  of 
selected  legal  services,  while  the  dynamics  of 
electricity  prices  was  below  overall  HICP.  Gas 
prices  fell  strongly  in  2016  and  to  lesser  extent 
also  in  2017,  while  heat  energy  prices,  after  a 
moderate increase in 2016, decreased in 2017. 

The  impact  of  tax  measures  on  overall  consumer 
price developments was close to zero in 2016 and 
2017  as  constant  tax  inflation  was  exactly  in  line 
with headline inflation in 2016 and 2017.  

Medium-term prospects 

to  partly  counteract 

Looking ahead, inflation is expected to continue to 
gradually  increase.  The  stronger  zloty  exchange 
rate  in  2018,  after  an  appreciation  in  late  2017  is 
expected 
strengthening 
pressure  from  accelerating  wages  amid  a  further 
tightening  of  the  labour  market.  The  Commission 
services'  Spring  2018  Forecast  projects  annual 
HICP inflation to average 1.3% in 2018 and 2.5% 
in 2019. 

Risks to the inflation outlook appear to be tilted to 
the  upside.  Wage  growth  could  accelerate  faster 
than  currently  projected  and  its  pass  through  to 
prices  can  become  stronger  than  was  recently 
observed.  Global  commodity  prices  and  the  zloty 
exchange rate can surprise both ways with ensuing 
higher or lower inflationary pressure.  

The  level  of  consumer  prices  in  Poland  was  at 
around 52% of the euro-area average in 2016. This 
suggests  a  significant  potential  for  price  level 
convergence in the long term, as GDP per capita in 
PPS (about 64% of the euro-area average in 2016) 
increases  towards  the  euro-area  average.  On  the 
other  hand,  in  the  last  decade  the  convergence  in 
income 
level  was  actually  associated  with 
divergence in comparative price levels.  

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,  to 
make  better  use  of  increased  labour  immigration 
and  to  facilitate  the  effective  allocation  of  labour 
market  resources  will  play  an  important  role  in 
limiting  wage  pressures,  resulting  inter  alia  from 
negative  demographic  developments.  As 
to 
product  markets,  there  is  scope  to  enhance  the 
competitive environment, especially in the services 
and  energy  sectors.  At  the  macro  level,  an 
to 
appropriate  monetary 

response 

policy 

Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

macroeconomic developments and a prudent fiscal 
stance  will  be  essential  to  contain  inflationary 
pressures. 

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 (44).  The 
general government deficit declined from 2.3% of 
GDP  in  2016  to  1.7%  in  2017.  The  ratio  of  total 
to  GDP  followed  a 
government  expenditure 
downward trend between 2010, when it amounted 
to  45.8%  of  GDP  and  2016  when  it  bottomed  at 
41.1%  of  GDP.  The  ratio  increased  marginally  to 
revenue 
in  2017.  Total  government 
41.2% 
remained at 38.8% of GDP in 2016 and increased 
to 39.6% of GDP in 2017. Its evolution was driven 
by  better  tax  collection,  especially  of  indirect 
taxes,  and  a  very  good  situation  on  the  labour 
market supporting income taxes and social security 
contributions. 

The  2017  headline  deficit  (1.7%  of  GDP)  turned 
out  to  be  significantly  lower  than  forecast  in  the 
2017  edition  of  the  Convergence  Programme 
(2.9%  of  GDP).  This  difference  stemmed  mainly 
from higher actual revenue supported inter alia by 
measures to improve tax compliance. At the same 
time,  expenditure,  in particular  gross fixed capital 
formation, remained at a lower level than projected 
in  the  Convergence  Programme.  In  turn,  the 
structural  deficit  followed  a  different  path.  After 
having reached 2½% of potential GDP in 2015, it 
decreased  to  2%  of  potential  GDP  in  2016  and 
remained  stable  in  2017.  This  occurred  in  the 
context  where  Poland's  economic  situation  and 
growth 
particularly 
performance 
favourable  conditions 
structural  and 
permanent fiscal consolidation. 

created 

for  a 

The  general  government  debt,  following 
its 
increase to 54.2% of GDP in 2016 (from 51.1% of 
GDP  in  2015),  decreased  to  50.6%  of  GDP  in 
2017.  The  evolution  of  the  general  government 
debt in 2016 and 2017 was driven mainly by fiscal 
deficits  and  valuation  effects 
the 
fluctuation  of  the  zloty  exchange  rate,  as  around 

reflecting 

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

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

governance/sgp/deficit/index_en.htm 

74 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

one  third  of  the  Polish  debt  was  denominated  in 
foreign currencies. 

6.3.2.  Medium-term prospects 

The 2018 budget was adopted on 11 January 2018. 
implies  a  continuation  of  major  policies 
It 
implemented  in  2017.  On  the  expenditure  side, 
social  spending  is  set  to  rise  further.  This  will  be 
driven  in  particular  by  the  full-year  impact  of  the 
lowering of the retirement age, which entered into 
force in the fourth quarter of 2017. On the revenue 
side,  a  further  increase  in  tax  collection  is 
expected.  It  is  set  to  occur  mainly  thanks  to 
macroeconomic  developments  and  additional 
measures to increase tax compliance, especially in 
the area of indirect taxation. The 2018 budget law 
projects the general government headline deficit at 
2.7%  of  GDP,  significantly  higher  than  projected 
in the Commission services' Spring 2018 Forecast 
1.4%  of  GDP.  This  is  due  to  the  assumption  of  a 
full 
the  central  government 
execution  of 
expenditure in the budget. 

According  to  the  Commission  services'  Spring 
2018 Forecast, under a no-policy-change scenario, 
the  general  government  headline  deficit  is  set  to 
stabilise at 1.4% of GDP in 2019. Simultaneously, 
against the background of strong economic growth 
and a consequently increasing positive output gap, 
the  structural  general  government  balance 
is 
forecast to deteriorate from around 2% of GDP in 
2017  to  2¼%  of  GDP  in  2019.  The  general 
to 
government  debt-to-GDP  ratio 

is  forecast 

decrease  to  49.1%  in  2019.  However,  considering 
that  an  important  part  of  the  sovereign  debt  is 
the  debt 
denominated 
projections are subject to considerable uncertainty. 

in  foreign  currencies, 

The national fiscal framework in Poland is overall 
strong.  The  numerical  fiscal  rules,  which  contain 
debt  and  expenditure  rules,  are  the  strongest 
element  of  the  framework.  A  debt  threshold 
anchored  in  the  Constitution  covers  the  general 
government,  while  a  separate  debt  rule  concerns 
local  governments.  Most  of 
the  general 
government  sector  is  subject  to  the  stabilising 
expenditure  rule  applied  for  the  first  time  for  the 
2015  budget.  The  amendments  to  the  rule  in  late 
2015 that allowed for higher expenditure limits in 
the  2016  budget  raised  concerns  about 
its 
credibility.  Since  then,  the  rule  has  not  been 
modified and the authorities have been committed 
to it. Medium-term budgetary planning is based on 
the Multiannual State Financial Plan which covers 
four years and serves as a basis for the preparation 
of annual budgets, but does not provide targets for 
them.  A  reform  to  strengthen  budgetary  planning 
and  procedures  is  underway.  Poland  has  no  fully-
fledged fiscal council and has no plans to set it up. 
Some  functions  performed  typically  by  fiscal 
councils  are  performed  by  different  separate 
bodies,  but  this  fragmented  set-up  reduces  their 
impact. 

75 

Table 6.3:(cid:9)Poland - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-3.7-4.1-3.6-2.6-2.3-1.7-1.4-1.4- Total revenues39.138.538.638.938.839.640.340.5- Total expenditure42.942.642.341.641.141.241.741.9   of which: - Interest expenditure2.72.51.91.81.71.61.51.5p.m.: Tax burden33.032.932.933.334.535.035.535.5Primary balance-1.1-1.6-1.7-0.9-0.6-0.10.10.1Cyclically-adjusted balance-3.8-3.4-3.0-2.3-2.0-2.0-2.2-2.2One-off and temporary measures0.10.0-0.20.00.00.00.00.0Structural balance 2)-3.9-3.4-2.8-2.3-2.0-2.0-2.2-2.2Government gross debt53.755.750.351.154.250.649.649.1p.m: Real GDP growth (%)1.61.43.33.83.04.64.33.7p.m: Output gap0.2-1.4-1.2-0.6-0.60.71.51.51) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

rates of the NBP and the ECB. In early 2018, the 
3-month  spread  vis-à-vis  the  euro  area  stood  at 
around 200 basis points. 

6.4. 

EXCHANGE RATE STABILITY 

The  Polish  zloty  does  not  participate  in  ERM  II. 
Since  April  2000,  Poland  has  been  operating  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. 

the 

range  of  4.3-4.5  PLN/EUR. 

The  zloty  was  trading  at  around  4.4  against  the 
euro  between  April  2016  and  late  2016,  mainly 
within 
It 
appreciated  between  December  2016  and  May 
2017,  cumulatively  by  almost  6%.  The  zloty  then 
weakened  somewhat  against  the  euro  until  early 
October  2017  (to  around  4.3  PLN/EUR) 
to 
subsequently  strengthen  again  during  the  rest  of 
2017.  Inter-day  exchange  rate  volatility  spiked  in 
summer  and  then  again  in  late  2016,  but  it 
moderated  over  2017.  In  early  2018,  the  zloty's 
exchange  rate  against  the  euro  was  at  about  4.2 
PLN/EUR.  Poland  had  benefited  from  a  Flexible 
Credit  Line  arrangement  with  the  IMF  between 
2009 and November 2017.  

International  reserves  held  by  the  NBP  increased 
from around EUR 90 billion in early 2016 to EUR 
108  billion  by  end-2016.  During  2017  reserves 
decreased  gradually  to  around  EUR  94  billion  by 
the  beginning  of  2018.  The  reserve-to-GDP  ratio 
was  at  around  20%  by  end-2017.  The  level  of 
international  reserves  was  mainly  influenced  by 
reverse 
debt 
transactions, 
management  decisions,  inflows  of  EU  funds  and 
FX fluctuations. 

sovereign 

repo 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  increased  slightly  in  2016  from  around 
190  to  about  200  basis  points.  They  remained 
remarkably stable at around that level in 2017 and 
in  early  2018,  in  line  with  the  unchanged  policy 

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 
with a residual maturity of around 9 years.  

The  Polish  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  last  convergence  assessment  in  2016.  It 
remained  at  a  level  slightly  below  3%  in  most  of 
2016  before  starting  to  gradually  rise  to  about 
3.4%  by  end-2017.  In  March  2018,  the  latest 
month  for  which  data  are  available,  the  reference 
value,  given  by  the  average  of  long-term  interest 
rates  in  Cyprus,  Ireland  and  Finland  plus  2 
percentage  points,  stood  at  3.2%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Polish  benchmark  bond  stood  at  3.3%,  i.e.  0.1 
percentage points above the reference value. 

76 

3.03.54.04.55.02012201320142015201620172018Graph 6.4: Poland -PLN/EUR exchange rate(monthly averages)Source: ECB.01002003004005002012201320142015201620172018Graph 6.5: Poland -3-M Wibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat.0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18PolandReference valueGraph 6.6: Poland -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services. 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

The  long-term  interest  rate  spread  vis-à-vis  the 
German  benchmark  bond  generally  hovered 
around  300  basis  points  over  the  past  two  years, 
with  the  exception  of  late  2016  and  early  2017 
when  it  was  somewhat  higher.  It  was  around  270 
basis points in early 2018 (45). 

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.  

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5),  which  concluded  that 
issues  related  to  the  external  investment  position 

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

in 

the  following  months  and 

The  long-term  interest  rate  of  Poland  increased 
from  below  3%  in  April  2016  to  around  3.8%  in 
early 2017, against the background of rising global 
long-term  yields.  Long-term  interest  rates  then 
decreased 
the 
benchmark  for  Poland  reached  around  3.2%  in 
June  2017.  Thereafter  it  slighlty  increased  again, 
mainly  reflecting  the  general  economic  recovery 
which fuelled expectations of monetary tightening 
by major central banks resulting in globally higher 
long-term  yields.  Poland's  long-term  interest  rate 
reached around 3.3% in early 2018. 

77 

-202462012201320142015201620172018PolandGermanyGraph 6.7: Poland -Long-term interest rates(percent, monthly values)Source: Eurostat.Table 6.4:(cid:9)Poland - Balance of payments(percentage of GDP)201220132014201520162017Current account-3.7-1.3-2.1-0.6-0.30.3of which: Balance of trade in goods-2.1-0.1-0.80.50.70.2                 Balance of trade in services1.51.92.22.53.34.0                 Primary income balance -3.1-3.0-3.4-3.4-4.0-3.8                 Secondary income balance0.0-0.1-0.1-0.2-0.30.0Capital account2.22.32.42.41.01.3External balance 1)-1.51.00.41.80.81.6Financial account-2.3-1.1-1.10.1-0.10.3of which: Direct investment-1.2-0.8-2.4-2.1-1.2-0.3                Portfolio investment-3.90.00.40.7-0.8-1.0                Other investment 2)0.6-0.50.71.4-2.93.1                Change in reserves2.20.20.10.24.8-1.5Financial account without reserves-4.5-1.3-1.3-0.1-4.91.8Errors and omissions-0.8-2.1-1.5-1.7-0.9-1.3Gross capital formation21.019.020.420.519.519.7Gross saving17.718.519.020.720.420.4Gross external debt72.170.571.270.475.167.8International investment position-65.3-68.9-69.1-62.1-60.7-60.71) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Poland. 
 
                                                           
 
 
 
 
 
existed but since overall risks remained limited, no 
In-Depth Review (IDR) was warranted for Poland. 
The  current  account  deficit  is  now  close  to 
balance,  allowing  the  net  international  investment 
position,  which  remains  negative  and  relatively 
large,  to  improve  slightly.  However,  external 
vulnerabilities  appear  to  be  contained,  given  that 
foreign direct investments account for a major part 
of  foreign  liabilities,  while  net  foreign  debt  has 
continued to gradually decline in recent years. 

6.6.1.  Developments  of 

the  balance  of 

payments 

Poland’s  external  balance  (i.e. 
the  combined 
current  and  capital  account)  has  stayed  positive 
since 2013, backed by a continued improvement in 
the  trade  balance.  The  deficit  in  the  current 
account  balance  had  decreased  consistently  since 
2014 and turned into a slight surplus in 2017. The 
trade  in  goods  balance  shifted  into  a  surplus  in 
2015  and  has  stabilised  in  positive  territory  since 
then,  partially  reflecting  a  drop  in  prices  of 
imported  energy  commodities.  The  gradual 
improvement  in  the  current  account  position  was 
also supported by consistently strong performance 
of  export  of  services.  In  2014-2016,  the  negative 
primary  income  balance  somewhat  widened  and 
the  secondary  income  balance  turned  slightly 
negative.  In  2017,  the  income  balances  remained 
broadly stable with a slight improvement. 

Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

private  sector  investment  remained  weak,  and  in 
relation  to  GDP  is  still  below  the  levels  observed 
among Poland's regional peers. 

Poland's  external  competitiveness  has  remained 
robust.  Poland's  export  performance  (as  measured 
by the growth of its exports relative to its markets) 
substantially  improved  in  2016,  but  in  2017  the 
pace  of  improvement  slowed  down.  This  was 
consistent 
cost-competitiveness 
developments.  After  some  years  of  depreciation, 
both  the  nominal  and  real  effective  exchange  rate 
stayed 
before 
stable 
appreciating in 2017. 

relatively 

2016, 

with 

in 

the  financial  account  of 

In 
the  balance  of 
payments, direct investment recorded a decreasing 
net inflow of 1.2% of GDP in 2016 and 0.3 % of 
GDP  in  2017, compared  with an  average of  3.4% 
of  GDP  per  annum  over  the  2005  –  2015  period. 
The  portfolio  investment  showed  net  inflows  in 
to  decreased 
2016  and  2017,  primarily  due 
residents’ holdings of equity abroad and moderate 
inflows  of  non-residents' 
the 
sovereign debt market. Other investment registered 
some  net 
in  2016,  followed  by  a  
noticeable outflow in 2017. 

financing  of 

inflows 

After  several  years  of  a  gradual  increase,  gross 
national  saving  (as  a  percentage  of  GDP)  has 
stabilised since 2015. The 2016 fall in gross saving 
of  the  corporate  and  the  government  sectors  was 
offset  by  higher  savings  by  households.  In  2017, 
the  corporate  sector  gross  saving  rebounded  and 
partially  compensated  for  decreased  household 
savings.  At  the  same  time,  gross  fixed  capital 
formation (as a percent of GDP) declined in 2016 
and  recovered  weakly  in  2017.  This  was  mainly 
driven  by  rising  public  investment  spending.  The 

According  to  the  Commission  services'  Spring 
2018 Forecast, which is based on national accounts 
data,  the  external  balance  is  expected  to  remain 
around 1.5% of GDP in both 2018 and 2019. 

Total  gross  external  debt  increased  considerably 
from 70.4% of GDP in 2015 to 75.1% of GDP in 
2016,  but  then  decreased  to  67.8%  of  GDP  in 
2017,  with 
international 
the  negative  net 
investment  position  (NIIP)  stabilising  at  around 
61%  of  GDP  in  2016  and  2017.  Although  this  is 
well beyond the indicative threshold set in the MIP 
scoreboard  (-35%  of  GDP),  a  major  part  of  the 

78 

0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 6.8: Poland -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 6.9: Poland -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100) 
 
 
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

Bank's  Ease  of  Doing  Business  Poland  scores 
comparatively  poorly  with  regard  to  starting  a 
business,  followed  by  the  sub-index  related  to 
the  World  Bank's 
enforcing  contracts. 
In 
Worldwide  Governance 
Poland 
Indicators 
performs  relatively  weakly  in  terms  of  "political 
stability  and  no  violence"  and  the  rule  of  law. 
According to the latest data, Poland lags behind in 
the  transposition  of  EU  directives  as  the  deficit 
was  at  1.5%,  which  is  substantially  above  the 
target 
the  European 
Commission in the Single Market Act (2011). 

(0.5%)  proposed  by 

to 

The  4th  Anti-Money  Laundering  Directive 
imposed  transposition  by  26  June  2017.  Poland 
communicated 
the  Commission  adopted 
measures  that  partially  transpose  the  directive  on 
17  April  2018,  only  after  a  reasoned  opinion  was 
addressed  by  the  Commission  to  Poland  on  8 
December  2017  due 
to  an  absence  of  an 
appropriate  response  to  the  letter  of  formal  notice 
from  19  July  2017.  The  Commission  is  analysing 
their 
the  communicated  measures 
completeness and conformity with the directive. 

to  assess 

The labour market situation is the best in Poland´s 
recent history and employment rates have risen to 
the  point  that  labour  shortages  are  affecting 
business  activity.  Overall, 
labour  market 
appears  flexible  as  it  is  easy  to  arrange  atypical 
work  contracts  and  employ  non-EU  nationals  and 
employment protection legislation does not appear 
to  be  very  strict  (as  also  measured  by  the  2013 
OECD  employment  protection  indicator).  The 

the 

NIIP  consists  of  the  accumulated  stock  of  foreign 
direct  investments.  Since  May  2009,  the  stability 
of the balance of payments had been supported by 
precautionary  access  to  the  IMF's  Flexible  Credit 
Line  (FCL)  arrangement.  Poland  gradually  exited 
from  the  arrangement,  lowering  the  size  of  the 
FCL  in  January  2015,  2016  and  2017  before 
terminating the access in November 2017. 

6.6.2.  Market integration 

Poland's economy is well integrated with the euro 
area  through  both  trade  and  investment  linkages. 
Trade  openness  increased  from  46%  in  2012  to 
some  53%  of  GDP  in  2017.  The  share  of  trade 
with euro-area partners expressed in percentage of 
GDP  has  also  been  increasing  in  recent  years, 
reaching  30%  in  2017.  Poland's  main  euro-area 
trade partners are Germany, the Netherlands, Italy 
and  France,  while  outside  the  euro  area  the  main 
partners  are  the  Czech  Republic,  Russia  and  the 
United Kingdom. 

FDI  inflows  to  Poland  have  mainly  originated 
from the Netherlands, Germany, Luxembourg and 
France,  which  together  provided  over  50%  of  the 
FDI stock at the end of 2016. The significant size 
and growth of the domestic market as well as good 
access  to  large  regional  markets  have  supported 
the attractiveness of the country for FDI. 

Concerning  the  business  environment,  Poland 
performs around the average of euro-area Member 
States  in  international  rankings.  In  the  World 

79 

Table 6.5:(cid:9)Poland - Market integration201220132014201520162017Trade openness 1) (%)45.946.948.549.751.353.1Trade with EA in goods & services 2)+3) (%)25.125.626.928.029.130.1Export performance (% change) 4)3.33.83.14.05.22.6World Bank's Ease of Doing Business Index rankings 5)554532252427WEF's Global Competitiveness Index rankings 6)414243413639Internal Market Transposition Deficit 7) (%)2.11.81.00.71.41.5Real house price index 8)101.196.397.4100.0102.3104.3Residential investment 9) (%)3.23.03.02.53.02.5 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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
structural  labour  market  challenges  include  low 
participation  of  certain  groups  and  lack  of  labour 
market flexibility in some areas, such as a limited 
use  of  part-time  employment  arrangements. 
Existing  barriers  to  labour  market  participation 
include disincentives to work originating from the 
benefit system and limited access to long-term care 
and  childcare.  Domestic 
is 
hampered by sector-specific arrangements (such as 
the  special  social  security  system  for  farmers), 
shortcomings  in  the  housing  market  and  the 
transport  infrastructure.  After  a  steady  rise  in 
immigration  in  recent  years,  non-EU  workers 
(especially  from  Ukraine)  now  play  an  important 
role in the Polish labour market. 

labour  mobility 

Poland's  financial  sector  is  well  integrated  within 
the  overall  EU 
system.  Foreign 
financial 
ownership  in  total  assets  of  the  Polish  banking 
sector  decreased  from  around  63%  in  2012  to 
around 48% by 2016, in line with the government's 
strategy 
ownership. 
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% at end-2016. 

domestic 

boost 

to 

Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

address the issue of foreign-currency denominated 
mortgage loans. 

According to Eurostat, real house prices in Poland 
started  to  increase  slowly  in  2014,  following  an 
earlier  decline  during  2011-2013.  Real  house 
prices  grew  by  about  2%  in  2017.  Investment  in 
dwellings has remained relatively stable at around 
2.5-3% of GDP, while net bank lending for house 
purchase remained weak. 

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  52%  of  GDP  in 
2017  from  around  50%  in  2012.  The  share  of 
foreign-currency  denominated  loans  (mainly  in 
Swiss franc and to lesser extent in euro) continued 
to decline, but it still amounted to about one-third 
of outstanding total housing loans. Sovereign-bank 
links  became  stronger  in  Poland  not  only  via 
increasing  state-ownership,  but  also  though  the 
rising  share  of  the  bank  tax  deductible  sovereign 
bonds  in  banks'  balance  sheet  (reaching  around 
14% of the total at end-2017). 

The  capital  adequacy  ratio  of  the  banking  sector 
increased to around 18% by  end-September 2017, 
which is close to the average of the euro area. The 
amount  of  non-performing  loans  fell  to  4.8%, 
somewhat above the euro-area average NPL level. 
Profitability,  as  measured  by  return  on  equity 
(ROE) decreased from double-digit levels early in 
the  decade  to  around  8%  by  the  third  quarter  of 
2017, which is above the average of the euro area. 
The  lower  bank  profitability  in  recent  years  is 
explained  mainly  by  record  low  interest  rates, 
higher  fiscal  burden  on  banks  via  the  tax  on 
financial  sector  assets  and  higher  contributions  to 
future, 
In 
the  Bank  Guarantee  Fund. 
profitability  of 
the  banking  sector  could  be 
negatively  affected  also  by  pending  proposals  to 

the 

The  total  capitalisation  of  the  Warsaw  Stock 
Exchange reached 33% of GDP in 2017, the same 
level as in 2012. The debt securities market is one 
of  most  liquid  in  the  region  but  remains  small  in 
comparison with the euro area (61% against 149% 

80 

010203040506070PL, 2012PL, 2016EA, 2012EA, 2016Concentration 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. -505101520PL, 2012PL, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 6.11: Poland -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180PL, 2012PL, 2017EA, 2012EA, 2017Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 6.12: Poland -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. 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 6 - Poland 

of  GDP)  and  is  dominated  by  government  bonds. 
Consolidated  private  sector  debt  increased  from 
around  73%  in  2012  to  76%  of  GDP  in  2017, 
significantly below the euro-area average. 

81 

 
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  2016.  Therefore, 
the 
comments  provided  in  the  Convergence  Report 
2016 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 Finance  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 

83 

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 2018 - 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  7.1.2.,  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 

84 

 
Convergence Report 2018 - 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. 
The  Romanian  authorities  are  invited  to  remedy 
the abovementioned incompatibilities.  

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  below  the 
reference value at the time of the last convergence 
assessment  of  Romania  in  2016.  It  has  increased 
steadily  since  then,  moving  into  positive  territory 
since  May 2017  and gradually  increasing  to  1.1% 
by  December  2017.  In  March  2018,  the  reference 
value  was  1.9%,  calculated  as  the  average  of  the 
12-month average inflation rates in Cyprus, Ireland 
and  Finland  plus  1.5  percentage  points.  The 
corresponding inflation rate in Romania was 1.9%, 
i.e.  at  the  reference  value.  The  12-month  average 

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);  

85 

-20246Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18RomaniaReference valueGraph 7.1: Romania -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast. 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

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

inflation  remained  subdued  (0.5%)  due  to  lower 
excise duties on fuel between January and October. 

7.2.2.  Recent inflation developments 

Inflation  in  recent  years  has  been  markedly 
influenced  by  successive  reductions  of  the  VAT 
rates  for  different  categories  of  products  and  in 
2016, also by decreasing global oil prices. Inflation 
entered negative territory in June 2015, mainly on 
account of a cut of the VAT rate on food from the 
standard 24% rate to a reduced 9% and persistently 
weak energy inflation. Inflation further declined in 
the  first  quarter  of  2016  after  the  standard  VAT 
rate was cut by 4 percentage points to 20%. After 
reaching  a  -3%  low  in  May  2016,  HICP  inflation 
progressively increased, but remained subdued due 
to a further 1 percentage point cut in the standard 
VAT  rate  in  January  2017  and  a  reduction  in 
excise duties on fuel. Inflation started to accelerate 
in  the  second  half  of  2017,  moving  from  0.6%  in 
August to 2.6% in December 2017. Overall, HICP 
inflation  was  1.1%  in  2017.  Inflation  further 
accelerated  in  early  2018  as  the  effect  of  the 
January 2017 tax cuts faded away, reaching 4% in 
March. 

In  2016,  core 
inflation  (measured  as  HICP 
inflation  excluding  energy  and  unprocessed  food) 
was  slightly  negative  (-0.2%)  but  significantly 
higher  than  headline HICP  inflation  (-1.1%).  This 
sharp difference mainly reflecting the steep drop of 
energy  prices  (-4.4%)  that  was  in  line  with 
declining global fuel prices.  Over the course of the 
2017,  core  inflation  increased  by  more  than  1.5 
percentage  points,  from  0.3%  in  January  to  1.9% 
in  December  and  reached  0.8%  for  the  year  as  a 
whole.  Core  inflation  in  2017  was  slightly  lower 
than  headline  inflation  (1.1%)  as  energy  price 

Both  processed  and  unprocessed  food  price 
inflation were negative in 2016, mainly due to the 
4  percentage  points  VAT  rate  cut  taking  effect  in 
January. In 2017, processed and unprocessed food 
price  inflation  turned  positive  despite  a  further  1 
percentage  point  cut  in  the  VAT  rate.  Similarly, 
non-energy  industrial  goods  price  inflation  was 
negative  (-0.7%)  in  2016  and  turned  positive 
(0.9%)  in  2017.  Services  price  inflation  remained 
subdued in both 2016 (0.7%) and 2017 (-0.5%). 

Producer  prices  in  industry,  which  had  fallen  for 
three  consecutive  years,  accelerated  in  2017  and 
grew by 3.6% for the year as a whole. 

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 4.8% 

86 

-4-202462012201320142015201620172018RomaniaEuro areaGraph 7.2: Romania -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 7.1:(cid:9)weights  Romania - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP3.43.21.4-0.4-1.11.11.91000Non-energy industrial goods2.42.01.61.0-0.70.91.1274Energy6.94.12.3-2.7-4.40.53.3121Unprocessed food 0.66.4-0.7-3.4-2.52.93.3153Processed food3.52.30.2-1.6-0.92.23.0214Services4.22.63.12.20.7-0.50.4238HICP excl. energy and unproc. food3.32.31.70.7-0.20.81.4725HICP at constant tax rates 3.23.01.11.22.12.02.51000Administered prices HICP5.36.02.01.6-2.5-2.3-0.71091) 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 2018 - Technical annex 

Chapter 7 - Romania 

increase  further,  to  3¾ ¼%  in  2018  and  4¼%  in 
2019. 

The  BNR,  operating  within  an  inflation  targeting 
framework (46),  increased  the  key  policy  rate  in 
January  and  February  2018  by  a  total  of  50  basis 
points  to  2.25%,  the  first  policy  rate  hikes  in 
almost  a  decade.  Reserve  requirement  ratio  for 
foreign  currency  denominated 
liabilities  was 
further  reduced  to  8%  in  May  2017  but  kept 
unchanged  afterwards.  Reserve  requirement  ratio 
for leu denominated liabilities has been kept at 8% 
since  May  2015.  Credit  growth  turned  positive 
(1.2%) in 2016 on the back of a robust growth of 
mortgages, although corporate and consumer credit 
continued to contract. Credit growth further picked 
up in 2017 (4.3%) as mortgages continued to grow 
while both corporate and consumer credit returned 
to growth in the second half of the year. 

Wages and labour costs 

Labour  market  conditions  have  improved  in  line 
with  the  strong  economic  growth  in  2016-17. 
Against the background of an improved economic 
outlook,  activity  and  employment  rates  increased 
substantially 
the 
unemployment  rate  decreased  from  5.9%  in  2016 

period  while 

this 

in 

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

inflation target of 2.5% (± 1 percentage point.). 

in  2016,  with  private  consumption  serving  as  the 
main  motor  of  growth.  Real  GDP  growth 
accelerated further to almost 7% in 2017 as private 
consumption  continued  booming,  spurred  by 
indirect  tax  cuts  and  significant  hikes  in  both 
public  and  private  wages.  After  contracting  in 
2016,  investment  returned  to  growth  in  2017  on 
the  back  of  rising  private  investment  in  both 
machinery and equipment and residential housing. 
Public  investment,  however,  fell  sharply  for  the 
second  consecutive  year.  The  boom  in  private 
consumption also drove an acceleration of imports. 
As a consequence, despite relatively strong export 
growth, net exports have worked as a drag on real 
GDP  growth.  The  growth  of  private  consumption 
is  expected  to  temper  in  2018,  as  inflation  is 
expected to weight more heavily on real disposable 
incomes  and  wage  growth  is  expected  to  slow 
down. Consequently, Commission services' Spring 
2018  Forecast  GDP  growth  to  decelerate  to  4.5% 
in  2018  and  3.9%  in  2019.  The  output  gap  is 
estimated  to  have  turned  positive  in  2017  and  is 
forecast  to  remain  relatively  stable  over  the 
forecast horizon.  

The fiscal stance, as measured by the change in the 
structural  balance,  has  been  loosened  since  2016 
and  continues  to  be  pro-cyclical.  The  structural 
deficit has been on an increasing path since 2015. 
According  to  the  Commission  services'  Spring 
2018 Forecast, the structural deficit is projected to 

87 

Table 7.2:(cid:9)Romania - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationRomania3.43.21.4-0.4-1.11.14.23.4Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorRomania4.62.61.20.90.92.04.23.4Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeRomania9.43.86.71.910.116.08.76.7Euro area1.81.61.41.41.21.62.41.9Labour productivityRomania6.44.42.35.35.84.23.63.9Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsRomania2.9-0.64.3-3.34.111.34.92.7Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorRomania7.5-6.5-1.9-1.3-1.44.94.03.1Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
                                                           
 
 
 
 
 
to 4.9% in 2017, the lowest level in more than 20 
years. 

The  very  tight  labour  market,  coupled  with  a 
declining labour force due to a shrinking working 
age population and persistent skills shortages, have 
led  to  an  acceleration  of  wage  growth  in  recent 
years.  The  nominal  compensation  per  employee 
increased  by  10%  in  2016  and  16%  in  2017,  also 
driven  by  public-sector  wage  increases  and  19% 
and  16%  minimum  wage  hikes  in  May  2016  and 
February  2017,  respectively.  Wages  are  expected 
to  continue  to  grow  in  2018,  albeit  at  a  slower 
pace, due to further increases in public wages and 
an  additional  9%  increase  in  the  net  minimum 
wage which took effect in January. 

Labour  productivity  per  person  grew  by  5.8%  in 
2016  and  4.2%  in  2017.  Over  2018-19  labour 
productivity  is  forecast  to  continue  growing  by 
more  than  3%  per  year.  The  growth  of  labour 
compensation  outpaced  that  of  productivity  in 
2016 and 2017, resulting in significant increases in 
nominal  unit  labour  costs  (4.2%  in  2016  and 
10.3% in 2017), which could weigh on Romania's 
competitiveness.  According  to  the  Commission 
services' Spring 2018 Forecast, ULC are expected 
to  continue  growing  in  2018  and  2019  –  albeit  a 
somewhat slower pace than in 2016-17.   

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 price inflation in 
these 
Romania,  given 
categories in the Romanian HICP and the fact that 
Romania is a net importer of both energy and food. 

large  weight  of 

the 

Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

Import price inflation (measured by the imports of 
goods  deflator)  was  negative  and  significantly 
below consumer price inflation in 2016 as the price 
of  fuel  commodities  declined.  With  the  price  of 
fuel  commodities  increasing  again,  import  price 
inflation 
rose 
significantly above the inflation rate. 

in  2017  was  positive  and 

Fluctuations  of  the  leu  have  only  moderately 
influenced  import  price  dynamics  in  recent  years. 
The  nominal  effective  exchange  rate  (measured 
against  a  group  of  36  trading  partners)  has 
remained broadly stable in the last two years. 

Administered prices and taxes 

in 

influenced 

considerably 

Changes  in  administered  prices  and  indirect  taxes 
have 
inflation 
developments 
recent  years.  Administered 
prices (47) have  a  slightly  larger  weight  in  the 
Romanian  HICP  basket  than  in  the  euro  area 
(14.1% compared to 13.4% in 2017). The average 
annual change in administered prices was -2.5% in 
2016  and  -2.3%  in  2017,  substantially  below 
headline  inflation  rate.  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 
declining  global  commodity  prices  in  2016.  In 
2017,  electricity  prices  increased  somewhat  while 
gas prices remained stable, but other administrated 
prices declined. 

Tax changes have markedly influenced inflation in 
Romania  in  the  last  two  years.  HICP  inflation 
measured  at  constant  taxes  was  2.1%  in  2016, 
more  than  3  percentage  points  higher  than  the 
headline HICP inflation rate, reflecting a reduction 
in  the  standard  VAT  rate  from  24%  to  20%.  In 
2017,  HICP  inflation  measured  at  constant  taxes 
was 2%, almost 1 percentage point higher than the 
headline  inflation  rate,  as  the  standard  VAT  rate 
was  further  cut  to  19%  and  excise  duties  on  fuel 
were reduced between January and October 2017.  

(47)  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 

88 

-4048121620122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 7.3: Romania -Inflation, productivity and wage trends(y-o-y percentage change)Source: Eurostat, Commission services' Spring 2018 Forecast. 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

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. 

7.3. 

PUBLIC FINANCES 

7.3.1.  Recent fiscal developments 

Since  2016  the  authorities  have  been  pursuing  an 
expansionary, pro-cyclical fiscal policy, driven by 
indirect tax cuts and increases to public wages and 
old-age  pensions.  In  particular,  the  standard  VAT 
rate was cut by 4 percentage points in 2016 and by 
an  additional  1  percentage  point  in  2017.  On  the 
expenditure  side,  public  wages  were  significantly 
in  2018.  The 
in  2017  and 
increased  both 
government  has  been  also  pursuing  significant 
increases  to  old-age  pensions,  going  beyond  the 
standard  pension  indexation  mechanism.  On  the 
other  hand,  public  investment  fell  in  2016  and 
2017 to a post- EU accession low. 

in  2017.  Due 

The  headline  deficit  increased  sharply  from  0.8% 
of GDP in 2015 to 3.0% in 2016 and slightly fell to 
the  fiscal  measures 
to 
2.9% 
undertaken  and  due  to  economic  growth  above 
potential,  the  structural  deficit  increased  from 
around  ¼%  of  potential  GDP  in  2015  to  around 
in  2017.  General 
2% 
government debt fell from 37.7% of GDP in 2015 
to 35% of in 2017, thanks to strong GDP growth. 

in  2016  and  3¼% 

Medium-term prospects 

According  to  the  Commission  services'  Spring 
2018  Forecast,  annual  HICP  inflation  is  projected 
to  increase  to  4.2%  in  2018  as  demand  pressures 
mount and the effect of the January 2017 tax cuts 
fades  away.  The  reversal  of  the  January  excise 
duties  cut  in  October  2017  and  higher  global  oil 
prices  should  further  push  up  energy  prices  and 
hence  inflation  in  2018.  As  the  growth  in  energy 
prices  tempers,  inflation  is  forecast  to  decline  to 
3.4% in 2019. 

Risks to the inflation outlook are broadly balanced. 
Downside risks stem from possible additional cuts 
in  indirect  taxes,  which  could  have  a  dampening 
effect  on  inflation.  Upside  risks  to  the  projection 
relate mainly to a stronger-than-expected build-up 
of domestic demand and wage pressures. The size 
and timing of the impact on inflation of the BNR's 
ongoing  monetary 
remains 
uncertain. 

tightening 

also 

In  2016,  the  level of consumer prices  in  Romania 
was  about  51%  of  the  euro  area  average  and  the 
GDP  per  capita  was  about  55%  of  the  euro  area 
average in PPS terms. In line with the catching-up 
of  the  Romanian  economy,  further  price  level 
convergence is expected. 

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 

89 

Table 7.3:(cid:9)Romania - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-3.7-2.1-1.3-0.8-3.0-2.9-3.4-3.8- Total revenues33.633.233.635.031.630.530.931.1- Total expenditure37.235.435.035.834.633.434.334.9   of which: - Interest expenditure1.71.81.61.61.51.31.41.4p.m.: Tax burden27.827.327.428.026.625.826.025.9Primary balance-1.9-0.40.30.8-1.5-1.6-2.0-2.4Cyclically-adjusted balance-1.9-0.9-0.30.1-2.5-3.3-3.9-4.2One-off and temporary measures0.50.00.00.3-0.40.0-0.10.0Structural balance 2)-2.4-0.9-0.3-0.2-2.1-3.3-3.8-4.2Government gross debt36.937.539.137.737.435.035.336.4p.m: Real GDP growth (%)1.23.53.14.04.86.94.53.9p.m: Output gap-5.1-3.6-3.1-2.5-1.51.21.41.11) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
 
 
 
 
 
in 

Since  2016  Romania  has  been  diverging  from  its 
Medium-Term budgetary Objective as required by 
regulation  1466/97.  As  a 
the  Council 
consequence,  a  significant  deviation  procedure 
(SDP)  was  launched  in  spring  2017.  On  16  June 
the  Council  issued  a  recommendation  asking 
Romania  for  an  annual  structural  adjustment  of 
0.5%  of  GDP  in  2017.  On  22  November  the 
Commission concluded that Romania did not take 
effective  action 
the  Council 
in  response 
recommendation  so  that  on  5  December  the 
Council issued a revised recommendation in which 
it  asked  for  a  structural  adjustment  of  0.8%  of 
GDP in 2018. 

to 

7.3.2.  Medium-term prospects 

The  2018  budget  was  adopted  by  Parliament  in 
December  2017.  It  aims  at  a  general  government 
deficit of just below 3% of GDP. The unified wage 
law  enacted  in  summer  2017  increased  gross 
wages in the public sector by 25% in January 2018 
and  contains  additional  increases  for  doctors  and 
teachers.  Old-age  pensions  will  continue  to  be 
increased  beyond  the  standard  pension  indexation 
mechanism. A shift of social security contributions 
from the current 22.75% for employers and 16.5% 
for  employees  to  2.25%  and  35%,  respectively, 
will partially contain the fiscal cost of the increases 
of  gross  wages  in  the  public  sector  in  2018.  
Moreover,  the  personal  income  flat  tax  (PIT)  rate 
has been cut from 16% to 10%. 

The  Commission  in  the  spring  2018  forecast 
projects  the  general  government  budget  deficit  to 
increase  to  3.4%  of  GDP  in  2018  and  to  3.8%  in 
2019. The structural deficit is projected to increase 
to  around  3¾%  and  4¼%  in  2018  and  2019, 
respectively.  The  public-debt-to-GDP  ratio 
is 
forecast to increase to 35.3% in 2018 and 36.4% in 
2019.  

Over  the  last  decade,  Romania  has  significantly 
strengthened  its  fiscal  framework  in  terms  of 
principles  and  rules  grounded  in  legislation  (in 
particular  the  Fiscal  Responsibility  Law)  and  the 
setting-up  of  an 
independent  Fiscal  Council. 
Romania is bound by the Fiscal Compact based on 
its own declaration of intention and has transposed 
its provisions in the national legal order. However, 
the fiscal framework's implementation track record 
has been poor in recent years. While the structural 
balanced-budget  rule  requires  compliance  with  or 
convergence 
the  medium-term  budgetary 
objective  (with  a  lower  deficit  limit  of  1%  of 

to 

Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

GDP), in 2016 the structural deficit increased well 
above  the  medium-term  objective,  thus  breaching 
the rule. Both the 2017 and 2018 budgets target a 
headline  deficit  of  close  to  3%  of  GDP,  which  in 
the presence of an increasing output gap implies a 
further  deterioration  of  the  structural  balance, 
again  contrary  to  the  structural  balanced-budget 
rule.  Additionally,  both  in  2016  and  2017  budget 
amendments  were  adopted  in  breach  of  the  rules 
prohibiting  increases  during  the  fiscal  year  of  the 
headline and primary deficit ceilings, of personnel 
expenditure  and  of  total  government  expenditure 
excluding EU funds. The medium-term fiscal plans 
are  not  adequately  guiding  the  budgetary  process; 
as in each of the last three years the fiscal strategy 
–  which  sets  out  the  medium-term  budgetary 
planning  –  was  adopted  at  the  same  time  as  the 
budget  law  and  way  past  the  statutory  deadline. 
Finally, 
the  Fiscal  Council's  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 (48).  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 
currency 
has, 
intervention 
remains  available  as  a  policy 
instrument. 

nonetheless, 

stressed 

that 

The leu's exchange rate against the euro displayed 
a  stable  behaviour  until  September  2016,  when  it 
has  started  to  depreciate.  Leu’s  depreciation  was 
spurred  by  Romania’s  pro-cyclical  fiscal  policy 
leading to increase in imports and a higher current 
inflation 
account 
expectations.  The  exchange  rate  reached  4.63 
RON/EUR  at  the  end  of  2017  and  continued  to 
depreciate  in  early  2018  up  to  4.66  RON/EUR  in 
March 2018, reaching the highest level since 2012. 

higher 

deficit 

and 

by 

(48)  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. 

90 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

increase  afterwards.  The  increase  was  especially 
pronounced  in  the  second  half  of  2017  and  the 
spread reached almost 250 basis points by the end 
of  2017.  In  January  and  February  2018,  the  NBR 
increased  the  key  policy  rate  for  the  first  time  in 
almost  a  decade.  Further  monetary  policy 
tightening  is  expected  in  the  light  of  recent 
increases  in  inflation  and  due  to  the  upside 
inflationary  risks  stemming  from  the  announced 
pro-cyclical fiscal measures. In March 2018, the 3-
month  spread  vis-à-vis  the  euro  area  stood  at 
around 240 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 9 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 2016. Since then, it declined further to 
around  3.3%  in  October  2016  before  increasing 
moderately  again  over  the  rest  of  2016  and  2017. 
In March 2018, the latest month for which data are 
available, the reference value, given by the average 
of  long-term  interest  rates  in  Cyprus,  Ireland  and 
Finland plus 2 percentage points, stood at 3.2%. In 
that  month,  the  12-month  moving  average  of  the 
yield  on  the  Romanian  benchmark  bond  stood  at 
4.1%, 
the 
reference value. 

i.e.  0.9  percentage  points  above 

During  the  two  years  before  this  assessment,  the 
leu  depreciated  against  the  euro  by  about  4%.  In 
comparison  with  other  regional  peers  operating 
under 
leu's 
exchange 
exchange rate  against  the  euro  remains  relatively 
less volatile. 

floating 

rate, 

the 

international 

The NBR's gross international reserves were on an 
increasing  path  over  much  of  2016-17  period, 
going from around 35bn EUR in the first quarter of 
2016 to almost 39bn EUR in the second quarter of 
2017.  Romanian  gross 
reserves 
decreased  in  the  second  half  of  2017  due  to  the 
central  bank’s  reduction  of  the  banks'  required 
reserves  denominated  in  foreign  currency,  re-
payments  of  financial  assistance  loans  to  the 
European Commission and World Bank and due to 
exchange 
bank 
possible 
intervention  aimed  at  preventing  a  steeper 
depreciation 
currency.  The 
international  reserves  level  was  at  around  37bn 
EUR  or  20%  of  GDP  by  end-2017.  In  2018, 
international reserves kept decreasing.  

foreign 

central 

local 

the 

of 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  were  stable  between  100  and  110  basis 
points  over  the  course  of  2016  and  started  to 

Long-term  interest  rates  declined  gradually  from 
some  3.5%  in  April  2016  to  2.9%  in  September 

91 

3.03.54.04.55.02012201320142015201620172018Graph 7.4: Romania -RON/EUR exchange rate(monthly averages)Source: ECB.02004006002012201320142015201620172018Graph 7.5: Romania -3-M Robor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Romania.0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18RomaniaReference valueGraph 7.6: Romania -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services. 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

international  investment  position,  in  particular  by 
reducing net  external  debt.  Reflecting  catching-up 
dynamics, most of the net international investment 
position  relates  to  net  foreign  direct  investment 
liabilities,  which  mitigates  external  risks.  Public 
debt  as  a  share  of  GDP  declined  slightly  in  2016 
and  remains  relatively  low.  However,  the  fiscal 
deficit  is  set  to  remain  high  in  the  medium  term, 
with  a  negative 
the  public  debt 
impact  on 
dynamics.  

7.6.1.  Developments  of 

the  balance  of 

payments 

Romania's  external  balance  (i.e.  the  combined 
current and capital account) has been progressively 
deteriorating. Since 2014, the external position has 
been  worsening  on  account  of  widening  current 
account  deficits  and,  in  2017,  stood  at  1.2%  of 
GDP,  the  lowest  level  in  five  years.  Despite 
increasing  export  market  shares,  the  growth  of 
imports  spurred  by  booming  private  consumption 
has  persistently  outpaced  that  of  exports.  The 
positive balance of trade in services driven mainly 
by  exports  of  transportation  and  IT  services 
continued  to  be  above  4%  of  GDP  in  2016  and 
2017,  but  could  not  offset  the  negative  and 
widening deficit in the trade of goods. The balance 
remained  negative 
of  primary 
the  outflow  of 
reflecting  mainly 
investment 
income 
the  country's  negative  net 
to 
international  investment  position.  The  balance  of 
secondary 
income,  which  consists  mainly  of 
remittances,  continues  to  be  positive  but  was 
outweighed  by  the  negative  balance  of  primary 
income. The capital account surplus was relatively 
stable  as  a  share  of  GDP  up  to  2016  but  dropped 
significantly afterwards, reflecting the slow uptake 
of projects financed by EU funds under the 2014-
2020 programming period. 

incomes  has 

linked 

and 

developments 

2016.  In  October  2016,  they  started  to  increase 
until March 2017 when they reached a new high at 
4.5%.  These  movements  reflected  expectations  of 
higher domestic short-term interest rates related to 
fiscal 
international 
environment of increasing long-term yields. At the 
same  time,  the  long-term  spread  vis-à-vis  the 
German  benchmark  bond  declined  from  around 
340 basis points in April 2016 to below 300 basis 
points in October 2016 when it started to increase 
again.  In  March  2018,  it  stood  at  400  basis 
points (49).  

an 

7.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination  of  other  factors relevant  to  economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
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  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP  -  see  also  Box  1.5),  which  concluded  that 
issues  related  to  the  external  investment  position 
and  the  sustainability  of  the  fiscal  policy  existed 
but 
remained 
contained,  no 
(IDR)  was 
warranted  for  Romania.  The  current  account 
deficit  deteriorated  in  2016  on  the  back  of  strong 
private  consumption,  but  strong  GDP  growth 
allowed  for  an  improvement  of  the  negative  net 

since  macroeconomic 

In-Depth  Review 

risks 

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

92 

-2024682012201320142015201620172018RomaniaGermanyGraph 7.7: Romania -Long-term interest rates(percent, monthly values)Source: Eurostat.0102030201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 7.8: Romania -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services. 
 
                                                           
 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

Current  account  developments  in  Romania  also 
reflect  the  evolution  of  the  savings-investment 
balance.  Romania's  saving-investment  balance 
deteriorated in 2016-17. Gross national saving as a 
share of GDP fell to 21.8% in 2016 and 21.3% in 
2017,  mainly  due  to  a  decline  in  gross  public 
savings.  Investment  also  declined  as  a  share  of 
GDP to 24% in 2016 and 24.4% in 2017. 

Export  performance  has  been  strong  in  2016-17 
despite growing unit labour costs and an effective 
exchange  rate.  Export  market  shares  increased  by 
8.5% in 2016, the highest rate of growth in the EU, 
and by 3.3% in 2017. 

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  EU-IMF  programme  and  two 
successor  programmes  (2011-2013  and  2013-
2015)  has  enabled  Romania  to  regain  full  market 
access since mid-2011. The latter two programmes 
were  treated  as  precautionary  and  no  drawings 
were made. Romania has repaid all liabilities to the 
IMF  and  77%  of  its  liabilities  to  the  EU.  Post-
programme  surveillance,  which  started  in October 
2015  after  the  end  of  the  third  programme,  has 
ended  at  the  beginning  of  April  2018,  when  70% 

of  the  financial  assistance  from  the  European 
Union  has  been  repaid.  The  outstanding  amount 
(EUR 1.15 bn of the EUR 5 bn loan under the first 
programme) is equivalent to 0.6% of GDP. 

After  net  FDI  inflows  had  improved  reaching  an 
average of 2% of GDP in 2013-2015, they further 
increased to above 2.5% of GDP in 2016-17. After 
2015,  the  net  portfolio  inflows  have  started  to 
increase gradually reaching 1.5% of GDP in 2017. 
Other investment continued to record net outflows 
over and 2016 and 2017. Despite a widening of the 
current account deficit, Romania's net international 
investment  position  continued  to  improve  on  the 
back  of  high  nominal  GDP  growth  rates  and 
declined to -49.9% of GDP in 2016 and -46.6% in 
2017.  Gross  external  debt  was  55.3%  in  GDP  in 
2016 and 50.3% in 2017. 

According  to  the  Commission  services'  Spring 
2018 Forecast, the external balance is expected to 
continue worsening in 2018 and 2019, mainly due 
to  a  widening  trade  deficit.  The  current  account 
deficit is expected to be 3.6% in 2018 and 3.9% in 
2019.  The  capital  account  surplus,  however,  is 
expected to improve, reflecting a higher absorption 
of EU funds under the 2014-2020 programme. 

93 

Table 7.4:(cid:9)Romania - Balance of payments(percentage of GDP)201220132014201520162017Current account-4.8-1.1-0.7-1.2-2.1-3.4of which: Balance of trade in goods-6.9-4.0-4.3-4.9-5.4-6.3                 Balance of trade in services1.93.33.94.24.54.2                 Primary income balance -1.7-2.2-1.3-2.4-2.6-2.6                 Secondary income balance2.01.91.11.71.51.4Capital account1.42.12.62.42.51.2External balance 1)-3.41.02.01.20.4-2.2Financial account -2.51.11.91.40.9-1.8of which: Direct investment-1.9-2.0-1.8-1.8-2.7-2.4                Portfolio investment-2.6-3.8-1.90.0-0.6-1.5                Other investment 2)3.15.56.63.62.81.9                Of which International financial assistance1.13.33.01.80.10.6                Change in reserves-1.11.4-0.9-0.41.30.2Financial account without reserves-1.4-0.32.91.8-0.4-2.0Errors and omissions0.90.10.00.20.50.4Gross capital formation26.825.624.725.224.024.4Gross saving22.624.924.524.621.920.9Gross external debt75.368.263.057.455.350.3International investment position-67.4-62.6-57.3-54.6-49.9-46.61) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Romania. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

by 47% in 2016 but declined by 21% in 2017. The 
inward FDI stock reached 44.7% of GDP in 2016 
and  42.6%  in  2017.  FDI  inflows  originate  mainly 
from 
the 
euro-area  Member  States,  with 
Netherlands,  Austria  and  Germany  accounting  for 
about half of the FDI stock at the end of 2017.  

environment, 

the  business 

Concerning 
the 
performance  of  the  country  is  relatively  weak 
compared  to  most  euro-area  Member  States  in 
international  rankings.  In 
the  WEF's  Global 
Competitiveness  Index,  Romania's  position  is  still 
low  and  deteriorating  (68  out  of  137),  with 
government  efficiency,  bureaucracy  and 
the 
quality  of  infrastructure  as  the  most  problematic 
factors.  On  the  World  Bank's  Ease  of  Doing 
Business 
indicator  Romania's  rank  has  also 
deteriorated.  The  most  problematic  issues  include 
dealing  with  construction  permits  and  getting 
electricity.  Moreover,  the  ranking  in  terms  of 
public  administration  performance 
(including 
government  effectiveness,  control  of  corruption, 
voice and accountability, political stability and no 
violence, regulatory quality and rule of law) scores 
relatively  poorly  according  to  the  World  Bank's 
Worldwide  Governance  Indicators.  According  to 
the  December  2017  Internal  Market  Scoreboard, 
Romania's  transposition  deficit  of  EU  Directives 
was  at  2.0%,  above  the  EU  average  of  1.5%  and 
above the target (0.5%) proposed by the European 
Commission in the Single Market Act (2011).  The 
4th  Anti-Money  Laundering  Directive  imposed 
transposition by 26 June 2017. A reasoned opinion 
was addressed by the Commission to Romania on 

94 

7.6.2.  Market integration 

Romania's  economy  is  well  integrated  with  the 
euro  area  through  both  trade  and  investment.  The 
increased 
trade  openness  of  Romania  has 
significantly  in  the  aftermath  of  the  crisis,  but  is 
still  relatively  low.  Trade  openness  in  2016  and 
2017 stood at around 45% of GDP, respectively. In 
2017  Romania's  main  trading  partners  within  the 
euro  area  are  Germany,  Italy  and  France,  while 
outside  the  euro  area  it  mainly  trades  with 
Hungary,  the  United  Kingdom,  and  Poland.  The 
share  of  trade  with  the  euro  area  expressed  in 
percentage  of  GDP  has  been  increasing  in  recent 
years and has stabilized at around 25% in 2016 and 
2017. 

Romania  attracted  substantial  amounts  of  FDI  in 
the past decade. However, FDI inflows have been 
volatile in recent years. Net FDI inflows increased 

8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 7.9: Romania -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100)Table 7.5:(cid:9)Romania - Market integration201220132014201520162017Trade openness 1) (%)43.844.045.044.945.145.7Trade with EA in goods & services 2)+3) (%)22.724.024.625.025.425.8Export performance (% change) 4)0.616.93.90.85.24.0World Bank's Ease of Doing Business Index rankings 5)727348373645WEF's Global Competitiveness Index rankings 6)787659536268Internal Market Transposition Deficit 7) (%)1.20.41.11.01.12.0Real house price index 8)104.4101.498.1100.0105.0109.2Residential investment 9) (%)3.12.42.42.42.6n.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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

8  December  2017  due  to  an  absence  of  an 
appropriate  response  to  the  letter  of  formal  notice 
from  19  July  2017.  Transposition  measures  are 
expected to be adopted in May 2018. 

days  overdue)  have  increased  significantly  in  the 
post-crisis period (i.e. from below 2% in 2007). 

However, the measures implemented since 2014 to 
facilitate  the write off and sale of non-performing 
loans led to their decline from above 20% in 2014 
to below 7% by the end of 2017.  

Romania  has  continued  to  show  a  comparatively 
low  penetration  of  financial  services.  Insurance 
penetration  (i.e.  the  ratio  between  gross  written 
premiums for life and non-life insurance and GDP) 
in  Romania  is  still  one  of  the  lowest  in  the  EU, 
whereas the insurance market continues to remain 
highly  dependent  on  compulsory  car  insurance.  
The  private  pension  system  including  mandatory 
pension  funds  (Pillar  II)  and  voluntary  pension 
funds  (Pillar  III)  recorded  a  positive  trend  until 
2017.  The  total  net  assets  of  the  Pillar  II  pension 
funds  increased  from  0.2%  of  GDP  in  2008  to 
roughly  4.6%  of  GDP  in  2017.  However,  starting 
in  January  2018,  the  government  reduced  the 
social  security  contributions 
the  private 
mandatory  pension  pillar  (Pillar  II)  from  5.1%  to 
3.75% of gross wages. 

to 

labour  market  suffers 

The  Romanian 
from 
significant  structural  challenges.  Unfavourable 
demographic  trends  are  expected  to  continue  for 
the  foreseeable  future.  Population  aging,  limited 
internal  labour  mobility  and  continued  emigration 
represent a significant drag on potential economic 
growth. Despite recent improvements, labour force 
participation rates remain well below EU averages. 
Skills  shortages  and  mismatches  also  have  an 
adverse  impact  on  the  quality  and  quantity  of 
labour  supplied.  Undeclared  work  continues  to 
labour  market.  Minimum  wage 
distort 
increases  are  decided  in  a  discretionary  manner, 
and social partners' involvement in policy making 
is very limited. 

the 

The  Romanian  financial  sector  continues  to  be 
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  stood  at 
67% in 2016, well above the euro area average of 
nearly  17%.  Concentration  in  the  banking  sector, 
as measured by the market share of the largest five 
credit  institutions  increased  to  59%  in  2016  and 
remained above the euro area average.  

The  Romanian  banking  sector  has  remained 
resilient and well-capitalised as capital adequacy at 
system  level  stood  at  roughly  19%  at  the  end  of 
2017,  well  above  the  euro  area  average.  The 
banking  system  returned  to  profit  in  2015  and 
remained profitable through 2017 (return on equity 
was 12.7% in Q4 2017). Non-performing loans (90 

95 

01020304050607080RO, 2012RO, 2016EA, 2012EA, 2016Concentration 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 -10-505101520RO, 2012RO, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 7.11: Romania -Selected banking sector soundness indicators%Source: ECB, EC calculations, NBR.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180RO, 2012RO, 2017EA, 2012EA, 2017Debt 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. 
 
 
 
  
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 7 - Romania 

House  prices  adjusted  downwards  in  the  wake  of 
the  crisis  but  have  started  to  grow  again  since 
2015. Real house prices increased by 7.1% in 2016 
and by a further 5% in 2017.  

The  size  of  the  financial  sector  in  Romania  is 
relatively  small  compared  to  the  Euro  Area. 
Romania  still  lags  considerably  behind  the  euro 
area  as  regards  bank  credit  to  the  private  non-
financial  sector  (26.9%  of  GDP  in  2017).  The 
share of foreign-currency loans to the private non-
financial  sector  decreased  from  a  peak  of  around 
62%  of  total  loans  in  2012  to  37%  at  the  end  of 
2017, inter alia due to the measures introduced by 
the  National  Bank  of  Romania  to  curb  foreign-
currency  lending  to  unhedged  households  and 
corporates,  in particular  SMEs,  and restricting  the 
state  guaranteed  mortgage  scheme  to  lending  in 
domestic currency.  

Equity  and  debt  markets  in  Romania  remain 
considerably  underdeveloped.  In  2017,  stock 
market  capitalisation  (9.6%  of  GDP)  remained 
significantly  below  the  euro  area  average  (67.5% 
of GDP). The debt securities market remained only 
a  fraction  of  the  euro  area  average  (28.8%  vs. 
148.7%  of  GDP)  and  continued  to  be  dominated 
by  issuances  of  government  debt  (T-bills  and 
bonds  denominated 
leu  and  foreign 
currency),  whereas  the  issuance  of  corporate  and 
municipal 
limited. 
Consolidated  private  sector  debt  has  continued  to 
decline from the peak of 74% of GDP observed in 
2010 to 56% in 2016, the lowest level in the EU.  

in  both 

remains 

bonds 

very 

96 

 
 
 
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),  the  Riksbank  Act  from  1988,  as 
amended,  and  the  Law  on  Exchange  Rate  Policy 
from  1998.  No  amendments  to  these  legal  acts 
were  passed  with  regard  to  the  incompatibilities 
and  the  imperfections  mentioned  in  the  2016 
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 
information  of  government 
regular  upfront 
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 
to 
limits 
independently 
the 
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 
tasks  directly 
performance  of  ESCB-related 

97 

to 

entrusted  by  the  Treaties.  By  means  of  broad 
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  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  since  2013  but  those  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 

to  banking 

Under Article 8 of Chapter 6 of the Riksbank Act, 
the  Riksbank  may,  in  exceptional  circumstances, 
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. 
When  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 
suggested  above.  Therefore, 
to 
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  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 
central  banks, 
these  publicly  owned  credit 
institutions should be given the same treatment as 
private credit institutions.  

of 

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, 

profit 

Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

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 
allocation  and  as  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. 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 
subordinated 
the  primary  and  secondary 
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 
Instrument 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 the Instrument of Government); 
Articles  1  to  4  of  the  Law  on  Exchange  Rate 
Policy of 1998; 

 

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 Instrument of Government); 

98 

 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

rate  in  Sweden  was  1.9%,  i.e.  at  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected  to  decline  below  the  reference  value  in 
the months ahead. 

8.2.2.  Recent inflation developments 

HICP  inflation  in  Sweden  started  to  pick-up  in 
2016.  The  recovering  oil  prices,  tax  hikes (50)  as 
well  as  expanding domestic  demand  supported by 
an  accommodative  monetary policy  resulted  in  an 
average  inflation  rate  of  1.1%  in  2016,  up  from 
0.7%  the  year  before.  In  2017,  HICP  inflation 
increased  to  1.9%,  driven  by  services  and  energy 
prices and the weakening of the krona. On a year-
on-year  basis  it  went  above  2%  in  the  summer, 
driven  by  a  temporary  surge  in  service  prices. 
Since  then  HICP  inflation  fell  back  to  1.6%  in 
January and stood at 2.0% in March 2018. 

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  grew  at 
the same rate as headline inflation in 2016 (1.1%) 
and  stood  at 1.5%  in 2017.  In particular,  inflation 

(50)  Changes  in  taxes  and  subsidies  occurred  in  January  2016 
but also higher administrative prices, banking services and 
foreign flights. 

  ECB's  right  to  impose  sanctions  (Chapter  11, 

Articles 2a, 3 and 5). 

are 

There 
regarding the: 

furthermore 

some 

imperfections 

  non-recognition  of  the  role  of  the  ECB  and  of 
the EU 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 

the 

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.  It  is  understood 
that the Swedish Parliament is currently examining 
a  review  of  the  Riksbank  Act  and  the  monetary 
policy framework in general and will report on the 
matter  by  end-May  2019  at  the  latest.  In  this 
context  the  Swedish  authorities  are  invited  to 
remedy the abovementioned incompatibilities. 

8.2. 

PRICE STABILITY 

8.2.1.  Respect of the reference value 

The twelve-month average inflation rate, which is 
used  for  the  convergence  evaluation,  was  above 
the  reference  value  at  the  time  of  the  last 
convergence  assessment  of  Sweden  in  2016.  The 
twelve-month average inflation rate in Sweden has 
then been increasing through October 2017, when 
it  reached  1.8%  and  broadly  stabilised  after.  In 
March  2018,  the  reference  value  was  1.9%, 
calculated as the average of the 12-month average 
inflation rates in Cyprus, Ireland and Finland plus 
1.5 percentage points. The corresponding inflation 

99 

01234Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18SwedenReference valueGraph 8.1: Sweden -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2018 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2018 Forecast.-20242012201320142015201620172018SwedenEuro areaGraph 8.2: Sweden -HICP inflation(y-o-y percentage change)Source: Eurostat. 
 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

The  fiscal  stance,  as  measured  by  changes  in  the 
structural  balance,  was  restrictive  in  2016  and 
2017  and  is  expected  to  become  expansionary  in 
2018 before turning restrictive in 2019. 

has 

(52), 

framework 

Monetary  policy,  conducted  within  an  inflation 
targeting 
remained 
expansionary.  In  response  to  low  inflationary 
pressures  and  initially  sluggish  economic  growth, 
the  Riksbank  gradually  cut  its  main  policy  rate 
from  2%  in  autumn  2011  to  minus  0.5%  in 
February 2016 and has kept it unchanged since.  

purchases 

conducting 

Additionally,  in  February  2015,  the  Riksbank 
started 
of  Swedish 
government  bonds  and  continuously  reinvested 
the 
redemptions  and  coupon  payments 
government bond portfolio. As a result, Riksbank's 
total  holdings  of  domestic  government  bonds 
amounted to a cumulative SEK 320 billion (about 
half of the outstanding stock) by mid-March 2018. 

in 

In 2017 inflation was close to target but, in spite of 
strong economic growth and a tight labour market, 
inflationary pressures did not seem to be on a firm 
upward  path  over  the  medium-term.  Still,  the 
Executive  Board  of  the  Riksbank  decided  in 
December  2017 
the  asset  purchase 
programme  but  announced  that  it  would  reinvest, 
starting  in  January  2018,  the  bonds  maturing  in 
2019  in  order  to  attain  a  relatively  even  pace  of 
purchases going forward. The Riksbank at its latest 
meeting in April 2018 indicated that it expected to 

to  halt 

(52)  Since  1995,  the  Riksbank  has  targeted  increases  in  the 
domestic  CPI  with  the  aim  of  keeping  inflation  at  2%.  In 
September  2017  the  Riksbank  changed  its  target  from 
measuring inflation in terms of CPI to CPIF (CPI with the 
interest rate component kept unchanged) resulting in higher 
inflation rates. 

100 

in  2017 

reflecting  partly 

in the service sector surged from 1.3% in 2016 to 
2.2% 
the  new 
methodology  for  measuring  prices  of  package 
holidays (51).  Processed 
rate  of 
inflation  increased  from  0.5%  in  2016  to  2.1%  in 
2017.  Non-energy  industrial  goods  prices  rose  by 
1.1%  in  2016  and  were  broadly  unchanged  in 
inflation  was  slightly 
2017.  Producer  price 
negative  in  2016  before  turning  strongly  positive 
in 2017 on the back of higher energy prices. 

food  prices 

8.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

in  2017.  Strong  domestic  demand, 

After  a  strong  performance  in  2016,  Sweden's 
economic  growth  remained  solid  in  2017  and  is 
expected  to  remain  solid  2018  but  to  moderate  in 
2019.  Real  GDP  expanded  by  3.2%  in  2016, 
making  Sweden  a  front-runner  in  the  economic 
expansion among EU countries, before slowing to 
2.4% 
in 
particular  buoyant  investment  growth,  supported 
by  an  expansionary  monetary  policy,  contributed 
to  economic  growth  in  both  2016  and  2017.  Real 
GDP  is  projected  to  grow  around  2.6%  in  2018 
before  decelerating  to  2.0%  in  2019,  as  domestic 
demand  flattens  and  the  economic  cycle  matures. 
The  output  gap  has  turned  slightly  positive  since 
2016, after some years in negative territory, and is 
expected to turn slightly negative again in 2019.  

(51)  From  2017  Statistics  Sweden  changed  its  handling  of 
seasonal prices of package holidays. For more details about 
the 
Sweden:  
http://www.scb.se/contentassets/6dc31ffdd808460eb498b6
6419042afb/andringar-i-kpi-fran-2017-en-
editetr_feb_mt.pdf 

new  methodology, 

Statistics 

see 

Table 8.1:(cid:9)weights  Sweden - Components of inflation(percentage change)1)in total   201220132014201520162017Mar-182018HICP0.90.40.20.71.11.91.91000Non-energy industrial goods-1.0-0.8-0.40.31.10.10.0290Energy0.5-1.4-2.0-4.71.05.34.689Unprocessed food 1.63.50.04.12.62.21.761Processed food2.41.31.02.10.52.12.3137Services1.81.10.91.31.32.22.5423HICP excl. energy and unproc. food1.00.50.51.11.11.51.6850HICP at constant tax rates 1.30.40.20.51.01.71.71000Administered prices HICP3.02.01.71.30.92.12.11511) 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 2018 - Technical annex 

Chapter 8 - Sweden 

start  raising  the  repo  rate  at  a  slow  pace  towards 
the end of 2018. 

Wages and labour costs 

Employment  recovered  quickly  following 
the 
financial crisis and has been expanding at a strong 
pace  since, growing  at  1.7%  in  2016  and  2.3%  in 
2017.  This  rise  was  driven  primarily  by  services, 
the  public  sector,  and  construction,  while  the 
number of employed persons in manufacturing and 
energy  sectors  decreased.  Employment  in  the 
public sector is expected to grow over the coming 
years  particularly  in  healthcare  and  education  as 
the  population  is  ageing  and  the  number  of 
migrants  has  been  growing,  including  of  school-
age migrants.  

In spite of strong employment growth, the decline 
in  the  unemployment  rate  has  been  moderate, 
decreasing  from  6.9%  in  2016  to  6.7%  in  2017, 
due  to  migrants  joining  the  labour  force,  and  is 
expected  to  hover  around  6.3%  over  the  next  two 
years.  

Growth  of  nominal  compensation  per  employee 
increased  from  1.9%  in  2013  to  2.8%  in  2016.  In 
the first half of 2017, the exporting industry agreed 
to  annual  wage  increases  of  about  2.2%  for  the 
period 2017-2019. This relatively modest outcome 
was the result of negotiations that started in 2016, 

101 

with  a  mandate  to  maintain  cost  competitiveness 
vis  a  vis  major  trading  partners.  Since  then,  other 
sectors  have  closely  followed  this  benchmark 
agreement.  Against  this  backdrop,  growth  of 
nominal compensation per employee is expected to 
have  slowed  at  2.1%  in  2017,  and  is  projected  to 
increase again to 2.7% in 2018 before decelerating 
in  2019  to  2.4%  according  to  the  Commission 
services' Spring 2018 Forecast. 

Given  these  wage  developments,  increase  in  cost 
competitiveness  is  expected  to  remain  contained. 
Growth  in  labour  productivity  has  been  slowing 
from 3.0% in 2015 to 0.1% in 2017. It is forecast 
to  remain  subdued  in  2018  and  2019,  not  above 
1.0%.  Nominal  unit  labour  costs  growth  (ULC), 
was  at  1.3%  in  2016  and  increased  to  2.0%  in 

-404820122013201420152016201720182019Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 8.3: Sweden -Inflation, productivity and wage trends(y-o-y percentage change)Source: Eurostat, Commission services'Spring 2018 Forecast.Table 8.2:(cid:9)Sweden - Other inflation and cost indicators(annual percentage change)20122013201420152016201720181)20191)HICP inflationSweden0.90.40.20.71.11.91.91.7Euro area2.51.30.40.00.21.51.51.6Private consumption deflatorSweden0.50.71.10.91.01.71.92.1Euro area1.91.10.50.30.41.41.51.6Nominal compensation per employeeSweden3.11.92.22.72.82.12.72.4Euro area1.81.61.41.41.21.62.41.9Labour productivitySweden-1.00.31.23.01.50.11.00.7Euro area-0.10.60.71.00.40.81.01.0Nominal unit labour costsSweden4.11.71.0-0.31.32.01.71.8Euro area1.91.00.60.50.70.81.41.0Imports of goods deflatorSweden-1.9-3.71.2-0.1-2.34.64.91.7Euro area2.6-2.0-2.4-3.4-3.43.41.20.71) Commission services' Spring 2018 Forecast.Source: Eurostat, Commission services. 
 
 
 
 
 
 
 
2017. ULCs are projected to stabilize below 2.0% 
as  from  2018.  Against 
this  backdrop  price 
pressures from labour costs are expected to remain 
limited in 2018-2019. 

External factors 

the 

Given  the  openness  of  the  Swedish  economy, 
developments  in  import  prices  play  an  important 
role  in  domestic  price  formation.  Import  price 
imports  of  goods 
growth  (measured  by 
deflator)  has  fluctuated  significantly  over  the  past 
few  years.  In  2016,  the  import  deflator  was 
negative  despite  higher  commodity  prices  due  to 
the  dampening  effect  of  the  krona  appreciation. 
The  import  deflator  turned  strongly  positive  in 
2017 as the krona started depreciating. The import 
deflator is expected to remain positive in 2018 and 
2019. 

The real effective exchange rate (measured against 
a  group  of  36  trading  partners)  remained  broadly 
stable in 2016 and 2017. In 2016, domestic prices 
continued  to  grow  slower  than  Sweden's  main 
trading partners offsetting the small increase in the 
nominal  effective  exchange  rate.  This  trend  was 
reversed 
cost 
developments  do  not  pose  major  challenges  to 
competitiveness. 

in  2017.  Overall,  Swedish 

Administered prices and taxes 

in 

The  share  of  administered  prices (53) 
the 
Swedish  HICP  basket  amounts  to  15%,  a  value 
slightly  above  the  euro-area  average  of  13%.  The 
most  important  item  in  the  administrate  price 
basket  is  rents  (7%  of  total  HICP).  In  contrast  to 
2016,  administrative  price  inflation  outpaced  total 
HICP  inflation  in  2017,  increasing  from  0.9%  in 
2016 to 2.1% in 2017. This is largely explained by 
strong increase in charges for combined passenger 
transport  and  for  social  protection  by  about  7% 
each in 2016 and 2017, while rent prices increased 
by a modest 0.9%. 

Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

constant  taxes  increased  over  the  past  two  years 
was slower than the one of HICP. 

Medium-term prospects 

HICP  inflation  is  projected  to  remain  broadly 
stable  and  to  hover  slightly  below  the  Riksbank's 
2% target in 2018-2019. Oil prices are projected to 
exert  upward  pressure  on  the  HICP  in  2018  but 
muted wage developments are expected to dampen 
the 
somewhat 
Commission Spring 2018 Forecast projects annual 
average  inflation  at  1.9%  in  2018  and  1.7%  in 
2019. 

effect.  Accordingly, 

this 

Risks to the inflation outlook appear to be broadly 
balanced.  The  Riksbank  has  announced 
its 
intention to begin increasing the repo rate at a slow 
pace, a move entailing some risks of appreciation. 
An appreciating krona could dampen the currently 
projected  inflation  trajectory.  The  Riksbank  has 
indicated  that  should  the  krona  appreciate  too 
quickly, 
the 
appropriate measures. 

it  would  stand  ready 

take 

to 

The level of consumer prices in Sweden relative to 
the euro area has gradually increased since Sweden 
joined the EU in 1995. In 2016, the Swedish price 
level was at 122% of the euro-area average. At the 
same time, the GDP per capita level in Sweden has 
remained  stable  over  the  past  ten  years,  reaching 
about  116%  of  the  euro-area  average  in  PPS  in 
2016.  

In the medium term, inflation could gradually rise 
given  the  high  capacity  utilisation  and  acute  skill 
shortages  that  have  been  reported  over  the  last 
year.  However,  there  is  uncertainty  how  resource 
pressure  will  feed  to  inflation,  and  low  wage 
expectations  will  continue  weighing  on  consumer 
price developments. 

8.3. 

PUBLIC FINANCES 

Tax  changes  also  contributed  somewhat  to  higher 
headline  inflation  as  the  pace  at  which  HICP  at 

8.3.1.  Recent fiscal developments 

(53)  According  to  the  Eurostat  definition,  fully  administered 
prices  in  Sweden  include  prices  or  charges  for  water 
supply,  refuse  and  sewerage  collection,  social  protection, 
postal services, and combined passenger transport. Mainly 
administered  prices  include  actual  rents  for  housing, 
pharmaceutical products, hospital, dental and other medical 
services, and education. For details, see 

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

administered-prices 

Sweden’s  general  government  surplus  increased 
from  1.2%  of  GDP  in  2016  to  1.3%  of  GDP  in 
2017.  Revenue  collection,  underpinned  by  solid 
economic  growth,  surprised  on  the  upside.  By 
contrast,  expenditure  for  taking  in  and  integrating 
asylum seekers, was lower than expected in 2016-
2017.  

102 

 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

expenditure measures are waning off. According to 
the  Commission  services'  Spring  2018  Forecast, 
which is based on a no-policy-change assumption, 
the  general  government  balance  will  stabilise  at  a 
lower  level,  reaching  0.8%  of  GDP  in  2018  and 
0.9% in 2019 while the structural balance is set to 
decline to 0.7% in 2018 before increasing again to 
1.0%  of  potential  GDP  in  2019.  The  revenue-to-
GDP ratio is expected to decline to 49.3% of GDP 
in 2019 while expenditures are forecast to decrease 
to around 48.4% of GDP. 

Gross  government  debt  is  well  below  the  60%  of 
GDP  Treaty  reference  value  and  is  expected  to 
continue  its  gradual  decline  in  the  coming  years, 
reaching  38.0%  of  GDP  in  2018  and  35.5%  of 
GDP  in  2019,  mainly  on  the  back  of  strong 
economic  growth  and  a 
rate 
environment.  

interest 

low 

extensive  deliberations  within 

Building  on  a  strong  institutional  set-up  and  a 
robust fiscal track record, the Swedish authorities, 
a 
following 
dedicated  parliamentary  Committee 
(Surplus 
Target  Committee),  adopted  a  fiscal  governance 
reform package in late 2017, with effect from 2019 
onwards.  

While  the  main  conceptual  pillars  of  the  existing 
framework  were  preserved  with  some  numerical 
modifications  and  clarifications,  a  number  of  new 
elements  were  added.  Some  of  those  elements 
contributed 
the  Swedish  national 
provisions in line with the Budgetary Frameworks 

to  bring 

The  expenditure-to-GDP  ratio  decreased  from 
49.4%  of  GDP  in  2016  to  49.1%  in  2017,  a 
decrease  by  0.3  similar  in  size  to  the  decrease  in 
the revenues-to-GDP ratio from 50.6% to 50.3% of 
GDP between 2016 and 2017.  

The  2017  general  government  surplus  was  higher 
than  the  surplus  of  0.3%  of  GDP  targeted  in  the 
2017  Convergence  Programme.  The  structural 
balance  surplus  increased  and  reached  0.9%  of 
GDP in 2016 and 1.2% in 2017. 

The  government  debt-to-GDP  ratio  decreased  to 
40.6% in 2017, i.e. down by 1.5 percentage points 
compared to 2016 on the back of strong economic 
growth and prudent fiscal management. 

8.3.2.  Medium-term prospects 

The  2018  budget  bill,  which  was  adopted  on  15 
December 2017, included new measures to address 
key  government  priorities.  These  measures  result 
in additional tax cuts (for a total effect of SEK-7.2 
billion  or  -0.1  %  of  GDP  as  they  are  partially 
compensated  by  some  tax  increases)  and  new 
spending  totalling  about  0.9%  of  GDP.  The 
amended 2018 spring bill proposed additional new 
reforms  worth  SEK2.6  billion  (0.1%  of  GDP). 
These  measures  focus  on  labour  market  and 
migrant  integration,  climate  and  environment, 
education, health and defence.  

As  a  result the  budget  balance  surplus  is foreseen 
to decline in 2018 and slightly increase in 2019 as 

103 

Table 8.3:(cid:9)Sweden - Budgetary developments and projections(as percentage of GDP unless indicated otherwise)Outturn and forecast 1)20122013201420152016201720182019General government balance-1.0-1.4-1.60.21.21.30.80.9- Total revenues50.450.649.649.850.650.349.749.3- Total expenditure51.452.051.149.649.449.148.948.4   of which: - Interest expenditure0.90.80.70.40.40.40.30.2p.m.: Tax burden43.143.543.243.644.644.544.043.9Primary balance-0.1-0.6-0.90.61.61.61.11.1Cyclically-adjusted balance0.20.1-0.30.30.91.20.71.0One-off and temporary measures0.00.00.00.00.00.00.00.0Structural balance 2)0.20.1-0.30.30.91.20.71.0Government gross debt38.140.745.544.242.140.638.035.5p.m: Real GDP growth (%)-0.31.22.64.53.22.42.62.0p.m: Output gap-2.1-2.6-2.1-0.10.40.10.1-0.31) Commission services’ Spring 2018 Forecast.2) Cyclically-adjusted balance excluding one-off and other temporary measures.Source: Commission services. 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

8.4. 

EXCHANGE RATE STABILITY 

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

The krona continued depreciating against the euro 
since 2013, with a total depreciation of more than 
19% in early 2018 compared to the 2013 peak. In 
2016  and  2017  the  depreciating  trend  continued 
but  slowed  down  compared  with  previous  years. 
The krona fluctuated around 9.5 euro in 2016 and 
9.6 euro in 2017. In March 2018 the krona reached 
a value of above 10 krona per euro. 

Directive, (54)  e.g.  introducing  a  new  debt  anchor 
as  an  explicit  multi-annual  debt  objective  or 
mandating  the  Fiscal  Council  with  the  regular 
assessment of government's economic forecasts. 

to 

to 

allow 

Sweden 

One  of  the  main  features  of  the  reform  was  the 
lowering of the 1% of GDP surplus target defined 
over  the  cycle  (in  place  since  2007)  to  0.33  %  of 
GDP with effect from 2019. This new target would 
continue 
partially 
accommodate the projected increase in the costs of 
the  pension  system  while  maintaining  adequate 
safety  margins  for  economic  fluctuations.  In 
addition,  the  mechanisms  for  monitoring  the 
revised  surplus  target  were  clarified (55),  thereby 
identified  shortcomings  and 
addressing  some 
adding credibility to the new target. Additionally, a 
correction  mechanism  in  case  of  deviation  from 
the target of the rule was introduced. Furthermore, 
the structural balance rule was complemented by a 
new debt anchor set at 35% of GDP of the general 
government, consistent with the surplus target and 
which includes a correction mechanism.  

The  Fiscal  Policy  Council  (Finanspolitiska  rådet) 
received  a  stronger  mandate.  It  will  exert  a  more 
prominent  role  in  assessing  compliance  with  the 
rules and will conduct the regular evaluation of the 
government's  economic  forecasts.  However,  the 
nomination  procedure  for  the  Council's  members 
has also been amended, rendering the process more 
politically  guided.  The  current  selection  process, 
which  gave  full  autonomy  to  the  Council  itself  in 
electing  its  members,  will  be  replaced  on  1  July 
2018  by  one  steered  by  a  nomination  committee 
which  will  include,  among  others,  the  Chair  and 
Deputy  Chair  of 
the  Riksdag’s  Finance 
Committee. While motivated by the desire to give 
the independent body more democratic legitimacy 
and  increase  its  responsibilities  and  diversity,  this 
change  was  opposed  by  former  and  current 
members  of  the  Council  because  it  may  decrease 
the members’ autonomy. 

Short-term  interest  rate  spreads  vis-à-vis  the  euro 
area turned negative (euro area short-term interest 
rates  being  higher  than  Swedish  ones)  since 
February  2015,  when  the  Riksbank  introduced  a 
negative policy rate, cutting its repo rate to minus 
0.1%. Following the additional cuts introduced by 
the  Riksbank  in  February  2016,  the  repo  rate 
reached today's level of minus 0.5%.  

(54)  The Council Directive 2011/85/EU of 8 November 2011 on 
requirements  for  budgetary  frameworks  of  the  Member 
States, 
http://eur-lex.europa.eu/legal-
content/EN/ALL/?uri=CELEX:32011L0085 

available 

at: 

(55)  Specifically, the fulfilment of the target will be assessed on 
the  basis  of  a  single  indicator  (i.e.  the  structural  balance 
over  the  current  and  subsequent  year)  instead  of  the 
previous  system  of  several  indicators  whose  relative 
weights were not defined.   

These  moves  widened  the  3-months  STIBOR-
EURIBOR  spread  to  about  on  average  -20  basis 
points  during  2016-2017,  with 
fluctuations 
between broadly -30 basis points (November 2016 

104 

8.08.59.09.510.010.52012201320142015201620172018Graph 8.4: Sweden -SEK/EUR exchange rate(monthly averages)Source: ECB.-500501001502002012201320142015201620172018Graph 8.5: Sweden -3-M Stibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat. 
                                                           
 
 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

and  September  2017  respectively)  and  -10  basis 
points (July 2017). In early 2018 the spread stood 
at around -10 basis points. 

Swedish  benchmark  bond  stood  at  0.7%,  i.e.  2.5 
percentage points below the reference value. 

After averaging slightly less than SEK 500 billion 
in early 2016, international reserves crossed again 
the  SEK  500  billion  threshold  reached  a  year 
earlier  in  May  2016,  where  they  have  remained 
since, with SEK 540 billion by the end of 2016. In 
the  last  quarter  of  2017,  international  reserves 
hoovered  around  the  level  of  SEK  520  billion,  or 
11% of GDP. Since December 2015, the Riksbank 
can  intervene  on  foreign  exchange  markets  in 
order  to  prevent  a  de-anchoring  of  inflation 
expectations  due  to  a  strengthening  krona.  The 
level of international reserves has remained pretty 
stable since. 

8.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  used  to  assess  adherence 
to  the  convergence  criterion  reflect  secondary 
market  yields  on  a  single  benchmark  government 
bond with a residual maturity of above ten years.  

In  term  of  monthly  data,  long-term  interest  rates, 
while always remaining below 1% since the 2016 
Convergence  Report,  have  recovered  from  the 
August 2016 all-time low of 0.1%, reaching 0.9% 
in  early  2018,  which  remains  very  low  by 
historical  standards.  The  compression  of  Swedish 
long-term  interest  rates  reflected  the  continuation 
of  the  expansionary  monetary  policy  stance,  with 
negative policy rates and the continued acquisition 
of  governments  bonds  as  a  response  to  the  low 
domestic  inflation  environment.  The  safe-haven 
status  of  Swedish  government  bonds  was 
confirmed  also  over  the  last  two  years  with  the 
yields of the Swedish benchmark government bond 
following  the  German  benchmark  bond,  even  if 
less closely than in previous years. Thus long-term 
interest  spreads  vis-à-vis  the  German  benchmark 
bond  remained  extremely 
they 
increased from the negative values of the summer 
2016. They remained in the range of 20 to 40 basis 
points  until  the  last  quarter  of  2017  when  they 
slightly  moved  above  this  range.  In  March  2018 
they were above 50 basis points (56). 

low,  even 

if 

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  2016  convergence  assessment  of 
Sweden.  Average  long-term  rates  in  Sweden 
continued  to  stay  below  1%  over  the  last  two 
years, where they have been since June 2015. They 
were  on  a  continuously  declining  trajectory  until 
June  2017,  when  they  reached  0.5%,  to  increase 
back  to  0.7%  in  December  2017.  In  March  2018, 
the  latest  month  for  which  data  are  available,  the 
reference value, given by the average of long-term 
interest rates in Cyprus, Ireland and Finland plus 2 
percentage  points,  stood  at  3.2%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 

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 

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

105 

0246810Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17Jan-18SwedenReference valueGraph 8.6: Sweden -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-101232012201320142015201620172018SwedenGermanyGraph 8.7: Sweden -Long-term interest rates(percent, monthly values)Source: Eurostat. 
 
 
                                                           
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

Member  State's  ability  to  integrate  into  the  euro 
area without difficulties.  

to  address 
so  far  have  not  been  sufficient 
overvaluation in the housing sector, and key policy 
gaps remain. 

to 

Sweden 

In  March  2018, 

(IDR)  was  warranted 

In  November  2017,  the  Commission  published  its 
seventh  Alert  Mechanism  Report  (AMR  2018) 
under  the  Macroeconomic  Imbalance  Procedure 
(MIP - see also Box 1.5), which concluded that an 
In-Depth  Review 
for 
the  Commission 
Sweden. 
published its annual country report on Sweden (57), 
including an IDR. This report led to the conclusion 
that 
experience 
continued 
macroeconomic  imbalances,  as  overvalued  house 
price  levels  coupled  with  a  continued  rise  in 
household  debt  poses  risks  of  a  disorderly 
correction.  The  already  high  household  debt 
remains  on  an  upward  path.  House  prices  have 
been growing at fast pace virtually for much of the 
past 20 years. Negative growth has been recorded 
in  the  last  quarter  of  2017.  Still,  valuation 
indicators  suggest  that  house  prices  remain  very 
to  fundamentals.  Awareness  of 
high  relative 
mounting  risks  among  authorities  is  high,  and  in 
recent  years  measures  have  been  taken  to  rein  in 
mortgage  debt  growth  and 
raise  housing 
construction.  However,  policy  steps  implemented 

(57)  https://ec.europa.eu/info/sites/info/files/2018-european-

semester-country-report-sweden-en.pdf 

8.6.1.  Developments  of 

the  balance  of 

payments 

According to Balance of Payments data, Sweden's 
current  account  surplus  has  gradually  been 
declining  from  5.6%  of  GDP  in  2012  to  3.2%  of 
GDP  in  2017. The  decline  in the  balance  of  trade 
in  goods  and  in  the  primary  income  balance 
contributed  to  the  decline  in  the  current  account 
surplus,  only  partially  compensated  for  by  the 
increase in the services balance until 2016. In 2017 
the service balance posted a marked decrease. The 
secondary income balance improved in 2016, thus 
contributing to support the overall current account 
balance,  but 
improvement  was  partially 
reversed in 2017. Current transfers have delivered 
a negative impact, 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. 

this 

According  to  National  Accounts  data,  Sweden's 
large savings-investment surplus persisted in 2016 
and  2017,  primarily  on  the  back  of  high  net 

106 

Table 8.4:Sweden - Balance of payments(percentage of GDP)201220132014201520162017Current account5.65.24.54.54.23.2of which: Balance of trade in goods4.03.23.02.82.32.4                 Balance of trade in services1.21.71.32.22.11.0                 Primary income balance 2.42.01.91.21.11.4                 Secondary income balance-2.0-1.8-1.8-1.7-1.4-1.6Capital account-0.2-0.2-0.1-0.2-0.1-0.1External balance 1)5.45.04.44.34.13.0Financial account 1.63.72.72.0-3.41.2of which: Direct investment2.44.60.91.5-1.21.6                Portfolio investment-3.1-8.44.1-2.71.2-1.4                Other investment 2)2.24.9-2.22.9-4.20.9                Change in reserves0.12.60.00.30.80.1Financial account without reserves1.51.12.71.8-4.21.1Errors and omissions-3.9-1.3-1.7-2.3-7.5-1.9Gross capital formation22.622.523.324.324.725.7Gross saving28.227.628.128.829.429.8Gross external debt187.3185.0190.7181.7174.2174.3International investment position-15.8-16.1-2.3-1.25.09.61) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Statistics Sweden, Commission services. 
                                                           
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

mirrors prudent fiscal management and the decline 
in gross government debt. 

According  to  the  Commission  services'  Spring 
is  based  on  National 
2018  Forecast,  which 
Accounts  data,  net  exports  are  expected 
to 
contribute  positively  to  real  GDP  growth  in  2018 
and  2019,  while  the  current  account  surplus  is 
expected  to  remain  above  4.0%  of  GDP  over  the 
forecast period. 

savings by the private sector, but also due to fiscal 
surpluses.  This  reflects  increased  precautionary 
savings  and  a  pension  regime  with  defined 
contributions.  Gross 
fixed  capital  continued 
increasing  and  gross  capital  formation  reached 
around 26% of GDP in 2017. 

Sweden's  export  market  share  has  been  declining 
overall  since  the  early  2000s.  The  export  market 
share  decreased  by  about 0.3%  and  0.6%  in  2016 
and  2017  respectively  following  an  average 
increase  by  about  2.0%  in  2014-2015,  which 
appeared  largely  driven  by  a  denominator  effect 
related  to  the  temporary  global  slowdown  rather 
than a structural change in the long-run trend. The 
decline  in  export  market  share  is  linked  to 
changing  global  trade  patterns  affecting  most 
mature,  industrialised  economies  with  a  similar 
focus  on  high-value-added  exports,  and  does  not 
suggest any underlying competitiveness issues. 

8.6.2.  Market integration 

Sweden  is  well  integrated  with  the  euro  area 
through  trade  and  investment  linkages.  Trade 
openness  of  the  Swedish  economy  has  remained 
rather stable with values above 40% of GDP since 
2012  and  went  above  this  threshold  in  2017  at 
almost  42%  of  GDP.  The  main  euro-area  trading 
partners  are  Germany, 
the  Netherlands  and 
Finland,  while  Norway,  Denmark  and  the  UK  are 
the main non-euro-area partners.  

The level of inward FDI has remained stable. Over 
the  period  2016-2017  more  than  80%  of  the  total 
FDI stock originating from the EU, with the largest 
share from the Netherlands, the UK, Luxembourg, 
Finland and Germany. 

Regarding 
the  business  environment,  Sweden 
regularly  scores  top  positions  in  international 
rankings, well above most euro-area Member State 
and  currently  ranks  in  the  top  ten  at  global  level, 
with  respect  to  the  World  Bank's  Ease  of  Doing 
Business  indicator  and  to  the  WEF's  Global 
Competitiveness Index. Sweden also tops rankings 
in the public administration performance according 
to  the  World  Bank's  Worldwide  Governance 
Indicators. Sweden's deficit in the transposition of 
EU directives in 2017 was at 1.4%, below the EU 
average, after meeting the 0.5% target as proposed 

This conclusion is buttressed by the benign change 
in  cost  competitiveness 
indicators.  The  real 
effective exchange rate remained broadly stable in 
2016-2017.  Unit  labour  costs  (ULC)  have  been 
growing  in  line  with  Sweden's  main  trading 
partners over the same period.  

Sweden's net international investment position has 
been positive since 2014,  reaching 5%  of GDP  in 
2016 and almost 10% in 2017. Sweden's financial 
account  shows  relatively  large  fluctuations  over 
time.  However,  the  financial  account  balance 
consistently  reflects  Sweden's  role  as  a  net  FDI 
investor  abroad,  with  the  exception  of  2016.  The 
balance  of  portfolio  investments  fluctuated  from 
negative  in  2016  to  positive  in  2017.  External 
reserves  increased  somewhat  in  2016  and  2017. 
External  debt  has  been  on  a  declining  trend,  and 
decreased by more than 15 percentage points since 
2014,  from  above  190%  of  GDP  in  2014  to 
174.3% of GDP in 2017. This development largely 

107 

010203040201220132014201520162017Gross national savingGross capital formation at current prices; total economyGraph 8.8: Sweden -Saving and investment(in percentage of GDP at market prices)Source: Eurostat, Commission services.8090100110120201220132014201520162017NEERREER, HICP deflatedREER, ULC deflatedGraph 8.9:Sweden -Effective exchange ratesSource: Commission services.(vs. 36 trading partners;  monthly averages;index numbers, 2012 = 100) 
 
 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

have  substantial  market  shares  in  Denmark  and 
Norway.  Nordea’s  move  to  Finland  will  have 
significant  implications  for  the  Swedish  banking 
sector as it would reduce the asset-to-GDP ratio of 
the  Swedish  banking  sector  by  over  100  GDP 
points.  

Foreign ownership in the Swedish financial market 
has  been  persistently  lower  than  the  euro-area 
average and remained below 10% in 2016, against 
a  euro  area  average  of  16.5%.  At  almost  60%, 
bank  concentration  measured  by  the  market  share 
of the largest five credit institutions in total assets 
has  remained  significantly  above  the  euro-area 
average, which was 48% at the end of 2016.  

The  capital  adequacy  of  Swedish  banks  measured 
by standard regulatory ratios is relatively high, just 
above  26%  in  the  second  quarter  2017,  compared 
to  the  euro  area  average  (18%  in  the  second 
the  ratio  of  non-
quarter  2017).  Moreover, 

108 

by the European Commission in the Single Market 
Act  (2011)  between  2011  and  2016.  In  particular, 
the 4th Anti-Money Laundering Directive imposed 
transposition  by  26  June  2017,  and  Sweden 
notified  the  Commission  of  the  transposition 
measures within that deadline. The Commission is 
analysing 
their 
these  measures 
conformity with the directive. 

assess 

to 

the 

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 
rates.  Sweden  has  one  of 
lowest  wage 
dispersions  in  the  EU,  with  high  entry  wages  and 
relatively  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 
that  of 
temporary workers. Adjustment by labour mobility 
is  adequate,  with  a  relatively  low  dispersion  of 
regional  unemployment  rates.  The  integration  of 
low-skilled  and  foreign-born  workers  remains  the 
key  challenge  for  the  Swedish  labour  market, 
though,  as  the  employment  rate  of  both  groups  is 
significantly below the overall employment rate.  

indicator)  compared 

to 

sector, 

financial 

Sweden's financial sector is well integrated into the 
EU 
through 
interlinkages in the Nordic-Baltic financial cluster. 
Subsidiaries and branches of the Swedish banking 
groups  hold 
in 
Lithuania,  Latvia,  Estonia  and  Finland.  They  also 

the  majority  of 

the  market 

especially 

010203040506070SE, 2012SE, 2016EA, 2012EA, 2016Concentration 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:(cid:9)Sweden - Market integration201220132014201520162017Trade openness 1) (%)42.340.341.241.540.341.6Trade with EA in goods & services 2)+3) (%)18.017.517.617.617.618.3Export performance (% change) 4)-1.5-3.61.42.6-0.2-0.7World Bank's Ease of Doing Business Index rankings 5)1314118910WEF's Global Competitiveness Index rankings 6)4610997Internal Market Transposition Deficit 7) (%)0.60.10.30.20.41.4Real house price index 8)78.782.489.2100.0107.6112.5Residential investment 9) (%)3.43.54.04.65.25.7 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.    (November data, as of 2016 date refers to the year of publication). 8) Deflated house price index (2015=100) (Eurostat). 9) Gross capital formation in residential buildings (in % of GDP) (Eurostat).Sources: Eurostat, World Bank, World Economic Forum, Commission services. 
 
 
 
 
 
 
Convergence Report 2018 - Technical annex 

Chapter 8 - Sweden 

performing  loans  (0.5%  in  the  second  quarter 
2017)  is  back  to  2012  levels  and  is  significantly 
lower  than  the  euro  area  average,  which  remains 
above  4%.  High  asset  quality,  cost-efficiency  and 
market  concentration  support  the  profitability  of 
Swedish  banks,  which  is  among  the  highest  in 
Europe.  The  sector's  average  return  on  equity 
(ROE) in the second quarter 2017 stood above 6%, 
double than the euro area average of above 3%. 

House  prices  in  Sweden  have  been  gradually 
falling  in  autumn  2017,  but  this  follows  a  long 
period  of  virtually  uninterrupted  strong  growth. 
Real house prices have more than tripled over the 
past  two  decades,  significantly  outpacing  income 
growth.  House  price  inflation  peaked  in  2015  at 
about 12 % in real terms, but since then there has 
been  a  notable  loss  of  momentum:  in  2016,  real 
house prices rose by 7.6 % and in autumn 2017 the 
housing  market  experienced  a  gradual  decline  but 
prices  remain  above  fundamentals.  Residential 
investment  has  picked  up  significantly  in  recent 
years, from 3.6% of GDP in 2010 to 5.1% of GDP 
in  2016,  and  is  now  roughly  in  line  with  the  EU 
average. Overvalued house prices entail risks of a 
disorderly deleveraging process, potentially with a 
significant  broader  impact  on  the  banking  sector 
and  the  real  economy.  In  addition,  the  ongoing 
housing shortage has negative knock-on effects on 
labour mobility and social equality. 

The  total  amount  of  outstanding  debt  securities 
stood at 161% of GDP, 4 percentage points above 
the  2012  level.  Outstanding  bank  credit  to  non-
financial companies and households stood at about 
126% of GDP (roughly the same level as in 2012). 
More  than  60%  of  this  credit  was  given  to 
households.  The  private  sector  started  slowly 
deleveraging,  with  a  consolidated  stock  of  private 
sector debt that slightly decreased to 189% of GDP 
in  2016,  down  from  the  peak  at  195%  of  GDP  in 
2013.  This  is  significantly  above  the  euro-area 
average which stood at 137% in 2016. 

in  Sweden  are  very  well 
Capital  markets 
developed  compared 
the  euro  area.  The 
to 
capitalization index, measuring the ratio to GDP of 
the  value  of  the  stock  of  quoted  shares  issued  by 
Swedish enterprises stood at about 135% at the end 
of 2016, thus broadly stabilizing at the level of the 
end of 2015 (well up from about 105% of GDP in 
2012). This compares to a euro-area capitalization 
index of 68%. 

109 

-5051015202530SE, 2012SE, Q3-17EA, 2012EA, Q3-17Return on equityCapital adequacyNon performing loansGraph 8.11: Sweden -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-17 Return on equity is calculatedover the last four quarters.020406080100120140160180SE, 2012SE, 2017EA, 2012EA, 2017Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 8.12: Sweden -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.