COMMISSION STAFF WORKING DOCUMENT CONVERGENCE REPORT 2020 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2020 (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union)
Date: 2020-06-10
Institutions: Directorate-General for Economic and Financial Affairs, European Commission
Subjects: Bulgaria, Croatia, Czechia, Economic and Monetary Union, Hungary, Poland, Romania, Sweden, convergence criteria, euro area

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 10.6.2020  SWD(2020) 107 final  COMMISSION STAFF WORKING DOCUMENT CONVERGENCE REPORT 2020 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2020  (prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union) {COM(2020) 237 final}  
 
 
ABBREVIATIONS 

Member States 

Bulgaria 
Czechia 
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) and from February 
2020 (i.e. EU-28 excl. UK) 
EU-25  European Union, 25 Member States before 2007 (i.e. EU-28 excl. BG, RO and HR) 
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 Czechia) 
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 

i 

 
 
 
European Union 

In-Depth Review 

European System of Accounts 

Foreign direct investment 
Funding for Growth Scheme 
Financial Supervisory Authority 

ERM II  Exchange rate mechanism II 
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 
SGP 
TFEU  Treaty on the Functioning of the European Union 
ULC   Unit labour costs 
VAT  Value added tax 

Stability and Growth Pact 

ii 

 
 
 
ACKNOWLEDGEMENTS 

The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic 
and  Financial  Affairs.  The  main  contributors  were  Lucian  Briciu,  Balázs  Forgó,  Adriana  Reut,  
Matteo Salto and Ulrike Stierle-von Schütz. 

Other  contributors  were  Ronald  Albers,  Laura  Bardone,  Wojciech  Balcerowicz,  Barbara  Bernardi,  
Isabel  Grilo,  
Stefan  Ciobanu,  Karl  Croonenborghs,  Patrick  D'Souza,  Enache  Enache, 
Leire  Ormaetxea  Igarzabal,  László  Jankovics,  Andreas  Kappeler,  Willem  Kooi,  Ivan  Kusen,  
Júlia  Lendvai,  Ivan  Lozev,  Maria  Maierean,  Allen  Monks,  Sylwia  Nowak,  Mona  Papadakou,  
Gábor  Pellényi,  Arian  Perić,  Francesco  Perticari,  Lucia  Piana,  Diana  Radu,  Hugo  Ferradans  Ramonde, 
Juan  Antonio  Salazar  Romero,  Maja  Šamanović,  Michael  Stierle,  Septimiu  Szabo,  Henk  Van  Noten, 
Martina von Terzi, Bartlomiej Wiczewski, Rafał Wielądek, Marcin Zogala. 

Statistical  assistance  was  provided  by  Ulrike  Stierle-von  Schütz,  Eric  McCoy  and  André  Verbanck, 
administrative assistance by Erdemia Malagrida and Sien Vangompel. 

The  report  was  coordinated  by  Balázs  Forgó  and  Lucian  Briciu  under  the  supervision  of  Eric  Ruscher, 
Head  of  Unit  and  approved  by  Lucio  Pench,  Director,  Declan  Costello,  Deputy  Director  General,  and 
Maarten Verwey, Director General. 

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

iii 

 
CONTENTS 

Convergence Report 2020 

Convergence Report 2020 - 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. 

Introduction 

LEGAL COMPATIBILITY 
2.1.1. 
2.1.2.  Central Bank independence 
2.1.3.  Prohibition of monetary financing and privileged access 
2.1.4. 
Integration in the ESCB 
2.1.5.  Assessment of compatibility 

2.2.  PRICE STABILITY 

2.2.1.  Respect of the reference value 
2.2.2.  Recent inflation developments 
2.2.3.  Underlying factors and sustainability of inflation 

2.3.  PUBLIC FINANCES 

2.3.1.  Recent fiscal developments 
2.3.2.  Medium-term prospects 

2.4.  EXCHANGE RATE STABILITY 
2.5. 
LONG-TERM INTEREST RATES 
2.6.  ADDITIONAL FACTORS 

2.6.1.  Developments of the balance of payments 
2.6.2.  Market integration 

3.  Czechia 

3.1. 

Introduction 

LEGAL COMPATIBILITY 
3.1.1. 
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 

3.6.1.  Developments of the balance of payments 

1 

3 

5 

5 
6 
7 
7 
11 
12 
12 
15 

17 

17 
17 
17 
18 
18 
19 
19 
19 
19 
20 
22 
22 
23 
24 
25 
25 
26 
27 

31 

31 
31 
31 
32 
32 
32 
33 
33 
33 
33 
36 
36 
37 
37 
38 
39 
39 

v 

3.6.2.  Market integration 

4. Croatia 

4.1. 

Introduction 

LEGAL COMPATIBILITY 
4.1.1. 
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. 

Introduction 

LEGAL COMPATIBILITY 
5.1.1. 
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. 

Introduction 

LEGAL COMPATIBILITY 
6.1.1. 
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 

6.3.  PUBLIC FINANCES 

vi 

40 

43 

43 
43 
43 
43 
43 
43 
43 
43 
44 
44 
46 
46 
47 
48 
49 
49 
50 
51 

55 

55 
55 
55 
56 
58 
58 
58 
58 
59 
60 
62 
62 
62 
64 
64 
65 
65 
67 

69 

69 
69 
69 
70 
70 
71 
71 
71 
71 
72 
74 

 
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. 

Introduction 

FLEGAL COMPATIBILITY 
7.1.1. 
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. 

Introduction 

LEGAL COMPATIBILITY 
8.1.1. 
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 prospect. 

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 

74 
75 
76 
77 
77 
77 
79 

83 

83 
83 
83 
84 
85 
85 
85 
85 
86 
87 
90 
90 
90 
91 
91 
92 
93 
94 

99 

99 
99 
99 
99 
100 
101 
101 
101 
101 
102 
106 
106 
106 
107 
108 
109 
109 
111 

vii 

 
 
LIST OF TABLES 

2.1. Bulgaria - Components of inflation 
2.2. Bulgaria - Other inflation and cost indicators 
2.3. Bulgaria - Budgetary developments and projections (as % of GDP unless indicated otherwise) 
2.4. Bulgaria - Balance of payments 
2.5. Bulgaria - Market integration 
3.1.  Czechia - Components of inflation 
3.2.  Czechia - Other inflation and cost indicators 
3.3.  Czechia - Budgetary developments and projections (as % of GDP unless indicated 

otherwise) 

3.4.  Czechia - Balance of payments 
3.5.  Czechia - Market integration 
4.1. Croatia - Components of inflation 
4.2. Croatia - Other inflation and cost indicators 
4.3. Croatia - Budgetary developments and projections (as % of GDP unless indicated otherwise) 
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 (as % of GDP unless indicated 

otherwise) 

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 (as % of GDP unless indicated otherwise) 
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 (as % of GDP unless indicated 

otherwise) 

7.4.  Romania - Balance of payments 
7.5.  Romania - Market integration 
8.1. 
8.2. 
8.3. 

Sweden - Components of inflation 
Sweden - Other inflation and cost indicators 
Sweden - Budgetary developments and projections (as % of GDP unless indicated 
otherwise) 
Sweden - Balance of payments 
Sweden - Market integration 

8.4. 
8.5. 

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(1) 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 

viii 

19 
20 
22 
25 
28 
33 
34 

35 
39 
41 
43 
44 
46 
49 
51 
58 
60 

63 
66 
66 
71 
72 
74 
77 
79 
85 
87 

88 
93 
94 
101 
102 

105 
109 
110 

19 
20 
21 
24 
24 
25 
25 
26 
27 
28 
29 

 
 
2.12. Bulgaria - Recent development of the financial system relative to the euro area 
3.1.  Czechia - Inflation criterion 
3.2.  Czechia - HICP inflation 
3.3.  Czechia - Inflation, productivity and wage trends 
3.4.  Czechia - CZK/EUR exchange rate 
3.5.  Czechia - 3-M Pribor spread to 3-M Euribor 
3.6.  Czechia - Long-term interest rate criterion 
3.7.  Czechia- Long-term interest rates 
3.8.  Czechia - Saving and investment 
3.9.  Czechia - Effective exchange rates 
3.10.  Czechia - Foreign ownership and concentration in the banking sector 
3.11.  Czechia - Selected banking sector soundness indicators 
3.12.  Czechia - 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(1) spread to 3-M Euribor 
4.6. Croatia - Long-term interest rate criterion 
4.7. Croatia - Long-term interest rates 
4.8. Croatia - Effective exchange rates 
4.9. Croatia - Foreign ownership and concentration in the banking sector 
4.10. Croatia - Selected banking sector soundness indicators 
4.11. 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 ratescent 

29 
33 
33 
35 
38 
38 
38 
39 
39 
40 
41 
42 
42 
44 
44 
46 
48 
49 
49 
49 
51 
52 
53 
53 
59 
59 
61 
64 
64 
65 
65 
66 
66 
68 
68 
68 
71 
72 
73 
76 
76 
77 
77 
78 
78 
80 
80 
81 
85 
86 
88 
91 
91 
92 
92 

ix 

 
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. 
8.2. 
8.3. 
8.4. 
8.5. 
8.6. 
8.7. 
8.8. 
8.9. 
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 

Sweden - Inflation criterion 
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 

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.  A reinforced approach to ERM II participation by means of upfront policy commitments by 

the applicant Member States 
The Macroeconomic Imbalance Procedure (MIP) 

1.6. 
1.5.  Data for the interest rate convergence 

93 
94 
96 
96 
96 
101 
102 
104 
107 
108 
108 
108 
109 
110 
112 
113 
113 

6 
8 
10 

13 
16 
16 

x 

 
 
 
 
 
 
Convergence Report 2020 

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

 
 
1. 

REPORT PROPER 

2 

 
 
 
 
 
 
Convergence Report 2020 

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 also adopted the euro. 

Member  States  for  which  the  Council  has  not  yet 
decided that they fulfil 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  convergence  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 negotiated an opt-out arrangement before 
the adoption of the Maastricht Treaty (1) and does 
not  participate  in  the  third  stage  of  EMU.  Until 
Denmark  indicates  that  it  wishes  to  participate  in 
the  third  stage  and  adopt  the  euro,  it  is  not  the 
subject of an assessment as to whether it fulfils the 
necessary conditions for such a participation.  

In  2018,  the  Commission  and  the  ECB  adopted 
their latest regular Convergence Reports (2). None 
of the Member States assessed in those reports was 
deemed  to  meet  the  necessary  conditions  for 
adopting the euro.  

In 2020, two years will have elapsed since the last 
regular  reports  were  prepared.  Denmark  has  not 
expressed  a  wish  to  enter  the  third  stage  of 
EMU (3).  Therefore,  this  convergence  assessment 
covers  Bulgaria,  Czechia,  Croatia,  Hungary, 
Poland,  Romania  and  Sweden.  This  Commission 
Staff Working Document is a Technical  Annex to 
the  Convergence  Report  2020  and  includes  a 
detailed 
the  progress  with 
convergence,  as  required  by  Article  140(1)  of  the 
Treaty. 

assessment  of 

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

to 

Denmark. 

(2)  European  Commission,  Convergence  Report  2018, 
COM(2018)  370  final,  23  May  2018;  European  Central 
Bank, Convergence Report 2018, May 2018. 

(3)  The United Kingdom has withdrew from the EU since the 

May 2018 Convergence Report. 

The  2008-2009  financial  and  economic  crisis, 
along with the euro-area sovereign debt crisis, had 
revealed certain gaps in the economic  governance 
system  of  the  Economic  and  Monetary  Union 
(EMU) and showed that its instruments need to be 
strengthened  and  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 
sub-section 
imbalances 
macroeconomic 
1.2.6.).  

(see 

The  COVID-19  pandemic  represents  a  severe 
shock that fundamentally disrupts the economy of 
the  EU  and  of  its  Member  States.  Accordingly,  it 
could  have  a  significant  impact  on  economic 
convergence  indicators  going  forward,  making  it 
more  difficult  to  assess  the  sustainability  of 
convergence. However, the impact of the COVID-
19  pandemic  on  the  historical  data  used  in  the 
2020  Convergence  Report  is  limited.  This  is 
mainly  due  to  the  constraints  imposed  by  its  cut-
off  date,  which  together  with  the  Treaty-defined 
calculation methods of the price stability and long-
term  interest  rate  criteria  (i.e.  one  year  averages 
have to be used), mean that the corresponding data 
still  largely  reflect  the  situation  prior  to  the 
COVID-19  pandemic.  Furthermore, 
latest 
of  macroeconomic 
Commission 
imbalances  has  also 
the 
pandemic (see Box 1.6).  

taken  place  before 

assessment 

the 

through 

inputs  from 

into  account 

The  implications  of  the  COVID-19  pandemic  for 
the  forward-looking  elements  of  this  Report  are 
the 
taken 
Commission  services’  Spring  2020  Forecast,  i.e. 
using  the  latest  available  Commission  forecast. 
This forecast is the first comprehensive assessment 
from  the  Commission  of  the  likely  economic 
effects of the COVID-19 crisis in 2020 and 2021, 
and as such, it is surrounded by  higher than usual 
uncertainty. 

The  remainder  of  the  first  chapter  presents  the 
methodology  used  for  the  application  of  the 
assessment criteria. Chapters 2 to 8 examine, on a 

5 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

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 
2020. 

1.2.  APPLICATION OF THE CRITERIA 

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

compatibility  of  national  legislation  with  Articles 
130  and  131  of  the  Treaty  and  the  Statute  of  the 
European System of Central Banks (ESCB) and of 
the European Central Bank. The reports shall also 
examine  the  achievement  of  a  high  degree  of 
sustainable  convergence  by  reference 
the 
fulfilment of the four convergence criteria dealing 
with price stability, public finances, exchange rate 
stability  and  long  term  interest  rates  as  well  as 
some  additional  factors.  The  four  convergence 
in  a  Protocol 
criteria  are  developed  further 

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

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

Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

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; 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”. 

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 
and  practices, 
the 
appropriate  means to  meet the Treaty requirement 
that  inflation  must  be  measured  on  a  comparable 
basis.  To  this  end,  the  Council  adopted  on  23 
October  1995  a  framework  regulation (4)  setting 
the 
the  establishment  of  a 
harmonised  methodology  for  compiling  consumer 
price  indices  in  the  Member  States.  This  process 
resulted  in  the  production  of  the  Harmonised 
Indices  of  Consumer  Prices  (HICPs),  which  are 
used  for  assessing  the  fulfilment  of  the  price 
stability criterion.  

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 
'best-
average  rate  of  inflation  of  the 
performing  EU  Member  States  in  terms  of  price 
stability' plus 1.5 percentage points (see Box 1.2). 

three 

(4)  Council  Regulation  (EC)  No  2494/95  of  23  October  1995 
concerning  harmonised  indices  of  consumer  prices  (OJ  L 
257,  27.10.1995,  pp.  1-4),  amended  by  Regulations  (EC) 
No  1882/2003  and  No  596/2009  of 
the  European 
Parliament and of the Council, and repealed by Regulation 
(EU)  2016/792  of  the  European  Parliament  and  of  the 
Council. 

7 

 
                                                           
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(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, EU-28 for reports between 2014 and 2018 and EU-27 for the 2020 report.  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 2020 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

Accordingly, the reference value is currently 1.8%, 
based  on  the  data  of  Portugal  (0.2%),  Cyprus 
(0.4%), and Italy (0.4%) over the 12-month period 
covering April 2019-March 2020. 

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  Global  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 
factors 
influencing  price  developments 
the 
structural  manner,  rather 
factors. 
influence  of  cyclical  or 
Therefore, this Technical Annex also takes account 
of  the  role  of  the  macroeconomic  situation  and 
cyclical  position  in  the  inflation  performance,  of 

than  reflecting 
temporary 

in 

developments  in  unit  labour  costs  as  a  result  of 
trends 
labour  productivity  and  nominal 
compensation  per  head,  and  of  developments  in 
to  assess  how  external  price 
import  prices 
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  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’  forecast  of 
inflation. That forecast can subsequently be used to 
assess whether the Member State is likely to meet 
the  reference  value  also  in  the  months  ahead (5). 
Medium-term inflation prospects are also assessed 
by  reference  to  the  economies'  key  structural 
characteristics,  including  the  functioning  of  the 
labour and product markets. 

(5)  Based on the Commission services’ Spring 2020 Forecast, 
the inflation reference value is forecast to stand at 1.1% in 
December 2020. 

9 

      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, Finland1.91.42020March 2020Portugal, Cyprus, Italy1.81.11) EU15 until April 2004; EU25 between May 2004 and December 2006; EU27 between January 2007 and June 2013; EU28 between July 2013    and January 2020; EU27 (without UK) from February 2020 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.                                                           
 
 
 
 
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(Continued on the next page) 

10 

Box 1.3: Excessive deficit procedureThe excessive deficit procedure (EDP) 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). Together, these 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. The debt criterion in Article 126(2) of the Treaty was operationalised in the 2011 amendment of Council Regulation (EC) No 1467/97. 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)). Compliance with budgetary discipline is 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% of GDP, unless:  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 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% of GDP, unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace. According to the EDP Protocol, the Commission provides the statistical data for the implementation of the procedure. Member States have to provide data on government deficits, government debt, nominal GDP and other associated variables twice a year, before 1 April and before 1 October (2). Eurostat validates the submitted data subject to its compliance with ESA2010 (3) rules and related Eurostat decisions. Under Article 126(3), the Commission prepares a report if a Member State does not fulfil the requirements under one or both of the above criteria. The report takes into account whether the government deficit exceeds government investment expenditure and all other relevant factors. These include developments related to the medium-term economic position (4), the medium-term budgetary position (5), the medium-term government debt position (6), and 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 make a balanced overall assessment of the relevant factors. Those factors shall be taken into account in the steps leading to the decision on the existence of an excessive deficit when assessing compliance on the basis of the debt criterion. When assessing compliance on the basis of the deficit criterion in a country with a debt ratio exceeding the reference value, those factors shall be taken into account in the steps leading to the decision on the existence of an excessive deficit subject to the double                                                            (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, debt dynamics and sustainability, including risk factors, 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 implicit liabilities related to ageing and private debt, to the extent that it may represent a contingent implicit liability for the government.  
 
 
 
    
 
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

1.2.3.  Public finances 

The  convergence  criterion  dealing  with 
the 
government  budgetary  position  is  defined  in  the 
second  indent  of  Article  140(1)  of  the  Treaty  as 
“the  sustainability  of  the  government  financial 

position; 
this  will  be  apparent  from  having 
achieved a government budgetary position without 
a  deficit  that  is  excessive  as  determined  in 
accordance  with  Article  126(6)”.  Furthermore, 
Article  2  of  the  Protocol  on  the  convergence 
criteria states that this criterion means that “at the 

11 

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 two weeks of its publication (Article 126(4), Article 3.1 of Regulation 1467/97). If the Commission 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 the Commission’s proposal and the overall assessment 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 to correct the deficit within a given period (Article 126(7)). According to Regulation 1467/97, the Council recommendation should specify the deadline for the correction of the excessive deficit, the annual budgetary targets, and 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 actions taken. The report shall include targets for government expenditure, revenue and 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. The revised recommendation may 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. If the Council establishes lack of 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 expiration 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 sanctions in case of non-compliance, as well as the 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 can be found in the Vade Mecum on the Stability and Growth Pact, European Economy Institutional Paper 101, April 2019: https://ec.europa.eu/info/publications/vade-mecum-stability-and-growth-pact-2019-edition_en    
    
 
 
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

on  the  establishment  of  the  ERM  II  (8),  the 
European  Monetary  System  has  been  replaced  by 
the 
the  Exchange  Rate  Mechanism  II  upon 
introduction of the euro, and the euro has become 
the centre of the mechanism. 

in  auxiliary 

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

including 

foreign 

In  principle,  the  assessment  of  this  criterion 
verifies the participation  in ERM  II and examines 
exchange rate behaviour within the mechanism. As 
currently  none  of  the  Member  States  assessed  in 
this  Convergence  Report  participates  in  ERM  II, 
de  facto  exchange  rate  stability  is  reviewed  for 
analytical  purposes  (see  Box  1.4  for  further 
information on ERM II participation). The relevant 
period for assessing exchange rate stability in this 
Technical  Annex  is  24  April  2018  to  23  April 
2020. 

1.2.5.  Long-term interest rates 

The  fourth  indent  of  Article  140(1)  of  the  Treaty 
requires 
that  “the  durability  of  convergence 
achieved  by  the  Member  State  with  a  derogation 
and  of  its  participation  in  the  exchange  rate 
mechanism” is “reflected in the long-term interest 
rate  levels”.  Article  4  of  the  Protocol  on  the 
convergence  criteria  further  stipulates  that  “the 
criterion  on  the  convergence  of  interest  rates  […] 
shall mean that, observed over a period of one year 
before the examination, a Member State has had an 
average  nominal  long-term  interest  rate  that  does 
not  exceed  by  more  than  two  percentage  points 
that of, at most, the three best performing Member 
States in terms of price stability. Interest rates shall 
be measured on the basis of long-term government 
bonds  or  comparable  securities, 
into 
account  differences  in  national  definitions”  (see 
Box 1.5). 

taking 

for  an  appreciation  may  be  taken  into  account,  in 
accordance  with  the  Common  Statement  on  Acceding 
Countries  and  ERM II  by  the  Informal  ECOFIN  Council, 
Athens, 5 April 2003. 

(8)  97/C 236/03 of 16 June 1997, OJ C 236, 2.8.1997, p.5. 

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 (6). 

1.2.4.  Exchange rate stability 

third 

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

Article  3  of  the  Protocol  on  the  convergence 
criteria  stipulates:  “The  criterion  on  participation 
in  the  exchange  rate  mechanism  of  the  European 
Monetary  System  […]  shall  mean  that  a  Member 
State has respected the normal fluctuation margins 
provided  for  by  the  exchange-rate  mechanism  of 
the  European  Monetary  System  without  severe 
tensions  for  at  least  the  last  two  years  before  the 
examination. In particular, the Member State shall 
not  have  devalued  its  currency’s  bilateral  central 
rate  against  the  euro  on  its  own  initiative  for  the 
same period” (7). Based on the Council Resolution 

(6)  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 
since 
at: 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm. 

found 

2002 

can 

be 

(7)  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 

12 

                                                           
                                                                                   
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

(Continued on the next page) 

13 

Box 1.4: A reinforced  approach to ERM II participation by means of upfront policy commitments by the applicant Member StatesParticipating in ERM II is an essential step for a Member State with a derogation on the way to fulfil the exchange rate criterion and to euro adoption. Fulfilling the exchange rate criterion through the smooth participation in ERM II is provided for in Article 140 of the TFEU, Protocol No 13 to the TFEU on the convergence criteria and the Resolution of the European Council on the establishment of an exchange-rate mechanism in the third stage of economic and monetary union adopted in Amsterdam on 16 June 1997 (1). In accordance with this framework, ERM II entry of a Member State with a derogation requires a mutual agreement of all ‘ERM II parties’. These include the finance ministers of euro area Member States, the European Central Bank, and the finance ministers and the central bank governors of the non-euro area Member States participating in ERM II. At the time of writing this report, Denmark was the only non-euro-area Member State participating in ERM II. The European Commission provides analytical support to the ERM II process, but has no voting right and no right of initiative in the ERM II entry process. In July 2018, learning from past episodes of economic overheating in ERM II and the euro-area crisis, the ERM II parties clarified the modalities of a reinforced approach for future ERM II participation with a view of ensuring a smooth transition to, and participation in, ERM II, in their statement on Bulgaria’s path towards ERM II, stating that this approach would apply to all Member States wishing to join ERM II from then onwards (2). The reinforced approach was confirmed in the later statement of the ERM II parties of July 2019 on Croatia’s path towards ERM II participation (3). According to this reinforced approach, the applicant Member State and ERM II parties agree on a number of policy commitments to be implemented by the former before joining ERM II. This package of so called prior policy commitments aims at maximising the country’s chances to operate smoothly in ERM II. It is country-specific, targeted and covers policy areas that are highly relevant for a smooth transition to and participation in ERM II including, for instance institutional quality, governance, the financial sector, fiscal policy, or the business environment. In particular, as being part of the euro area now also implies for a Member State to be part of the Banking Union’s pillars of the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM), the applicant Member State is expected to enter into ‘close cooperation’ with the ECB for banking supervision purposes at the latest by the time of its participation in ERM II. A Member State with a derogation can join the Banking Union before its euro adoption via an arrangement called ‘close cooperation’. Entering in close cooperation with the ECB means that the significant credit institutions established in the country concerned are supervised by the ECB via the involvement of the domestic national supervisor. Entering in close cooperation also implies participation in the Single Resolution Mechanism, including the Single Resolution Fund (4). In addition to establishing close cooperation with the ECB, the two Member States currently intending to participate in ERM II have taken a number of other prior policy commitments. The Bulgarian authorities have taken prior-commitments in the following areas: the macroprudential framework, the supervision of the non-banking financial sector, the insolvency framework, the anti money-laundering framework and the governance of state-owned enterprises (5). Besides close cooperation, the prior-commitments of Croatian authorities cover measures related to the macroprudential framework, the anti money-laundering framework, the collection, production and dissemination of statistic, public sector governance and firms’ administrative and financial burden (6).                                                            (1) See:  https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A31997Y0802%2803%29 (2) See: https://www.consilium.europa.eu/en/press/press-releases/2018/07/12/statement-on-bulgaria-s-path-towards-erm-ii-participation/ (3) See: https://www.consilium.europa.eu/en/press/press-releases/2019/07/08/statement-on-croatia-s-path-towards-erm-ii-participation/ (4) See: https://www.bankingsupervision.europa.eu/press/publications/newsletter/2018/html/ssm.nl181114_1.en.html, and see also: https://www.bankingsupervision.europa.eu/ecb/legal/pdf/celex_32014d000501_en_txt.pdf (5) For more details on the prior-commitments taken by Bulgarian authorities see:  https://www.consilium.europa.eu/media/36125/st11119-en18.pdf (6) For more details on the prior-commitments taken by Croatian authorities see: https://www.consilium.europa.eu/media/40282/letter-of-intent.pdf  
 
 
        
 
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

Box (continued) 

14 

In terms of process, the ECB and the Commission monitor the fulfilment of the prior-commitments undertaken by the applicant Member States in the respective areas of competence of the ECB and the Union and in close cooperation with the Member State concerned. The two institutions regularly inform ERM II parties on the progress made with the prior-commitments. A comprehensive assessment of the applicants’ banking sector is carried out by the ECB as part of the process of establishing close cooperation with the ECB. This includes an asset quality review and a stress test that aims at assessing whether banks are fundamentally sound. The results of the comprehensive assessment are made public on the ECB’s website (7). In line with the long-standing ERM II practice, ERM II parties also expect applicant Member States to take further policy commitments at the moment of joining ERM II with the aim of achieving a high degree of sustainable economic convergence by the time the euro will be adopted.                                                            (7) The results of the comprehensive assessment of six Bulgarian banks are available at: https://www.bankingsupervision.europa.eu/press/pr/date/2019/html/ssm.pr190726~1b474e3467.en.html Box 1.5: 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 and Luxembourg with residual maturity below 5 and 7 years respectively. All yields are calculated on the basis of secondary market rates, where available. For Czechia, Germany and Malta a basket of bonds is used, while a single benchmark bond is used in twenty-three Member States. For Estonia, no appropriate harmonised series or proxy could be identified, primarily reflecting the very low level of Estonian government debt.  Data used in this Report can be found on Eurostat ("Maastricht criterion bond yields (mcby): EMU convergence criterion bond yields", code: tec00097). The same series is also published by the ECB's Statistical Data Warehouse (code IRS.M.Country Code.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 2020 - Technical annex 

Chapter 1 - Introduction 

The  section  on  additional  factors  makes  reference 
to  the  surveillance  of  macroeconomic  imbalances 
under  the  Macroeconomic  Imbalance  Procedure, 
which  was  adopted  in  December  2011  as  one  of 
the  key  elements  of  the  legislative  package  (the 
"Six-Pack")  to  enhance  the  governance  structures 
into  the 
in  EMU,  and  integrates 
assessment (see Box 1.6). 

its  results 

the  criterion  on 

the  assessment  of 

For 
the 
convergence of interest rates, yields on benchmark 
long-term bonds have been taken, using an average 
rate over the latest 12 months. The reference value 
for March 2020 is calculated as the simple average 
of the average  long-term interest rates in Portugal 
(0.5%),  Cyprus  (0.8%)  and  Italy  (1.6%),  plus  2 
percentage  points,  yielding  a  reference  value  of 
2.9%. 

1.2.6.  Additional factors 

factors  relevant 

into  account  other 

Article 140(1) TFEU also requires that the reports 
take 
to 
economic 
integration  and  convergence.  These 
additional  factors  include  financial,  product  and 
labour  market  integration  and  the  development  of 
the  balance  of  payments.  The  analysis  of  the 
development  of  unit  labour  costs  and  other  price 
indices, which is also prescribed by Article 140 of 
the Treaty, is covered in the price stability section. 

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 
the  situation  and  development  of  the  external 
balance (9). Market integration is assessed through 
trade,  foreign  direct  investment  and  a  smooth 
functioning  of  the  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. 

is  aligned  with 

Starting  with  the  2012  Convergence  Report,  the 
convergence  assessment 
the 
broader  European  Semester  approach  which  takes 
the  economic  policy 
an 
challenges 
fiscal 
sustainability,  competitiveness,  financial  market 
stability and economic growth (10). 

look  at 
facing  EMU 

in  ensuring 

integrated 

(9)  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. 

(10)  In  line  with  the  statistical  data  cut-off  date  of  this 
Convergence Report (23 April 2020), an assessment of the 
2020  updates  of  the  Convergence  Programmes  is  not 
included in this Staff Working Document. Moreover, on 19 
March  2020  the  Commission  set  out  its  view  that  the 

conditions  allowing  the  Union  institutions  to  activate  the 
general  escape  clause  of  the  EU  fiscal  framework  were 
fulfilled,  to  which  the  Finance  Ministers  of  the  Member 
States  reacted  favourably  on  23  March  2020,  which 
facilitates 
the 
the  necessary  budgetary  response 
economic  consequences  of  the  COVID-19  crisis.  The 
activation  of  the  general  escape  clause  allows  for  a 
temporary departure from the adjustment path towards the 
medium-term  budgetary  objective,  provided  that  this  does 
not endanger fiscal sustainability in the medium term. 

to 

15 

                                                           
                                                                                   
Convergence Report 2020 - Technical annex 

Chapter 1 - Introduction 

16 

Box 1.6: 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 2020 Alert Mechanism Report (AMR) and In-Depth Reviews (IDR) The Commission published its latest AMR in December 2019 concluding that IDRs were warranted for 13 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. Four of the Member States for which IDRs were prepared are covered in this Convergence Report (Bulgaria, Croatia, Romania and Sweden). On the basis of this year's IDRs, in February 2020, the Commission concluded that Croatia, Romania and Sweden are experiencing imbalances, as last year. Instead, Bulgaria was found to no longer experience 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.  
 
   
 
 
2. BULGARIA 

2.1. 

LEGAL COMPATIBILITY 

2.1.1.  Introduction 

serious  misconduct  of  which  the  Governor  has 
been guilty within the meaning of Article 14 (1) of 
the BNB Law.  

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  since  the  2018  Convergence 
Report.    Bulgarian  authorities  have  amended  the 
BNB  Law  to  remedy  certain  incompatibilities 
highlighted 
2018 
Convergence  Report(11).  In  particular,  it  concerns 
issues  flagged  in  previous  convergence  reports  in 
the  section  on  central  bank  independence.  Other 
issues 
remain  unresolved.  Therefore,  certain 
comments provided in the 2018report are repeated 
also in this year's assessment. 

Commission's 

the 

in 

2.1.2.  Central Bank independence 

Regarding  the  rules  on  a  possible  removal  of  the 
Governor  from  office,  Article  14(1)  of  the  BNB 
Law  has  been  amended.  It  now  provides  that  the 
competent  authority  may  only  remove  a  member 
of  the  Governing  Council  from  office  if  he  no 
longer  fulfils  the  conditions  required  for  the 
performance of  his duties or  if  he  has been  found 
guilty  of  serious  misconduct.  This  provision  is 
compatible  with  Article  14.2  of  the  ESCB/ECB 
Statute. 

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 (12).  However,  similar  to  the  repealed  Act, 
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. It  should be specified that a dismissal of 
the  Governor  is  only  admissible  if,  as  set  out  in 
the 
Article  14.2  of 
ascertainment of a conflict of interest corresponds 
to  a  lack  of  fulfilment  of  the  conditions  required 
for  the  performance  of  the  Governor's  duties  or  a 

the  ESCB/ECB  Statute, 

(11)  SG No 106/21 21.12.2018; SG No 37/7.05.2019; SG No  
83/22.10.2019; SG No 14/18.02.2020. 
(12)  SG No. 7/19.01.2018. 

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 
amending  or  annulling 
its  decisions.  Such 
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  13(2)  of  the  BNB  Law  foresees  that  the 
Governor  of  the  BNB  shall  swear  an  oath  before 
the Parliament.  The content of the  oath laid down 
in paragraph one of the same provision refers inter 
alia  to  abiding  by  law  and  to  contribute  to  the 
performance  of  the  functions  of  the  BNB.  The 
Governor  of  the  BNB  acts  in  dual  capacity  as  a 
member of BNB’s decision-making bodies and of 
the  relevant  decision-making  bodies  of  the  ECB. 
Article 13 of the BNB Law needs to be adapted to 
reflect the status and the obligations and duties of 
the  Governor  of  the  BNB  as  member  of  the 
relevant  decision-making  bodies  of  the  ECB. 
Moreover, the oath does not contain a reference to 
central bank independence as enshrined in  Article 
130 of the TFEU. The oath as it stands now is an 
imperfection and should be remedied.  

Article  44  of  the  BNB  Law  has  been  amended 
since the 2018 Convergence Report with a view to 
achieving  compatibility  with  Article  130  of  the 
TFEU  and  Article  7  of  the  ESCB/ECB  Statute. 
The amended Article 44 of the BNB Law now also 
encompasses  a  reference,  as  suggested  in  the 
previous report, that the BNB and members of the 
Governing  Council,  in  the  performance  of  their 
tasks,  shall  be  independent  and  shall  not  seek  or 
instructions  from  foreign  and  EU 
take  any 

17 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

institutions  or  bodies.  However,  an  imperfection 
remains in the second sentence of Article 44 of the 
BNB Law where it refers to the public institutions 
and  bodies  not  having  the  right  to  influence  the 
BNB,  the  Governor  and  the  members  of  the 
Governing Council. The wording should be further 
improved  by  referring  to  the  wording  of  Article 
130  of 
the  TFEU,  which  states  that  public 
authorities may not seek to influence the members 
of national central banks’ decision-making 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  has  been  suspended  this 
might  constitute  an  incompatibility  in  the  area  of 
independence,  with  Article  130  of  the  TFEU  and 
Article 7 of the ESCB/ECB. 

2.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Since the 2018 Convergence Report, Article 45(1) 
and  (2)  of  the  BNB  Law,  which  were  not  fully 
consistent  with  Article  123  of  the  TFEU  and 
Article  21.1  of  the  ESCB/ECB  Statute  have  been 
amended  with  a  view  to  including  all  European 
and  other  national  public  entities  mentioned  in 
Article 123(1) of the TFEU and Article 21.1 of the 
ESCB/ECB  Statute.  However,  an  imperfection 
remains  given  the  original  list  of  national  entities 
referred  to  in  Article  45(1)  was  maintained.  The 
imperfection  in  the  latter  provision  referred  to  in 
the 2018 Convergence Report regarding the scope 
of  public  sector  debt  that  can  be  purchased  by  a 
national central bank has been solved.  

In  addition,  Article  45(3)  of  the  BNB  Law  was 
amended  since  the  2018  Convergence  Report.  It 
provides  that  the  BNB  shall  not  purchase  in  the 
primary  and  secondary  markets  public  debt 
instruments.  This  paragraph  is  inconsistent  with 
the  amended  Article  45(1)  of  the  BNB  Law  and 
with  Article  123  of  the  TFEU  given  the  word 
‘direct’  refers  to  the  prohibition  to  purchase  debt 
instruments on the primary market only. 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 
wording  ‘and  secondary”  in  Article  45(3)  should 
be  removed.  In  addition,  since  the  first  paragraph 

of  Article  45  of  the  BNB  Law  already  covers  the 
prohibition to buy directly debt instruments, i.e. on 
the  primary  market,  the  third  paragraph’s  content 
becomes redundant after adjustment.  

Pursuant  to  Article  45(2)  in  conjunction  with 
Article 33(2) of the BNB Law, Article 45(1) of the 
BNB  Law  does  not  apply  to  the  extension  of 
credits  to  state-owned  and  municipal  banks  in 
emergency  cases  of  liquidity  risk  that  may  affect 
the  stability  of  the  banking  system.  The  scope  of 
this  exemption  should  be  amended  to  be  fully 
consistent  with  the  wording  of  Article  123(2)  of 
the  TFEU  and  Article  21.3  of  the  ESCB/ECB 
Statute. 

2.1.4.  Integration in the ESCB 

Objectives 

The secondary objective of the BNB (Article 2(2) 
of the BNB Law) is compatible with the Treaty on 
the Functioning of the European Union. 

Article 2(1) of the BNB Law correctly reflects that 
the  primary  objective  of  the  BNB  is  to  maintain 
price  stability.  However,  as  from  the  day  that 
Bulgaria adopts the euro, the latter will replace the 
national currency (lev) in accordance  with  Article 
140 (3) of the TFEU. The reference to the wording 
‘through  ensuring  the  stability  of  the  national 
currency’ will become obsolete as from that day.  

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

  absence  of  a  general  reference  to  the  BNB  as 
an  integral  part  of  the  ESCB  (Article  1(1)  of 
the  BNB  Law)  and  to  its  subordination  to  the 
ECB’s legal acts (Articles 16 (1) and (2) and 60 
of the BNB Law); 

  definition  of  monetary  policy  and  monetary 
functions,  operations  and  instruments  of  the 
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, 30, 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); 

18 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

 

 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); 

projected  to  approach  the  reference  value  in  the 
months ahead. 

  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). 

2.1.5.  Assessment of compatibility 

remedy 

authorities 

the  efforts  of 
The  Commission  welcomes 
Bulgarian 
the 
to 
incompatibilities  and  imperfections  in  comparison 
its  previous  2018  Convergence  Report. 
to 
However,  the  BNB  Law  and  the  Conflict  of 
Interest Prevention and Ascertainment Act are not 
yet fully compatible with Article 131 of the TFEU 
as 
the 
regards  central  bank 
the 
prohibition  of  monetary 
integration  in  the  ESCB  at  the  time  of  euro 
adoption. 

independence, 
financing  and 

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  2018.  It  then  increased 
to 3.0% by April 2019, before decreasing to 2.4% 
by November 2019. In March 2020, the reference 
value  was  1.8%,  calculated  as  the  average  of  the 
12-month  average  inflation  rates  in  Portugal, 
Cyprus  and  Italy  plus  1.5  percentage  points.  The 
corresponding inflation rate in Bulgaria was 2.6%, 
i.e.  0.8  percentage  points  above  the  reference 
value.  The  12-month  average  inflation  rate  is 

2.2.2.  Recent inflation developments 

The annual HICP inflation rose from 1.7% in April 
2018 to 3.7% by  August and returned to 2.3% by 
end-2018. It then increased to 3.1% by April 2019, 
before  falling  back 
to  1.6%  by  September. 
Inflation  then  started  to  rise  again,  reaching  3.4% 
in  January  2020  and  then  fell  to  2.4%  in  March. 
The  fluctuation  of  inflation  was  mainly  driven  by 
energy  and  unprocessed  food  prices.  Fuel  price 
increases  propped  up  inflation  between  May  and 
November  2018,  in  the  first  five  months  of  2019 
and  then  again  in  the  end  of  2019  and  the  two 
months  of  2020.  Their  contribution 
turned 
negative,  following the depressed oil prices in the 
second  half  of  2019  and  again  in  March  2020. 
Unprocessed  food  prices  spiked  in  2018  due  to  a 
bad  harvest  and  higher  international  grain  prices. 
High  unprocessed  food  inflation  continued  in 
2019, following the outbreak of the African swine 
fever  in  April  and  higher  import  prices  of  meat. 
Inflation rates in Bulgaria  have exceeded those of 
the euro area over the past two years. 

inflation  (measured  as  HICP 

Core 
inflation 
excluding  energy  and  unprocessed  food)  hovered 
around  2.5%  over  the  last  two  years.  It  remained 
below headline inflation in most of 2018. In 2019, 
core inflation was close to the headline figure and 
remained  below  overall 
inflation  between 
December  2019  and  February  2020.  Inflation  in 
processed  food  gathered  pace  over  the  last  two 
years,  reflecting  both  higher  international  food 
prices  and  domestic  factors,  such  as  higher  prices 
of  unprocessed  food.  Inflation  in  services  also 
picked  up  in  2018  and  2019,  reaching  6.1%  in 
August 2018 and 4.3% in July 2019. The cyclical 
upturn  and  the  convergence  process  sustained  the 

19 

-2-101234Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20BulgariaReference valueGraph 2.1: Bulgaria -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.    
Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

to  turn  deeply  negative  in  2020  and  then  recover 
only partially, remaining below zero in 2021. 

The fiscal stance, as measured by the change in the 
structural  balance,  was  tightened  in  2018  and 
loosened  in  2019,  but  was  overall  broadly  neutral 
over the two  years.  According to the  Commission 
services' Spring 2020 Forecast, the fiscal stance is 
set to be expansionary in the current and next year. 

The  BNB  pursues  its  primary  objective  of  price 
stability  through  an  exchange  rate  anchor  in  the 
context  of  a  currency  board  arrangement  (CBA) 
with  the  lev  pegged  to  the  euro.  The  CBA  serves 
as a key macroeconomic policy anchor.  

Wages and labour costs 

Employment  rates  continued  to  increase  in  2018 
and 2019. The improved prospects for employment 
and  higher  wages  attracted  more  working  age 
population  to  the  labour  market,  thus  increasing 
rate 
the  activity 
reaching 
downward 
continued 
historically  low  levels  of  5.2%  in  2018  and  4.2% 
in  2019.  However,  the  imposition  of  containment 

rates.  The  unemployment 

trend, 

its 

dynamics  in  prices  of  services  over  those  two 
years.  Specific  factors  have  also  contributed  to 
services  inflation.  Higher  food  prices  fed  into 
higher  prices  for  catering  services.  Statistical 
effects and a more pronounced seasonality pushed 
up  prices  of  accommodation  services  during  the 
summer months of 2018 and 2019. Sharp increases 
in car insurance premiums in mid-2018 also added 
to annual inflation in 2018 and early 2019. Prices 
of  non-energy  industrial  goods  had  a  negligible 
effect on overall price movements.  

2.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

in 

relation  with 

Real  GDP  growth  accelerated  from  3.1%  in  2018 
to 3.4% in 2019, despite relatively weaker external 
demand  and  higher  uncertainty  abroad.  Private 
consumption  was 
the  main  driving  force  of 
economic  growth  on  the  back  of  rapid  wage 
growth  and  high  employment.  Overall  investment 
favourable 
growth  was  moderate,  although 
financing  conditions  and  high  capacity  utilisation 
were  in  place.  Export  growth  slowed  in  2018, 
mainly 
trade 
slowdown  with  major 
trading  partners  and 
temporary  one-off  factors  (i.e.  closure  of  oil 
refinery)  and  became  volatile  in  the  course  of 
2019.  Net  exports  had  a  sizable  negative 
contribution to GDP growth in 2018, while in 2019 
the  contribution  was  less  negative  at  -0.3%. 
According  to  the  Commission  services’  Spring 
2020  Forecast,  real  GDP  is  expected  to  contract 
sharply  by  7.2%  in  2020  due  to  the  coronavirus 
pandemic  and  then  to  recover  by  6%  in  2021  on 
the  back  of  a  relatively  swift  rebound  in  private 
consumption  and  exports.  Output  gap  is  projected 

the  external 

20 

-4-2024201420152016201720182019BulgariaEuro areaGraph 2.2: Bulgaria -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 2.1:weights  Bulgaria - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP-1.6-1.1-1.31.22.62.52.61000Non-energy industrial goods-2.2-1.6-1.6-1.1-0.50.20.2268Energy-3.8-6.7-7.05.86.41.41.6122Unprocessed food -0.80.6-1.15.91.35.36.154Processed food-0.40.61.22.32.34.04.5236Services-1.30.1-0.60.04.33.23.0320HICP excl. energy and unproc. food-1.3-0.3-0.40.32.12.52.5824HICP at constant tax rates -1.6-1.1-1.51.02.42.42.61000Administered prices HICP-1.01.50.11.72.22.62.61571) 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 2020 - Technical annex 

Chapter 2 - Bulgaria 

in  productivity.  ULC  dynamics  are  projected  to 
slow  down  somewhat  in  2021  alongside  the 
recovery. 

External factors 

the  high  openness  of 

Given 
the  Bulgarian 
economy,  developments  in  import  prices  play  an 
important role in domestic price formation. Import 
food  and  other 
fuels, 
prices  of  mineral 
manufactured  articles, 
including  clothing  and 
footwear,  are  particularly  relevant  for  inflation  in 
Bulgaria,  due  to  the  high  energy  intensity  of  the 
Bulgarian  economy  and  the  relatively  large  share 
of manufactured goods in the consumer basket. In 
2018, growth in the import deflator stood at 2.2%, 
pushed  up  by  higher  oil  and  gas  prices  as  well  as 

21 

to 

longest.  According 

measures against the COVID-19 pandemic already 
caused job losses in  the  first  months of 2020. Job 
losses  are  set  to  be  most  pronounced  in  the 
services sector (which accounts for more than 60% 
of  employment),  where  the  disruption  is  likely  to 
last 
the  Commission 
services' Spring 2020 Forecast, the unemployment 
rate  is  expected  to  jump  to  7%  in  2020,  after 
having  declined  to  historic  lows  of  around  4%  in 
2019.  Government  measures 
support 
employment  in  hard-hit  sectors  are  expected  to 
cushion  the  impact  of  the  crisis  on  the  labour 
market.  The  government  has  taken  measures  to 
protect  employment,  notably  a  new  short-time 
work  scheme  according  to  which  the  State  will 
in 
cover  60%  of 
companies  with  a  proven  impact  from  the  crisis. 
Nominal compensation per employee increased by 
9.7% in 2018 and 7.8% in 2019, owing to the tight 
labour market and wage convergence pressures. 

the  wages  of  employees 

to 

Labour productivity growth hovered around 3% in 
2018 and 2019. It is projected to decrease by 4.8% 
in 2020 due to partial labour hoarding and recover 
in  2021.  Nominal  unit  labour  cost  (ULC)  growth 
remained  high  at  6.3% 
then 
decelerated  to  3.0%  in  2019  while  labour  market 
tightness  and  skill  shortages  persisted.  According 
to the Commission services' Spring 2020 Forecast, 
ULC  growth  is  expected  to  strongly  increase  in 
2020 as labour hoarding would cause a sharp drop 

in  2018  and 

-6-303691220142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflation(y-o-y % change)Source: Eurostat, Commission services' Spring 2020 Forecast.Graph 2.3: Bulgaria -Inflation, productivity and wage trendsTable 2.2:Bulgaria - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationBulgaria-1.6-1.1-1.31.22.62.51.11.1Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorBulgaria0.01.60.43.22.02.00.02.0Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeBulgaria5.65.65.810.59.76.13.42.3Euro area1.41.31.21.72.22.11.10.4Labour productivityBulgaria1.53.63.31.73.23.0-4.85.6Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsBulgaria4.01.92.48.76.33.08.6-3.1Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorBulgaria-2.9-2.9-6.07.52.20.4-3.02.8Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services.     
 
 
     
 
 
Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

Risks  to  the  inflation  outlook  appear  broadly 
balanced.  However,  the  interplay  between  supply 
and  demand  constraints  related  to  the  COVID-19 
pandemic  presents  additional  uncertainty  to  the 
inflation forecast. 

The  level  of  consumer  prices  in  Bulgaria  stood  at 
about 49% of the euro area average in 2018. This 
suggests  that  there  is  a  significant  potential  for 
price  level  convergence  in  the  long  term,  as  GDP 
per  capita  in  PPS  (about  48%  of  the  euro-area 
average  in  2018)  increases  towards  the  euro-area 
average. 

Medium-term  inflation  prospects  will  depend  on 
wage and productivity developments as well as on 
the  functioning  of  product  and  services  markets. 
These developments may be substantially affected 
by the COVID-19 crisis. Given the openness of the 
Bulgarian  economy  and  its  limited  resource  base, 
commodity  prices  and  other  external  price  shocks 
will  continue  to  exercise  significant  influence  on 
domestic inflation. 

2.3. 

PUBLIC FINANCES 

2.3.1.  Recent fiscal developments 

in 

to  38.4%.  This 

The  general  government  budget 
registered 
surpluses  of  2%  of  GDP  in  2018  and  2019.  The 
overall  improvement  in  budget  surpluses  relative 
to the previous years was mostly driven by higher 
revenue.  Total  public  revenue  increased  by  more 
than  2  percentage  points  of  GDP  between  2017 
and  2019, 
increase  reflects 
improvements 
tax  collection  and  higher 
transfers  from  the  EU.  Moreover,  a  large  part  of 
the  increase  in  the  level  of  total  revenue  (by 
around 1 percentage point of GDP) was due to the 
introduction of a fee on electricity supply in favour 
of the  national energy  security  fund in 2018. This 
change,  however,  does  not  affect  the  government 
balance as it is  matched  with an equal increase in 
expenditure through  subsidies. In this context,  the 
1.4 
ratio 
expenditure-to-GDP 
percentage  points  between  2017  and  2019  to 
36.3%, mainly due to wage increases in education 
and  a  recovery  in  public  investment  from  a  very 
low  level  in  2017.  The  main  driving  forces  of 
public  investment  were  the  picking  up  in  EU 
funded  projects  and  some  investment  in  road 
infrastructure and defence. 

increase 

by 

The general government balance was 2.1% of GDP 
in 2019, overshooting the target of  -0.3% of GDP 
in  the  2019  Convergence  Programme.  The  better 

prices of some non-durable consumer products. In 
2019,  growth  in  the  import  deflator  was  close  to 
zero,  as  prices  of  mineral  fuels  dropped  sharply 
and 
imported  consumer  goods 
decelerated. 

inflation 

in 

Over  the  last  two  years,  the  appreciating  nominal 
effective  exchange  rate  (NEER)  decreased  import 
price  dynamics.  The 
lev’s  NEER  (measured 
against  a  group  of  36  trading  partners),  which  is 
determined  by  the  price  of  the  lev  (and  therefore 
the  euro)  vis-à-vis  the  currencies  of  major  trade 
partners, appreciated by 3.4% in 2018 and by 0.6% 
in  2019.  The  appreciation  in  2018  was  strongly 
influenced  by  the  depreciation  of  the  Turkish  lira 
against  the  euro.  Turkey  is  the  most  important 
trading  partner  for  Bulgaria  outside  the  EU,  with 
8% of total exports and 6% of total imports. 

Administered prices and taxes 

The growth rate of administered prices accelerated 
in 2019, reaching 2.6% on the back of increases in 
utilities  prices  and  (tertiary)  education  fees. 
Administered  prices  inflation  remained  below 
overall  HICP  in  2018  and  slightly  surpassed 
headline  consumer  price  inflation  in  2019.  The 
share of administered prices in the HICP basket is 
relatively high at around 16%, compared to 12% in 
the euro area. Regulated prices of electricity,  heat 
and  water  follow  a  seasonal  pattern,  as  they  are 
usually  updated at the beginning of the  year or in 
the summer months. 

Indirect  tax  changes  had  only  a  small  positive 
effect on inflation over the last two years. Annual 
thus  slightly  below 
constant-tax  HICP  was 
headline inflation during the assessment period. 

Medium-term prospects 

Annual  HICP  inflation  is  expected  to  decline 
significantly  in  2020  before  stabilizing  at  a  low 
level  in  2021.  Following  the  oil  price  collapse  at 
the  beginning  of  2020,  energy  prices  are  set  to 
push  inflation  downwards  substantially  in  2020 
and  the  beginning  of  2021.  In  2020,  services 
inflation  is  projected  to  decline  given  the  demand 
reduction  in  sectors  that  are  affected  by  the 
imposed lockdown due to the COVID-19 outbreak 
as  well as by the  negative cyclical position of the 
economy.  Inflation  of  processed  and  unprocessed 
food  prices  is  forecast  to  gradually  decelerate,  as 
price  pressures  in  the  beginning  of  2020  are 
expected  to  abate.  Average  annual  inflation  is 
projected at 1.1% for both 2020 and 2021. 

22 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

GDP  relative  to  the  previous  year.  This  is  mainly 
due  to  the  deteriorated  macroeconomic  outlook, 
which  is  expected  to  lead  to  lower  revenues  from 
taxes and social security contributions and a higher 
spending  on  unemployment  and  social  benefits. 
Moreover,  as  part  of  the  package  of  measures  to 
contain 
the 
government  announced  a  higher  spending  on 
medical  equipment  and  wage  bonuses  and 
increases for the medical and security staff, as well 
as  subsidies,  tax  deferrals,  state  guarantees  and  a 
reallocation  of  investment  funds  to  support  the 
economy. 

the  pandemic  and 

impact, 

its 

the  deficit  of 

According  to  the  Commission  services’  Spring 
2020  Forecast, 
the  general 
government  balance  in  ESA  terms  is  set  to  reach 
2.8%  of  GDP  in  2020  and  to  slightly  diminish  to 
1.8%  of  GDP  in  2021  (assuming  unchanged 
policies),  mainly  due  to  the  positive  impact  of 
higher  economic  growth  on  revenues  and  the 
fading  impact  of  some  expenditure  measures. 
Taking  into  account  the  estimated  positive  output 
gap,  the  structural  deficit  is  projected  to  be  in  the 
neighbourhood of -1.5% of GDP in both 2020 and 
2021.  The  public-debt-to-GDP  ratio  is  forecast  to 
increase  to  25.5%  of  GDP  in  2020  and  remain  at 
that level in 2021. The rise in general government 
debt  is  mainly  driven  by  a  return  to  primary 

23 

outcome  is  mainly  due  to  better  than  projected 
revenue and lower than planned public investment. 
In  structural  terms,  after  the  peak  of  2018  at 
around 1.3% of GDP the surplus returned to 1% of 
GDP  in  2019.  The  general  government  debt 
declined  from  around  25%  of  GDP  in  2017  to 
close to 20% of GDP in in 2019. 

2.3.2.  Medium-term prospects 

The  2020  budget  was  originally  adopted  by 
Parliament  in  December  2019  and  aimed  at  a 
balanced general government budget in cash terms, 
corresponding  to  a  close  to  balanced  budget  in 
ESA  terms.  The  budget  envisaged  an  increase  in 
all  public  wages  by  10%  and  for  some  categories 
of teaching staff by 17% and no new measures on 
the  revenue  side.  The  medium  term  plan  of  the 
government up to 2022 was to maintain a balanced 
budget and to continue decreasing debt. 

In April 2020, the Parliament amended the budget 
law  to  take  into  account  a  deteriorated  economic 
outlook  and  the  new  budgetary  plans  of  the 
government 
the  COVID-19 
pandemic.  The  updated  2020  budget  envisages  a 
deficit  slightly  over  3%  of  GDP  in  cash  terms,  as 
the overall impact of the pandemic on the budget is 
estimated  to  be  close  to  5  percentage  points  of 

response 

to 

in 

Table 2.3:Bulgaria - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-5.4-1.70.11.12.02.1-2.8-1.8- Total revenues37.938.735.136.038.538.439.338.3- Total expenditure43.340.435.034.936.636.342.040.2   of which: - Interest expenditure0.90.90.90.80.70.60.60.7p.m.: Tax burden28.429.129.129.429.930.931.330.1Primary balance-4.6-0.81.01.92.62.6-2.2-1.2Cyclically-adjusted balance 2)-4.8-1.5-0.10.71.31.1-1.3-1.6One-off and temporary measures 3)-3.2-0.10.00.00.00.00.00.0Structural balance 2)4)-1.6-1.4-0.10.71.31.1-1.3-1.6Government gross debt27.126.029.325.322.320.425.525.4p.m: Real GDP growth (%)1.94.03.83.53.13.4-7.26.0p.m: Output gap 2)-2.0-0.80.51.52.23.4-5.0-0.71) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services. 
 
   
 
 
deficits,  the  contraction  in  GDP  and  certain 
measures to support liquidity in the economy (e.g. 
the  Bulgarian 
the  capital 
Development  Bank  to  provide  state  guaranteed 
loans) that do not affect the deficit but do weigh on 
debt. 

strengthening  of 

fiscal 

The  Bulgarian 
framework  has  been 
strengthened  over  the  recent  years.  It  should  be 
recalled  that  Bulgaria  is  bound  (based  on  its  own 
declaration  of  intention)  by  the  Fiscal  Compact 
provisions  of  the  intergovernmental  Treaty  on 
Stability,  Coordination  and  Governance  in  the 
Economic  and  Monetary  Union  (TSCG)(13)  and 
has  transposed  those  requirements  in  the  national 
legal  order.  Based  on  the  Commission’s  Fiscal 
Governance  Database,  Bulgaria  has  in  place  no 
less  than  nine  domestic  numerical  rules  (highest 
number  in  the  EU),  with  a  recently  improving 
trend of compliance. Based on its broad remit, the 
Fiscal Council has gradually established its system 
for  releasing  its  mandatory  monitoring  reports  on 
the  annual  and  medium-term  fiscal  plans  and 
compliance with all the numerical rules laid down 
in  the  Public  Finance  Act.  The  mandate  of  the 
Council  was  further  extended  in  2019  to  include 
regular  and  comprehensive  ex  post  evaluations  of 
the  government’s  macroeconomic  and  budgetary 
forecasts (the first evaluation is yet to be released). 

2.4. 

EXCHANGE RATE STABILITY 

to,  and  participation 

The Bulgarian lev does not participate in ERM II. 
In  July  2018,  Bulgaria  announced  its  intention  to 
put in place the necessary elements for a successful 
entry  into  ERM  II.  In  order  to  ensure  a  smooth 
transition 
in,  ERM  II, 
Bulgaria  committed  to  implement  before  joining 
the  ERM  II  a  number  of  measures  (i.e.  prior-
commitments)  in  the  following  six  policy  areas: 
banking supervision, macro-prudential framework, 
financial  sector, 
supervision  of  non-banking 
insolvency 
laundering 
framework,  anti-money 
framework, governance of state-owned enterprises. 
the 
Bulgaria 
completion  of  these  prior-commitments,  in  close 
liaison  with  the  Commission  and  the  ECB  who 
monitor their progress. 

is  currently  working 

towards 

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 

(13)  Fiscal Compact is Title III of the intergovernmental Treaty 
the 

on  Stability,  Coordination  and  Governance 
Economic and Monetary Union (TSCG). 

in 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

1.95583  BGN/EUR).  Under  the  CBA,  the  BNB’s 
monetary liabilities have to be fully covered by its 
foreign reserves. The BNB is obliged to exchange 
monetary 
the  official 
exchange rate without any limit. 

liabilities  and  euro  at 

Bulgaria's  international  reserves  hovered  around 
EUR  25  billion  in  2019,  after  having  increased 
from EUR 22.6 billion at the beginning of 2018 to 
around EUR 25 billion at the end of the same year. 
International  reserves  increased  in  the  course  of 
2018  on  account  of  inflows  of  EU  funds  and  the 
related  net  purchases  of  euros  by  the  BNB.  As 
international reserves  were broadly stable  in 2019 
compared  to  2018,  their  share  as  a  percentage  of 
GDP declined slightly to below 41% from around 
45% at the end of 2017. 

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. 
The  BNB  discontinued  the  production  of  short-
term  reference  rates  (e.g.  SOFIBOR)  as  of  1  July 
2018.(14) 

(14)  The BNB continues to calculate and publish the  LEONIA 
Plus,  which  is  a  reference  rate  of  concluded  and  effected 

24 

1.81.92.02.1201420152016201720182019Graph 2.4: Bulgaria -BGN/EUR exchange rate(monthly averages)Source: ECB.01020304050607080201420152016201720182019Graph 2.5: Bulgaria -3-M Sofibor(1) spread to 3-M Euribor(basis points, monthly values)(1) The production of SOFIBOR reference rate was discontinued by the National Bank of Bulgaria as of 1 July 2018. An equivalent rate is not currently available.Source: Eurostat and National Bank of Bulgaria.                                                           
    
    
                                                           
2.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  used  for  the  convergence 
examination reflect the secondary market yield on 
a  single  benchmark  Bulgarian  government  bond 
with a residual maturity of around 10 years. 

The  Bulgarian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  below  the  reference  value  in 
the  2018  convergence  assessment  of  Bulgaria.  It 
further  declined  to  below  1%  at  the  end  of  2018 
and  to  below  0.50%  by  the  end-2019.  In  March 
2019, the reference value, given by the average of 
long-term  interest  rates  in  Portugal,  Cyprus,  and 
Italy  plus  2  percentage  points,  stood  at  2.9%.  In 
that  month,  the  12-month  moving  average  of  the 
yield  on  the  Bulgarian  benchmark  bond  stood  at 
0.3%, 
the 
reference value. 

i.e.  2.6  percentage  points  below 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

2019, before widening only moderately to close to 
70  basis  points  in  March  2020,  mainly  reflecting 
developments  in  German  long-term  government 
bond yields. 

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. 

remained  subdued.  Falling 

The long-term interest rate of Bulgaria has been on 
a  downward  path  since  the  beginning  of  2018, 
declining from close to 1% to below 0.20% in the 
first  three  months  of  2020.  Bulgarian  benchmark 
bond yields fell throughout 2018-19, supported by 
local  market  conditions  and  continuing  strong 
demand  for  government  securities  while  their 
supply 
long-term 
interest  rates  were  supported  also  by  external 
forces,  i.e.  expectations  of  loose  monetary  policy 
in  the  euro  area  for  an  extended  period  of  time. 
After falling sharply to below 50 basis points at the 
beginning  of  2018,  the  spread  to  German  long-
term  benchmark  bond  increased  somewhat,  while 
remaining  below  100  basis  points,  between  mid-
2018 and mid-2019, reflecting a sharp drop in the 
German 
interest  rates.  The  spread 
declined  again  to  close  to  50  basis  points  by  end 

long-term 

In  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see  also  Box  1.6),  which  concluded  that  an  In-
Depth  Review  (IDR)  was  warranted  for  Bulgaria. 
In  February  2020,  the  Commission  published  its 
annual country report on Bulgaria, including an In-
Depth  Review  (IDR).  The  report  concluded  that 
Bulgaria is experiencing no imbalances. In the past 
years,  vulnerabilities  in  the  financial  sector  were 
indebtedness  and  non-
coupled  with  high 
performing 
sector. 
favourable 
Consistent  policy  action  and  a 
macroeconomic  environment  have  reduced  risk 
and vulnerabilities further. Progress has been made 
in  strengthening  financial  sector  governance  and 
issues.  The 
addressing  outstanding  regulatory 
insolvency framework reform has been advancing. 
Robust  economic  growth  has  supported 
the 
reduction  of  corporate  debt  and  non-performing 
loan ratios. 

the  corporate 

loans 

in 

overnight  deposit  transactions  in  Bulgarian  levs  on  the 
interbank market in Bulgaria. 

25 

02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20BulgariaReference valueGraph 2.6: Bulgaria -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-2024201420152016201720182019BulgariaGermanyGraph 2.7: Bulgaria -Long-term interest rates(percent, monthly values)Source: Eurostat.    
                                                                                   
    
Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

2.6.1.  Developments  of 

the  balance  of 

payments 

Capital  account  also  improved  on  the  back  of 
higher inflows from EU funds transfers. 

Bulgaria’s  external  balance  (i.e.  the  combined 
current  and  capital  accounts)  continued  to  record 
surpluses in both 2018  and 2019, with the surplus 
rising from 2.5% of GDP in 2018 to 5.5% of GDP 
in 2019. This improvement was mostly driven by a 
substantial increase in the current account surplus, 
which rose to 4% in 2019 from 1.4% in 2018, on 
account of declining deficits of goods and primary 
income  balances  while  the  surplus  of  the  balance 
of trade services continued to increase for the third 
consecutive  year.  The  balance  of  goods 
strengthened in 2019, as nominal exports expanded 
faster  than  nominal  imports.  The  terms  of  trade 
have also improved, supporting Bulgaria’s external 
position. The balance of services remained positive 
and  strengthened  further  in  2019  due  to  lower 
imports  of  other  services.  Declining  profits  from 
FDI  in  2019  led  to  improved  balance  of  primary 
income.  Given  the  high  share  of  FDI  revenues  in 
income outflow and their volatility, they determine 
to  a  large  extent  the  evolution  of  primary  income 
balance.  The  surplus 
income 
increased in 2019, as the income outflow returned 
to  normal  levels  following  an  increase  in  2018. 

in  secondary 

26 

The  saving-investment  gap  of 
the  Bulgarian 
economy  increased  in  2019  compared  to  2018, 
reaching  5.5%  of  GDP.  The  higher  surplus  was 
driven by higher  net  savings  in the private sector. 
The somewhat depressed investment rate  in 2019, 
influenced  by  the  increased  uncertainty  abroad, 
accounted  for 
the  saving-
investment  gap.  Aggregate  savings  rate  remained 
roughly constant. 

the  widening  of 

The  financial  account  continued  to  show  net 
outflow  of  capital.  Increasing  net  deposits  of 
commercial  banks  abroad,  coupled  with  more 

0102030201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 2.8: Bulgaria -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.Table 2.4:Bulgaria - Balance of payments(percentage of GDP)201420152016201720182019Current account1.20.13.23.51.44.0of which: Balance of trade in goods-6.5-5.7-2.0-1.5-3.3-2.8                 Balance of trade in services5.96.77.05.85.96.2                 Primary income balance -2.0-4.5-5.1-4.4-4.4-2.8                 Secondary income balance3.83.63.33.53.23.4Capital account2.23.12.21.01.11.5External balance 1)3.53.25.44.52.55.5Financial account1.07.99.14.45.44.2of which: Direct investment-0.3-4.1-1.1-2.5-1.3-1.3                Portfolio investment-2.8-1.3-1.35.02.62.6                Other investment 2)0.05.14.52.11.73.9                Change in reserves4.28.27.1-0.22.4-0.9Financial account without reserves-3.2-0.22.04.63.05.1Errors and omissions-2.44.73.8-0.12.9-1.3Gross capital formation21.621.119.019.921.319.5Gross saving21.821.624.025.525.924.7Gross external debt97.180.678.571.865.962.2International investment position-72.2-62.5-48.7-44.2-36.8-31.61) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Bulgarian National Bank.     
 
 
     
 
 
foreign currency held domestically, account for the 
largest  part  of  the  financial  account  balance. 
Correspondingly,  the  negative  Net  International 
Investment  Position  (NIIP),  continued  to  decrease 
rapidly.  The  net  external  liabilities  consist  mostly 
of  FDI  equity,  which  have  been  rather  stable  as  a 
share of GDP after the crisis of 2009. 

The  measures  of  price  and  cost  competitiveness 
worsened  somewhat  in  2018  and  were  kept 
broadly  unchanged  in  2019.  In  2018,  the  pace  of 
appreciation  of  the  real  effective  exchange  rate 
(REER), deflated by ULC, slowed to 3.2% and in 
2019 its level stayed roughly constant. The REER 
deflated by HICP appreciated moderately in 2018. 
By the end of 2018, it was 1.6% higher than a year 
earlier. It then remained at that level in 2019. 

The  long-term  trend  of  growing  export  market 
share continued in 2018 and 2019, suggesting that 
Bulgaria’s  external  competitiveness  has  been 
preserved  so  far.  Productivity  gains,  expansion  in 
production  capacity  and  improvement  in  product 
sophistication 
non-price 
competitiveness factors compensated for price and 
cost increases. 

indicate 

that 

According  to  the  Commission  services’  Spring 
2020  Forecast,  the  current  account  surplus  is 
expected  to  deteriorate  as  an  external  demand 
slump  is  set  to  drive  exports  down  in  2020. 
Nevertheless,  the  current  account  is  projected  to 
remain in surplus in 2020, and to improve  further 
in 2021 on the back of a rebound in exports. 

2.6.2.  Market integration 

The economy is well integrated with the euro area 
through  trade  and  investment  linkages.  Although 
the  ratio  of  trade  openness  declined  to  close  to 
64%  in  2019  from  above  68%  in  2017,  Bulgaria 
remained  a  relatively  open  economy.  Trade  with 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

the euro area was about 29% of total trade in 2019. 
Outside  the  EU,  Bulgaria's  main  trading  partners 
are Turkey and Russia (especially for imports). 

FDI inflows remained low at about 1% of GDP in 
2018  and  2019.  The  stock  of  FDI  amounted  to 
some 78% of GDP in 2018 and 76% in 2019, with 
FDI mainly coming from the Netherlands, Austria, 
Germany  and  Italy.  27%  of  all  FDI  stock  is 
directed to industry (excluding construction), 23% 
are  invested  in  real  estate,  while  the  trade  sector 
attracted 14% of total FDI stock. 

improving 

the  functioning  of 

Concerning  the  business  environment,  Bulgaria 
performs  relatively  worse  than  many  euro-area 
Member  States  in  international  rankings  (WEF's 
Global  Competitiveness  Index,  the  World  Bank's 
Ease  of  Doing  Business).  The  slow  pace  of  
improvement  and  the  lack  of  substantial  reforms 
dragged  Bulgaria  down  from  the  50th  place  in 
2017  to  61st  place  in  the  2019  ‘Ease  of  Doing 
Business’  ranking.  The  major  challenges  relate  to 
the  institutional  framework,  including  fighting 
the 
corruption, 
judicial system, reducing the administrative burden 
on  corporations,  and  improving  the  quality  of 
public services. Shortcomings in the functioning of 
the 
institutions  are  a  significant  obstacle 
economic  and  social  potential  of  the  country. 
However,  action  is  being  taken  to  improve  the 
business  environment,  in  particular  regarding  the 
insolvency  framework  and  governance  of  state-
owned  enterprises.  Bulgaria  ranks  low  in  the 
World  Bank’s  Worldwide  Governance  Indicators 
and  the  European  Quality  of  Government  Index. 
Bulgaria's  transposition  deficit  of  EU  Directives 
has  decreased  by  0.6  percentage  points  since 
December  2017  (the  second  highest  decrease 
amongst all Member States) to 0.7%, according to 
the  2019  Internal  Market  Scoreboard.  Bulgaria 
now equals the EU average, but it is still above the 
target 
the  European 
Commission in the Single Market Act (2011). 

(0.5%)  proposed  by 

to 

transpose 

the  Commission 
to 

The  4th  Anti-Money  Laundering  Directive 
imposed  transposition  by  26  June  2017.  Bulgaria 
several 
communicated 
to 
measures  adopted 
the  directive 
between  April  2018  and  November  2019.  The 
the  communicated 
Commission 
measures 
their  completeness  and 
conformity  with  the  directive  and  also  in  light  of 
the prior ERM II commitments. As regards the 5th 
Anti-Money 
Laundering  Directive,  whose 
transposition deadline elapsed on 10 January 2020, 

is  analysing 

to  assess 

27 

80859095100105110115120125201420152016201720182019Graph 2.9: Bulgaria -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.   
Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

the  available 
sustainable future growth. 

labour 

force  might 

jeopardise 

Bulgaria's  financial  sector  is  well  integrated  into 
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  stood  at  77%  in  2018.  Bank 
concentration, as measured by the market share of 
the  five  largest  credit  institutions  in  total  assets, 
reached  almost  60%,  some  10  percentage  points 
above the euro area average in 2018. 

to  assess 

the  directive.  Beyond 

Bulgaria  has  notified  national 
transposition 
measures  and  declared  a  complete  transposition. 
The  Commission  is  analysing  the  communicated 
their  completeness  and 
measures 
conformity  with 
the 
transposition  of  the  latest  anti-money  laundering 
directives,  the  recently  completed  National  Risk 
Assessment  shows  weaknesses  that  need  urgent 
mitigation 
laundering  and 
terrorist  financing.  Actions  need  to  be  designed 
and 
effective 
application 
laundering 
of 
framework by obliged entities. 

to  prevent  money 

implemented 

to  deliver 

anti-money 

the 

an 

in  2019  and 

reaching  75% 

The employment rate increased steadily in the past 
5  years, 
the 
unemployment  rate  reached  3.8  %  in  the  last 
quarter  of  2019.  However,  Bulgaria’s  labour 
market  suffers  from  a  number  of  vulnerabilities, 
such as regional disparities, skills mismatches and 
still  high  levels  of  inactivity  in  some  population 
groups  (e.g.  NEETs,  Roma).  In  a  context  of 
worsening demographics, the supply of labour has 
been  negatively  affected  by  high  emigration  and 
brain drain. 

Demographic  developments  strongly  affect  the 
labour market, and may constrain future economic 
growth.  The  population  decreased  by  50,000  in 
2018,  to  reach  nearly  7  million  in  January  2019. 
Bulgaria’s labour force is expected to decrease by 
10% by 2030. The age cohort 25-49 (with a labour 
market  participation  rate  of  86%  on  average)  is 
expected  to  decline  the  most.  Such  a  reduction  in 

Based  on  the  available  data,  the  capital  adequacy 
of  the  banking  sector  is  somewhat  higher  than  in 
the  euro  area.  The  average  capital  adequacy  ratio 
stood at 19.5% in the third quarter of 2019, which 
was some 1.4 percentage points higher than in the 
euro area. However, according to the results of the 
ECB  comprehensive  assessment  of  six  Bulgarian 
banks  published  on  26  July  2019  and  which 

28 

0102030405060708090BG, 2014BG, 2018EA, 2014EA, 2018Concentration 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.Table 2.5:Bulgaria - Market integration201420152016201720182019Trade openness 1) (%)69.066.064.668.367.364.4Trade with EA in goods & services 2)+3) (%)30.630.029.530.330.529.0Export performance (% change) 4)-0.73.34.6-0.8-1.6-0.4World Bank's Ease of Doing Business Index rankings 5)363739505961WEF's Global Competitiveness Index rankings 6)545450495149Internal Market Transposition Deficit 7) (%)0.70.90.61.71.30.7Real house price index 8)98.8100.0106.6112.2117.3121.9Residential investment 9) (%)1.61.42.72.92.72.6 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total.    (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.    
 
 
     
 
 
included  an  asset  quality  review  (AQR)  and  a 
stress  test,  two  banks  faced  capital  shortfalls,  as 
their capital adequacy ratios fell below some of the 
relevant thresholds used in the AQR and the stress 
test.(15)  The  ratio  of  NPLs  to  the  loan  portfolio 
held by the banking sector has fallen substantially 
over  the  last  two  years,  but  at  7.2%  in  the  third 
quarter  of  2019,  was  still  more  the  double  of  the 
euro-area average of 3.4%. The profitability of the 
domestic  banking  sector  remained  well  above  the 
euro-area  level,  with  an  average  return  on  equity 
(RoE)  close  to  13%  in  the  third  quarter  of  2019. 
The COVID-19 pandemic could have a significant 
impact on the indicators analysed in this paragraph 
over the coming months. 

House  prices  continued  to  grow  at  a  rather  rapid 
pace  of  about  5%  yearly  in  real  terms,  reaching 
121.9%  of  its  2015  level  in  2019.  Residential 
investment grew at much more moderated rates of 
around 2.5% both in 2018 and 2109. The stock of 
loans  for  house  purchases  increased  annually  by 
12.5% at the end of 2018 and by 15.1% at the end 
of  2019.  Although  growth  in  household  debt 
increased  due  to  intensified  mortgage  lending,  it 
still remains among the lowest in the EU.(16) 

Relative  to  GDP,  the  financial  system  is  much 
smaller in Bulgaria than in the euro area. Domestic 
bank  credit  stood  at  below  50%  of  GDP  in  2019 
compared to almost 90% of GDP in the euro area. 
The capitalization of the stock market increased to 
around  23%  of  GDP  in  2019,  but  remained  well 
below the euro-area average of over 70%. The debt 
securities  market  remained  small  in  comparison 
with  the  euro  area  average  (just  over  19%  vs. 
148%  of  GDP).  According  to  available  data,  the 
consolidated  stock  of  private  sector  debt  stood  at 

(15)  https://www.bankingsupervision.europa.eu/press/pr/date/ 

2019/html/ssm.pr190726~1b474e3467.en.html 

(16)  Growth rates of loans are calculated from notional stocks, 
which  reflect  only  changes  that  arise  from  financial 
transactions. 

Convergence Report 2020 - Technical annex 

Chapter 2 - Bulgaria 

95% of GDP in 2018 and was below the euro-area 
average of 135%. 

29 

0510152025BG, 2014BG, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 2.11: Bulgaria -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180BG, 2014BG, 2019EA, 2014EA, 2019Debt 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.  CZECHIA 

3.1. 

LEGAL COMPATIBILITY 

3.1.1.  Introduction 

The  Česká  národní  banka  (ČNB  –  Czech  national 
bank,  hereafter  ČNB)  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  Commission’s  2018  Convergence 
Report, 
slightly 
the  ČNB  Law  was  only 
amended (17).  However,  since  there  have  been  no 
incompatibilities 
amendments  as 
2018 
in 
highlighted 
Convergence  Report,  the  comments  made  in  the 
latter  report  are  largely  repeated  in  this  year's 
assessment. 

the 
Commission's 

regards 
the 

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 Czechia, 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. 

(17)  Act No 89/2018 Coll. provides for the right of the ČNB to 
issue  commemorative  banknotes  and  trade  coins.  Act  No 
111/2019 Coll. implements data protection rules.. 

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

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 

31 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

3.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

(Article  2(2)(b),  Articles  12  to  22  of  the  ČNB 
Law); 

institutions  or  other  entities  of 

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

Moreover,  the  footnote  in  Article  34a(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 

  ECB's right to impose sanctions (Article 46a of 

the ČNB Law);  

 

policy 
the 

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

developments 
content/scope 

regarding 

and 
of 

the 

  There are also some imperfections regarding: 

 

the  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). 

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

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 
invited 
abovementioned 
incompatibilities. 

remedy 

the 

to 

  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); 

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

  non-recognition of the competences of the ECB 
and of the Council on the banknotes and coins 

32 

 
 
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

3.2. 

PRICE STABILITY 

3.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for the convergence assessment, was above (2.2%) 
the  reference  value  (1.8%)  at  the  time  of  the  last 
convergence  assessment  of  Czechia  in  2018.  It 
declined  gradually  to  2%  in  November  2018  and 
then steadily increased up to 2.6% by end-2019. In 
March  2020,  the  reference  value  was  1.8%, 
calculated as the average of the 12-month average 
inflation  rates  in  Portugal,  Cyprus  and  Italy  plus 
1.5 percentage points. The corresponding inflation 
rate  in  Czechia  was  2.9%,  i.e.  1.4  percentage 
points above the reference value. According to the 
Commission  Service’s  2020  Spring  Forecast,  the 
12-month  average  inflation  rate  is  projected  to 
remain  well  above  the  reference  value  in  the 
months ahead. 

capacity. Since end 2018, annual HICP inflation in 
Czechia has been higher than in the euro area with 
a  fast  increasing  gap.  Core  inflation  (measured  as 
HICP  inflation  excluding  energy  and  unprocessed 
food  prices)  remained  below  headline  inflation  in 
2018  and  2019.  This  was  mainly  due  to  high 
energy inflation. Core inflation oscillated between 
1.3% and 2.1% in 2018. It decreased  markedly in 
September  2018  as  a  result  of  a  drop  in  service 
prices and rose steadily up to 2.4% in March 2019. 
After decreasing again  in  April 2019 to 1.8% due 
to  food  prices,  it  grew  strongly  to  3.6%  in  March 
2020,  driven  by  a  sustained  increase  in  service 
prices  and  prices  of  processed  food.  Domestic 
producer  prices  increased  steadily  in  2018  and 
2019,  in  line  with  rising  prices  for  manufactured 
products and electricity. 

3.2.2.  Recent inflation developments 

The annual HICP inflation rate  was broadly on an 
upward path during the last two  years. In 2018, it 
fluctuated between 1.6% and 2.4%. After dropping 
at  the  end  of  2018,  mainly  due  to  declining  food 
prices,  HICP  inflation  increased  steadily  from 
2.0%  to  3.2%  in  2019,  exceeding  the  central 
bank’s  tolerance  band  of  3.0%  in  both  November 
and  December (18).  This  resulted  mainly  from  a 
rapid hike in food prices, as well as a sustained rise 
in  services  and  energy  prices  throughout  2019.  In 
annual terms, the inflation rate dropped to 2.0% in 
2018  (vs.  2.4%  in  2017),  before  rising  again  to 
2.6%  in  2019.  The  acceleration  is  explained  by  a 
combination  of  high  wage  growth  and  strong 
domestic  demand  in  an  economy  working  at  full 

(18)  It is important to note, however, that the  CNB’s tolerance 
band  is  based  on  CPI  inflation,  which  stood  at  3.1%  in 
November and increased to 3.4% in March 2020. 

3.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

to  a  more 

After a significant economic  upswing  up to 2017, 
the Czech economy decelerated in 2018 and 2019, 
subdued  external 
mostly  due 
environment.  Real  GDP  expanded  by  2.8%  in 
2018,  considerably  less  than  in  2017  (4.4%).  The 
economy continued its deceleration in 2019, when 
it  grew  by  2.6%.  Private  consumption  was  the 
main  driver  of  GDP  growth,  supported  by  low 
unemployment  and  strong  wage  growth.  Yet, 
private  consumption  growth  moderated  gradually 
throughout  the  period,  falling  from  3.2%  in  2018 
to  3%  in  2019.  Gross  fixed  capital  formation 
increased strongly in 2018 by 7.6%, mainly driven 
by  an 
in 
automation and robotisation in manufacturing, and 
a  revival  of  investment  in  construction.  As  the 
external  environment  deteriorated,  growth 
in 
investment  in  2019  fell  significantly  to  2.8%. 

influx  of  EU  funds, 

investment 

33 

0123Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20CzechiaReference valueGraph 3.1: Czechia -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.-101234201420152016201720182019CzechiaEuro areaGraph 3.2: Czechia -HICP inflation(y-o-y percentage change)Source: Eurostat.               
                                                           
 
              
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

countries,  the  Bank  Board  debased  interest  rates 
first by 50 basis point, followed by a 75 reduction 
rate to 1% during two monetary policy meetings in 
March 2020. 

tightened 

the  ČNB 

Growth in loans to domestic sectors slowed down 
during  last  two  years.  According  to  the  Bank 
Lending  Survey,  credit  standards  were  tightened 
after 
its  macroprudential 
policies  in  June  2018  and  June  2019 (19).  This 
specifically  led  to  a  decline  in  loans  for  house 
purchase  in  2019.  After  credit  volumes  to  non-
financial  corporations  expanded  in  2018,  firms, 
especially  in  industry  and  wholesale  and  retail 
trade,  reduced  their  demand  for  loans  in  2019. 
According to the latest Bank Lending Survey, this 
was  mainly  due  to  the  increased  use  of  internal 
financing  and  lower  need  to  finance  inventories 
and working capital. 

Wages and labour costs 

The  labour  market  continued  to  perform  well  in 
2018  and  2019.  The  unemployment  rate  dropped 
further  in  both  years,  to  2.9%  in  2018  and  2%  in 
2019,  making  Czechia  the  best  performer  in  the 
EU for the fourth year in a row. Nevertheless, the 
labour market is set to be impacted by the COVID-
19  pandemic,  with  the  unemployment  rate  hiking 
to  5%  in  2020,  despite  temporary  measures 
supporting  self-employed  and  companies.  The 
employment rate of those aged between 20 and 64 
reached  80.4%  in  the  second  half  of  2019, 
6 percentage points above the EU average. Overall 
nominal  wage growth accelerated sharply in 2018 
and  2019,  reaching  9.5%  and  7.0%  respectively. 
Although  wage  growth  moderated  slightly  in  end 
of  2019  and  beginning  of  2020,  the  still  high 

(19)  This  mainly  concerns  DTI  (debt-to-income)  and  DSTI 

(debt service-to-income) limits. 

According  to  the  Commission  services’  Spring 
2020  Forecast,  due  to  the  COVID-19  pandemic 
real GDP is expected to decrease by around 6.2% 
in  2020,  before  recovering  by  5%  in  2021.  As  a 
result, although the Czech economy is estimated to 
have been operating above its potential since 2016 
the  output  gap  will  become  sharply  negative  in 
2020 due to the strong fall in the GDP. 

The fiscal stance, as measured by the change in the 
structural balance, eased considerably in 2018 and 
in  2019.  In  particular,  the  structural  balance 
decreased  by  0.8  percentage  points  to  0.0%  of 
GDP  in  2018,  and  went  into  negative  territory  at  
-0.7%  of  GDP 
the 
Commission  services’  Spring  2020  Forecast,  it  is 
expected  to  decrease  significantly  in  2020  to  -5% 
of  GDP,  due  to  a  large  decline  of  the  balance  in 
light  of  the  fiscal  measures  taken  against  the 
pandemic.  It  is  then  projected  to  recover  partially 
to -3.5% of GDP in 2021. 

in  2019.  According 

to 

The  ČNB  conducts  monetary  policy  within  an 
inflation  targeting  framework.  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 raise its main policy rate 
(the 2-week repo rate) as annual inflation remained 
above  its  2%  inflation  target.  The  rate  increased 
from  0.75%  in  February  2018  to  2.0%  in  May 
2019.  Due 
inflation 
pressure  at  end  of  the  year  2019  and  beginning 
2020,  the  CNB  Board  raised  the  policy  rate  by 
25 basis points to 2.25% during the February CNB 
Board  meeting.  After  observing  and  assessing  the 
measures taken by governments in trading partner 

increasing  domestic 

to 

34 

Table 3.1:weights  Czechia - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP0.40.30.62.42.02.62.91000Non-energy industrial goods0.40.50.80.60.60.50.6259Energy-3.8-3.0-2.51.23.24.84.5122Unprocessed food 1.20.70.52.22.31.44.750Processed food2.71.11.24.41.72.73.1229Services0.60.91.52.92.63.43.7340HICP excl. energy and unproc. food1.10.81.22.61.82.32.6828HICP at constant tax rates 0.30.10.42.61.92.62.91000Administered prices HICP0.40.51.41.11.53.74.21491) 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 2020 - Technical annex 

Chapter 3 - Czechia 

growth  rate  is  mainly  attributable  to  persisting 
labour shortages, due to e.g.  demographic  factors, 
and an increase in the minimum wage (20). Wages 
in  both  the  public  and  private  sector  showed 
similar growth dynamics during 2018 and 2019.  

eases,  but  growth  in  unit  labour  costs  is  set  to 
increase  to  5.4%  due  to  a  likely  drop  in  labour 
productivity.  In  2021,  unit 
labour  costs  are 
projected  to  remain  broadly  unchanged  as  both 
labour productivity and  wage growth are likely to 
rebound. Unit labour cost growth will also notably 
depend on the way labour shortages are adressed. 

External factors 

the  size  and  openness  of 

Given 
the  Czech 
economy,  import  prices  have  a  sizeable  effect  on 
domestic  price  formation.  The  imports  of  goods 
deflator fell by -0.6% in 2018, mainly due to lower 
industrial  producer  price 
trading 
partners  in  the  euro  area  and  declining  oil  prices. 
In  2019,  goods’  import  prices  increased  by  0.6%, 
driven  by  prices  for  machinery  and  transport 
equipment.  

inflation  of 

Labour productivity increased  moderately in 2018 
and  2019,  mainly  driven  by  manufacturing.  As 
compensation  per  employee  kept  growing  at  a 
faster  pace  than  productivity,  nominal  unit  labour 
costs grew markedly in 2018 and 2019 (6.5% and 
4.3%, respectively). According to the Commission 
services’  Spring  2020  Forecast  wage  growth  is 
expected to moderate in 2020 as the labour market 

(20)  Despite  the  increase  in  the  minimum  wage,  the  relative 
value in PPS of the statutory minimum wage in Czechia is 
the  fifth  lowest  in  the  EU, after  Latvia, Bulgaria, Estonia, 
and Slovakia.  

The  nominal  effective  exchange  rate  (measured 
against  the  main  36  trading  partners)  remained 
relatively stable throughout 2018 and 2019. It then 
appreciated  end  of  2019  and  beginning  of  2020, 
bringing  import  prices  down  during  that  period. 
Import  prices  are  set  to  remain  broadly  stable  in 
2020 and 2021, as the expected depreciation of the 
koruna  in  2020  and  2021  should  be  offset  by 
emerging  anti-inflationary  pressures  stemming 
from the COVID-19 crisis and by falling oil prices. 

35 

-6-3036920142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 3.3: Czechia -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2020Forecast.Table 3.2:Czechia - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationCzechia0.40.30.62.42.02.62.31.9Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorCzechia0.60.10.52.42.33.02.01.6Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeCzechia2.63.04.06.48.06.22.54.2Euro area1.41.31.21.72.22.11.10.4Labour productivityCzechia2.23.80.82.81.51.9-3.24.2Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsCzechia0.4-0.83.13.66.54.25.90.0Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorCzechia2.0-1.9-3.80.7-0.60.60.40.2Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services.                
                                                           
 
 
               
 
 
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

wage  growth  bring  inflation  down.  According  to 
the  Commission  services’  Spring  2020  Forecast, 
annual HICP inflation is projected to average 2.3% 
in 2020 and 1.9% in 2021. 

Risks  to  the  inflation  outlook  mainly  stem  from 
external  developments.  The  main  downside  risk 
comes from a potential slower recovery in trading 
the  upside,  domestic 
partners’  demand.  On 
inflation  pressures  stemming  from  higher  than 
expected  wage  growth  could  push  prices  up.  The 
level  of  uncertainty  of  this  inflation  forecast  is 
unusually high. 

The level of consumer prices in Czechia increased 
to  about  69%  of  the  euro-area  average  in  2018, 
suggesting  that  there  is  still  potential  for  further 
price  level  convergence  in  the  long  term.  Since 
2012,  Czechia  has  steadily  converged  to  the  euro 
area  average  in  GDP  per  capital  in  PPS,  to  about 
86% in 2018. 

3.3. 

PUBLIC FINANCES 

3.3.1.  Recent fiscal developments 

Since  2016,  the  general  government  balance  has 
been constantly in surplus, supported by a constant 
increase  in  tax  revenues.  In  2019,  the  total 

Administered prices and taxes 

The  share  of  administered  prices  in  the  HICP 
basket  increased  markedly  in  2019  to  15.8%, 
which is significantly above the euro area average 
(12.2%).  This  came  after  a  gradual  decline  in  the 
share  since  2011,  from  11.2%  to  9.8%  in  2018. 
Changes  in  administered  prices  were  a  significant 
driver  of  inflation  in  2019,  as  they  increased  by 
3.8%,  i.e.  almost  double  that  of  headline  HICP. 
This was not the case in 2018, where the growth in 
administered  prices  was  just  1.6%,  compared  to 
2.0%  for  the  overall  HICP.  Increases  in  heat 
energy and pharmaceutical products were the main 
contributors to  the increase in administered prices 
in  2019.  Administered  transport  prices  decreased 
considerably  by  roughly  6.5%  on  average  that 
year.  HICP  at  constant  tax  rates  was  somewhat 
below headline inflation in 2018 (1.9%) and at the 
same level in 2019 (2.6%). 

Medium-term prospects 

inflation 

remained 

Annual  HICP 
relatively 
elevated  in  early  2020,  driven  by  a  hike  in  food 
prices, increasing administered prices, and changes 
to  indirect  taxes.  It  is  expected  to  moderate 
substantially  in  the  second  half  of  2020,  as 
declining  oil  prices,  falling  demand,  and  lower 

36 

Table 3.3:Czechia - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-2.1-0.60.71.50.90.3-6.7-4.0- Total revenues40.341.140.741.042.242.141.941.7- Total expenditure42.441.740.039.541.241.948.545.7   of which: - Interest expenditure1.31.10.90.70.80.70.90.9p.m.: Tax burden33.934.135.335.936.836.736.036.2Primary balance-0.80.51.62.31.71.0-5.8-3.1Cyclically-adjusted balance 2)-1.2-0.70.70.80.1-0.5-4.6-2.9One-off and temporary measures 3)-0.30.0-0.10.00.00.00.00.0Structural balance 2)4)-0.9-0.70.70.80.1-0.5-4.6-2.9Government gross debt42.240.036.834.732.630.838.739.9p.m: Real GDP growth (%)2.75.32.54.42.82.6-6.25.0p.m: Output gap 2)-2.20.20.11.82.12.0-5.2-2.61) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services. 
 
   
 
 
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

expenditure-to-GDP  and  revenue-to-GDP  ratios 
reached 41.9% and 42.1% respectively. While the 
growth  in  revenues  was  marginal  compared  to 
2018,  the  growth  of  expenditure  increased  more 
significantly.  Public  investment  levels  also  grew 
by  4.4.%  in  2019,  the  highest  since  2016,  as  the 
current EU funds cycle is starting to close.  

According  to  the  Commission  services’  Spring 
2020  Forecast  and  based  on  a  no-policy  change 
scenario,  the  government  balance  is  expected  to 
improve  only  slightly  in  2021,  to  -4%  of  GDP, 
while  the  structural  balance  is  forecast  to  reach 
-2.9% of GDP. The debt-to-GDP ratio is expected 
to stabilise, reaching 39.9%. 

The  2019  general  government  surplus  of  0.3%  of 
GDP  was  in  line  with  the  target  in  the  2019 
to  previous 
Convergence  Programme.  Similar 
years, the surplus was supported by high growth in 
tax revenue on the back of a strong labour market 
and  domestic  consumption.  On  the  back  of  a 
shrinking  general  balance  and  a  positive  output 
gap, the structural balance turned slightly negative 
in 2019 at -0.5% of GDP.  

The general government debt further declined from 
32.6% of GDP in 2018 to 30.8% of GDP in 2019, 
the  lowest  figure  in  the  past  10  years,  remaining 
well below the 60% threshold. 

3.3.2.  Medium-term prospects 

The  initial  2020  state  budget  was  adopted  by  the 
Parliament  in  December  2019  with  an  envisaged 
headline  deficit  of  0.75%  of  GDP,  similar  to 
previous  years.  The  budget  proposed  increased 
social  expenditures,  such  as  higher  pension 
indexation,  increased  salaries  for  teachers  and 
higher  parental  allowances,  but  also  additional 
discretionary  revenues  such  as  an  increase  in 
excise duties. In order to adopt measures to contain 
the  COVID-19  pandemic,  the  state  budget  was 
revised twice in March and in April 2020 and now 
envisages a headline deficit of 5.5% of GDP. The 
new  measures  adopted  by  the  government  to 
contain  the  crisis  amount  to  around  4%  of  GDP. 
The  most  important  measures  foresee  financial 
support  and  deferral  of  health  and  social 
contributions  for  the  self-employed  and  a  short-
time subsidy working scheme for firms. 

is  projected 

According  to  the  Commission  services’  Spring 
2020  Forecast,  in  2020,  the  headline  general 
government  balance 
to  decline 
significantly to -6.7% of GDP, while the structural 
balance  will  reach  -4.6%  of  GDP.  The  debt-to-
GDP  ratio  is  expected  to  increase  significantly  to 
38.7%.  This  fiscal  weakening  is,  in  addition  to  a 
denominator effect, due to the combined loss in tax 
revenues,  on  the  back  of  the  economic  drop,  and 
the  adopted  policy  measures 
the 
pandemic.  

to  contain 

took 

eventually 

proceedings 

The  Czech  national  fiscal  framework  is  well 
developed,  after  the  adoption  of  several  legal  acts 
in  recent  years.  Since  the  appointment  of  its 
members  in  2018,  the  Czech  Fiscal  Council  has 
fulfilled its mandated tasks to assess the long-term 
sustainability  of  public  finances  and  compliance 
with the national rules on budgetary responsibility. 
The  assessment  of  compliance  with  the  local 
triggered 
government  debt  rule  at  end-2018 
three 
administrative 
for 
municipalities,  which 
the 
corrective  measures  specified  by  the  law  on  the 
budgetary  responsibility  rules  within  the  specified 
timeframe.  Furthermore, 
2019 
assessments, the Committee on Budgetary Forecast 
confirmed  the  realism  of  the  macroeconomic  and 
budgetary  forecasts.  However,  the  assessment  of 
budgetary  forecasts  only  covers 
the  revenue 
parameters  and  provides  a  partial  picture  of  the 
underlying  budgetary  developments.  The  law  on 
financial control in public administration amended 
in April 2019 entered into force on 1 January 2020, 
adding to the set of acts defining the  Czech  fiscal 
framework.  Against  the  backdrop  to  the  COVID-
19  pandemic,  the  Parliament  recently  fast-tracked 
a  legislative  amendment  to  widen  the  structural 
deficit ceiling in 2021 from 1% to 4% of GDP and 
alter  the  adjustment  path  between  2022  and  2027 
with  an  annual  consolidation  of  at  least  0.5 
percentage points of GDP . 

all 

its 

in 

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 
framework 
combined  with  a  floating  exchange  rate  regime, 
allowing 
exchange  market 
interventions by the central bank. 

targeting (21) 

inflation 

foreign 

for 

(21)  Since 2010, the inflation target is set at 2% with a tolerance 

band of +/- 1%.  

37 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

3.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Czechia  used  for  the 
convergence examination reflect 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 2018. It 
followed  a  gradual  upward  trend  up  to  December 
2018 and oscillated around 2% during the first half 
of 2019. From June 2019, it gradually decreased to 
1.5%  in  January.  In  March  2020,  the  reference 
value,  given  by  the  average  of  long-term  interest 
rates 
Italy  plus 
2 percentage points, stood at 2.9%. In that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Czech  benchmark  bond  stood  at  1.5%, 
i.e. 
1.4 percentage points below the reference value. 

in  Portugal,  Cyprus  and 

The  long-term  interest  rate  of  Czechia  slowly 
increased to about 2.0% by end-2018 as the ČNB 
gradually  tightened  its  monetary  policy  stance. 
Consequently, the spread against the German long-

trend  against 

temporarily  after 

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  25.5  CZK/EUR  in  May  2018.  It 
the  CNB 
appreciated  only 
increased policy rates four times in the second half 
of 2018. Beginning 2019, it fluctuated in a relative 
narrow  band  around  25.7  CZK/EUR  before 
in 
slightly  depreciating 
September 
koruna 
appreciated  steadily  and  reached  25.1  CZK/EUR 
in  February.  Following  the  lock-down  measures, 
the  koruna  depreciated  significantly  and  stood 
above 27 CZK/EUR at the end of March 2020. 

to  25.9  CZK/EUR 

2019.  Thereafter, 

the 

The 3-month interest rate  differential vis-à-vis the 
euro  area  increased  by  around  120  basis  points 
between  August  2017  and  May  2019,  following 
regular  policy  rate  hikes  by  25  basis  points  from 
0.05% in 2017 to 2% in May 2019. Afterwards, the 
ČNB kept its policy rates unchanged and the three-
month  interest  rate  spread  relative  to  the  euro 
fluctuated  around  255  up  to  January  2020.  In 
March  2020,  the  Czech  3-month  rate  fell  in 
response  to  easing  measures  implemented  by  the 
ČNB,  and  the  spread  vis-à-vis  the  euro  area 
reached around 240 basis points. 

increased 

stable  and 

International  reserves  held  by  the  ČNB  were 
from  EUR 
relatively 
121 billion  beginning  of  2018  (60%  of  GDP)  to 
above  EUR  133  billion  (61%  of  GDP)  in  2019. 
The  level of reserve assets  was  mainly influenced 
by  a  rise  in  returns  on  the  CNB’s  securities  and 
inflows of EU funds. 

38 

202224262830201420152016201720182019Graph 3.4: Czechia -CZK/EUR exchange rate(monthly averages)Source: ECB.050100150200250300201420152016201720182019Graph 3.5: Czechia -3-M Pribor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat and Czech National Bank.02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20CzechiaReference valueGraph 3.6: Czechia -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.              
                
           
term benchmark bond (22) widened from 130 basis 
points in March 2018 to some 180 basis points. In 
2019,  the  long-term  interest  rate  stabilised  around 
1.8%  during  the  first  half  of  the  year  and  then 
declined  rapidly  to  1%  in  August  driven  by 
the  prospect  of 
developments  abroad  when 
central  banks 
monetary 
suppressed  long-term  yields.  Czechia’s  long-term 
interest  rate  increased  again  and  stood  at  2.0%  in 
March  2020,  with  a  spread  against  the  German 
long-term  benchmark  bond  of  around  180  basis 
points. 

easing  by  major 

3.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination of other  factors  relevant to economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
financial 
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  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see  also  Box  1.6),  which  highlighted  issues 
relating  to  competitiveness  and  pressures  in  the 
housing  market.  However,  since  overall  risks 
remained  limited,  no  In-Depth  Review  (IDR)  was 
warranted.  The  end  of 
rate 
commitment  in  April  2017  led  to  an  appreciation 
of  the  real  effective  exchange  rate.  Nominal  unit 
labour  costs  have  increased  significantly,  on  the 
back of strong wage rises and acute labour market 

the  exchange 

(22)  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 2020 - Technical annex 

Chapter 3 - Czechia 

shortages  although  a  deceleration  is  expected.  At 
the  same  time,  the  country  is  exposed  to  risks 
relating  to  the  trade  policy  environment  and  the 
disruption of global value chains. Real house price 
growth  has  remained  high  but  with  a  deceleration 
in 2018 compared to 2017. 

3.6.1.  Developments  of 

the  balance  of 

payments 

According to balance of payments data, Czechia’s 
external  balance  (i.e.  the  combined  current  and 
capital  account)  has  remained  in  surplus  until 
2018.  It  has  been  declining  steadily  since  2016, 
reaching 0.7% in 2018 and turning negative, -0.1% 
in  2019,  mainly  due  to  a  lower  current  account 
surplus.  This  reflected  both  a  fall  in  the  trade 
surplus in 2018 as well as a more negative income 
balance.  The  capital  account  balance  stayed  at  a 
broadly stable level at 0.3% of GDP in both years.  

According  to  national  accounts  data,  the  savings-
investment balance has been practically negligible 
since 2015. This is mainly due to a strong decline 
in public investment in 2016 (-34%), which shrank 
the 
savings-investment  gap.  Savings  have 
remained fairly stable over the reporting period, at 
26.1%  of  GDP  in  2018  and  25.7%  of  GDP  in 
2019. 

Measured  by  the  export  market  share,  the  trade 
performance 
in  2018.  
improved  marginally 
External  price  and  cost  competitiveness,  as 
real 
measured  by  ULC-  and  HICP-deflated 
effective  exchange 
roughly 
unchanged in 2018 and 2019.  

remained 

rates, 

39 

-2024201420152016201720182019CzechiaGermanyGraph 3.7: Czechia-Long-term interest rates(percent, monthly values)Source: Eurostat.0102030201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 3.8: Czechia -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.               
                                                           
             
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

According  to  the  Commission  services’  Spring 
2020 Forecast based on national accounts data, the 
external  balance 
to  contribute 
negatively  to  GDP  growth  in  2020.  However,  as 
the  external  environment  is  expected  to  improve, 
the trade balance is set to increase in 2021. 

is  expected 

3.6.2.  Market integration 

The  Czech  economy  is  highly  integrated  with  the 
euro  area  through  trade  and  investment  linkages, 
although  the  related  indicators  decreased  during 
the  reporting  period.  Trade  openness  of  Czechia 
remained  very  high  at  just  below  90%  of  GDP  in 
2019.  Its  share  of  trade  with  euro  area  countries 
stood  at  53%  of  GDP  in  2019  (56%  in  2018). 
Neighbouring 
as 
Germany, Poland and Slovakia are among its most 
important trade partners. 

countries, 

euro-area 

such 

FDI inflows  have grown  steadily and the stock of 
FDI  as  percentage  of  GDP  reached  64%  in  2018. 
Belgium,  Germany  and  the  Netherlands  are  the 
biggest  investor  partners  providing  nearly  two-
thirds  of  the  FDI  inflows  in  2019.  Motor  vehicle 
manufacturing,  financial  services,  wholesale  and 
retail  are  the  main  target  sectors  for  FDI  inflows. 
The geographical proximity to EU core markets, a 
infrastructure  and  a  highly 
relatively  good 

The financial account balance of Czechia remained 
positive  in  2018  and  2019  (0.2%  and  1.4%  of 
GDP,  respectively),  but  decreased  significantly 
compared  to  2017  (2.3%).  Although  portfolio 
investment  increased  to  0.4%  of  GDP  in  2018 
(from -5.1% in 2017), it was offset by a drop in the 
accumulation  of  reserves  from  24.1%  of  GDP  in 
2017  to  0.9%  in  2018,  following  the  end  of  the 
the 
commitment. 
exchange 
accumulation  of  reserves  increased  to  1.2  %  of 
GDP,  while  other  investments  also  increased  to 
5.4%  of  GDP,  leaving  a  more  positive  financial 
account compared to 2018.  

In  2019, 

rate 

40 

9095100105110115120201420152016201720182019Graph 3.9: Czechia -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 3.4:Czechia - Balance of payments(percentage of GDP)201420152016201720182019Current account0.20.21.61.60.4-0.4of which: Balance of trade in goods5.14.15.25.13.84.2                 Balance of trade in services1.31.72.32.52.31.8                 Primary income balance -6.0-5.6-5.3-5.1-4.9-5.7                 Secondary income balance-0.20.0-0.6-0.9-0.8-0.7Capital account0.82.21.10.80.30.3External balance 1)0.92.42.72.40.7-0.1Financial account 1.53.82.52.31.10.6of which: Direct investment-1.91.1-3.9-0.9-1.0-1.1                Portfolio investment2.1-3.6-3.6-5.10.6-2.1                Other investment 2)-0.4-1.4-1.9-15.70.61.8                Change in reserves1.77.711.824.10.91.9Financial account without reserves-0.2-3.9-9.4-21.70.2-1.3Errors and omissions0.51.4-0.2-0.10.40.7Gross capital formation25.928.026.025.926.326.3Gross saving24.726.426.126.226.127.0Gross external debt67.868.573.489.182.778.3International investment position-36.3-33.2-26.9-25.8-24.7-20.91) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Czech National Bank. 
    
 
 
   
 
 
Convergence Report 2020 - Technical annex 

Chapter 3 - Czechia 

in  2019,  the  lowest  in  the  EU.  Labour  shortages 
are  pervasive  in  the  labour  market,  which  have 
hampered  Czechia´s  growth  potential.  Protection 
of  permanent  employees  against  collective  and 
individual  dismissals 
(as 
is 
the  2013  OECD  employment 
measured  by 
protection  indicator)  whereas  the  duration  of 
unemployment  benefits  is  below  the  EU  average. 
Cross-border  migration  flows  have  remained 
relatively  subdued,  although  the  tightening  labour 
market has started to attract workers from both EU 
and non-EU countries. 

relatively  strict 

educated 
the 
attractiveness of the country for foreign investors.   

force  have 

supported 

labour 

for 

requirements 

On  the  basis  of  selected  indicators  relating  to  the 
business  environment,  Czechia  performs  around 
the  average  of  euro-area  Member  States.  In  the 
latest  World  Bank's  Ease  of  Doing  Business, 
Czechia lost some score points due to introducing 
new 
filing  VAT  control 
statements,  which  made  it  more  difficult  to  do 
business.  According 
the  World  Bank's 
to 
Worldwide  Governance  Indicators  Czechia  scores 
relatively poorly in terms of corruption control and 
time, 
government  effectiveness.  At  the  same 
Czechia's deficit in the transposition of EU internal 
market  directives  decreased  to  0.7%  in  2019  and 
equals the EU average.  

The  4th  Anti-Money  Laundering  Directive 
imposed  transposition  by  26  June  2017  and 
Czechia  notified 
the 
transposition  measures  within 
that  deadline. 
However,  the  Commission  identified  a  number  of 
gaps 
is 
addressing this issue with the national authorities. 

transposition  measures  and 

the  Commission  of 

the 

in 

the  5th  Anti-Money  Laundering 
As  regards 
Directive, whose transposition deadline elapsed on 
10 January 2020, Czechia has notified its national 
transposition  measures  and  declared  a  partial 
transposition. 

The labour market performed strongly in 2018 and 
2019.  The  unemployment  rate  decreased  to  2.0% 

integration 

The Czech financial sector is highly integrated into 
the  EU  financial  sector.  This 
is 
noticeable  in  ownership  linkages  of  the  banking 
system. Foreign institutions held more than 90% of 
banking sector's assets via their local branches and 
subsidiaries in 2018. Concentration in the banking 
sector,  as  measured  by  the  market  share  of  the 
largest  five  credit  institutions  in  total  assets, 

41 

0102030405060708090100CZ, 2014CZ, 2018EA, 2014EA, 2018Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 3.10: Czechia -Foreign ownership and concentration in the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators. Table 3.5:Czechia - Market integration201420152016201720182019Trade openness 1) (%)90.691.689.391.290.487.7Trade with EA in goods & services 2)+3) (%)55.756.155.256.355.553.4Export performance (% change) 4)4.71.70.30.90.5-0.9World Bank's Ease of Doing Business Index rankings 5)332627303541WEF's Global Competitiveness Index rankings 6)373131312932Internal Market Transposition Deficit 7) (%)0.30.30.81.51.20.7Real house price index 8)96.3100.0106.6116.3123.5130.9Residential investment 9) (%)3.43.63.73.94.04.2 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total.    (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 2020 - Technical annex 

Chapter 3 - Czechia 

increased  from  61%  in  2014  to  almost  65%  in 
2018  and  thus  continued  to  exceed  the  euro-area 
average of 51%. 

GDP  between  2017  and  2018, 
remaining 
significantly below the euro-area average of 135%. 

The  Czech banking sector is  well capitalised  with 
the  average  capital  adequacy  ratio  at  19%  in  the 
third  quarter  of  2019,  i.e.  exceeding  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 
14%  in  the  third  quarter  of  2019,  compared  to 
5.3% in the euro area. At the same time, the share 
of  non-performing  loans  has  been  continuously 
declining and stood at 1.7% in the third quarter of 
2019,  while  it  was  at  3.4%  in  the  euro  area.  The 
COVID-19  pandemic  could  have  a  significant 
impact on the indicators analysed in this paragraph 
over the coming months. 

its  2015 

The  real  house  price  index  has  continued  the 
upward  trend  started  in  2013,  driven  by  supply 
constraints  and  strong  demand.  In  2019, 
it 
level  by  30%.  Although 
exceeded 
increasing, household mortgage loans as a share of 
GDP (24%) remained below the euro-area average 
(38%)  in  2019.  The  GDP  share  of  residential 
investment  has  remained  broadly  stable  at  below 
4% of GDP in recent years.  

The financial system in Czechia is smaller relative 
to  GDP  than  that  of  the  euro  area  countries.  In 
2019,  outstanding  bank  credit  to  non-financial 
companies and households reached 52% of GDP in 
Czechia, compared to almost 90% in the euro area. 
The  valuation  of  quoted  shares  issued  by  Czech 
enterprises decreased from 15% of GDP in 2014 to 
11%  in  2019,  while  it  exceeded  70%  in  the  euro 
area. In 2019, the total amount of outstanding debt 
securities was at about 90% of GDP, i.e. far below 
the  euro-area  average  of  147%.  The  consolidated 
stock  of  private  sector  debt  averaged  at  70%  of 

42 

02468101214161820CZ, 2014CZ, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 3.11: Czechia -Selected banking sector soundness indicators%Source: ECB, IMF,  EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180CZ, 2014CZ, 2019EA, 2014EA, 2019Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 3.12: Czechia -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services.Note: Debt  Securities other than shares, excluding financial derivatives.              
             
 
4. CROATIA 

4.1. 

LEGAL COMPATIBILITY 

4.1.1.  Introduction 

The  main  legal  rules  governing  the  Croatian 
National  Bank  (Hrvatska  narodna  banka  –  HNB) 
are  laid  down  in  Article  53  of  the  Constitution  of 
the  Republic  of  Croatia (23)  and  the  Act  on  the 
Croatian  National  Bank  (the  HNB  Act) (24).  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.  The  Act  was  further 
amended  in  2020,  inter  alia  to  cater  for  technical 
updates  regarding  the  potential  entry  into  close 
cooperation  by  Croatia  with  the  ECB  for  banking 
supervision  purposes  in  the  context  of  its  bid  to 
join the Exchange Rate Mechanism II (25). 

No incompatibilities and imperfections exist in this 
area. 

4.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

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

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. 

4.1.2.  Central Bank independence 

Tasks 

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 
independence  as 
principle  of  central  bank 
enshrined  in  the  TFEU,  stating  that  the  HNB  and 
members  of  its  decision-making  bodies  shall  be 
independent in achieving its objective and carrying 
out its tasks under the Act and relevant EU rules in 
accordance  with  Article  130  of  the  TFEU  while 
adding that public authorities have to respect such 
independence.  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. 

(23)  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. 

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

54/2013. 

(25)  Official  Journal  of  the  Republic  of  Croatia  no.  47/2020. 
Moreover,  some  technical  amendments  were  made  to 
further detail the euro cash rules that have been updated at 
EU level and the financial regime governing the HNB. The 
latter  pertain  to  a  mix  of  provisions  dealing  with  reserve 
building and risk provisioning, reporting, and introduction 
in the HNB Act of a clear loss and profit distribution rules.  

The  provisions  under  chapters  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. 

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. 

4.2. 

PRICE STABILITY 

4.2.1.  Respect of the reference value 

time  of 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  below  the 
reference  value  at 
the  2018 
the 
convergence  assessment  of  Croatia.  After  having 
peaked at 1.6% in the summer of 2018, it showed a 
declining  trend  thereafter,  bottoming  out  at  0.8% 
in  November  2019.  In  March  2020,  the  reference 
value  was  1.8%,  calculated  as  the  average  of  the 
12-month  average  inflation  rates  in  Portugal, 
Cyprus, and Italy, plus 1.5 percentage points. The 
corresponding  inflation  rate  in  Croatia  was  0.9%, 
i.e.  0.9  percentage  points  below  the  reference 

43 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

value.  The  12-month  average  inflation  rate  is 
projected  to  remain  below  the  reference  value  in 
the months ahead. 

processed  food  inflation  increased  moderately  on 
average  in  2019,  supported  by  increases  in  the 
excises  on  alcohol  and  cigarettes.  Services 
stable  while  non-energy 
inflation 
industrial  goods  inflation  declined  in  2018  and 
turned  negative  in  2019.  Core  inflation  remained 
stable around 1% in the first three months of 2020. 

remained 

4.2.2.  Recent inflation developments 

The  annual  inflation  rate  peaked  in  July  2018  at 
2.2%  due  to  rising  prices  of  energy,  services  and 
processed  food.  It  averaged  1.6%  in  2018  as  it 
moderated in the second half of 2018 and declined 
further  in  2019,  reaching  a  low  of  0.5%  in  June 
2019.  Average  inflation  stood  at  0.8%  in  2019. 
VAT  reduction  on  selected  unprocessed  foods 
depressed  HICP  inflation  in  2019,  while  energy 
inflation  started  moderating  already  towards  the 
end  of  2018  and  remained  low  throughout  2019. 
The  annual  inflation  rate  picked  up  again  in  the 
last quarter of 2019. After having peaked at 1.8% 
in January 2020, it declined significantly due to the 
sharp  drop  in  energy  prices  in  the  following  two 
months, reaching 0.5% in March 2020. 

inflation  (measured  as  HICP 

inflation 
Core 
excluding  energy  and  unprocessed  food)  was 
stable at 1.1% on average in both 2018 and 2019. 
After  showing  a  declining  trend  throughout  2018, 

4.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

After having recorded a real GDP growth of 2.7% 
in 
in  2018,  Croatia  experienced  an  increase 
economic  activity  of  2.9%  in  2019,  with  the 
volume  of  output  reaching  its  pre-crisis  peak. 
Domestic  demand, 
in  particular  household 
consumption,  was  the  main  driver  of  growth  in 
both  2018  and  2019,  underpinned  by  rising 
employment and wages. Investment growth slowed 
in  2018,  partly  due  to  the  restructuring  of  the 
Agrokor  conglomerate.  However,  it  picked  up 
sharply in 2019 as more projects, supported by EU 
funds,  entered  implementation  phase,  towards  the 

44 

-10123Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20CroatiaReference valueGraph 4.1: Croatia -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.-2-10123201420152016201720182019CroatiaEuro areaGraph 4.2: Croatia -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 4.1:weights  Croatia - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP0.2-0.3-0.61.31.60.80.91000Non-energy industrial goods-1.10.10.60.70.3-0.2-0.2259Energy0.7-5.9-5.7-0.15.60.90.7128Unprocessed food -3.60.8-0.92.90.2-4.0-1.256Processed food0.90.60.22.61.42.01.8219Services1.71.40.01.21.41.51.5338HICP excl. energy and unproc. food0.60.80.21.41.11.11.0817HICP at constant tax rates -0.6-0.6-0.81.21.51.41.51000Administered prices HICP1.70.4-1.0-0.11.21.41.41201) 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 2020 - Technical annex 

Chapter 4 - Croatia 

in  global 

trade,  but 

end  of 
the  2014-2020  programming  period. 
Exports  growth  unexpectedly  slowed  in  2018  on 
account  of  smaller  market  share  gains  and 
recovered 
uncertainties 
somewhat in 2019 driven by higher exports to the 
EU. Due to the negative impact of the COVID-19 
pandemic on the economy, real GDP is expected to 
contract by 9.1% in 2019 and rebound by 7.5% in 
2020  according 
the  Commission  services’ 
Spring  2020  Forecast.  Domestic  demand  should 
drive  the  rebound  thanks  to  the  expected  fast 
recovery  in  the  labour  market  and  a  strong 
contribution of EU funds to both private and public 
investment. 

to 

liquidity in the banking system and simultaneously 
maintaining  a  broadly  stable  exchange  rate  of  the 
kuna  against  the  euro.  In  March  2020,  the  HNB 
undertook  several  measures  aimed  at  maintaining 
the stability of the exchange rate and the financial 
sector  amid  the  COVID-19  crisis.  Notably,  the 
HNB  undertook 
exchange 
several 
interventions  to  maintain  the  stability  of  the 
exchange rate. The HNB also conducted purchases 
of  Croatian  government  bonds  in  the  secondary 
market  and  took  several  measures  to  provide 
the  Croatian  financial 
additional 
system. 

liquidity 

foreign 

to 

The fiscal stance, as measured by the change in the 
structural  balance,  turned  moderately  pro-cyclical 
in  2018-2019  partly  as  a  result  of  tax  cuts,  but 
mainly  due  to  expenditure  growth,  which  was 
affected  by  a  substantial  materialisation  of 
liabilities 
contingent 
4.3.1). 
According 
to  Commission’s  services’  Spring 
Forecast,  the  fiscal  stance  is  expected  to  be 
expansionary  in  2020  due  to  the  government’s 
policy response to the COVID-19 crisis. Assuming 
no  policy  changes,  the  structural  balance  should 
improve 
implying  a 
restrictive fiscal policy stance. 

(see  Section 

significantly 

in  2021, 

The HNB has continued to pursue accommodative 
levels  of 
monetary  policy  by  ensuring  high 

Wages and labour costs 

The  labour  market  situation  continued  improving 
in  2018  and  2019,  although  both  the  activity  and 
employment rates remain among the lowest in the 
EU.  The  unemployment  rate  dropped  to  6.8%  in 
2019, an all-time low. 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  strong  wage  growth  in 
2018  and  2019.  However,  the  labour  market  is 
expected to react fast to the disruption of economic 
activity  related 
the  COVID-19  outbreak. 
Although  government  wage  and  liquidity  support 
measures should mitigate the fall in employment in 
some sectors, employment is set to drop sharply in 

to 

45 

Table 4.2:Croatia - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationCroatia0.2-0.3-0.61.31.60.80.40.9Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorCroatia-0.3-0.3-1.10.91.40.80.40.9Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeCroatia-5.10.70.40.22.23.4-1.21.1Euro area1.41.31.21.72.22.11.10.4Labour productivityCroatia-2.71.23.20.90.81.5-5.54.3Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsCroatia-2.4-0.5-2.7-0.71.41.94.5-3.1Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorCroatia-0.9-1.2-2.52.61.10.2-0.71.3Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services. 
 
   
 
 
sectors  that  are  likely  to  experience  the  longest 
disruption,  e.g.  hospitality.  Employment  should 
bottom out towards the end of the year, leaving the 
unemployment rate  above 10% in 2020, some  3.5 
percentage points above its level in 2019. 

Nominal  unit  labour  costs  (ULC)  growth  turned 
positive  in  2018,  as  nominal  compensation  per 
employee  growth  strengthened  (based  on  national 
accounts  data),  while  labour  productivity  growth 
In  2019,  nominal  ULC  growth 
stagnated. 
moderated on the account of stronger productivity 
growth. Going forward, labour productivity growth 
is  likely  to  be  much  more  volatile  than  that  of 
nominal wages, essentially reflecting the impact of 
the  COVID-19  crisis  and  that  of  the  related 
measures on the economic activity and  wages.  As 
a  result,  nominal  ULC  growth  is  expected  to  rise 
significantly in 2020 before contracting sharply in 
2021. 

Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

administered price inflation picked up only slightly 
in  2019,  it  accounted  for  around  a  quarter  of  the 
subdued 
overall  HICP 
developments in non-administered prices that year. 
In  the  first  three  months  of  2020,  administered 
prices grew in line with the overall inflation. 

inflation 

due 

to 

Tax  changes  had  a  strong  impact  on  headline 
inflation  in  2019.  The  VAT  on  fresh  fruit, 
vegetables,  meat,  fish,  eggs  and  diapers  was 
moved  from  the  general  rate  (25%)  to  a  reduced 
rate  of  13%  as  of  January  2019.  Excises  on 
tobacco  were  raised  in  2018,  2019  and  again  in 
early 2020. 

Medium-term prospects 

According  to  the  Commission  services’  Spring 
2020 Forecast, annual HICP inflation is forecast to 
halve  to  0.4%  in  2020  compared  to  2019  and  to 
remain moderate at 0.9% in 2021. Weaker demand 
is  expected  to  weigh  on  inflation  in  2020  in 
addition to the sharp drop in oil prices in the first 
months  of  2020.  On  the  other  hand,  dissipating 
effects  of  the  VAT  rate  change  should  boost 
unprocessed  foods  inflation.  Core  inflation  is 
expected to decline to 0.7% in 2020 before picking 
up in 2021. 

Risks to the inflation outlook are broadly balanced. 
However, several sources of uncertainty related to 
the  impact  of  the  COVID-19  pandemic  on  the 
functioning of the product and services markets as 
well  as  on  consumers’  behaviour  surround  the 
inflation outlook. 

External factors 

Import price inflation (measured by the imports of 
goods deflator) increased only moderately by 1.1% 
in  2018  and  even  slower  by  0.2%  in  2019.  This 
mainly  reflected  oil  price  developments  and  the 
moderate appreciation of the kuna in 2018. 

The  level  of  consumer  prices  in  Croatia  rose  to 
66%  of  the  euro-area  average  in  2018.  There  is 
potential  for  price  level  convergence  in  the  long 
term.  Croatian  GDP  per  capita  in  purchasing 
power  standards  has  been  increasing  since  2015 
and stood at 60% of the euro-area average in 2018. 

The exchange rate exerted a dampening impact on 
domestic  price  developments  in  2018  but  it 
remained  neutral  in  2019.  The  nominal  effective 
exchange  rate  (measured  against  a  group  of  36 
trading partners) appreciated by 2.5% in 2018 but 
remained broadly unchanged in 2019. 

Administered prices and taxes 

The  weight of administered prices in  the  Croatian 
HICP  basket  amounted  to  12%  in  2020,  in  line 
with  the  euro  area.  In  2018,  administered  prices 
grew  in  line  with  the  overall  inflation.  Although 

Medium-term  inflation  prospects  in  Croatia  will 
depend on wage and productivity developments as 
well  as  on  global  commodity  price  trends.  These 
prospects  will  also  be  affected  by  the  pace  of  the 
recovery in economic activity, following the sharp 
expected contraction in 2020. 

4.3. 

PUBLIC FINANCES 

4.3.1.  Recent fiscal developments 

After  having  recorded  the  first  surplus  since  the 
EU  accession  in  2017  (0.8%  of  GDP),  the 

46 

-6-4-2024620142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 4.3: Croatia -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2020 Forecast.    
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

2019,  the  budget  foresaw  a  surplus  of  0.2%  of 
GDP  in  2020.  The  government’s  projections 
underpinning  the  2020  budget  have  since  become 
outdated  because  of  the  fundamentally  changed 
macroeconomic  outlook  and  sizable  unanticipated 
fiscal  measures  in  response  to  the  COVID-19 
pandemic.  The  latter  most  notably  relate  to  the 
wage  subsidy  paid  out  to  businesses  for  keeping 
workers  in  employment  and  tax  cuts  for  the  most 
has 
affected 
announced  that  a  new  budget  will  feature  a 
substantially more negative target. 

companies.  The 

government 

from 

resulting 

slowdown 

The  Commission  services'  Spring  2020  Forecast 
projects the general government balance to fall to -
7.1%  of  GDP  in  2020,  driven  largely  by  the 
economic 
the 
containment  measures  taken  in  the  context  of  the 
COVID-19  pandemic.  Assuming  unchanged 
policies,  the  headline  deficit  should  diminish  to 
2.2% of GDP in 2021 as revenues are expected to 
recover  strongly  on  the  back  of  the  economic 
recovery  and  the  base  effect  from  2020.  Taking 
into  account 
the 
structural  balance  is  projected  to  fall  significantly 
in  2020  before  recovering  towards  the  2019  level 
in  2021.  The  general  government  debt  is  forecast 
to increase to almost 89% of GDP in 2020 before 

the  estimated  output  gap, 

47 

a 

notwithstanding 

government  balance  remained  positive  also  in 
2018  and  2019  (0.2%  and  0.4%  of  GDP, 
respectively).  The  recent  years’  surpluses  were 
mainly 
the  result  of  revenue  growing  more 
strongly  than  nominal  GDP  (most  notably  VAT, 
income  taxes  and  contributions)  in  spite  of  tax 
cuts.  Meanwhile,  expenditure  growth  was  overall 
contained, 
substantial 
materialisation  of  contingent  liabilities  associated 
with ailing shipyards.(26) Savings on debt servicing 
allowed  for  somewhat  stronger  growth  in  the 
compensation  of  public  employees  and 
in 
investment. 
the  general 
government balance fell from a surplus of 0.2% of 
GDP in 2017 to a deficit of 1.2% of GDP in 2019. 
However,  government  balance  surpluses  and  the 
pick-up  in  nominal  GDP  growth  put  the  general 
government  debt  ratio  on  a  declining  path:  from 
77.8% of GDP in 2017 to 73.2% of GDP in 2019. 

In  structural 

terms, 

4.3.2.  Medium-term prospects 

The 2020 budget was adopted by the Parliament on 
14  November  2019.  Based  on  the  then  expected 
general  government  balance  of  -0.3%  of  GDP  in 

(26)  The deterioration was mainly due to the impact of the call 
of  the  government  guarantees  in  the  Uljanik  and  3.  Maj 
shipyards. 

Table 4.3:Croatia - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-5.3-3.3-1.00.80.20.4-7.1-2.2- Total revenues43.445.346.546.146.547.546.347.4- Total expenditure48.748.647.445.346.347.153.449.6   of which: - Interest expenditure3.43.43.12.72.32.22.32.3p.m.: Tax burden36.737.337.837.838.538.936.437.5Primary balance-1.90.12.13.52.52.6-4.80.1Cyclically-adjusted balance 2)-4.0-2.6-1.00.1-0.9-1.2-4.4-1.9One-off and temporary measures 3)0.20.00.1-0.10.00.00.00.0Structural balance 2)4)-4.2-2.6-1.10.2-0.9-1.2-4.4-1.9Government gross debt84.784.380.877.874.773.288.683.4p.m: Real GDP growth (%)-0.12.43.53.12.72.9-9.17.5p.m: Output gap 2)-3.0-1.60.11.52.53.7-6.1-0.71) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services.                                                           
 
 
   
 
 
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

depreciation  pressures  in  March  2020  amid  the 
pandemic  outbreak,  the  HNB  conducted  several 
foreign  exchange  interventions  to  maintain  the 
stability of the exchange rate. 

thanks 

in  summer 

In  recent  years,  the  kuna's  exchange  against  the 
euro has continued to exhibit a seasonal pattern of 
temporary  appreciation 
to 
foreign  currency  inflows  related  to  the  tourism 
sector.  While 
trading  mostly  around  7.44 
HRK/EUR,  it  appreciated  temporarily  to  around 
7.38  HRK/EUR  during 
the  2018  and  2019 
summers. The kuna traded around 7.44 HRK/EUR 
in early 2020, before depreciating by some 2% in 
March 2020 amid the COVID-19 outbreak. 

International  reserves  held  by  the  HNB  stood  at 
EUR  18.5  billion  (or  34%  of  GDP)  in  the  last 
quarter of 2019. After having hovered around EUR 
16.5  billion  in  the  first  three  quarters  of  2018, 
international  reserves  showed  an  upward  trend 
thereafter,  peaking  at  over  EUR  20  billion  in  the 
third  quarter  of  2019,  as  a  result  of  both  foreign 
currency  purchases  by  the  HNB  and  increased 
foreign currency deposits of the government at the 
central  bank.  The  NHB  conducted 
foreign 
exchange  interventions  amounting  to  EUR  2.5bn 
in  March  2020  to  maintain  the  stability  of  kuna 
exchange  rate  against  the  euro  in  midst  of  the 
pandemic-induced crisis. 

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  was  broadly  flat,  averaging  about  80 
basis  points 
the  2018-2019  period.  The 
production  of  the  ZIBOR  reference  rate  with  a 
maturity  of  three  months  used  to  measure  the 
Croatian  short-term  rate  was  discontinued  by  the 

in 

resuming  its  downward  trend,  reaching  around 
83% of GDP in 2021. 

so  as 

The  Croatian  fiscal  framework  remains  relatively 
weak.  Following  repeated  delays,  the  new  Fiscal 
Responsibility  Act  was  eventually  adopted  by 
Parliament  in  December  2018.  It  aims  principally 
at reinforcing the set-up and mandate of the Fiscal 
Policy  Commission 
to  become  an 
independent fiscal council, as well as laying down 
including  a  structural 
numerical  fiscal  rules, 
budget balance rule. However, the  Commission is 
still  not  operating  in  line  with  the  new  provisions 
as  attempts  to  appoint  its  chair  have  so  far  been 
unsuccessful. In 2018, Croatia became a signatory 
to the TSCG, but is currently exercising its right of 
exemption  from  the  TSCG’s  Fiscal  Compact 
provisions. The  new Budget  Act,  which  inter alia 
should 
term  budgetary 
the  medium 
framework both at central and local level, is yet to 
be adopted. 

improve 

4.4. 

EXCHANGE RATE STABILITY 

The Croatian kuna does not participate in ERM II. 
In  July  2019,  Croatia  announced  its  intention  to 
put in place the necessary elements for a successful 
entry  into  ERM  II.  In  order  to  ensure  a  smooth 
transition to, and participation in, ERM II, Croatia 
committed to implement before joining the ERM II 
a number of  measures (i.e. prior-commitments) in 
banking 
the 
supervision,  macro-prudential  framework,  anti-
money 
sector 
governance  and  business  environment.  Croatia  is 
currently working towards the completion of these 
prior-commitments, 
the 
in  close 
Commission  and  the  ECB  who  monitor  their 
progress. 

statistics,  public 

liaison  with 

laundering, 

following 

policy 

areas: 

six 

The  HNB  operates  a  managed  floating  exchange 
rate  regime,  using  the  exchange  rate  against  the 
euro  as  the  main  nominal  anchor  to  achieve  its 
primary objective of price stability. The HNB does 
not  target  a  specific  level  or  band  for  the  kuna 
exchange  rate  against  the  euro  but,  through  its 
foreign  exchange  transactions,  it  aims  to  prevent 
excessive  exchange  rate  fluctuations.  Between 
early  2018  and  early  2020,  the  kuna  was  mostly 
stable  against  the  euro,  experiencing  only  some 
short-lived 
which 
necessitated  foreign  exchange  purchases  from 
banks by the HNB aimed at the stabilisation of its 
exchange  rate  against  the  euro.  As  the  kuna 
exchange  rate  against  the  euro  experienced  some 

appreciation 

episodes, 

48 

7.07.27.47.67.88.0201420152016201720182019Graph 4.4: Croatia -HRK/EUR exchange rate(monthly averages)Source: ECB.    
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

term  interest  rates  in  Portugal,  Cyprus,  and  Italy 
plus  2  percentage  points,  stood  at  2.9%.  In  that 
month, the 12-month  moving average of the  yield 
on the Croatian benchmark bond stood at 0.9%, i.e. 
2 percentage points below the reference value. 

The  long-term  interest  rate  of  Croatia  declined 
gradually  during  2018.  It  fell  more  sharply  in  the 
first  half  of  2019  dropping  even  slightly  below 
0.50%  in  September  2019.  While  the  long-term 
interest rate had showed some stabilisation around 
0.50% thereafter, it rose sharply  to close to 1% in 
March 2020 amid the COVID-19 crisis. In order to 
maintain  the  stability  of  the  Croatian  government 
bond  market,  the  HNB  conducted  in  March  2020 
purchases  of  Croatian  government  bonds  in  the 
secondary  markets  and  accepted  pension  and 
investment  funds  as  well  as  insurance  companies 
as  counterparties  in  its  operations.  The  spread  to 
long-term  benchmark  bond  also 
the  German 
widened  sharply  to  close  to  150  basis  points  in 
March 2020 after having fallen to below 100 basis 
points  by  the  end  of  2019,  as  the  Croatian 
sovereign  debt  rating  was  raised  to  investment 
grade. 

NHB  as  of  1  January  2020.  In  April  2020,  the 
HNB  agreed  upon  establishing  a  precautionary 
currency  swap  line  with  the  ECB.  The  currency 
swap line allows for the exchange of the kuna for 
up  to  EUR  2bn  that  could  be  used  to  provide 
additional  euro  liquidity  to  Croatian  financial 
the  HNB  own 
institutions  without  using 
international  reserves,  if  needed.  The  swap  line 
will  remain  in  place  until  31  December  2020, 
unless it is extended. 

4.5. 

LONG-TERM INTEREST RATES 

The long-term interest rates in Croatia used for the 
convergence  assessment  reflect 
the  secondary 
market  yield  on  a  single  benchmark  government 
bond with a residual maturity of around 9 years. 

4.6.  ADDITIONAL FACTORS 

The  Treaty  (Article  140  TFEU)  calls  for  an 
examination of other  factors  relevant to economic 
integration  and  convergence  to  be  taken  into 
account  in  the  assessment.  The  assessment  of  the 
additional factors – including balance of payments 
developments,  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  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 

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 2018 convergence assessment of Croatia. It 
was on a gradual downward trend over the last two 
years,  declining  to  2.2%  at  the  end  of  2018  and 
further to 1.3% at the end of 2019. In March 2020, 
the reference value, given by the average of long-

49 

0100200300201420152016201720182019Graph 4.5: Croatia -3-M Zibor(1) spread to 3-M Euribor(basis points, monthly values)(1) The production of ZIBOR reference rate was discontinued by the nationalcentral bank as of 1 January 2020. An equivalent rate is not currently available.Source: Eurostat and Thomson Reuters.02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20CroatiaReference ValueGraph 4.6: Croatia -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-20246201420152016201720182019CroatiaGermanyGraph 4.7: Croatia -Long-term interest rates(percent, monthly values)Source: Eurostat.   
    
    
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

needed  to  reform  the  public  administration  and 
improve  governance  of  state-owned  enterprises. 
Key aspects of the recent pension reform aimed at 
lengthening working lives have been reversed. 

4.6.1.  Developments  of 

the  balance  of 

payments 

After  having  stood  at  1.9%  of  GDP  in  2018,  the 
current account surplus increased to 2.5% of GDP 
in  2019.  The  trade  balance  worsened  markedly  in 
2018  on  the  account  of  a  significant  slowdown  in 
the  growth  of  goods  exports.  The  capital  account 
balance  improved  in  both  2018  and  2019  on  the 
account  of  the  higher  uptake  of  EU  funds.  As  a 
result, Croatia’s external surplus (i.e. the combined 
current  and  capital  account)  increased  to  4.5%  of 
GDP in 2019 from 3.3% of GDP in 2018. 

still 

reflect 

Positive  external  balances 
the 
continued deleveraging by the government and the 
corporate  sector. While lending slowly picked  up, 
especially 
investment  activity 
remained  subdued,  at  more  than  12%  below  its 
pre-crisis peak in real terms. 

to  households, 

imbalances. 

the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see  also  Box  1.6),  which  concluded  that  an  In-
Depth Review (IDR) was warranted for Croatia. In 
February  2020,  the  Commission  published  its 
annual  country  report  on  Croatia(27),  including  an 
In-Depth  Review  (IDR).  This  report  led  to  the 
conclusion  that  Croatia  continues  to  experience 
macroeconomic 
Remaining 
vulnerabilities  are  linked  in  particular  to  high 
levels  of  public,  private  and  external  debt  in  a 
context of low potential growth. Stock imbalances 
have been narrowing over the past years, driven by 
resuming  growth  and  a  prudent  fiscal  policy.  The 
negative  net 
investment  position 
remains large, but continues improving, driven by 
GDP  growth  and  the  positive,  albeit  weakening, 
current account balance.  Household and corporate 
debt  decreased  significantly  over  the  last  few 
years.  However,  debt  remains  relatively  high  and 
the  pace  of  household  debt  reduction  has  been 
slowing.  As  a  result  of  prudent  fiscal  policy  in 
recent years, public debt is decreasing from a high 
level.  Policy  implementation  has  been  uneven. 
Reforms in the education system and the business 
environment  are  progressing,  with  more  action 

international 

(27)  European  Commission  (2020),  Country  Report  Croatia 
2020,  Commission  Staff  Working  Document  (2020)  510 
final, 26.02.2020, Brussels. 

In  2018,  exports  growth  slowed  markedly  after 
several years of strong growth following Croatia’s 

50 

Table 4.4:Croatia - Balance of payments(percentage of GDP)201420152016201720182019Current account0.23.22.13.41.92.5of which: Balance of trade in goods-15.3-16.0-16.3-17.2-18.7-19.1                 Balance of trade in services14.916.217.517.917.818.6                 Primary income balance -2.0-0.6-3.0-1.5-1.5-1.5                 Secondary income balance2.63.63.94.24.24.5Capital account0.40.81.51.11.42.0External balance 1)0.74.03.64.53.34.5Financial account1.84.03.24.83.64.5of which: Direct investment-1.6-0.5-4.3-2.3-1.4-1.6                Portfolio investment1.6-0.32.90.81.71.0                Other investment 2)3.03.25.11.10.33.3                Change in reserves-1.21.7-0.65.33.01.8Financial account without reserves3.02.33.8-0.50.62.7Errors and omissions1.10.0-0.40.30.30.0Gross capital formation19.120.621.021.823.222.8Gross saving19.423.823.125.125.125.2Gross external debt113.2108.095.989.882.875.8International investment position-86.5-78.1-72.2-65.8-57.9-50.91) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Croatian National Bank.                                                           
 
 
    
 
 
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

EU  accession.  The  slowdown  was  particularly 
pronounced  for  the  extra  EU  exports,  reflecting 
uncertainties  surrounding  global  trade,  while  intra 
EU  exports  remained  strong.  Exports  recovered 
somewhat in 2019 as gains in export market shares 
resumed. 

investment 

both years. At the same time, net foreign liabilities 
in 
stemming  from  foreign  direct 
Croatia continued to increase although at a slower 
pace than in previous two years. The international 
reserves  held  by  the  HNB  increased  markedly  in 
international 
both  2018  and  2019.  The  net 
investment  position 
improved 
substantially from about -65.8% of GDP in 2017 to 
-50.7%  of  GDP  at  the  end  of  2019  while  gross 
external  debt  declined  to  75.8%  of  GDP  from 
89.8% of GDP in 2017. 

(NIIP) 

thus 

Based  on  national  accounts,  external  cost 
competitiveness, as measured by the ULC-deflated 
real  effective  exchange 
improved 
somewhat  since  2017.  On  the  other  hand,  the 
HICP-based  REER  indicates  a  slight  deterioration 
in external price competitiveness since 2017 due to 
the NEER appreciation. 

rate,  has 

The financial account continued to display positive 
balances  in  2018  and  2019.  This  reflected  the 
positive  net  contribution  of  portfolio  investments 
in  2018  and  as  well  as  other  investment  flows  in 

According  to  the  Commission  services'  Spring 
2020  Forecast,  the  current  account  balance  is 
expected  to  deteriorate  to  -1.7%  of  GDP  in  2020 
amid  a  strong  expected  contraction  in  exports  of 
services.  A  small  surplus  is  expected  in  2021  as 
economic activity normalises. 

4.6.2.  Market integration 

The  Croatian  economy  is  well  integrated  with  the 
euro  area  through  trade  and  investment  linkages. 
Its degree of trade openness increased gradually in 
recent  years  and  stood  at  56.1%  of  GDP  in  2019 
but it still remained relatively low given the small 
size  of  the  Croatian  economy.  The  trade  with  the 
euro area amounted to 22.3% of GDP in 2019 and 
trade with Germany, Italy, Slovenia and Austria as 
Croatia's  largest  trade  partners  constituted  over 
half of its total trade. 

FDI  has  so  far  been  mainly  directed  into  the 
banking,  real  estate  and  retail  sectors,  with  the 

51 

8090100110201420152016201720182019Graph 4.8: Croatia -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 4.5:Croatia - Market integration201420152016201720182019Trade openness 1) (%)46.049.351.054.255.456.1Trade with EA in goods & services 2)+3) (%)26.128.328.930.031.031.7Export performance (% change) 4)2.95.43.00.6-0.31.5World Bank's Ease of Doing Business Index rankings 5)393943515851WEF's Global Competitiveness Index rankings 6)777774746863Internal Market Transposition Deficit 7) (%)0.60.10.32.21.30.3Real house price index 8)102.7100.0102.0105.0109.8118.7Residential 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). Due to lack of services data for 2019, the value of 2018 had been taken. 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 2020 - Technical annex 

Chapter 4 - Croatia 

the 

improvement  on 

been  decreasing  since  2017,  in  the  context  of  an 
overall 
labour  market 
conditions. After attaining a peak of 11% in 2013, 
the long-term unemployment rate has been steadily 
decreasing and it stood at 3.4% in 2018 (below the 
euro-area  average  of  3.8%)  and  at  2.4%  in  2019. 
Still,  non-harmonised  wage  setting  frameworks  in 
the public sector hamper 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  high,  with  the  largest  five  banking  institutions 
accounting for close to 80% of sector’s total assets, 
compared to 50% in the euro-area. 

inflows  originating  from  Austria, 

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 

With  regard  to  the  business  environment,  Croatia 
performs  worse  than  many  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).  In  the  World 
Bank's  Ease  of  Doing  Business,  Croatia's  worst 
rankings concern dealing with construction permits 
and  starting  a  business.  According  to  the  World 
Bank's Worldwide Governance Indicators, Croatia 
performs  relatively  poorly  in  terms  of  rule  of  law 
and  control  of  corruption.  On  the  other  hand, 
Croatia stepped up its transposition of EU internal 
market directives. The transposition gap decreased 
from  2.2%  in  2017  to  0.3%  in  2019.  In  addition, 
there  has  been  renewed  effort  to  improve  the 
business  environment,  in  particular  to  reduce  the 
administrative burden and regulatory restrictions. 

to 

The  4th  Anti-Money  Laundering  Directive 
imposed transposition by 26 June 2017 and during 
2017-18  Croatia  has  communicated 
the 
Commission  the  adoption  of  several  transposition 
measures,  which  ensure  a  complete  transposition 
of the Directive. The Commission is completing its 
analysis  of  whether  the  notified  measures  are  in 
conformity  with  the  Directive  As  regards  the  5th 
Laundering  Directive,  whose 
Anti-Money 
transposition deadline elapsed on 10 January 2020, 
Croatia  has  officially  notified 
its  national 
transposition  measures  and  declared  a  partial 
transposition.  As  a  part  of  the  prior-commitments 
is 
made  before 
expected to fully transpose and implement the 5th 
Anti-Money Laundering Directive. 

the  ERMII,  Croatia 

joining 

Activity and employment rates remain persistently 
low  compared  to  the  euro-area  average.  This  is 
partly  related  to  early  retirement  schemes  and 
pension  eligibility  criteria.  A  pension  reform 
package  was  adopted  in  2018,  however  key 
elements  of  the  reform  aimed  at  lengthening 
working  lives  were  reversed  in  the  autumn  of 
2019.  After 
in  employment 
relaxation 
protection  legislation  in  2013-14  resulted  in  a 
significant  increase  in  the  use  of  temporary 
contracts,  the  share  of  temporary  employees  has 

the 

52 

The  banking  system  in  Croatia  remains  well 
capitalized, with the average capital adequacy ratio 
exceeding 20% in the third quarter of 2019, which 
was  more  than  2  percentage  points  above  that  of 
the euro-area banking sector. While the quality of 
the loan portfolio improved, with the ratio of non-
performing loans (NPLs) declining to 5.6% in the 
third quarter of 2019, this remains still well above 
the  NPL  ratio  recorded  in  the  euro  area  3.4%.  At 
the  same  time,  the  profitability  of  the  Croatian 
banking  sector  has  improved  substantially  on 
account  of  larger  non-interest  rate  income  and 
lower expenses in impairments and provisions over 
the  last  two  years,  with  the  average  annual  return 
on  equity  (RoE)  standing  at  8.6%  in  the  third 
quarter of 2019. This is well above the profitability 
of  the  euro  area  banking  system,  which  stood  on 
average  at  5.3%.  The  COVID-19  pandemic  could 
have  a  significant 
indicators 
analysed  in 
this  paragraph  over  the  coming 
months. 

impact  on 

the 

0102030405060708090100HR, 2014HR, 2018EA, 2014EA, 2018Concentration in the banking sector (CR5 ratio)Share of foreign institutions as % of total assetsGraph 4.9: Croatia -Foreign ownership and concentrationin the banking sector(in percent, weighted averages)Source: ECB, Structural financial indicators  and HNB Banks Bulletin.    
Convergence Report 2020 - Technical annex 

Chapter 4 - Croatia 

The  real  house  prices  showed  a  rapid  increase  in 
2018-2019.  The  real  house  price  index  rose  to 
close  to  110%  of  its  2015  level  in  2018  and 
increased  further  to  118.7%  in  2019.  Over  the 
same period, lending to households also picked up, 
with  general-purpose 
increasing  more 
substantially.  Lending  for  house  purchases  was 
supported  by  government  subsidies  for  first-time 
homeowners. 

loans 

The financial system in Croatia is smaller relative 
to  GDP  than  that  of  the  euro  area.  In  2019, 
outstanding  bank  credit  to  Croatian  non-financial 
corporations  and  households  amounted  to  about 
54%  of  GDP,  compared  to  87%  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 
37%  of  GDP  while  this  was  close  to  60%  in  the 
euro  area.  The  debt  securities  market  was  largely 
dominated 
and 
government 
corresponded  to  60%  of  GDP,  thus  remaining  far 
euro-area  market 
less  developed 
encompassing debt securities in the nominal value 
of  148%  of  GDP.  The  consolidated  stock  of 
private  sector  debt  fell  below  100%  of  GDP  in 
2017  and  declined  further  to  94%  in  2018,  which 
was well below the euro-area average of 135%. 

securities 

that 

the 

by 

53 

0510152025HR, 2014HR, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 4.10: Croatia -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180HR, 2014HR, 2019EA, 2014EA, 2019Debt securitiesStock market capitalisationCredit to non-financial corporationsCredit to householdsGraph 4.11: Croatia -Recent development of the  financial system relative to the euro area(in percentage of GDP)Source: ECB, Commission services, HNB, Zagreb Stock Exchange.Note: Debt  Securities other than shares, excluding financial derivatives.     
    
5.  HUNGARY 

5.1. 

LEGAL COMPATIBILITY 

5.1.1.  Introduction 

The  main  rules  governing  the  Magyar  Nemzeti 
Bank  (MNB  –  Hungarian  national  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 
for  macro-prudential  policy  and, 
responsible 
the  Hungarian 
further 
the  dissolution  of 
to 
for  micro-
Financial  Supervisory  Authority, 
prudential  supervision  of  the  Hungarian  financial 
sector.  After  this  the  MNB  Act  was  amended  at 
several occasions (28), including some amendments 
since  the  most  recent  convergence  assessment  of 
2018 (29).  None  of 
these  amendments  are 
remedying  the incompatibilities and imperfections 
referred to in the Commission’s 2018 Convergence 
Report. 

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 Article 176 of the 

(28)  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. In addition, they also relate to 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 

(29)  The amendments pertain inter alia to the functioning, tasks 
and  powers  of  the  Financial  Stability  Board  (the  body  of 
the MNB in charge of macro-prudential policy); the expiry 
of  the  mandate  of  the  Supervisory  Board  (the  MNB’s 
oversight  body);  procedural  and  data  access  rules  in  the 
context  of  criminal  proceedings  regarding  banknotes, 
amendments due to EU harmonisation measures as well as 
technical  amendments  related  to  the  reform  system  of  the 
administrative jurisdiction. 

the 

implies 

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 
transfer  of  all 
employees from the HFSA to the MNB pursuant to 
Article  183  of  the  MNB  Act.  The  principle  of 
central bank independence pursuant to Article 130 
of  the  TFEU  implies  that  the  MNB  must  have 
sufficient financial resources  to perform its ESCB 
and  ECB-related  tasks,  in  addition  to  its  national 
tasks. The tasks transferred from the HFSA to the 
MNB  must not affect its 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, Article 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  Article  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 

55 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

stake.  Such  an  exemption  could  create  situations 
where the privileged position of Monetary Council 
members  could  give  them  an  unfair  advantage  in 
obtaining  nominations  or  posts 
in  other 
organisations, putting them in a position of conflict 
of interest while still in employment at the MNB.   

to  close 

Moreover,  Article  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 Article 90 of the Law XXXVI 
of  2012  on  the  Parliament.  According  to  Article 
157(1)  of  the  MNB  Act  and  Article  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  Article  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 
incompatibility 
removed  by  an 
should  be 
amendment of Article 157 of the MNB Act, which 
would  provide  for  an  exception  for  such  kind  of 
unintentional omission. 

5.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Pursuant to Article 36 of the MNB Act and subject 
to  the  prohibition  of  monetary  financing  set  out 
under  Article 146 of the MNB Act, the  MNB can 
provide an emergency loan 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. 

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.  

involved, 

including 

Article  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  Article  162(2)  of 
the MNB Act without being subject to the conflict 
of  interest  rules  provided  for  in  Article  152(1)  to 
(5)  of  the  MNB  Act,  including  any  formal 
disclosure  requirement.  Hence, for those  activities 
the 
the  MNB  officials 
Governor,  are  fully  shielded  from  any  scrutiny. 
Moreover,  Article  153(6)  of  the  MNB  Act  also 
provides  for  an  explicit  exemption  to  the  rule  of 
Article 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 Article 
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.  

In addition, Article 156(7) read in conjunction with 
Article  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 Article 39 in which 
the  Hungarian  State  or  the  MNB  has  a  majority 

termination  of 

56 

Pursuant to Article 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  Article 
146 of the Act. Though the Act adequately reflects 
conditions for central bank financing provided to a 
deposit  guarantee  scheme  a  specific  requirement 
should be included to ensure that the loans granted 
to 
the  National  Deposit  Insurance  Fund  are 
provided  against  adequate  collateral  (e.g.  a  claim 
government 
on 
securities,  etc.)  to  secure  the  repayment  of  the 
loan.  Therefore,  Article  37  is  incompatible  with 
the prohibition on monetary financing as laid down 
in Article 123 of the TFEU. 

contributions, 

future 

cash 

of 

the 

insulate 

from  all 

the  bank 

expenses.  Therefore, 

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

including 

result 

Article  162(3)  and  (4)  of  the  MNB  Act  lay  down 
the conditions of disclosure of data by a company 
related  to  the  MNB (30) (31).  Furthermore,  Article 

(30)  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 

Convergence Report 2020 - 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  Article  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 (32). 
Moreover,  the  exemption  provided  under  Article 
153(6)  of  the  MNB  Act  to  the  rule  of  Article 
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 

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. 
(31)  Article  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 
(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. 

(32)  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 

to  fund 

57 

                                                           
                                                                                   
business associations under MNB ownership. This 
incompatibility needs to be removed. 

5.1.4.  Integration in the ESCB 

Objectives 

Article  3(2)  of  the  MNB  Act  determines  that, 
without prejudice to the primary objective of price 
stability,  the  MNB  shall  uphold  to  maintain  the 
stability  of  the  financial  intermediary  system,  to 
increase  its  resilience,  to  ensure  its  sustainable 
contribution  to  economic  growth  and  support  the 
economic policy of the government. The objective 
laid  down  in  Article  3(2)  of  the  MNB  Act  is 
reduced  to  supporting  the  economic  policy  in 
Hungary.  The  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 (Articles 1 (2), 4(1), 9, 16 – 21, 159 and 
171 of the MNB Act); 

  conduct  of 

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

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

(Article  K  of 

Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

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

  non-recognition  of  the  role  of  the  ECB  in  the 
international  cooperation  (Article 

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 (Article 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 
(Articles 6(1) (b), 15 and 144 of the MNB Act). 

5.1.5.  Assessment of compatibility 

to 

remedy 

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 
the 
invited 
are 
authorities 
abovementioned  incompatibilities.  Finally,  it  is 
understood  that  the  Hungarian  authorities  have 
enacted an Emergency Act to deal with the state of 
danger  due  to  the  COVID-19  outbreak (33).  It 
enables  the  Government  to  suspend  by  decree  the 
application  of  Acts,  derogate  from  the  provisions 
of Acts and take other extraordinary measures inter 
alia  to  guarantee  the  stability  of  the  economy.  In 
the absence of an exception applicable to the MNB 
Act,  Government  decrees  under  the  Emergency 
Act  could  have  a  bearing  on  the  MNB  Act  or  on 
the functioning of the MNB. In such a context, the 
principle  of  independence  and  the  prohibitions  of 
monetary financing and privileged access deriving 
from EU law should be fully respected. 

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

5.2. 

PRICE STABILITY 

  non-accurate  reflection  of  the  principle  of 
central  bank  independence  in  the  MNB  Act 
(Article 1(2) and (3) of the MNB Act);  

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

5.2.1.  Respect of the reference value 

The 12-month average inflation rate, which is used 
for  the  convergence  assessment,  was  above  the 
reference value at the time of the last convergence 
assessment  of  Hungary  in  2018.  It  increased 
further  to  3.5%  by  June  2019  and  stayed  close  to 
that  level  in  the  rest  of  2019.  In  March  2020,  the 

(33)  Act XII of 2020 on the containment of coronavirus SG No. 

58/2020 30 March 2020. 

58 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

annual HICP inflation in Hungary was higher than 
in the euro area, with an increasing gap. 

reference  value  was  1.8%,  calculated  as  the 
average of the 12-month average inflation rates in 
Portugal,  Cyprus  and  Italy  plus  1.5  percentage 
in 
points.  The  corresponding 
Hungary  was  3.7%,  i.e.  1.9  percentage  points 
above  the  reference  value.  The  12-month  average 
inflation rate is projected to remain well above the 
reference value in the months ahead. 

inflation 

rate 

inflation  (measured  as  HICP 

Core 
inflation 
excluding energy and unprocessed food) rose from 
2.3%  in  May  2018  to  3.9%  in  March  2019  and 
stabilized  around  that  level  thereafter,  reaching 
4.0%  in  March  2020.  Non-core  items  had  mixed 
effects on HICP inflation over the past two  years. 
Energy price  inflation  was volatile and  moderated 
from  2018  to  2019,  in  line  with  global  oil  prices. 
Unprocessed food inflation was also volatile and it 
increased  markedly in late-2019, partly due to the 
African  swine  flu  epidemic.  Processed  food 
inflation  surpassed  headline  inflation  from  late-
2018,  but  it  then  stabilized  at  around  6%.  Non-
energy  industrial  goods  inflation  has  remained 
modest.  Services  inflation  gradually  increased 
from  2.4%  in  May  2018  to  4.4%  by  early  2020, 
partly  reflecting  the  tightening  labour  market. 
Domestic  producer  price  inflation  rose  in  early 
2020  for  industries  producing  consumption  and 
investment  goods,  reflecting  strong  underlying 
demand before COVID-19 hit the economy. 

5.2.2.  Recent inflation developments 

Over the last two years, HICP inflation was on an 
upward  path  in  Hungary,  with  unprocessed  food 
and energy prices adding volatility to the headline 
figure. Annual HICP inflation rose to 2.9% in 2018 
and further to 3.4% in 2019, on the back of broad-
based  price  increases,  reflecting  strong  demand 
growth  and  rapidly  rising  unit  labour  cost.  Value 
added tax cuts for selected food and services items 
reduced  inflation  in  2018,  but  rising  excise  duties 
on  tobacco  added  to  inflation  in  2019.  Inflation 
peaked  at  4.7%  in  January  2020,  due  to  a  rapid 
increase of unprocessed food and energy prices. It 
decreased  to  3.9%  in  March  2020,  thanks  to  the 
falling  price  of  fuels.  During  the  last  two  years, 

59 

-101234Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20HungaryReference valueGraph 5.1: Hungary -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.-2-1012345201420152016201720182019HungaryEuro areaGraph 5.2: Hungary -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 5.1:weights  Hungary - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP0.00.10.42.42.93.43.71000Non-energy industrial goods0.00.81.00.40.41.11.0231Energy-6.6-7.4-3.74.24.80.51.3123Unprocessed food -1.93.60.01.46.47.09.056Processed food2.40.51.04.04.15.75.8241Services2.32.21.81.92.44.04.2348HICP excl. energy and unproc. food1.61.31.42.12.33.73.8820HICP at constant tax rates 0.00.00.62.93.43.23.61000Administered prices HICP-6.6-0.80.30.60.31.00.91401) 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 2020 - Technical annex 

Chapter 5 - Hungary 

is  projected 

downturn. According to the Commission services’ 
Spring  2020  Forecast,  GDP 
to 
decrease  by  7%  in  2020  and  recover  by  6%  in 
2021. The positive output gap  widened  further, to 
4.1%  by  2019.  However,  it  is  estimated  to  turn 
negative  in  2020-2021  as  a  result  of  the  large 
recession. 

in  2019.  According 

The fiscal stance, as measured by the change in the 
structural balance was neutral in 2018 and slightly 
expansionary 
the 
Commission  services’  Spring  2020  Forecast, 
which is based on a no-policy change assumption, 
the  fiscal  stance  is  expected  to  be  restrictive  in 
2020 and expansionary in 2021. 

to 

Monetary  policy,  conducted  within  an  inflation 
targeting  framework (34),  has  remained  loose.  The 
MNB  has  kept  its  policy  rate  unchanged  at  0.9% 
since  May  2016,  but  it  increased  its  overnight 
deposit rate from minus 15 basis points to minus 5 
basis  points  in  March  2019.  The  central  bank 
endeavoured  to  fine-tune  monetary  conditions,  as 
measured  i.a.  in  the  BUBOR  interbank  rates, 
through  regulating  the  level  of  excess  liquidity  of 
the banking sector via FX swap tenders. In January 
2019, the MNB launched a new round of its SME-

(34)  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). 

               a  

5.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

remained 

accommodative. 

Hungary’s  real  GDP  increased  rapidly  in  recent 
years.  Economic  growth  peaked  at  5.0%  in  2018 
and remained at 4.9% in 2019. While the external 
environment  became  less  supportive,  domestic 
policies 
Private 
consumption was boosted by rapid wage rises and 
continued employment growth. The share of gross 
fixed  capital  formation  in  GDP  reached  a  record 
level  by  2019.  Public  investment  rose  due  to  the 
funds  and  higher 
rising  absorption  of  EU 
the  2018-2019 
investment 
elections.  Business  investment  was  spurred  by 
favourable  demand,  low  financing  costs  and  the 
recovery of the commercial real estate sector. 

activity 

around 

The COVID-19 pandemic is expected to result in a 
deep  recession,  followed  by  a  gradual  recovery. 
Although  the  sanitary  measures  implemented  by 
Hungary are less restrictive to business activity in 
international  comparison,  exports  are  strongly 
exposed  to  the  global  downturn  due  to  the  strong 
integration of Hungarian exporters in global value 
chains,  and 
in  cyclical 
specialisation 
their 
tourism  and 
industries  (e.g.  automotive)  and 
transport  services.  Furthermore,  fiscal  policy  has 
the 
so  far  provided 

limited  cushion  against 

60 

Table 5.2:Hungary - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationHungary0.00.10.42.42.93.43.02.7Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorHungary1.1-0.10.22.73.13.63.02.7Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeHungary0.62.02.47.06.29.45.04.4Euro area1.41.31.21.72.22.11.10.4Labour productivityHungary-0.41.6-1.52.42.73.2-3.44.8Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsHungary1.00.44.04.53.46.08.6-0.4Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorHungary0.1-1.1-2.51.94.01.12.82.5Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services.                                                           
 
 
 
 
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

financing Funding  for Growth Scheme (FGS)  and 
in  July  2019  it  started  the  Bond  Funding  for 
Growth Scheme for large corporates, for which the 
original  total  amount  was  raised  from  January 
2020  onwards.  In  response  to  the  COVID-19 
crisis, the MNB took several measures to stabilize 
the  financial  sector  and  the  economy.  These 
included  the  introduction  of  a  one-week  deposit 
facility  (effectively 
the  short-term 
market  rate)  and  of  an  unlimited  collateralized 
lending  facility,  the  extension  of  its  collateral 
framework,  the  expanding  of  the  FGS  and  the 
announcement  that  it  intends  to  buy  government 
bonds  on  the  secondary  market.  Net  credit  to  the 
private  sector  has  been  growing  at  double-digit 
in  an  environment  of 
rates  since  mid-2018 
negative real interest rates. 

increasing 

Wages and labour costs 

reduce wage growth. Labour productivity is set to 
decline in 2020 but recover in 2021, following its 
typical  pattern  around  recessions.  Employers’ 
social  contributions  will  be  further  reduced  in 
2020. Nominal ULC is projected to grow by 8.6% 
in  2020,  but  decrease  by  0.4%  in  2021  as  the 
labour  market  gradually  adjusts  to  the  contraction 
of output. 

External factors 

in 

Due  to  the  high  degree  of  openness  of  the 
Hungarian  economy,  developments 
import 
prices  play  an  important  role  in  domestic  price 
formation.  Growth  of  import  prices  (measured  by 
the imports of goods deflator) increased consumer 
price inflation in 2018, mainly as a result of higher 
oil  prices.  From  2019,  external  disinflationary 
effects took hold, due to slowing global economic 
growth and lower commodity prices. 

in 

high 

Employment  continued  to  expand  to  reach  a 
historically 
2019.  The 
70.1% 
unemployment rate fell to 3.4% in 2019. However, 
growth in labour demand eased in the second half 
of  2019,  in  anticipation  of  slowing  economic 
growth. Labour shortages and administrative wage 
increases  generated  strong  wage  growth,  with 
wages and salaries per employee rising by close to 
10% on average in 2018-2019. 

Over the last two years, the depreciating exchange 
rate  contributed  to  the  increase  of  import  prices. 
The  forint’s  nominal  effective  exchange  rate 
(measured  against  a  group  of  36  trading  partners) 
depreciated on average by 1.5% in 2018 and by a 
further  2.1%  in  2019.  The  change  of  the  nominal 
effective exchange rate would suggest inflationary 
pressures,  but  the  pass-through  of  the  exchange 
rate  changes  to  consumer  prices  appears  much 
smaller than in the past.  Looking ahead, imported 
inflation 
following 
significant  depreciation  of  the  forint  since  the 
beginning of this year. 

is  expected 

increase, 

to 

social 

contributions. 

The  effect  of  high  wage  growth  on  production 
costs  was  mitigated  by  large  successive  cuts  in 
employers’ 
Labour 
productivity  growth  also  picked  up  to  around  3% 
in 2018-2019, although the level of productivity is 
lagging  behind  regional  peers.  Still,  nominal  unit 
labour  costs  rose  by  3.4%  and  6.0%  in  2018  and 
2019  respectively,  well  above  the  euro  area 
average. Looking ahead, the large recession caused 
by  the  COVID-19  pandemic  is  projected  to  raise 
unemployment  to  7%  in  2020,  despite  temporary 
job protection measures offered to companies, and 

Administered prices and taxes 

The share of administered prices in the Hungarian 
HICP  basket  (14%)  is  somewhat  above  the  euro 
area  average.  Administered  prices  increased  by 
0.3% in 2018 and 1.0% in 2019. Regulated energy 
and  other  utility  prices  practically  did  not  change 
in 2018 and 2019. Overall, administered prices had 
a  minor  effect  on  headline  inflation,  contributing 
around 0.1 pp. in both 2018 and 2019. 

Changes  in  indirect  taxation  lowered  headline 
inflation by 0.5 pp. in 2018 and increased it by 0.2 
pp. in 2019. Starting from 2018, the VAT rate was 
reduced  on  internet  and  restaurant  services,  milk, 
fish and pork offal. The financial  transaction duty 
for  households’  smaller  transactions  was  also 
abolished.  At  the  same  time,  the  excise  duty  on 
tobacco has been continuously increasing, and it is 
also expected to add to inflation in 2020-2021. 

61 

-4-2024681020142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 5.3: Hungary -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2020 Forecast.                   
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

Medium-term prospects 

Inflation is projected to ease after peaking at 3.4% 
in  2019.  The  recession  caused  by  the  COVID-19 
shock  is  expected  to  reduce  core  inflation.  Food 
price  inflation  is  set  to  decrease  as  the  temporary 
impact of the African swine flu fades. Energy price 
inflation is projected to remain low, in line with oil 
market 
the 
developments.  According 
Commission  services’s  Spring  2020  Forecast, 
inflation is set to remain around the central bank’s 
target  of  3%,  with  an  average  3.0%  in  2020  and 
2.7% in 2021. 

to 

There  are  both  upside  and  downside  risks  to  the 
inflation  outlook.  The  large  currency  depreciation 
could  result  in  a  large  one-time  repricing  of 
imported  goods,  while  food  price  inflation  could 
remain high due to supply shortages. On the other 
hand,  a  deeper  or  longer  economic  contraction 
could further reduce core inflation. 

The level of consumer prices in Hungary  stood at 
about 61% of the euro area average in 2018, with 
the  relative  price  gap  larger  for  services  than  for 
goods.  This  suggests  that  there  is  potential  for 
price  level  convergence  in  the  long  term,  as  GDP 
per  capita  in  PPS  (around  67%  of  the  euro  area 
average  in  2018)  increases  towards  the  euro  area 
average. 

Medium-term 
inflation  prospects  will  depend 
strongly  on  wage  and  productivity  developments, 
notably in the non-traded sector and on the success 
with anchoring inflation expectations at the central 
bank’s  3% 
target.  These  elements  may  be 
substantially affected by the COVID-19 crisis. 

5.3. 

PUBLIC FINANCES 

5.3.1.  Recent fiscal developments 

The  improvement  in  public  finances  remained 
limited  over  the  2018-2019  period,  with  the 
general government deficit reaching 2.0% of GDP 
in 2019, down from 2.5% of GDP in 2017. 

Revenues as a share of GDP remained unchanged 
in  2018  at  44.5%  and  then  dropped  to  44.0%  in 
2019.  Nominal  tax  revenues  grew  relatively  fast 
thanks  to  the  high  growth  of  the  main  tax  bases, 
including  nominal  income  and  consumption,  and 
to  measures  to  improve  tax  compliance.  The 
increase  was,  however,  below  nominal  GDP 
growth, reflecting the reduction, in both 2018 and 
in  employers’  social  contribution  rate. 
2019, 

62 

Revenues  from  EU  funds  continued  to  increase, 
reaching  a  peak  in  2019.  The  moderation  in  the 
ratio  was  slightly  more 
expenditure-to-GDP 
pronounced, from 47.0% in 2017 to 46.7% in 2018 
and then further to 46.1% in 2019. This was driven 
by  the  moderate  increase  in  current  expenditure 
compared  to  GDP,  in  particular  public  wages, 
social transfers and interest expenditure. However, 
these  savings  were  partially  absorbed  by  rising 
capital  expenditure, 
increased 
absorption of EU funds and the implementation of 
the  measures  under  the  ‘demography  programme’ 
in 2019. 

following 

the 

especially 

The  2019  budgetary  outturn  was  worse  than  the 
1.8%  of  GDP  deficit  target  set  in  the  2019 
Convergence  Programme.  This  was  explained  by 
higher-than-planned  expenditure,  especially  at  the 
end  of 
the  year.  The  higher-than-expected 
revenues, thanks to high income and consumption 
growth,  were  offset  by  higher-than-projected 
expenditure, 
intermediate 
consumption  and  subsidies.  Public  investment 
continued  growing  also  on  the  back  of  increased 
EU  funds  absorption,  while  capital  transfers  were 
boosted  by  the  take-up  of  the  prenatal  funding 
scheme  of  the  ‘demography  programme’.  The 
structural balance remained unchanged at -3.6% of 
GDP in 2018 and worsened marginally to -3.8% in 
2019, well below the country's MTO (i.e. -1.5% of 
GDP). 

on 

Since  2017,  the  structural  balance  significantly 
deviated  from  the  adjustment  path  towards  the 
Medium-Term  budgetary  Objective  (a  structural 
deficit of 1.5% of GDP) as required by the Council 
in regulation 1466/97. As a consequence, Hungary 
has  been  under  consecutive  Significant  Deviation 
Procedures  since  June  2018.  Since  then,  the 
Council  has  issued  bi-annual  recommendations  to 
which  Hungary  has  not  responded  with  effective 
action. 

The government debt-to-GDP ratio decreased from 
72.9% in 2017 to 66.3% by the end of 2019. The 
decline since 2017 was driven mainly by the high 
nominal economic growth, which was partly offset 
by  the  fiscal  deficit  and,  especially  in  2018,  by  a 
debt-increasing  stock-flow  adjustment  related  to 
the pre-financing needs of EU-funded projects. 

5.3.2.  Medium-term prospects 

The  2020  budget  was  adopted  by  the  Hungarian 
Parliament on 12 July 2019. It targeted a headline 
deficit  of  1.0%  of  GDP,  and  included  significant 

Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

been announced: those are planned to be financed 
through  further  budgetary  reallocations  and  their 
details  are  yet  to  be  specified.  As  a  result,  the 
headline deficit target was revised to 2.7% of GDP 
in 2020. 

The  Commission  services’  Spring  2020  Forecast 
projects  the  current  year's  general  government 
deficit  at  5.2%  of  GDP,  well  above  the  official 
target.  Based  on  a  no-policy-change  assumption, 
the deficit is projected to decrease to 4.0% of GDP 
in  2021.  In  structural  terms,  the  deficit  is  overall 
estimated  to  improve  over  2020-2021,  reaching 
3.1% by 2021. The debt-to-GDP ratio is expected 
to  increase  to  75.0%  in  2020  and  to  decline  to 
73.5% by the end of 2021. 

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.  There 
had  been  a  number  of  recent  legislative  steps  to 
reinforce and clarify some elements of the national 
framework.  First,  the  Fiscal  Council’s  monitoring 
mandate  was  extended  in  mid-2018  to  cover  all 
domestic  fiscal  rules.  Second,  the  system  of 
domestic  rules  was  streamlined  in  late  2019, 
including  by  removing  the  discrepancy  in  the 

63 

some 

those  under 

deficit-increasing 

free  reserves  (1%  of  GDP)  to  cover  potential 
slippages under the risk scenario. The 2020 budget 
included 
spending 
measures  (i.e. 
the  ‘demography 
programme’  and  the  expansion  of  subsidies  for 
home building) and some tax cuts, among which a 
further reduction of employers' social contribution 
rate  by  2  pp.  as  of  October  the  reduction  of  the 
rates  of  certain  taxes  and  some  measures  to 
simplify  taxation.  Following  the  outbreak  of  the 
COVID-19  pandemic, 
the  authorities  adopted 
fiscal  policy  measures  aimed  at  containing  its 
economic  impact,  with  a  net  budgetary  impact  of 
0.2%  of  GDP.  Expansionary  measures  amount  to 
1%  of  GDP  and  include  some  temporary  tax  cuts 
in  the  most  affected  sectors  such  as  tourism  and 
services;  the  anticipation  of  the  planned  2  pp.  cut 
to employers’ social contributions from October to 
July;  a  job  protection  scheme  that  covers  part  of 
lost  wages  for 
three  months  under  certain 
conditions; a wage subsidy scheme for R&D jobs; 
and a one-off bonus for health workers. Moreover, 
medical emergency expenditures have amounted to 
0.8%  of  GDP  until  now.  Overall,  these  measures 
are  financed  largely  from  the  reshuffling  of 
existing budgetary chapters and reserves as well as 
new 
taxes  on  banks  and  retail  companies. 
Additional  measures  to  support  the  recovery  have 

Table 5.3:Hungary - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-2.8-2.0-1.8-2.5-2.1-2.0-5.2-4.0- Total revenues47.448.645.444.544.544.045.143.6- Total expenditure50.250.647.247.046.746.150.347.7   of which: - Interest expenditure4.03.53.12.72.42.32.52.4p.m.: Tax burden38.739.139.638.437.637.137.736.5Primary balance1.21.41.30.20.20.2-2.6-1.6Cyclically-adjusted balance 2)-2.6-2.4-2.1-3.3-3.6-3.9-2.8-3.1One-off and temporary measures 3)-0.10.0-0.10.40.0-0.2-0.20.0Structural balance 2)4)-2.5-2.3-2.0-3.6-3.6-3.8-2.6-3.1Government gross debt76.876.275.572.970.266.375.073.5p.m: Real GDP growth (%)4.23.82.24.35.14.9-7.06.0p.m: Output gap 2)-0.40.80.61.83.14.1-5.2-2.11) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services. 
 
   
 
 
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

calculation  of  the  public  debt  ratio  between  the 
‘Maastricht’  definition  and  the  domestic  one. 
Nonetheless, the role of the Council in scrutinizing 
and shaping fiscal policies is still weak, in contrast 
to  its  constitutionally-enshrined  veto  power  over 
the annual budget bill. 

the  positive  effect  of  EU  fund  inflows  and  the 
liquidity providing FX swaps tenders exceeded the 
foreign currency demand by the Government Debt 
Management  Agency 
the  Treasury. 
International reserves reached around EUR 28bn at 
end-2019,  which  corresponded  to  about  20%  of 
GDP. 

and 

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 
the  continuous 
band  was  designated  around 
medium-term  inflation  target  of  3  percent  (that  is 
in place since 2005). 

The  forint  fluctuated  around  320  HUF/EUR  for 
most part of 2018 and the first half of 2019. It was 
weaker for a few months from July 2018, before it 
appreciated  against  the  euro  till  March  2019. 
Thereafter the forint depreciated to the euro, as the 
MNB  signalled  its  intent  to  keep  loose  monetary 
conditions longer than other regional central banks 
and  inflation  rose  above  its  target.  The  forint 
weakened  to  337  HUF/EUR  in  February  2020, 
before  the  COVID-19  crisis  set  in.  Inter-day 
exchange  rate  volatility  was  generally  moderate 
during  the  past  two  years,  with  the  notable 
it  sharply 
exception  of  March  2020,  when 
increased.  In  that  month,  the  forint  traded  against 
the euro on average at about 346 HUF/EUR. 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro area increased from around 40 basis points in 
May 2018 to around 60 basis points in July 2018, 
before falling back to about 40 basis points by end-
2018.  Short-term  interest  rate  differentials  then 
increased  to  70  basis  points  by  August  2019, 
before rising further to 90 basis points in February 
2020.  The  MNB  influenced  forint  short-term 
money  market  rates  mainly  via  its  FX  swap 
tenders,  while  markets  priced  in  a  10  basis  points 
policy rate cut by the ECB during summer 2019. In 
April  2020,  the  MNB  activated  its  one-week 
deposit instrument at the policy rate to increase the 
effective  short-term  rates.  In  March  2020,  the 
3-month  spread  vis-à-vis  the  euro  area  reached 
around 100 basis points. 

5.5. 

LONG-TERM INTEREST RATES 

the  development  of 

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

International  reserves  held  by  the  MNB  reached 
around  EUR  23bn  both  at  end-2017  and  at 
end-April 2018. They increased from late 2018, as 

64 

260280300320340360201420152016201720182019Graph 5.4: Hungary -HUF/EUR exchange rate(monthly averages)Source: ECB.050100150200250300201420152016201720182019Graph 5.5: Hungary -3-M Bubor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Hungary.                 
               
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

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,  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  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see also Box 1.6), which highlighted issues related 
to  unit  labour  costs,  the  housing  market  and 
possible risks from the exposure to the automotive 
industry.  However,  since  overall  risks  remained 
limited, no In-Depth Review (IDR) was warranted. 
Risks  from  domestic  demand  pressures  warrant 
attention.  Unit  labour  cost  growth  has  been  very 
dynamic,  as  productivity  growth 
lags  behind 
substantial  wage  rises,  driven  by  the  tight  labour 
market and administrative measures. The large role 
of  the  automotive  industry  may  represent  a  risk 
over the longer term. Real  house prices continued 
lending  volumes  are 
to  grow  rapidly.  New 
increasing,  but  private  debt  as  a  percentage  of 
GDP continued to decrease, because of the gradual 
amortisation of previously accumulated stocks.  

5.6.1.  Developments  of 

the  balance  of 

payments 

According to balance of payments data, the surplus 
of  Hungary’s  external  balance  (i.e.  the  combined 
current  and  capital  account)  declined  to  2.1%  of 
GDP  in  2018  and  to  1.0%  of  GDP  in  2019.  The 
current account decreased from previous surpluses 
to a deficit of 0.8% in 2019. Export growth slowed 
in  line  with  the  weaker  economic  growth  of  the 
main 
imports  grew 
dynamically  on  the  back  of  soaring  domestic 
consumption and investment. The primary income 
balance  improved  with  the  reduction  of  external 
debt.  The  capital  account  surplus  was  higher  in 
2018-2019  than  in  2017,  due  to  the  increased 
absorption  of  EU  funds  from  the  2014-2020 
Multiannual Financial Framework. 

trading  partners,  while 

65 

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  2018  convergence  assessment  of 
Hungary.  It  increased  to  3.3%  by  May  2019  and 
then started to decrease again. In March 2020, the 
latest  month  for  which  data  are  available,  the 
reference value, given by the average of long-term 
interest  rates  in  Portugal,  Cyprus  and  Italy  plus  2 
percentage  points,  stood  at  2.9%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Hungarian benchmark bond stood at 2.3%, i.e. 0.6 
percentage points below the reference value. 

The  long-term  interest  rate  of  Hungary  increased 
from around 2.9% in May 2018 to about 3.7% by 
October  2018,  as  the  market  priced  in  a  higher 
exchange  rate  risk  of  the  forint.  It  then  started  to 
decrease  again  and  reached  1.9%  in  December 
2019, reflecting a renewed international search for 
yield, as  major central banks  embarked on further 
monetary easing. Hungary's long-term interest rate 
increased  to  2.4%  by  March  2020,  amidst  the 
unfolding COVID-19 crisis. The long-term spread 
vis-à-vis  the  German  benchmark  bond  peaked 
around  330  basis  points  in  October  2018  and  it 
stood at around 300 basis points in March 2020. 

02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20HungaryReference valueGraph 5.6: Hungary -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-202468201420152016201720182019HungaryGermanyGraph 5.7: Hungary -Long-term interest rates(percent, monthly values)Source: Eurostat.              
                
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

to 

the  depreciation  of 

led 
the  real-effective 
exchange  rates,  offsetting  some  of  the  decline  in 
cost  competitiveness  of  earlier  years.  Hungary’s 
export  performance  stagnated 
in  2018,  but 
improved in 2019. 

Hungary’s savings-investment surplus decreased in 
recent  years  as  gross  fixed  capital  formation  rose 
markedly.  The  investment  rate  rose  to  a  record 
high 28.6% in 2019. The rise in private investment 
was  due 
the  favourable  economic  cycle, 
including  the  recovery  in  the  real  estate  sector. 
Public  investment  also  rose  markedly  until  2019, 
fuelled  by  increasing  absorption  of  EU  funds.  At 
the  same  time,  the  saving  rate  increased  further 
from already high levels. 

to 

Price  and  cost  competitiveness 
indicators  of 
Hungary  deteriorated  in  2018,  but  improved  in 
2019. The real-effective exchange rate deflated by 
ULC  appreciated  markedly  until  2018,  driven  by 
high  domestic  wage  growth.  Since  2018,  the 
depreciating  nominal  effective  exchange  rate  also 

66 

Mirroring the development of the external balance, 
the  surplus  of  the  financial  account  melted  by 
2019.  Direct  investment  continued  to  register  net 
inflows in both 2018 and 2019. Large outflows of 
portfolio  investment  ended  by  2018,  as  non-
residents’ forint-denominated bondholdings started 
to  increase,  in  line  with  the  yield  premium  on 
Hungarian  assets.  Other  investment  flows  were 
close  to  balance  over  the  past  two  years.  The 

010203040201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 5.8: Hungary -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.8090100110201420152016201720182019Graph 5.9: Hungary -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 5.4:Hungary - Balance of payments(percentage of GDP)201420152016201720182019Current account1.22.34.62.40.0-0.8of which: Balance of trade in goods2.03.63.41.5-1.3-1.9                 Balance of trade in services4.34.45.35.85.85.6                 Primary income balance -4.3-4.5-2.6-4.0-3.8-3.6                 Secondary income balance-0.9-1.1-1.5-1.0-0.6-0.9Capital account3.74.60.00.92.31.8External balance 1)4.96.94.53.22.31.0Financial account4.25.93.01.40.7-0.4of which: Direct investment-2.8-2.3-2.4-1.6-2.0-1.3                Portfolio investment3.15.04.23.0-0.11.1                Other investment 2)3.27.56.50.00.2-0.4                Of which International financial assistance1.90.01.3n.a.n.a.n.a.                Change in reserves0.7-4.4-5.30.02.70.2Financial account without reserves8.112.612.03.00.10.7Errors and omissions-0.7-1.1-1.5-1.8-1.6-1.4Gross capital formation23.423.321.322.827.228.6Gross saving24.725.626.025.126.927.7Gross external debt144.0128.4120.8102.2100.488.8International investment position-78.6-66.6-59.9-54.9-51.3-47.21) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, Magyar Nemzeti Bank. 
            
   
 
 
        
 
 
Convergence Report 2020 - Technical annex 

Chapter 5 - Hungary 

contributes  significantly  to  economic  integration 
with the euro area. 

Concerning  the  business  environment,  Hungary 
performs  in  general  worse  than  many  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  dealing  with  construction  permits. 
In  the  World  Bank's  Worldwide  Governance 
Indicators  Hungary  performs  relatively  worse  in 
terms of "voice and accountability" and control of 
corruption. According to the latest data, Hungary's 
transposition deficit of EU Directives was at 0.9% 
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. New measures were 
notified during 2019 and 2020. The Commission is 
analysing  the  communicated  measures  to  assess 
their  completeness  and  conformity  with 
the 
directive.  As 
the  5th  Anti-Money 
transposition 
Laundering  Directive,  whose 
deadline elapsed on 10 January 2020, Hungary has 
notified  national 
transposition  measures  and 
declared a partial transposition. 

regards 

The Hungarian labour market can be considered as 
rather  flexible  in  terms  of  employment  protection 

67 

decrease of gross external debt proceeded in 2018 
and  2019  at  a  fast  pace,  falling  to  around  89%  of 
GDP at the end of this period. The net international 
investment  position  improved  from  its  low  of  
-113.4% of GDP in 2009 to -47.2% by end-2019. 

According  to  the  Commission  services’  Spring 
2020 Forecast, which is based on national accounts 
data,  the  external  surplus  is  expected  to  increase 
above 3% of GDP in both 2020 and 2021, due  to 
the  contraction  of  domestic  demand  and  falling 
imports. 

5.6.2.  Market integration 

through 

trade  and 

The Hungarian economy is  highly integrated  with 
the  euro  area 
investment 
linkages.  Trade  openness  remains  high  at  around 
92% in 2019, reflecting the deep integration of the 
Hungarian  economy  into  continental  and  global 
supply chains. Flows  with the euro area dominate 
trade,  accounting  for  more  than  half  of  the  total 
trade  in  goods  and  services.  The  main  goods 
trading  partners  in  2019  were  Germany,  Austria, 
Slovakia and Poland. 

The  stock  of  FDI  in  Hungary  amounted  to  about 
63% of GDP in 2018 (excluding SPEs),  with FDI 
mainly originating from Germany, the Netherlands 
and  Austria.  The  main  recipient  sectors  of  FDI 
were services (mostly financial services, trade and 
real  estate  activities)  and  manufacturing  (39%  of 
the  total),  suggesting  that  FDI  plays  an  important 
role  in  enhancing  Hungary’s  export  capacity  and 

Table 5.5:Hungary - Market integration201420152016201720182019Trade openness 1) (%)92.292.292.794.394.991.9Trade with EA in goods & services 2)+3) (%)52.953.153.653.753.752.0Export performance (% change) 4)5.12.8-0.60.80.13.5World Bank's Ease of Doing Business Index rankings 5)404041485352WEF's Global Competitiveness Index rankings 6)606369604847Internal Market Transposition Deficit 7) (%)0.70.60.40.80.30.9Real house price index 8)88.3100.0113.1123.6137.1151.9Residential investment 9) (%)1.92.22.42.73.03.2 1) (Imports + Exports of goods and services / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics, Balance of Payments). 2) (Imports + Exports of goods with EA-19 / (2 x GDP at current market prices)) x 100 (Foreign Trade Statistics). 3) Trade in services with EA-19 (average credit and debit in % of GDP at current prices) (Balance of Payments). 4) Index for exports of goods and services divided by an index for growth of markets (percentage change on preceding year). 5) New methodology as of 2014 (World Bank). 6) (World Economic Forum) 7) Percentage of internal market directives not yet communicated as having been transposed, relative to the total.    (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 2020 - Technical annex 

Chapter 5 - Hungary 

statutory 

indicator 

retirement 

(as  measured  by  the  2013  OECD  employment 
protection 
for  permanent  workers). 
Policies  on  social  transfers,  early  retirement  and 
increasing 
have 
strengthened  labour  supply.  The  regulation  of 
working hours has also become more flexible from 
2019.  Both  domestic  and  international  labour 
mobility  is  rather  low  in  Hungary,  although 
outward  migration from the country  has increased 
since the financial crisis. 

age 

The  rapid  increase  of  real  house  prices  continued 
in  2018-2019,  supported  by  favourable  financing 
conditions,  the  improving  financial  situation  of 
households  and  expanding  government  subsidies. 
Homebuilding was slow to respond to rising house 
prices,  partly  due 
to  capacity  constraints. 
Investment  in  residential  buildings  remained  at 
around  3%  of  GDP  in  2019.  The  stock  of  forint-
denominated  housing 
increased  quite 
dynamically,  reaching  an  annual  growth  rate  of 
around 10% at end-2019. 

loans 

The financial system in Hungary is smaller relative 
to  GDP  than  that  of  the  euro  area  countries. 
Domestic bank credit amounted to 33% of GDP at 
the  end-2019,  split  broadly  evenly  between 
households  and  non-financial  corporations.  The 
total  capitalization  of 
the  Budapest  Stock 
Exchange  amounted  to  about  20%  of  GDP  in 
2019,  well  below  the  stock-market  capitalization 
of  the  euro-area.  The  central  bank  continues  to 
have  a  controlling  ownership  of  the  Budapest 
Stock  Exchange,  which  may  generate  conflict  of 
interests. The debt securities market remains small 
in  comparison  with  the  euro  area  average  (67% 
against  148%  of  GDP)  and  is  mainly  used  for  re-
financing  public  debt.  The  consolidated  stock  of 
private  sector  debt  fell  from  around  92%  in  2014 
to  around  67%  of  GDP  in  2019,  which  is 
significantly  below  the  private  debt  level  of  the 
euro area. 

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. Foreign ownership 
in  total  assets  of  the  Hungarian  banking  sector 
increased  from  39.3%  in  2014  to  41.2%  in  2018. 
Bank  concentration,  as  measured  by  the  market 
share  of  the  largest  five  credit  institutions  in  total 
assets, reached 50% in 2018, which is close to the 
euro-area average. 

The  Hungarian  banking  system  remains  well-
capitalized, with a capital adequacy ratio of 17.4% 
at end-September 2019, which is somewhat below 
that  of  the  euro  area.  Banks'  profitability  has 
recovered after a large loss in 2014, which was due 
to provisioning for the settlement of FX mortgage 
loans. The sector's return on equity reached around 
14%  in  the  year  to  end-September  2019,  well 
above  the  approximately  5%  average  of  the  euro 
area.  Profitability  was  supported  by  dynamic 
lending to both household and corporate clients, as 
the  potential 
to  write  back  NPL  provisions 
diminished. The improvement of the loan portfolio 
quality continued and the NPL ratio reached 4.5% 
in  September 2019,  which is  somewhat above the 
average of the euro area. The COVID-19 pandemic 
could  have  a  significant  impact  on  the  indicators 
analysed 
the  coming 
this  paragraph  over 
months. 

in 

68 

0102030405060HU, 2014HU, 2018EA, 2014EA, 2018Concentration 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.-25-20-15-10-50510152025HU, 2014HU, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 5.11: Hungary -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180HU, 2014HU, 2019EA, 2014EA, 2019Debt 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  main  rules  governing  the  Narodowy  Bank 
Polski  (NBP  –  Polish  national  bank,  hereafter 
NBP)  are  laid  down  in  the  Act  on  the  Narodowy 
Bank Polski (the NBP Act) which was adopted on 
29  August  1997.  The  consolidated  version  that 
includes  all  amendments  to  the  NBP  Act  was 
published  in  Dziennik  Ustaw  of  2019,  item  1810. 
The NBP Act has been slightly amended since the 
Commission’s  2018  Convergence  Report (35).  In 
absence  of  any  legislative  action  regarding  the 
issues  mentioned 
the  Commission’s  2018 
Convergence  Report,  the  comments  provided  in 
the  latter  report  are  largely  repeated  in  the  2020 
assessment. 

in 

6.1.2.  Central Bank independence 

content 

constitutes 

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

an 

(35)  The amendments stem from the Law of 9 November 2018 
regarding the strengthening of financial market supervision 
and  investor  protection  (Dziennik  Ustaw  of  2019,  item 
2243), the  Act  of 22  February  2019 restricting the pursuit 
of  business  activities  by  persons  exercising  public 
functions and the NBP Act (Dziennik Ustaw of 2019, item 
371)  and  Union  data  protection  legislation  (Dziennik 
Ustaw of 2019, item 730). 

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 
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  Article  9(5)  of  the  NBP  Act 
containing  grounds  for  dismissal  of  the  NBP's 
Governor could lead to interpretative issues and is 
an imperfection. The provision would benefit from 
a  clarification  that  these  grounds  correspond  to  a 
lack  of  fulfilment  of  conditions  required  for  the 
performance of the Governor’s duties or a serious 
misconduct of which the Governor has been guilty, 
as  set  out  in  Article  14.2  of  the  ESCB/ECB 
Statute.  

The  State  Tribunal  Act (36)  provides  for  the 
suspension  of  the  Governor  from  his/her  duties 
following  a  procedure,  which  raises  questions 
regarding  its  compatibility  with  the  principle  of 
central bank independence and Article 14.2 of the 
ESCB/ECB  Statute.  Pursuant 
the  second 
sentence of Article 11(1) of the State Tribunal Act 
read  in  conjunction  with  its  Articles  3  and  1.1(3), 

to 

(36)  State Tribunal Act, Dziennik Ustaw of 2019, item 2122. 

69 

                                                           
                                                           
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

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 

bank 

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

insolvency  of 

refinancing 

loans 

in 

As  such,  there  is  also  no  direct  reference  to  the 
prohibition on monetary financing in the NBP Act. 
While  Article  220(2)  of  the  Polish  Constitution 
provides  that  the  budget  shall  not  provide  for 
covering  a  budget  deficit  by  way  of  contracting 
credit  obligations  to  the  State’s  central  bank,  and 
this  could  be  interpreted  as  a  reference  to  the 
rationale  of  Article  123  of 
this 
provision  is  not  compatible  with  Article  123 
TFEU.  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  prohibition  on  monetary 
financing as enshrined in Article 123 of the TFEU 
and  Article  21  of  the  ESCB/ECB  Statute  applies. 
Alternatively, or in addition, the NBP Act could be 
amended  to  ensure  full  compatibility  with  the 
aforementioned principle. 

the  TFEU, 

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 

is 

taken  only 

the  Governor  of  the  NBP  can  be  suspended  as  a 
result  of  an  indictment  by  the  Parliament  for 
violating  the  Constitution  or  an  act  of  law  when 
performing  his/her  duties  even  before  the  State 
Tribunal has delivered its judgment on the removal 
from the  office. While suspending a Governor for 
the  purpose  of  a  (criminal)  investigation  may  be 
necessary, the Governor concerned should be able 
to  bring  an  action  for  annulment  of  a  temporary 
measure  before  the  Court  of  Justice  of  the 
European  Union  (CJEU)  pursuant  to  Article  14.2 
of  the  ESCB/ECB  Statute.  The  purpose  of  such 
action  is  to  enable  the  CJEU  to  verify  that  a 
temporary prohibition of performing a Governor’s 
duties 
there  are  sufficient 
if 
indications  that  he/she  has  engaged  in  serious 
misconduct 
a 
measure (37). Such a guarantee is a reflection of the 
principle  of  central  bank  independence  and  of 
in  case  of  a 
great 
suspension  from  office  on  grounds  of  serious 
misconduct 
indictment  by  a 
to  an 
parliamentary body depriving the  Governor of the 
possibility to continue exercising the duties. In the 
absence  of  any  clear  reference  in  the  NBP  Act  or 
Constitution  to  the  principle  of  central  bank 
independence 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,  including  suspension  before  the 
CJEU,  as  enshrined 
the 
ESCB/ECB Statute. 

importance,  especially 

in  Article  14.2  of 

capable  of 

justifying 

further 

such 

the 

to  Article  203(1)  of  Poland’s 
According 
Constitution, 
Supreme  Audit  Office 
(Najwyższa  Izba  Kontroli  (NIK))  is  entitled  to 
examine the NBP's activities as regards its legality, 
economic  prudence,  efficiency  and  diligence.  The 
NIK controls are not performed in the capacity of 
an  independent  external  auditor,  as  laid  down  in 
Article  27.1  of  the  ESCB/ECB  Statute  and  thus, 
should  for  legal  certainty  reasons  be  clearly 
defined  so  as  to  respect  Article  130  of  the  TFEU 
and  Article  7  of 
the  ESCB/ECB  Statute. 
the  provision's  relationship  with 
Furthermore, 
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 

(37)  Judgment  of  the  Court  of  Justice  of  the  EU  (Grand 
Chamber)  of  26  February  2019  Ilmārs  Rimšēvičs  and 
European Central Bank v Republic of Latvia, Joined Cases 
C-202/18  and  C-238/18,  ECLI:EU:C:2019:139.  In  this 
ruling,  the  CJEU  declared  it  has  jurisdiction  to  hear  and 
determine  an  action  of  annulment  brought  against  a 
temporary measure like a suspension of performing duties 
as  a  Governor  under  Article  14.2  of  the  ESCB/ECB 
Statute. 

70 

                                                           
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

Tasks 

6.1.5.  Assessment of compatibility 

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) and absence of a general reference to 
the  BNB  as  an  integral  part  of  the  ESCB 
(Article  227(1)  of  the  Constitution  and  Article 
1 of the NBP Act); 

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. 

  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),  second 
sentence of the Constitution and Articles 4, 31-
37 of the NBP Act). The NBP shall exercise its 
responsibility for issuing currency as part of the 
ESCB/Eurosystem; 

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 2018. It decreased to 1.1% 
by  early  2019  and  then  increased  gradually  to 
2.1%  by  end-2019.  In  March  2020,  the  reference 
value  was  1.8%,  calculated  as  the  average  of  the 
12-month  average  inflation  rates  in  Portugal, 
Cyprus,  Italy  plus  1.5  percentage  points.  The 
corresponding  inflation  rate  in  Poland  was  2.8%, 
i.e.  1.0  percentage  points  above  the  reference 
value.  The  12-month  average  inflation  rate  is 
projected to remain well above the reference value 
in the months ahead. 

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

independent 

external 

by 

There are also some imperfections regarding: 

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

 

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). 

6.2.2.  Recent inflation developments 

Poland  recorded  an  increase  in  annual  HICP 
inflation over the past two years, backed by rising 
core  inflation,  boosted  mainly  by  higher  service 
price  growth.  Annual  inflation  rose  to  1.5%  by 
September  2018,  before  dipping  back  to  0.6%  by 
January 2019. It moved to 2.1% by April 2019 and 
increased  further  to  2.4%  by  November.  Annual 
inflation increased sharply further at end-2019 and 
early  2020,  driven  up  by  rising  food  and  services 

71 

-101234Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20PolandReference valueGraph 6.1: Poland -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring Forecast.            
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

prices. Overall, headline inflation reached 1.2% in 
2018 and 2.1% in 2019. During the last two years, 
annual HICP inflation in Poland was lower than in 
the  euro  area  until  March  2019  and  higher 
thereafter. 

April 2018 to 5.6% in March 2020. Following six 
consecutive  years  of  a  decline,  prices  of  non-
energy industrial goods increased by 0.4% in 2019. 

6.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance  

social 

situation, 

consumer 

Poland’s  real  GDP  growth  reached  5.1%  in  2018, 
the fastest growth rate for the last ten years. It then 
slowed  to  4.1%  in  2019,  closer  to  estimates  of 
potential  output  growth  of  around  3.5%.  As  in 
previous  years,  growth  was  mainly  driven  by 
domestic  demand,  in  particular  strong  private 
investment.  Private 
consumption  and  public 
consumption was supported by an excellent labour 
market 
transfers, 
increased 
lowering  of  direct  taxes,  low  interest  rates  and 
ensuing 
Investment 
recovered  in  2018  and 2019, mainly  driven  by  its 
public  part,  but  its  share  in  GDP  remained  well 
below 
the 
the  EU  average.  According 
Commission services’ Spring 2020 Forecast, GDP 
is  projected  to  decline  by  4.3%  in  2020,  due  to  a 
disruption 
an 
unprecedented  fall  in  external  demand  caused  by 
the  COVID-19  pandemic.  In  2021,  GDP 
is 
expected to bounce back by 4.1% driven mainly by 
a  strong  recovery  in  household  consumption.  The 
sizeable positive output gaps of 2018 and 2019 are 
expected to reverse strongly in 2020-2021. 

confidence. 

economic 

activity 

and 

to 

in 

The fiscal stance, as measured by the change in the 
structural  balance,  was  slightly  tightened  in  2018. 
In  2019  a  pro-cyclical  fiscal  expansion  was 
observed.  According  to  the  Commission  services’ 
Spring 2020 Forecast, the fiscal stance is expected 
to  be  expansionary  in  2020,  driven  mainly  by  the 

inflation  (measured  as  HICP 

inflation 
Core 
excluding energy and unprocessed food) increased 
gradually  from  0.4%  in  May  2018  to  3.7%  by 
March  2020.  It  was  below  headline  inflation  in 
2018,  when  oil  prices  were  high,  but  fluctuated 
around  the  headline  figure  in  2019,  as  the  impact 
of  spiking  unprocessed  food  prices  was  then 
counterbalanced  by  falling  energy  prices.  The 
upward trend of core inflation in the past two years 
was spread over a wide range of HICP categories, 
driven 
in  particular  by  processed  food  and 
services.  Processed  food  inflation  increased  from 
1.3%  in  June  2018  to  5.4%  by  March  2020. 
Demand  and  supply  factors  such  as  rising  wages, 
higher input prices and a strong increase in private 
consumption  were  the  main  contributors  to  this 
increase.  Strongly  rising  domestic  demand  and 
difficulties  in  hiring  adequately  skilled  workers 
leading  to  rising  wages  also  played  a  role  for 
services  inflation,  which  increased  from  0.4%  in 

72 

-1.50.01.53.04.5201420152016201720182019PolandEuro areaGraph 6.2: Poland -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 6.1:weights  Poland - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP0.1-0.7-0.21.61.22.12.81000Non-energy industrial goods-0.9-0.8-1.5-1.0-0.30.40.5323Energy-1.2-4.9-3.72.93.70.00.4131Unprocessed food -1.7-1.71.65.63.05.49.446Processed food1.6-0.30.72.71.83.74.3195Services1.31.71.82.40.83.54.4305HICP excl. energy and unproc. food0.60.30.31.20.62.32.8824HICP at constant tax rates -0.3-0.7-0.21.61.22.12.71000Administered prices HICP1.21.02.11.20.81.22.81231) 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 2020 - Technical annex 

Chapter 6 - Poland 

measures to contain the pandemic and support the 
economy, and restrictive in 2021. 

December  2019.  The  labour  market  is  set  to  be 
impacted  by  the  COVID-19  pandemic,  with  the 
unemployment rate hiking to around 7.5% in 2020. 

Monetary  policy,  conducted  within  an  inflation 
targeting framework (38) remained accommodative 
over  the  past  two  years.  The  Monetary  Policy 
Council  (MPC)  kept  the  policy  rate  unchanged  at 
1.5%  between  March  2015  and  March  2020.  It 
decided to cut the policy rate in two 50 basis points 
steps  in  March  and  April  to  0.5%,  in  response  to 
the  COVID-19  crisis.  In  addition,  the  MPC 
launched  the  purchase  of  government  securities 
and  government-guaranteed  debt  securities  on  the 
secondary  market.  It  also  started  the  provisioning 
of  additional  liquidity  to  the  banking  sector 
through  repo  operations  and  a  discount  facility. 
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 
reaching  the  highest  level  since  comparable  data 
are  available  at  the  end  of  2019  (both  in  terms  of 
absolute numbers and of the  employment rate). In 
line with this, the unemployment rate has declined 
steadily,  reaching  a  record  low  of  2.9%  in 

(38)  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. 

in 

4.4% 

declined 

Labour  productivity  growth  rose  significantly  and 
reached  its  peak  of  4.8%  in  2018  before  it 
2019. 
to 
somewhat 
Compensation  per  employee  increased  nearly  8% 
in 2018 and above 7% in 2019. This translated into 
nominal ULC growth of 3.0% in 2018 and 2.8% in 
2019.  The  COVID-19  pandemic  is  expected  to 
lead  to  a  moderation  of  the  rapid  increase  in 
compensation  per  employee  to  3.8%  in  2020  and 
2.6%  in  2021.  Labour  productivity  growth  is  to 
slow down considerably to 0.3% in 2020 and 1.8% 
in 2021, resulting in nominal ULC growth of 3.5% 

73 

-3036920142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 6.3: Poland -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2020 Forecast.Table 6.2:Poland - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationPoland 0.1-0.7-0.21.61.22.12.52.8Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorPoland -0.1-1.1-0.42.01.61.92.42.6Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeePoland 2.21.74.85.87.97.33.82.6Euro area1.41.31.21.72.22.11.10.4Labour productivityPoland 1.62.32.23.64.84.40.31.8Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsPoland 0.6-0.62.52.23.02.83.50.7Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorPoland -2.2-1.3-0.31.32.91.20.00.1Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services.                                                           
                  
 
 
 
               
 
 
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

growth  is  expected  to  moderate,  but  this  will 
depend  on 
the  effectiveness  of  government 
measures  and  how  the  labour  market  evolves.  On 
the other hand, even though it is expected that the 
zloty  will  keep  depreciating  over  the  forecast 
horizon,  a  less-than-expected  depreciation  could 
contain  upward  dynamics  in  2021.  Coupled  with 
decreasing  oil  prices,  this  could  bring  down  the 
inflation outlook substantially. 

The  level  of  consumer  prices  in  Poland  was  at 
around 56% of the euro-area average in 2018. This 
suggests  a  significant  potential  for  price  level 
convergence in the long term, as GDP per capita in 
PPS (about 67% of the euro-area average in 2018) 
increases towards the euro-area average. 

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

response 

policy 

6.3. 

PUBLIC FINANCES 

6.3.1.  Recent fiscal developments 

The  general  government  deficit  –  following  a 
continuous downward evolution between 2014 and 
2018  –  increased  in  2019  to  0.7%  of  GDP.  Total 
government  revenue  reached  41.3%  of  GDP  in 
2018 and 2019, the highest level in the last decade. 
The  revenue  evolution  until  2018  was  driven 
mainly  by  a  robust  macroeconomic  environment 
and  higher  tax  collection,  in  particular  of  indirect 
taxes.  At  the  same  time,  a  very  good  situation  on 
the labour market supported higher revenues from 
income  taxes  and  social  security  contributions. 
Several changes to direct taxes introduced in 2019 
impacted  revenue  negatively.  The  ratio  of  total 
government expenditure to GDP, after six years of 
continuous  decline  from  45.8%  in  2010  to  41.1% 
in 2016, has been increasing since 2017. It reached 
42%  in  2019.  This  resulted  mainly  from  an 

in  2020  and  0.7%  in  2021,  according  to  the 
Commission services’ Spring 2020 Forecast. 

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.  Higher  oil  prices  led 
to  the  imports  of  goods  deflator  rising  to  3%  in 
2018, despite some appreciation of the zloty. 

The  zloty’s  nominal  effective  exchange  rate 
(measured  against  a  group  of  36  trading  partners) 
appreciated  on  average  by  1.5%  in  2018  and 
depreciated by 1.0% in 2019. The relative stability 
of  the  euro-zloty  exchange  rate  overall  in  2018-
2019  and  the  slow  price  growth  in  Poland's  trade 
partners  weighed  on 
increase. 
Imported  inflation  is  forecast  to  decrease  strongly 
during 2020-2021, due to the COVID-19 pandemic 
impact. 

import  price 

Administered prices and taxes 

The increase in administered prices, with a weight 
of around 12% in the HICP basket (similar to that 
of the euro area), was below HICP inflation both in 
2018  and  2019.  The  average  annual  increase  in 
administered prices was 0.8% in 2018 and 1.2% in 
2019. The  faster  growth  of  administered  prices  in 
2019  was  mainly  related  to  dynamics  of  refuse 
collection  and  the  gas  price,  but  was  moderated 
with  the  regulatory  capping  of  the  electricity 
prices. 

The  impact  of  tax  measures  on  overall  consumer 
price  developments  has  been  close  to  zero  as 
constant  tax  inflation  was  in  line  with  headline 
inflation. 

Medium-term prospects 

Looking  ahead,  inflation  is  expected  to  moderate 
over  the  course  of  2020  after  reaching  a  peak  in 
February.  Processed  and  unprocessed  food  are 
expected  to  be  the  product  groups  with  high 
inflation dynamics, but the sharp drop of oil prices 
is  to  counterbalance  their  impact.  Pressures  from 
wage  increases  are  expected  to  moderate  strongly 
due  to  the  COVID-19  pandemic’s  impact  on  the 
labour  market.  The  Commission  services'  Spring 
2020  Forecast  projects  annual  HICP  inflation  to 
average 2.5% in 2020 and 2.8% in 2021. 

The  inflation  outlook  remains  highly  uncertain, 
with risks appearing to be broadly balanced. Wage 

74 

Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

6.3.2.  Medium-term prospects 

The  2020  budget  was  adopted  on  14  February 
2020.  It  targeted  a  deficit  of  1.2%  of  GDP.  It 
broadly  assumed  a  continuation  of  major  policies 
carried out in previous years. On the revenue side, 
a  full-year  impact  of  measures  implemented  in 
2019  in  the  area  of  direct  taxes  was  assumed  to 
weigh  on  public  finances.  This  concerned  in 
particular the lowering of the first personal income 
tax rate from 18% to 17%, the increase of the tax-
free  allowance  and  the  exemption  of  young 
taxpayers  from  the  personal  income  tax.  On  the 
expenditure  side,  social  spending  was  expected  to 
rise  further.  This  was  due  mainly  to  a  full-year 
impact  of  the  removal  of  means  testing  in  the 
universal child benefit, which entered into force in 
mid-2019,  and  a  decision  to  pay  all  pensioners 
once per year an allowance equalling to one month 
minimum  pension  benefit.  Afterwards  Poland 
implemented a number of measures to contain the 
COVID-19 pandemic and to support the economy. 
They  covered  amongst  others:  subsidies  to  social 
contributions  of  employees,  subsidies  to  salaries, 
(cancellable)  loans  and  guarantees  to  companies, 
and benefits to parents who needed to take care of 
their  children.  The  2020  fiscal  impact  of  those 
measures  is  expected  to  exceed  5.5%  of  GDP.  In 
to 
particular, 

this  estimate 

includes 

loans 

75 

increase  in  social  transfers  to  pensioners  and 
middle- and high-income families with children. 

The  2019  headline  deficit  (0.7%  of  GDP)  turned 
out to be lower than forecast in the 2019 edition of 
the Convergence Programme (1.7% of GDP). This 
difference  stemmed  mainly  from  a  lower  than 
expected expenditure. In turn, the structural deficit 
turned  out  to  be  broadly  in  line  with  the  forecast. 
Poland  has  not  used  its  favourable  economic 
situation  in  the  recent  years  to  pursue  structural 
consolidation and build up fiscal buffers. 

low  headline  deficits, 

Thanks  to  strong  nominal  economic  growth  and 
relatively 
the  general 
government debt continued its descending path and 
reached  46%  of  GDP  in  2019.  The  decline  in  the 
general  government  debt 
in  2018  and  2019 
resulted mainly from falling nominal fiscal deficits 
and  strong  nominal  growth.  The  role  of  valuation 
effects has been diminishing, as the share of Polish 
foreign 
government 
currencies  has  been  gradually  decreasing  and  the 
złoty was relatively stable, in particular to the euro. 

denominated 

debt 

in 

Table 6.3:Poland - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-3.6-2.6-2.4-1.5-0.2-0.7-9.5-3.8- Total revenues38.739.138.739.841.341.340.840.3- Total expenditure42.441.741.141.241.542.050.344.1   of which: - Interest expenditure2.01.81.71.61.41.41.41.4p.m.: Tax burden32.933.434.435.036.036.135.335.2Primary balance-1.7-0.9-0.70.11.20.6-8.1-2.4Cyclically-adjusted balance 2)-2.8-2.1-2.1-2.1-1.9-2.7-8.3-2.9One-off and temporary measures 3)-0.20.00.00.00.00.00.30.2Structural balance 2)4)-2.6-2.1-2.1-2.1-1.9-2.7-8.5-3.1Government gross debt50.851.354.350.648.846.058.558.3p.m: Real GDP growth (%)3.33.83.14.95.34.1-4.34.1p.m: Output gap 2)-1.6-1.0-0.61.33.44.0-2.5-1.81) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services. 
 
    
 
 
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

The zloty traded against the euro in a quite narrow 
range  at  around  4.3  over  the  past  two  years,  up 
until  the  outbreak  of  the  COVID-19  crisis  in 
March  2020.  There  was  a  short  period  of  relative 
zloty weakness in July 2018 and another one from 
August  2019,  amidst  signs  of  an  economic 
slowdown.  This  was  followed  by  a  period  of 
strength  from  late  2019,  after  some  monetary 
easing  took  place  in  major  advanced  economies. 
Inter-day  exchange  rate  volatility  increased  in 
those two weaker periods, but spiked even higher, 
when the COVID-19 crisis set in. In March 2020, 
the  zloty's  exchange  rate  against  the  euro  reached 
on average about 4.4 PLN/EUR. 

International  reserves  held  by  the  NBP  increased 
from EUR 95 billion in early 2018 to around EUR 
115 billion by end-2019. The reserve-to-GDP ratio 
was at around 22% at end-2019. 

Short-term  interest  rate  differentials  vis-à-vis  the 
euro  area  were  stable  at  around  200  basis  points 
between spring 2018 and summer 2019, when they 
increased  to  around  210  basis  points.  The  Polish 
three-month  rate  remained  stable  until  March 
2020, in line with the unchanged policy rate of the 
NBP,  as  the  euro  money  market  priced  in  the 
September  2019  rate  cut  of  the  ECB.  In  March 
2020,  the  Polish  3-month  rate  fell,  as  the  NBP 

companies 
the  Polish 
to  be  granted  by 
Development  Fund.  In  line  with  the  authorities 
announcements  that  about  60%  of  loans  will  not 
have to be repaid, it is assumed that the amount of 
loans  to  become  grants  impacts  the  2020  deficit 
(by some 2¾ pp. of GDP). 

The  Commission  services’  Spring  2020  forecast, 
projects the general government headline deficit in 
2020 at 9.5% of GDP. The deficit is set to decrease 
to 3.8% of GDP in 2021.  At  the  same time, amid 
the  recession  caused  by  the  COVID-19  pandemic 
and  a  negative  output  gap,  the  structural  general 
government  deficit  is  forecast  to  increase  from 
around  2¾%  of  potential  GDP  in  2019  to  some 
8½% of potential GDP in 2020 and then to decline 
to around 3% of potential GDP in 2021. The ratio 
of  general  government  debt  to  GDP  is  set  to 
strongly  increase  to  over  58%  in  2021.  However, 
as  above  a  quarter  of  the  sovereign  debt  is 
denominated 
the  debt 
projections  are  subject  to  uncertainty  due  to 
possible valuation effects. 

in  foreign  currencies, 

since  2015  most  of 

The  fiscal  framework  in  Poland  is  overall  strong, 
but  it  has  shown  some  weaknesses  recently. 
Numerical  fiscal  rules  are  at  the  centre  of  the 
framework.  First,  debt  ceilings  anchored  in  the 
Constitution cover the general government, while a 
separate  debt  rule  concerns  local  governments. 
Second, 
the  general 
government  sector  is  subject  to  the  stabilising 
expenditure rule, which plays an important role in 
preventing  overspending.  However, 
recently 
several  new  expenditure 
items  have  been 
channelled through newly created funds that do not 
fall  under 
the  rule.  Medium-term  budgetary 
planning  is  based  on  the  four-year  Multiannual 
State  Financial  Plan,  which  serves  as  a  basis  for 
the  preparation  of  annual  budgets  but  does  not 
provide  targets  for  them.  A  reform  of  the  budget 
system  has  been  ongoing,  with  no  end  date 
established  so  far.  Poland  does  not  have  a  fully-
fledged  fiscal  council  and  activities  related  to  the 
control and monitoring of domestic fiscal rules are 
scattered among several bodies. 

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. 

76 

3.03.54.04.55.0201420152016201720182019Graph 6.4: Poland -PLN/EUR exchange rate(monthly averages)Source: ECB.050100150200250300201420152016201720182019Graph 6.5: Poland -3-M Wibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat and Thomson Reuters.                
              
started  its  easing  measures,  and  the  spread  vis-à-
vis the euro area reached around 190 basis points. 

6.5. 

LONG-TERM INTEREST RATES 

Long-term  interest  rates  in  Poland  used  for  the 
convergence  assessment  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 above the reference value at the time 
of  the  last  convergence  assessment  in  2018.  It 
gradually  decreased  from  3.3%  at  that  time  to 
about 2.3% by end-2019. In March 2020, the latest 
month  for  which  data  are  available,  the  reference 
value,  given  by  the  average  of  long-term  interest 
rates 
Italy  plus 
2 percentage points, stood at 2.9%. In that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Polish  benchmark  bond  stood  at  2.2%, 
i.e. 
0.7 percentage points below the reference value. 

in  Portugal,  Cyprus  and 

The  long-term  interest  rate  of  Poland  was  around 
3.2% between May and November 2018, before it 
decreased  to  2.7%  by  early  2019.  It  decreased 
further  to  around  2%  in  summer  2019,  as  the 

Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

prospect  of  monetary  easing  by  major  central 
banks  generally  suppressed 
long-term  yields. 
Poland's long-term interest rate fell to around 1.8% 
in  March  2020,  as 
its 
government securities purchases. 

the  NBP 

launched 

The  long-term  interest  rate  spread  vis-à-vis  the 
German  benchmark  bond  generally  hovered 
around  280  basis  points  between  May  2018  and 
May  2019,  before 
it  got  gradually  more 
compressed,  due  mainly  to  the  decrease  of  the 
Polish  rates.  It  stood  around  230  basis  points  in 
March 2020. 

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

labour  and 

the  net 

international 

In  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see also Box 1.6), which highlighted issues related 
to 
investment  position. 
However, since overall risks  remained  limited, no 
In-Depth  Review  (IDR)  was  warranted.  External 
vulnerabilities remain contained, given that foreign 
direct  investment  accounts  for  a  major  part  of 
foreign liabilities. The growth of house prices was 
strong, but risks of overheating are limited. 

6.6.1.  Developments  of 

the  balance  of 

payments 

Poland’s  external  balance  (i.e. 
the  combined 
current  and  capital  account)  stayed  positive  in 
2018-2019,  mostly  backed  by  an  improvement  in 
the services trade balance. The current account was 
close to balance and the capital account registered 
a  surplus  due  to  the  inflow  of  EU  funds.  The 
current  account  position  was  supported  by  the 
increasingly  strong  performance  of  export  of 
services.  Although  the  trade  in  goods  balance 
turned negative in 2018, it shifted into a surplus in 
2019, partially reflecting an increase in exports of 
manufacturing goods. After stabilising in 2018, the 
primary  income  balance  somewhat  deteriorated  in 
2019.  The  secondary  income  balance  remained 

77 

02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20PolandReference valueGraph 6.6: Poland -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-20246201420152016201720182019PolandGermanyGraph 6.7: Poland -Long-term interest rates(percent, monthly values)Source: Eurostat.            
              
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

negative  and  slightly  deteriorated  in  2018  and 
2019. 

Poland's  external  competitiveness  has  remained 
robust.  Poland's  export  performance  (as  measured 
by the  growth of its exports relative  to its foreign 
markets) 
in  2018  and  2019  with, 
an 
however, 
appreciation  in  2017,  both  the  nominal  and  real 
effective exchange rates broadly stabilised in 2018 
and 2019. 

slowing  pace.  Following 

improved 

a 

Gross  national  saving  in  terms  of  percentage  of 
in  2018  and 
GDP  remained  broadly  stable 
improved slightly in 2019. In the observed period, 
the  increase  in  gross  savings  of  the  corporate 
sector  and  households  has  offset  the  fall  in 
government savings. At the same time, gross fixed 
capital  formation  (as  a  percent  of  GDP)  has 
gradually  recovered  and  was  mainly  driven  by 
public investment spending with support of the EU 
funds.  The  private  sector  investment  remained 
weak,  and  in  relation  to  GDP  is  still  below  the 
levels observed among Poland's regional peers. 

the  financial  account  of 

In 
the  balance  of 
payments, direct investment recorded a net inflow 
of around 2.5% of GDP in 2018 and 2% of GDP in 
2019,  mainly  due  to  reinvested  earnings.  Net 
portfolio  investment  outflows  increased  in  2018 

78 

0102030201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 6.8: Poland -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.9095100105110201420152016201720182019Graph 6.9: Poland -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 6.4:Poland - Balance of payments(percentage of GDP)201420152016201720182019Current account-2.1-0.6-0.50.1-1.00.5of which: Balance of trade in goods-0.80.50.70.3-1.00.5                 Balance of trade in services2.22.53.33.84.44.8                 Primary income balance -3.4-3.4-4.2-4.1-4.1-4.4                 Secondary income balance-0.1-0.2-0.30.0-0.3-0.3Capital account2.42.41.01.32.12.0External balance 1)0.41.80.51.31.12.5Financial account-1.10.10.3-0.50.31.7of which: Direct investment-2.4-2.1-0.9-1.4-2.5-1.9                Portfolio investment0.40.7-0.8-0.90.72.1                Other investment 2)0.71.4-2.83.40.8-0.3                Change in reserves0.10.24.8-1.51.31.7Financial account without reserves-1.2-0.1-4.51.0-0.9-0.1Errors and omissions-1.5-1.7-0.2-1.8-0.7-0.8Gross capital formation20.420.519.619.820.719.6Gross saving19.020.719.619.919.820.0Gross external debt71.270.475.668.363.259.0International investment position-67.6-60.9-60.9-62.3-55.1-50.31) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Poland. 
   
   
 
 
    
 
 
Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

in  2019  were  Germany,  Czechia,  the  Netherlands 
and China. 

FDI  inflows  to  Poland  have  mainly  originated 
from the Netherlands, Germany,  Luxembourg  and 
France, which together provided nearly two-thirds 
of the FDI stock at the end of 2018. The significant 
size and growth of the domestic market as well as 
good  access 
large  regional  markets  have 
supported the attractiveness of the country for FDI. 

to 

On  the  basis  of  selected  indicators  relating  to  the 
business environment, Poland performs around the 
average of euro-area Member States. In the World 
Bank's  Ease  of  Doing  Business  index,  Poland 
scores comparatively poorly with regard to starting 
a  business,  followed  by  the  sub-index  related  to 
the  World  Bank's 
In 
registering  property. 
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  1.0%,  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  from 
2018  to  2020  Poland  has  communicated  to  the 
Commission  the  adoption  of  several  transposition 
measures,  which  ensure  a  complete  transposition 
of the Directive. The Commission is completing its 

79 

and  2019,  primarily  owing 
to  non-residents 
decreasing  the  value  of  their  portfolio  of  debt 
securities and residents expanding their holdings of 
foreign  bonds.  Net  outflows  of  other  investment, 
following a noticeable increase in 2017, stabilised 
at  around  0.8%  of  GDP  in  2018  and  ceased  in 
2019. 

The  total  gross  external  debt  has  kept  decreasing 
rapidly form around 68% of GDP in 2017 to 59% 
in 2019. The net international investment position 
(NIIP)  also  significantly  improved  from  minus 
62.3%  of  GDP  in  2018  to  minus  50.3%  in  2019. 
Although  this  remains  well  beyond  the  indicative 
threshold  set  in  the  MIP  scoreboard  (-35%  of 
GDP), 
remain 
contained, as major part of the NIIP consists of the 
accumulated stock of foreign direct investments. 

vulnerabilities 

external 

the 

According  to  the  Commission  services'  Spring 
2020 Forecast, which is based on national accounts 
data, the external balance is expected to remain in 
a  positive  territory,  with  around  1.3%  of  GDP  in 
2020 and 1.7% in 2021. 

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  48.5%  in  2014  to 
some  55%  of  GDP  in  2019.  The  share  of  trade 
with euro-area partners expressed in percentage of 
GDP  was  broadly  stable  in  recent  years,  reaching 
around 31%. Poland's main goods trading partners 

Table 6.5:Poland - Market integration201420152016201720182019Trade openness 1) (%)48.549.551.753.755.054.3Trade with EA in goods & services 2)+3) (%)27.027.929.430.631.230.4Export performance (% change) 4)3.33.95.13.73.32.3World Bank's Ease of Doing Business Index rankings 5)282524273340WEF's Global Competitiveness Index rankings 6)434136393737Internal Market Transposition Deficit 7) (%)1.00.71.41.51.41.0Real house price index 8)97.4100.0102.3104.1109.3116.5Residential investment 9) (%)3.02.52.42.21.91.9 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. 
 
             
 
 
analysis  of  whether  the  notified  measures  are  in 
conformity  with  the  Directive.  As  regards  the  5th 
Laundering  Directive,  whose 
Anti-Money 
transposition deadline elapsed on 10 January 2020, 
Poland  has  officially  notified 
its  national 
transposition  measures  and  declared  a  partial 
transposition. 

protection 

employment 

Overall,  the  labour  market  appears  flexible  and 
employment protection legislation does not appear 
to  be  very  strict  (as  also  measured  by  the  2013 
OECD 
indicator). 
However,  structural  challenges  include  a  low 
participation  of  certain  groups,  especially  women, 
the  low-skilled,  older  people  and  persons  with 
disabilities  and  their  carers.  A  lack  of  labour 
market flexibility in some areas, such as a limited 
use  of  part-time  employment  arrangements,  is 
another important challenge. Disincentives to work 
stemming  from  the  benefit  system  and  limited 
access 
long-term  care  and  childcare  are 
important  barriers  to  labour  market  participation. 
Domestic  labour  mobility  is  hampered  by  sector-
specific  arrangements,  such  as  the  special  social 
security 
farmers,  as  well  as 
underdeveloped  rental  housing  market  and  the 
transport infrastructure, in particular in rural areas. 
Non-EU workers, in particular from Ukraine, play 
an important role in the Polish labour market. 

system 

for 

to 

Poland's  financial  sector  is  well  integrated  within 
system.  Foreign 
financial 
the  overall  EU 
ownership  in  total  assets  of  the  Polish  banking 
sector  decreased  from  around  58%  in  2014  to 
around 42% by 2018, in line with the government's 
ownership. 
strategy 
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 50% at end-2018. 

domestic 

boost 

to 

Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

share  of  non-performing  loans  was  6.2%,  above 
the  euro-area  average  NPL  level.  Profitability,  as 
measured  by  return  on  equity  (ROE),  reached 
around  8%  by  the  third  quarter  of  2019,  which  is 
above  the  average  of  the  euro  area.  In  the  future, 
the  profitability  of  the  banking  sector  could  be 
negatively  affected  by  the  remaining  stock  of 
foreign-currency  denominated  mortgage 
loans, 
following the European Court of Justice’s ruling in 
October 2019 (39). The COVID-19 pandemic could 
also  have  a  significant  impact  on  the  indicators 
analysed  in 
this  paragraph  over  the  coming 
months. 

Real  house  prices  increased  dynamically  in  2018 
and  2019  in  Poland.  Investment  in  dwellings  has 
not  reacted  to  rising  demand  and  has  remained 
modest  at  around  2%  of  GDP.  Net  bank  lending 
for  house  purchase  gathered  momentum  over  the 
past  two  years  (with  growth  of  around  7%  in 
December  2019),  driven  up  by  variable  rate  zloty 
mortgages. 

The  financial  system  in  Poland  is  smaller  relative 
to GDP than that of the euro area countries. Credit 
to  the  private  economy  (households  and  non-
financial  corporations)  has  increased  to  51%  of 
GDP in 2019 from around 50% in 2014. 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  23%  of 
outstanding total housing loans.  

The  capital  adequacy  ratio  of  the  banking  sector 
increased to around 18% by  end-September 2019, 
which is close to the average of the euro area. The 

(39)  Judgement 

in  Case  C-260/18,  which  confirmed 

the 

possibility to annul a mortgage contract in specific cases. 

80 

010203040506070PL, 2014PL, 2018EA, 2014EA, 2018Concentration 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. 02468101214161820PL, 2014PL, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 6.11: Poland -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.              
                  
                                                           
The  total  capitalisation  of  the  Warsaw  Stock 
Exchange reached 25% of GDP in 2019, which is 
rather  small 
the  euro-area 
in  comparison  to 
average (of around 72%). However, it is maturing 
and  has  been  upgraded  to  the  "developed  market 
status" by index provider FTSE  Russell. The debt 
securities  market  is  one  of  most  liquid  in  the 
region  but  remains  small  in  comparison  with  the 
euro  area  (51%  against  148%  of  GDP)  and  is 
dominated  by  government  bonds.  Consolidated 
private  sector debt decreased from around 78% in 
2014 to 76% of GDP in 2018, significantly below 
the euro-area average. 

Convergence Report 2020 - Technical annex 

Chapter 6 - Poland 

81 

020406080100120140160180PL, 2014PL, 2019EA, 2014EA, 2019Debt 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.                  
7. 

ROMANIA 

7.1. 

FLEGAL COMPATIBILITY 

7.1.1.  Introduction 

The  Banca  Naţională  a  României  (BNR  –
Romanian  national  bank,  hereafter  ‘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 
2018  Convergence  Report. 
Commission’s 
Therefore, 
the 
Commission’s  2018  Convergence  Report  are 
largely repeated in this year's assessment. 

the  comments  provided 

in 

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 

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. 

public 
and 

functions 
for 

and 
the  prevention 

Article  33(7)  of  the  BNR  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.  Law  161/2003  on  certain 
measures for transparency in the exercise of public 
business 
dignities, 
relationships 
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 the sake of legal certainty, it is recommended 
to  remove 
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 

this 

83 

Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

results  in  the  provision  of  solvency  support  to  a 
credit institution that is facing financial difficulties 
and  thereby  would  breach  the  prohibition  of 
monetary  financing  and  be  incompatible  with 
Article  123  of  the  TFEU.  Article  26  of  the  BNR 
Law  should  be  amended  to  avoid  such  a  lending 
operation. 

Articles  6(1)  and  29(1)  of  the  BNR  Law  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 
state-owned 
and  other  majority 
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. 

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 

Board  of  BNR,  in  addition  to  those  contained  in 
Article 33 of the BNR Law. 

is 

to 

control 

empowered 

According  to  Articles  21  and  23  of  the  Law 
concerning the organisation and functioning of the 
Court  of  Auditors  (No  94/1992),  the  Court  of 
the 
Auditors 
establishment,  management  and  use  of  the  public 
sector’s  financial  resources, 
including  BNR's 
financial resources, and to audit the performance in 
the  management  of  the  funds  of  the  BNR.  Those 
provisions  constitute  an  imperfection  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 
independent  external 
auditors. 

the  BNR’s 

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  (see  section  7.1.3.),  which 
negatively  impacts  on  the  financial  independence 
of  the  BNR.  A  Member  State  may  not  put  its 
central bank in a position where it has insufficient 
financial resources to carry out its ESCB tasks, and 
also  its  own  national  tasks,  such  as  financing  its 
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. 

that 

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 

84 

second half. The adjustment would be made by the 
State  only  after  the  closure  of  the  financial  year 
and  would  thus  imply  an  intra-year  credit  to  the 
State,  which  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: 

  absence  of  a  general  reference  to  the  BNR  as 
an  integral  part  of  the  ESCB  (Article  1  of  the 
BNR Law); 

  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, 
21 (1) and (2), 22(3) and 33(1)(a) and (e) 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). 

Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

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);  

  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 above mentioned 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  above  the 
reference value at the time of the last convergence 
assessment  of  Romania  in  2018.  It  increased 
steadily since then to 4.1% in December 2018 and 
remained  close  to  4%  throughout  2019.  In  March 
2020, the reference  value  was 1.8%,  calculated as 
the average of the 12-month average inflation rates 
in  Portugal,  Cyprus  and  Italy  plus  1.5  percentage 

85 

-2-1012345Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20RomaniaReference valueGraph 7.1: Romania -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.     
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

inflation 

points.  The  corresponding 
in 
Romania  was  3.7%,  which  was  1.9  percentage 
points  above  the  reference  value.  The  12-month 
average  inflation  rate  is  projected  to  remain  well 
above the reference value in the months ahead.  

rate 

7.2.2.  Recent inflation developments 

After peaking in June 2018, annual HICP inflation 
in  Romania  slowed  down  in  2019.  The  annual 
average rate of inflation increased strongly to 4.1% 
in 2018 as the effect of past VAT cuts faded away, 
global  oil  prices  picked  up  and  the  January  2017 
cut in excise duties was reversed. In 2019, headline 
inflation  decelerated  somewhat  mainly  due  to 
declining  energy  prices.  Overall,  annual  HICP 
inflation  was  3.9%  in  2019.  Over  the  past  two 
years,  annual  HICP  inflation  in  Romania  was 
higher  than  in  the  euro  area  by  around  2.5 
percentage points on average.  Inflation declined in 
early 2020, reaching 2.7% in March. Core inflation 
(measured as HICP inflation excluding energy and 
unprocessed  food)  accelerated  from  1.9% 
in 
January to 2.9% in December 2018. Its average of 
2.7%  in  2018  was  lower  than  headline  inflation 
(4.1%) as energy prices increased significantly that 
year  (12.2  %).  In  2019,  core  inflation  accelerated 
further,  averaging  3.8%  for  the  year  as  a  whole. 
Although  declining,  robust  wage  growth  in  2019 
put  upward  pressure  on  core  inflation,  while  the 
evolution of pork meat prices further enhanced this 
trend. 

Both  processed  and  unprocessed  food  price 
inflation  continued  to  increase  in  2018,  despite  a 
four-percentage  point  VAT  rate  cut  for  food 
products adopted in mid-2018. In 2019, processed 
food  price  inflation  also  increased  due  to  the 
effects  of  the  African  swine  flu  epidemic,  which 
lowered  pork  meat  supply.  Similarly,  non-energy 
industrial  goods  price  inflation  increased  from 
1.7%  in  2018  to  2.4%  in  2019.  Services  price 
inflation  increased  from  2.7%  in  2018  to  3.6%  in 
2019.  The  introduction  of  a  3%  turnover  tax  for 
telecom  companies  at  the  end  of  2018  resulted  in 
higher prices for telephony and television services 
in 2019.  

86 

-4-20246201420152016201720182019RomaniaEuro areaGraph 7.2: Romania -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 7.1:weights  Romania - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP1.4-0.4-1.11.14.13.93.71000Non-energy industrial goods1.61.0-0.70.91.72.42.4288Energy2.3-2.7-4.40.412.22.71.3109Unprocessed food -0.7-3.4-2.53.95.36.25.8117Processed food0.2-1.6-0.92.23.75.55.4246Services3.12.20.7-0.52.73.63.8241HICP excl. energy and unproc. food1.70.7-0.20.92.73.83.8775HICP at constant tax rates 1.11.22.12.03.83.73.71000Administered prices HICP2.01.6-2.50.54.22.62.21141) 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 2020 - Technical annex 

Chapter 7 - Romania 

7.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

Economic  growth  was  strong  over  the  past  two 
years.  Romania's  economy  expanded  by  4.4%  in 
2018 and 4.1% in 2019, with private consumption, 
supported  by  significant  increases  in  public  and 
private  wages,  as 
the  main  growth  driver. 
Investment  was  rather  volatile  in  recent  years.  It 
fell in 2018 and rebounded strongly in 2019 driven 
mainly by construction and by increased spending 
on  local  public  investment  projects.  The  private 
consumption boom also fuelled import growth. As 
a  consequence,  despite  relatively  strong  export 
performance, net exports worked as a drag on real 
GDP  growth.  The  growing  trade  deficit  worsened 
the  current  account  deficit.  According  to  the 
Commission  services'  Spring  2020  Forecast,  real 
GDP growth is expected to drop by 6% this  year, 
due  to  the  impact  of  the  COVID-19  crisis,  and  to 
partially  recover  next  year  (+4.2%).  With  the 
exception of government expenditure, which is set 
to continue increasing this year reflecting the fiscal 
effort  requested  to  fight  the  pandemic,  all  GDP 
components  are  projected  to decline  substantially. 
Private consumption is expected to decline in 2020 
but  pick  up  again  in  2021,  as  consumer  spending 
reflects the gradual exit from lockdown measures. 

Investment,  on  the  other  hand,  is  projected  to 
record a double-digit dip in 2020 and recover only 
to  a  limited  extent  next  year,  due  to  confidence 
effects. As imports are set to contract more sharply 
than  exports,  the  trade  balance  deficit  as  well  as 
the  current  account  deficits  are  expected 
to 
improve in 2020. However, this positive evolution 
is  projected  to  start  reversing  next  year  as  the 
revival  of  consumption  is  expected  to  give  a  new 
impetus  to  imports.  The  output  gap  was  positive 
but  declined  further  in  2018  and  2019.  It  is 
projected  to  turn  negative  in  2020  and  remain 
negative over the forecast horizon, albeit less so in 
2021. 

Following  the  sharply  expansionary  fiscal  stance, 
as  measured  by  the  change  in  the  structural 
balance,  in  2017,  the  stance  remained  broadly 
stable  in  2018  and  was  loosened  further  in  2019 
due  to  high  expenditure  growth.  According  to  the 
Commission services' Spring 2020 Forecast, which 
is  based  on  a  no-policy  change  assumption,  the 
structural deficit is projected to increase further in 
2020  and  2021,  implying  an  expansionary  fiscal 
policy stance. 

The  BNR,  operating  within  an  inflation  targeting 
framework (40),  increased  the  key  policy  rate  in 

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

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

87 

Table 7.2:Romania - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationRomania1.4-0.4-1.11.14.13.92.53.1Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorRomania1.11.00.72.74.25.22.02.0Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeRomania6.91.915.014.813.48.92.64.8Euro area1.41.31.21.72.22.11.10.4Labour productivityRomania2.65.26.04.64.24.1-3.63.5Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsRomania4.2-3.18.59.88.84.56.41.3Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorRomania-1.9-1.3-7.35.34.52.1-1.51.0Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services.                                                           
 
 
     
 
 
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

In  2020 

Labour  productivity  per  person  grew  by  4.2%  in 
2018  and  3.8% 
labour 
in  2019. 
productivity  is  forecast  to  decline,  reflecting  the 
severe  economic  downturn  and  the  efforts  to 
support  labour  hording,  and  resume  growth  the 
following  year  by  around  3%.  The  growth  of 
labour compensation outpaced that of productivity 
in 2018 and 2019, resulting in significant increases 
in nominal unit labour costs by 8.9% in 2018 and  
4.9%  in  2019.  According  to  the  Commission 
services'  Spring  2020  Forecast,  ULC  growth  is 
expected  to  accelerate  in  2020  and  moderate  in 
2021,  while  remaining  among  the  highest  in  the 
EU.   

External factors 

the 

inflation 

large  weight  of 

Due  to  the  openness  of  the  Romanian  economy 
and its deep integration into the global and the EU 
economy,  developments  in  import  prices  play  a 
significant  role  in  domestic  price  formation.  In 
particular,  energy  and  food  prices  have  been  a 
in 
significant  determinant  of  price 
Romania,  given 
these 
categories in the Romanian HICP and the fact that 
Romania is a net importer of both energy and food. 
Import price inflation (measured by the imports of 
goods  deflator)  significantly  exceeded  consumer 
price inflation in 2018, partly due to the increasing 
price  of  fuel  commodities.  In  2019  import  price 
inflation  was  below  consumer  price  inflation 
reflecting  the  moderation  of  fuel  commodities 
prices. 

rate 
leu’s  nominal  effective  exchange 
The 
(measured  against  a  group  of  36  trading  partners) 
remained  broadly  stable  in  2018  and  depreciated 
on average by 2% in 2019. Despite the changes in 
the  nominal  effective  exchange  rate  suggesting 
inflationary  pressures,  the  fluctuations  of  the  leu 
appears  to  have  weighed  moderately  on  import 
price  dynamics  in  recent  years.  Looking  ahead, 

January,  February  and  May  2018  by  a  total  of  75 
basis  points  to  2.5%,  these  being  the  first  policy 
rate  hikes  in  almost  a  decade.  As  part  of  the 
measures announced in March 2020 in response to 
the  COVID-19  crisis,  the  BNR  reduced  the  key 
policy  rate  by  50  basis  points  to  2.0%.  It  also 
announced  purchases  of  government  bonds  in  the 
secondary  market  to  consolidate  the  structural 
liquidity in the banking system, thereby supporting 
favourable  financing  conditions  for  the  Romanian 
economy.  The  reserve  requirement  ratio  for 
foreign  currency  denominated  liabilities,  which 
had  remained  unchanged  at  8%  since  May  2017, 
was reduced to 6% in February 2020. The reserve 
requirement  ratio  for  leu  denominated  liabilities 
has  been  kept  unchanged  at  8%  since  May  2015. 
Credit to the economy continued to expand in 2018 
(6.5%)  and  2019  (7.4%),  supported  primarily  by 
double-digit growth in mortgage lending. Lending 
to  non-financial  corporations  accelerated  in  2019 
(7%)  and  in  the  first  3  months  of  2020  (5.4%)]. 
Consumer  credit  growth  hovered  around  5%  in 
both  2018  and  2019  and  declined  to  4.4%  in  the 
first quarter of 2020. 

Wages and labour costs 

Labour  market  conditions  continued  to  improve 
throughout  2018  and  2019  in  line  with  the  robust 
economic  growth.  Activity  and  employment  rates 
increased, while the unemployment rate continued 
to  decrease  from  4.2%  in  2018  to  3.9%  in  2019, 
the  lowest  level  in  more  than  20  years.  However, 
unemployment 
increase 
significantly in 2020 to 6.5%, in the context of the 
COVID-19 pandemic, also supported by the return 
of workers from abroad. Undeclared work remains 
a challenge and its  negative impact is expected to 
be  exacerbated  in  the  current  context,  underlining 
the  need  to  support  the  transition  into  declared 
work.  

is  projected 

rate 

to 

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.  Nominal  compensation  per  employee 
increased by 13.4% in 2018 and approximately 9% 
in  2019.  This  dynamic  was  also  driven  by 
significant  public-sector  wage  increases  while  the 
minimum  wage  was  repeatedly 
in 
January  2018  (31%),  January  2019  (9.5%)  and 
January 2020 (7.2%). The growth of compensation 
slow  down 
is  expected 
per  employee 
significantly in 2020, in the aftermath of the crisis, 
and recover somewhat in 2021. 

increased 

to 

88 

-404812162020142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 7.3: Romania -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services' Spring 2020 Forecast.         
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

imported  inflation  is  expected  to  remain  subdued 
in 
line  with  muted  global  commodity  and 
industrial prices.   

Administered prices and taxes 

the  capping  of 

Administered  prices  the  Romanian  HICP  basket 
(11.4%) is somewhat below the euro area average.  
The average annual change in administered prices 
was  4.2%  in  2018,  very  close  to  the  headline 
inflation  rate.  However,  in  2019  administered 
prices 
increased  by  2.7%,  which  was  1.2 
percentage points below headline inflation, mainly 
the  domestically 
reflecting 
produced  natural  gas  sold  to  households  to  RON 
68/Mwh  and  the  introduction  of  regulated  prices 
for  electricity  at  the  end  of  2018.  Following 
legislative  changes  adopted  at  the  beginning  of 
2020, the liberalisation of gas and electricity prices 
for  households  should  be  resumed  as  of  1  July 
2020  and  1  January  2021,  respectively.  However, 
uncertainties  persist  about  the  form  in  which  the 
related  government  emergency  ordinance  1/2020, 
which is currently under debate in Parliament, and 
will eventually be transformed into law. Following 
a  significant  increase  in  both  gas  and  electricity 
prices in 2018, in 2019 electricity prices remained 
stable  while  gas  prices  increased  somewhat,  but 
less than most other administrated prices. 

the 

last 

in  Romania 

Tax  changes  had  a  less  pronounced  influence  on 
inflation 
two  years 
in 
compared  with  previous  years.  HICP  inflation 
measured  at  constant  taxes  was  3.8%  in  2018, 
which  was  0.3  percentage  points  lower  than  the 
headline  HICP  inflation  rate.  In  2019,  HICP 
inflation  measured  at  constant  taxes  was  3.7%, 
only  0.2  percentage  points  below  the  headline 
inflation rate. 

Medium-term prospects 

According  to  the  Commission  services'  Spring 
2020  Forecast,  annual  HICP  inflation  is  projected 
to decline to 2.5% in 2020 and 3.1% in 2021. The 
significant decline expected in 2020 is mainly due 
to the drop in the international oil prices. Services 
inflation  is  projected  to  decline,  reflecting  the 
reduce  demand  pressure  during  the  COVID-19 
crisis.  Processed  and  unprocessed  food  price 
inflation is also expected to ease over the  forecast 
horizon. 

Risks to the inflation outlook are broadly balanced 
and stem mainly from the evolution of global food 
and  energy  prices  Other  aspects,  such  as  a 
persistent  high  unemployment  rate,  a  prolonged 
decline 
the 
evolution  of  fiscal  policy  in  the  aftermath  of  the 

in  demand  for  certain  services, 

89 

Table 7.3:Romania - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-1.2-0.6-2.6-2.6-2.9-4.3-9.2-11.4- Total revenues34.135.531.930.831.931.732.332.2- Total expenditure35.336.134.533.534.836.041.543.5   of which: - Interest expenditure1.71.61.51.31.11.21.51.7p.m.: Tax burden27.528.026.525.826.926.826.526.7Primary balance0.51.0-1.1-1.4-1.8-3.1-7.8-9.6Cyclically-adjusted balance 2)-0.8-0.1-2.3-3.0-3.3-4.4-6.7-9.2One-off and temporary measures 3)0.00.3-0.40.0-0.3-0.10.00.0Structural balance 2)4)-0.8-0.4-1.9-3.0-2.9-4.3-6.7-9.2Government gross debt39.237.837.335.134.735.246.254.7p.m: Real GDP growth (%)3.43.94.87.14.44.1-6.04.2p.m: Output gap 2)-1.4-1.5-1.11.31.00.5-8.0-6.61) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services. 
 
   
 
 
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

pandemic (i.e. the introduction of new taxes or the 
increase  of  existing  taxes)  also  contribute  to  the 
uncertainty of the inflation forecast. 

In 2018, the level of consumer prices in  Romania 
was  about  51%  of  the  euro  area  average  and  the 
GDP  per  capita  was  more  than  60%  of  the  euro 
area  average  in  PPS  terms.  In  line  with  the 
catching-up  of  the  Romanian  economy,  further 
price level convergence is expected. 

in 

categories  of  workers,  medical  equipment  and 
other  expenditures  to  help  fight  COVID-19  and 
the  health  sector 
bonuses  for  employees 
working  with  patients  infected  with  COVID-19. 
The  budget  amendment  maintained  a  significant 
increase of spending on old-age pensions driven by 
the  full  year  effect  of  the  15%  pensions’  increase 
of  September  2019  and  a  further  40%  pensions’ 
increase scheduled for September 2020. 

in 

The  Commission  services’  Spring  2020  Forecast 
which is based on a no-policy change assumption, 
projects  a  general  government  deficit  of  around 
9.2%  of  GDP  in  2020.  The  difference  from  the 
government’s  target  stems,  in  particular,  from  a 
the  underlying  macroeconomic 
difference 
projections  and  a  moderation  of  some  current 
spending  items  in  the  2020  budget,  which  is  not 
fully 
supported  by  enacted  measures.  The 
the  general  government 
Commission  projects 
deficit to further increase to around 11.4% of GDP 
in 2021, despite the phasing out of pandemic-relief 
related  expenditures.  This  is  due  to  the  full-year 
in 
effect  of 
September  2020,  an  additional  upward  pension 
recalculation  scheduled  for  September  2021,  and 
the doubling of child allowance payments. 

in  pensions 

the  40% 

increase 

The  structural  fiscal  deficit  is  projected  by  the 
Commission  to  significantly  increase  in  2020  and 
2021,  respectively.  The  public-debt-to-GDP  ratio 
is forecast by the Commission to increase to 46.2% 
in 2020 and 54.7%in 2021. 

The implementation track record of the Romanian 
fiscal framework has been generally weak and has 
not  improved  since  the  last  report,  despite  having 
the  appropriate  legislative  setting  (it  should  be 
recalled  that  Romania  is  bound  by  the  Fiscal 
Compact  provisions  of 
the  TSCG  and  has 
transposed those requirements in the national legal 
order).  The  annual  budget  laws  and  their  intra-
annual 
in 
contradiction  with  various  domestic  fiscal  rules 
(structural  balance  rule,  ceilings  for  the  nominal 
and  primary  balances,  personnel  expenditure  and 
total  government  expenditure  excluding  EU 
funds),  as  also  flagged  in  the  opinions  of  the 
Romanian  Fiscal  Council.  Moreover,  because  of 
significant  delays  in  its  publication,  the  medium-
term budgetary strategy has not guided the annual 
budgetary process. 

repeatedly  been 

revisions  have 

7.3. 

PUBLIC FINANCES 

7.3.1.  Recent fiscal developments 

The  general  government  deficit  increased  from 
2.9%  in  2018  to  4.3%  in  2019.  The  2019  general 
government  deficit  was  significantly  higher  than 
the  2.8%  of  GDP  target  set  by  the  government  in 
the  2019  Convergence  Programme.  The  deficit 
increase  was  driven  by  current  expenditures  (on 
public  wages,  goods  and  services  and  social 
benefits)  and  by  a  rebound  of  public  investment 
from  the  historically  low  levels  of  the  previous 
years. The structural deficit increased from around 
3%  of  potential  GDP  in  2018  to  around  4.3%  in 
2019.  The  public-debt-to-GDP  ratio  amounted  to 
34.7% in 2018 and 35.2% in 2019. 

7.3.2.  Medium-term prospects 

from 

Since  2016,  Romania  has  been 
increasingly 
its  Medium-Term  budgetary 
diverging 
Objective  required  by  the  Council  in  Regulation 
1466/97,  despite  high  economic  growth.  As  a 
consequence,  since  spring  2017  the  Council  has 
the 
issued  bi-annual  recommendations  under 
Significant  Deviation  Procedure, 
to  which 
Romania  has  not  responded  with  effective  action. 
Moreover, as a consequence of the breach in 2019 
of the 3% of GDP reference value of the Treaty, on 
4  April  2020  the  Council  opened  an  Excessive 
Deficit Procedure for Romania. 

The  2020  budget,  amended  on  17  April  2020, 
targets  a  general  government  deficit  of  6.7%  of 
GDP in 2020. The government increased the 2020 
deficit  target  from  the  originally  planned  3.6%  of 
GDP to account for the fiscal and macroeconomic 
effects  of  the  COVID-19  crisis.  The  amended 
budget  includes  around  1.3  pps  of  GDP  of 
additional  COVID-19  related  spending,  out  of 
which  0.4  pps  of  GDP  financed  by  EU  transfers. 
concerns 
This 
allocations  for  a  technical  unemployment  benefit 
to  other 
to  employees  and  similar  benefits 

spending  mainly 

additional 

90 

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

nonetheless, 

stressed 

that 

The leu continued to depreciate steadily against the 
euro  over  the  past  two  years.  After  remaining 
broadly  stable  at  around  4.5  RON/EUR  between 
2014  and  2016,  the  leu  experienced  a  gradual 
depreciation against the euro since 2017. Between 
early 2018 and late 2019, the leu weakened against 
the  euro  by  around  3%.  Over  this  period,  the 
volatility  of  leu’s  inter-day  exchange  rate  was 
moderate  compared  to  that  of  other  floating 
currencies in Member States with a derogation. In 
March  2020,  the  leu’s  exchange  rate  against  the 
euro averaged around 4.8.  

The  gross  international  reserves  held  by  the  BNR 
declined  throughout  most  of  2018,  to  a  low  of 
around EUR 35bn in the third quarter of 2018. The 
reserves  increased  to  close  to  EUR  37.5bn  at  the 
end of 2019, equivalent to 18% of GDP, and stood 
at EUR 39bn in the first quarter of 2020. Over this 
period,  movements  in  the  level  of  international 
influenced  by  sovereign  debt 
reserves  were 
management  decisions,  such  as  euro-denominated 

(41)  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. 

Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

government  bond  issuances  amounting  to  EUR 
2bn  in  both  February  2018  and  in  July  2019  and 
EUR  3bn  in  January  2020.  Over  the  same  period, 
Romania  also  repaid  its  last  instalments  of  the 
2009 financial assistance loans provided by the EU 
and  the  IMF,  notably  in  April  2018  (EUR  1bn), 
October 2018 (EUR 0.15bn) and May 2019 (EUR 
1bn).  

Short-term  interest  rate  spreads  vis-à-vis  the  euro 
increased  by  around  130  basis  points  between 
January  and  July  2018,  in  part  reflecting  three 
policy rate hikes by around 10 basis points each in 
January, February and May 2018. Following these 
increases,  the  BNR  kept  its  key  policy  rate 
unchanged  at  2.5%.  The  three-month  interest  rate 
spread  relative  to  the  euro  stood  at  around  325 
basis points in March 2020 compared to its peak of 
370 basis points in July 2018. 

7.5. 

LONG-TERM INTEREST RATES 

The  long-term  interest  rates  in  Romania  used  for 
the purpose of the convergence examination reflect 
secondary  market  yields  on  a  single  government 
benchmark  bond  with  a  residual  maturity  of 
around 9 years. 

91 

4.04.24.44.64.85.0201420152016201720182019Graph 7.4: Romania -RON/EUR exchange rate(monthly averages)Source: ECB.0100200300400201420152016201720182019Graph 7.5: Romania -3-M Robor spread to 3-M Euribor(basis points, monthly values)Source: National Bank of Romania.    
                                                           
        
 
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

German  benchmark  bond  peaked  at  around  510 
basis points in that month (42). 

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  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see  also  Box  1.6),  which  concluded  that  an  In-
Depth Review (IDR)  was  warranted for Romania. 
In  February  2020,  the  Commission  published  its 
annual  country  report  on  Romania,  including  an 
In-Depth Review (IDR). This report confirmed the 
the 
macroeconomic 
previous  year.  Romania  continues  to  experience 
strong  growth  of  unit 
labour  costs  and  a 
deteriorating external position,  while frequent and 
the 
unpredictable 
business environment.  

legislative  changes  affect 

imbalances 

identified 

in 

The  current  account  balance  continued 
to 
deteriorate  in  2019  due  to  a  strong  fiscal-led 
private  consumption  boom,  which  fuelled  import 
growth.  The  strong  GDP  growth  allowed  for  an 
improvement  of  the  negative  net  international 
the  unfavourable 
investment  position  despite 
the  current  account.  Reflecting 
evolution  of 
catching-up 
net 
dynamics,  most 
international  investment  position  related  to  net 
foreign  direct 
liabilities,  which 
mitigated  external  risks.  The  IDR  analysis  also 
cautioned  against  a  reversal  of  the  favourable 
evolution  of 
investment 
position  due  to  persistent  current  account  deficits 
lower  GDP  growth.  Cost 
and  projected 
competitiveness  had  deteriorated  on  the  back  of 
strong  wage  growth,  in  particular  successive 
minimum  wage  and  public  sector  wage  increases, 
in excess of productivity. 

international 

investment 

the  net 

the 

of 

The  Romanian  12-month  moving  average  long-
term interest rate relevant for the assessment of the 
Treaty  criterion  was  above  the  reference  value  at 
the  time  of  the  last  convergence  assessment  of 
Romania  in  2018.  Since  then,  it  increased  further 
to  around  4.8%  in  May  2019  and  decreased 
throughout  the  rest  of  2019.  In  March  2020,  the 
reference value, given by the average of long-term 
interest  rates  in  Portugal,  Cyprus  and  Italy  plus  2 
percentage  points,  stood  at  2.9%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Romanian  benchmark  bond  was  at  4.4%,  i.e.  1.5 
percentage points above the reference value. 

Long-term  interest  rates  increased  gradually  from 
around  4.5%  in  April  2018  to  5.1%  in  July  2018. 
After remaining stable at around 4.8% on average 
between  August  2018  and  May  2019,  long-term 
interest  rates  started  to  decline  and  reached  4.3% 
in  November  2019.  The 
the 
monetary  policy  loosening  measures  by  major 
central  banks,  which  suppressed  long-term  yields. 
Long-term  interest  rates  increased  to  4.6%  in 
March  2020  and  the  long-term  spread  versus  the 

latter  reflected 

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

92 

02468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20RomaniaReference valueGraph 7.6: Romania -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-20246201420152016201720182019RomaniaGermanyGraph 7.7: Romania -Long-term interest ratescent(percent, monthly values)Source: Eurostat.    
     
                                                           
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

7.6.1.  Developments  of 

the  balance  of 

payments 

Romania's  external  balance  (i.e.  the  combined 
current  and  capital  account)  deteriorated  further 
from  -1.6%  of  GDP  in  2017  to  -3.2%  of  GDP  in 
2018 and -3.3% of GDP in 2019. While the capital 
account  remained  in  surplus,  the  deterioration  of 
the external position was driven by the worsening 
of  the  current  account  deficit,  which  increased 
from  -4.4%  of  GDP  in  2018  to  -4.6%  of  GDP  in 
2019. 

Despite continued  growth  in  export  market  shares 
in  2018  and  2019,  the  growth  of  imports  spurred 
by  booming  private  consumption  has  persistently 
outpaced that of exports. As a result, the balance of 
trade  in  goods  deteriorated  markedly,  particularly 
in 2018 and 2019 when it exceeded  -7% of GDP. 
The balance of trade in services, driven mainly by 
exports of transportation and IT services, remained 
positive  but  declined  below  4%  of  GDP  in  2019 
and  could  not  offset  the  negative  and  widening 
deficit in the trade in goods. 

The balance of primary income remained negative, 
albeit slightly less so in 2019, reflecting mainly the 
investment  income  linked  to  the 
outflow  of 
country's  negative  net  international  investment 
position. The balance of secondary income, which 
consists  mainly  of  remittances,  continues  to  be 
positive,  and  slightly  more  so  in  2019,  but  was 
outweighed  by  the  negative  balance  of  primary 
income. The capital account surplus stood at 1.2% 
of  GDP  in  2018  (unchanged  compared  to  2017), 
reflecting  the  slow  uptake  of  projects  financed  by 
EU  funds  under  the  2014-2020  programming 
period.  However,  in  2019  the  capital  account 
surplus increased slightly to 1.3% of GDP.  

Current  account  developments  in  Romania  also 
reflect  the  evolution  of  the  savings-investment 
balance.  Romania's  saving-investment  balance 

continued to deteriorate in 2018-19. Gross national 
saving  as  a  share  of  GDP  fell  below  25%  in  both 
years,  mainly  due  to  a  decline  in  gross  public 
savings.  Investment  as  a  share  of  GDP  stabilized 
around 23% in 2018-2019. 

Net  FDI  inflows  declined  slightly  in  2018  and 
2019  to  2.4%  of  GDP.  Net  portfolio  inflows 
declined  gradually  from  1.4%  of  GDP  in  2018  to 
1.1% of GDP in 2019. Other investment continued 
to record net outflows in 2018 and 2019. Despite a 
widening of the current account deficit, Romania's 
net international investment position as a share  of 
GDP  continued  to  improve  on  the  back  of  high 
nominal  GDP  growth  rates.  It  slightly  increased 
from  -43.7%  of  GDP  in  2018  to  -43.4%  in  2019. 
Gross  external  debt  continued  to  decline  and 
remained below 50% of GDP in 2018 and 2019. 

According  to  the  Commission  services'  Spring 
2020 Forecast, the external balance is expected to 
improve in 2020, mainly due to a narrowing of the 
trade  deficit  as  a  result  of  imports  contracting 
sharper  than  exports  as  private  consumption  and 
investment  drop  during  the  lockdown  period.  The 
current  account  deficit  is  expected  to  decline  to 
3.3%  in  2020  but  start  increasing  again  in  2021 
when  it  is  projected  to  reach  3.4%.  The  capital 
account surplus, is expected to improve, reflecting 
a higher absorption of EU funds. 

Between 2009 and 2011, Romania benefitted from 
EU  balance-of-payments  assistance  programme 
and  an  IMF  stand-by  arrangement.  The  EU-IMF 
programme  was  followed  by 
two  successor 
programmes  (2011-2013  and  2013-2015),  which 
were  treated  as  precautionary  and  no  drawings 
were made. Post-programme surveillance ended in 
April  2018,  when  70%  of  the  financial  assistance 
from  the  European  Union  was  repaid.  In  October 
2018 and May 2019, Romania paid the outstanding 
amount (EUR 1.15 bn) of the EUR 5 bn loan under 
the first assistance programme. 

Romania’s  external  cost  competitiveness,  as 
measured by ULC-deflated real effective exchange 
rate  (REER),  continued  to  deteriorate  in  2018-
2019, driven by robust wage growth.  On the other 
hand,  the  HICP-based  REER  indicates  broadly 
stable  external  price  competitiveness,  as 
the 
depreciation of the NEER largely compensated for 
Romania’s  higher  inflation  relative  to  its  trading 
partners. 

93 

010203040201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 7.8: Romania -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.   
 
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

7.6.2.  Market integration 

Romania's  economy  is  well  integrated  with  the 
euro  area  through  both  trade,  including  through 
participation in supply chains, and investment. The 
trade  openness  of  Romania  has  increased  in  the 
aftermath  of  the  crisis,  but  is  still  relatively  low. 
Trade  openness  in  2018  stood  at  46.5%  of  GDP 
and  declined  in  2019  to  around  45%  of  GDP.  In 
2019,  Romania's  main  trading  partners  within  the 
euro  area  were  Germany,  Italy  and  France,  while 
outside  the  euro  area  it  mainly  traded  with 
Hungary, the United Kingdom, and Bulgaria. After 
increasing  steadily  for  several  years  and  reaching 
26.3%  of  GDP  in  2018,  trade  with  the  euro  area 
declined slightly to 25% of GDP in 2019. 

Romania  attracted  substantial  amounts  of  FDI  in 
the past decade. However, FDI inflows  have been 
volatile in recent years. Net FDI inflows increased 
by  about  18.6%  in  2018  and  declined  slightly  by 
0.8%  in  2019.  The  inward  FDI  stock  reached 
39.2%  of  GDP  in  2018  and  40%  in  2019.  FDI 
inflows originated mainly from euro-area Member 
States, with the Netherlands, Germany and Austria 
accounting  for  about  half  of  the  FDI  stock  at  the 
end of 2018. 

The persistent regulatory unpredictability has been 
one  of  the  main  factors  negatively  affecting  the 

Although  less  dynamic  than  in  2016,  export 
performance  has  remained  robust  in  2018-19 
despite  growing  unit  labour  costs.  Export  market 
shares  increased  by  4%  in  2018.  This  could  be 
explained  by  the  fact  that  the  largest  wage 
increases  took  place  in  sectors  not  exposed  to 
public 
international 
administration),  while  wages 
tradable 
sectors  had  a  less  dynamic  evolution.  Another 
potential  explanation  is  the  fact  that  the  large 
exporters  are  usually  multinational  companies, 
able 
increases 
to  accommodate  certain  wage 
without a significant pass-through to prices. 

(such 
in 

competition 

as 
the 

94 

90100110120130201420152016201720182019Graph 7.9: Romania -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 7.4:Romania - Balance of payments(percentage of GDP)201420152016201720182019Current account-0.2-0.6-1.4-2.8-4.4-4.6of which: Balance of trade in goods-4.3-4.9-5.5-6.5-7.2-7.8                 Balance of trade in services4.04.34.64.44.13.9                 Primary income balance -0.5-1.1-1.3-1.4-1.8-1.4                 Secondary income balance0.61.10.80.80.60.7Capital account2.62.42.51.21.21.3External balance 1)2.51.81.1-1.6-3.2-3.3Financial account 2.01.41.6-1.7-2.5-2.4of which: Direct investment-1.8-1.8-2.6-2.6-2.4-2.4                Portfolio investment-1.90.0-0.6-1.6-1.4-1.1                Other investment 2)6.63.63.42.31.71.2                Of which International financial assistance3.01.80.10.60.10.4                Change in reserves-0.9-0.41.30.2-0.4-0.1Financial account without reserves7.75.43.01.30.40.5Errors and omissions-0.5-0.50.4-0.10.60.9Gross capital formation24.725.123.323.422.822.9Gross saving24.224.021.320.117.718.4Gross external debt64.659.155.452.048.847.4International investment position-56.5-53.7-48.6-46.6-43.6-42.81) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Commission services, National Bank of Romania. 
   
 
 
     
 
 
Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

transposition deficit of EU Directives was at 1.1%. 
While it is still above the EU average (0.7%)  and 
the  target  (0.5%)  proposed  by  the  European 
Commission  in  the  Single  Market  Act  (2011),  it 
represents nevertheless an improvement compared 
to previous years (2% in 2017 and 1.5% in 2018). 

The  4th  Anti-Money  Laundering  Directive 
imposed  transposition  by  26  June  2017.  After 
being  referred  before  the  Court  of  Justice  for  not 
having notified any transposition measures on July 
2018 
has 
(Case  C-2018/549),  Romania 
communicated to the Commission the adoption of 
transposition  measures,  which  ensure  a  complete 
transposition of the Directive, without prejudice to 
its conformity assessment.  

the  5th  Anti-Money  Laundering 
As  regards 
Directive, whose transposition deadline elapsed on 
10  January  2020,  Romania  has  not  yet  officially 
notified  any  national 
transposition  measures, 
which has led to a letter of formal notice from the 
Commission 
in  February  2020.  Transposition 
measures are expected to be adopted in May-June 
2020. 

labour  market  suffers 

from 
The  Romanian 
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  improvements  observed  in  recent 

95 

business  environment  in  recent  years.  Frequent 
changes  in  legislation,  often  adopted  without 
stakeholder  consultation  or  adequate 
impact 
assessment  hurt 
investment  and  production 
decisions.  One  example  in  this  respect  is  the 
government  emergency  ordinance  (GEO)  114 
adopted in December 2018, which introduced a set 
of far-reaching  measures affecting the  functioning 
of  the  banking  sector,  the  second  pension  pillar, 
and  energy  and  telecommunication  companies. 
Although  it  was  subsequently  amended  and  the 
most  problematic  provisions  were  eliminated,  the 
perception 
regulatory 
an 
environment prevails.  

unpredictable 

of 

In 

Romania’s  performance  in  international  rankings 
of  competitiveness  and  ease  of  doing  business  is 
to  many  euro-area 
relatively  weak  compared 
Member 
the  WEF's  Global 
States. 
Competitiveness  Index,  Romania's  position  is  still 
low although slightly improving (from 68 in 2017 
to 51 in 2019 out of 141), with weakness in areas 
such  as  institutions,  the  quality  of  infrastructure 
and innovative capability. According to the World 
Bank's  Ease  of  Doing  Business 
indicator, 
Romania’s 
to  deteriorate. 
Moreover,  Romania  continues  to  score  relatively 
poorly  also  in  the  World  Bank's  Worldwide 
Governance 
terms  of  public 
administration performance, control of corruption, 
‘voice  and  accountability’,  political  stability, 
regulatory  quality  and  rule  of  law.  According  to 
the  2019  Single  Market  Scoreboard,  Romania's 

ranking  continued 

Indicators 

in 

Table 7.5:Romania - Market integration201420152016201720182019Trade openness 1) (%)45.345.245.346.446.544.9Trade with EA in goods & services 2)+3) (%)24.725.325.626.226.325.0Export performance (% change) 4)3.90.412.31.72.72.4World Bank's Ease of Doing Business Index rankings 5)373536455255WEF's Global Competitiveness Index rankings 6)595362685251Internal Market Transposition Deficit 7) (%)1.11.01.12.01.51.1Real house price index 8)98.2100.0105.2108.6110.0108.1Residential investment 9) (%)2.42.42.62.72.0n.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 2020 - Technical annex 

Chapter 7 - Romania 

years,  the  employment  and  activity  rates  remain 
below  EU  averages.  Skills 
shortages  and 
mismatches  also  have  an  adverse  impact  on 
employment. Undeclared work continues to distort 
the  labour  market.  Although  the  most  recent 
minimum  wage  increase  in  January  2020  was 
based  on  a  number  of  economic  indicators  and 
followed  discussions  with 
trade  unions  and 
employers’  organizations,  the  majority  of  such 
decisions  in  recent  years  were  taken  without 
social  partners.  The 
consultation  with 
functioning  of  social  dialogue  remains  weak  and 
social  partners' 
in  policymaking 
involvement 
continues to be 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,  insurance  companies  and  private  pension 
funds  in  Romania.  Foreign-owned  banks,  the 
majority of which are subsidiaries of parent banks 
based in the euro area, had a share of assets in the 
total held by the Romanian banking sector of 63% 
in 2018, well above the euro area average of nearly 
16%.  Concentration  in  the  banking  sector,  as 
measured  by  the  market  share  of  the  largest  five 
credit  institutions,  increased  to  62%  in  2018  and 
remained above the euro area average. 

The  Romanian  banking  sector  has  remained 
resilient  and  well  capitalised,  with  a  capital 

96 

adequacy ratio for the banking system of 18.7% at 
the  end  of  September  2019,  well  above  the  euro 
area  average.  After  posting  substantial  losses  in 
2014  mainly  due  to  sizeable  loan-loss  provisions 
on impaired assets, the banking system returned to 
profitability  in  2015  and  remained  profitable 
during  2016-2019.  The  return  on  equity  for  the 
banking sector was 13.4% in Q3 2019, well above 
the euro area average of 5.3%. The decline in the 
stock of non-performing loans in recent  years and 
the  low  inflow  of  new  non-performing  loans 
coupled  with 
loan  volumes 
increase 
supported  the  banking  sector’s  profitability.  The 
ratio  of  non-performing  loans  (90  days  overdue) 
stood  at  4.6%  in  September  2019,  which  was 
slightly above the euro area average. The COVID-
19  pandemic  could  have  a  significant  impact  on 
the  indicators  analysed  in  this  paragraph  over  the 
coming months. 

the 

in 

House  prices  continued  to  grow  in  2018  and 
declined in2019. However, the growth rate of real 
house  prices  slowed  down  in  2018  due  to  tighter 
conditions  by  the  public  programme  for  first-time 
home  buyers  (‘Prima  Casă’  programme)  and  on 
loans  provided  by  credit  institutions.  Real  house 
prices increased at an annual  growth rate of 1.3% 
in 2018 and decreased by 1.7% in 2019. Supported 
mainly  by  ‘Prima  Casă’  programme,  mortgage 
loans to households continued to increase in 2019, 
up  by  7.7%  in  December  2019  compared  to  the 
same month in previous year.  

The  size  of  the  financial  sector  in  Romania  as  a 
percent of GDP is small compared to the euro area 
countries. Domestic bank credit to the private non-
financial sector was around 24% of GDP at the end 
of 2019, well below the euro area average (almost 
90% of GDP), reflecting the low level of financial 
in  Romania.  Equity  and  debt 
intermediation 
considerably 
markets 
stock  market 
underdeveloped. 
remained 
capitalisation 

2019, 
of  GDP) 

in  Romania 

In 
(9.4% 

remain 

01020304050607080RO, 2014RO, 2018EA, 2014EA, 2018Concentration 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. -20-15-10-50510152025RO, 2014RO, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 7.11: Romania -Selected banking sector soundness indicators%Source: ECB, EC calculations, NBR.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180RO, 2014RO, 2019EA, 2014EA, 2019Debt 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.     
   
     
significantly below the euro area (72.3% of GDP). 
The size of the debt securities’ market is also very 
small relative to the euro area (30.3% compared to 
147.9%  of  GDP)  and  continued  to  be  dominated 
by  issuances  of  government  debt  (T-bills  and 
bonds  denominated 
leu  and  foreign 
issuance  of  corporate  and 
currency).  The 
municipal 
limited. 
Consolidated  private  sector  debt  continued  to 
decline  from  its  peak  of  75%  of  GDP  in  2010  to 
47%  in  2018,  which  was  the  lowest  ratio  in  the 
EU. 

in  both 

remains 

bonds 

very 

Convergence Report 2020 - Technical annex 

Chapter 7 - Romania 

97 

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 
of  Government 
the  Swedish 
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 
the 
imperfections  mentioned 
and 
Commission’s 2018 Convergence Report. 

the 

in 

8.1.2.  Central Bank independence 

Article 3 of Chapter 6 of the Riksbank Act obliges 
the  Riksbank  to  inform  the  minister  appointed  by 
the Swedish Government about a monetary policy 
decision of  major importance prior to its approval 
by  the  Riksbank.  A  dialogue  between  a  central 
bank and third parties is not prohibited as such, but 
regular  upfront 
information  of  government 
representatives  about  monetary  policy  decisions, 
especially when the Riksbank would consider them 
as of major importance, could structurally offer to 
the government an incentive and the possibility to 
influence the Riksbank when taking key decisions. 
Therefore,  the  obligation  to  inform  the  minister 
about  a  monetary  policy  decision  of  major 
importance  prior  to  its  approval  by  the  Riksbank 
limits  the  possibility  for  the  Riksbank  to  take 
decisions  independently  and  offers  the  possibility 
for  the  Government  to  seek  to  influence  them. 
Such  procedure 
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. 

incompatible  with 

is 

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

to 

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, 
therefore,  are  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.(43)  

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

the  Riksbank, 

from 

8.1.3.  Prohibition  of  monetary  financing  and 

privileged access 

Under Article 8 of Chapter 6 of the Riksbank Act, 
the  Riksbank  may,  in  exceptional  circumstances, 
grant  credits  or  provide  guarantees  on  special 
institutions  and  Swedish 
terms 

to  banking 

(43)  Legislative  proposals  to  tackle  the  flaw  have  been 
submitted  by  the  Swedish  legislator  since  2013  but  those 
still provided 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. 

99 

                                                           
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 

profit 

the  Riksbank’s 

The  provisions  of  Article  4  of  Chapter  10  on  the 
allocation 
are 
supplemented by non-statutory guidelines on profit 
distribution,  according  to  which  the  Riksbank 
should pay 80% of its profit to the Swedish State, 
after  adjustment  for  exchange  rate  and  gold 
valuation effects and based on a five-year average, 
with  the  remaining  20%  used  to  increase  its 
contingency  and  balancing  funds.  Although  these 
guidelines are not legally binding but accepted as a 
practice  by  Parliament  for  calculating  profit 
allocation  and  as  there  is  no  statutory  provision 
limiting the amount of profit that may be paid out, 

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

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,  Articles  1  and  2  of  the  Act  and  Chapter  9, 
Article 13 of the Instrument of Government); 

  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); 

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

Articles 2a, 3 and 5 of the Act). 

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, 

100 

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

Articles  4(2)  and  Article  9,  10  and  11  of  the 
Act); 

and  stay  below  the  reference  value  in  the  months 
ahead. 

  non-recognition  of  the  role  of  the  ECB  in  the 
functioning  of  payment  systems  (Chapter  1, 
Article 2; Chapter 6, Article 7 of the Act); 

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

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

8.1.5.  Assessment of compatibility 

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

the 

It is understood that the Committee on the Inquiry 
of the Riksbank set up by the Swedish Government 
in  2016  conducted  an  extensive  review  of  the 
Swedish  monetary  system, 
including  relevant 
constitutional provisions and the Riksbank Act and 
published  a 
report.  Swedish  authorities  are 
currently  waiting  for  the  results  of  a  public 
consultation  on  this  report  before  engaging  in  a 
legislative  process  with  a  view  to  amend  relevant 
Swedish  legislation.  In  this  context,  the  Swedish 
authorities  are  invited  and  encouraged  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  assessment,  was  at  the 
reference value at the time of the last convergence 
assessment of Sweden in 2018. The twelve-month 
average  inflation  rate  in  Sweden  then  gradually 
increased  to  a  peak  of  2.1%  in  April-May  2019, 
and  fell  again  thereafter.  In  March  2020,  the 
reference  value  was  1.8%,  calculated  as  the 
average of the 12-month average inflation rates in 
Portugal,  Cyprus,  and  Italy  plus  1.5  percentage 
points. The corresponding inflation rate in Sweden 
was 1.6%, i.e. below the reference value. The 12-
month average inflation rate is projected to decline 

8.2.2.  Recent inflation developments 

HICP  inflation  in  Sweden  started  to  pick-up  in 
2018 to reach a peak of 2.5% in September of that 
year.  This  was  mainly  due  to  sharply  increasing 
energy and unprocessed food prices and resulted in 
an average inflation rate of 2.0% in 2018. In 2019, 
HICP inflation reached 1.7% on average. Year-on-
year inflation fell markedly from the middle of the 
year  to  a  low  of  1.3%  in  September,  driven  by 
negative  base  effects  of  energy  and  unprocessed 
food  prices,  before  picking  up 
somewhat 
subsequently.  In  the  first  part  of  2020  headline 
HICP  inflation  fell  back  from  1.5%  in  January  to 
0.8% in March 2020. 

in 

the 

lagged 

in  part 

impact  of 

In  2018,  core 
inflation  (measured  as  HICP 
inflation  excluding  energy  and  unprocessed  food) 
was  subdued  at  1.2%,  as  unit  labour  cost  gains 
remained  muted  despite  the  tight  labour  market. 
Core  inflation  increased  to  1.6%  in  2019,  likely 
reflecting 
the 
weakening  of  the  krona  as  well  as  an  increase  of 
2.0% 
new 
methodology  for  measuring  prices  of  package 
holidays (44)  coupled  with  changes  in  calculating 
dental costs led to some volatility in inflation rates. 
Price  increases  for  non-energy  industrial  goods 
remained very low in both 2018 and 2019, whereas 
prices  for  processed  food  and  services  rose 
somewhat more rapidly in 2019 before moderating 
in  the  early  months  of  2020.  Both  producer  and 

prices.  The 

administered 

(44)  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 

101 

0123Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20SwedenReference valueGraph 8.1: Sweden -Inflation criterion(percent, 12-month moving average)Note: The dots  in December 2020 show the projected reference value and 12-month average inflation in the country.Sources: Eurostat, Commission services' Spring 2020 Forecast.     
                                                           
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

import price inflation fell back since 2019, having 
surged in 2018 on the back of higher energy prices. 

exports  is  expected  to  drive  such  an  increase  in 
GDP growth in 2021. 

The fiscal stance, as measured by the change in the 
structural  balance,  turned  expansionary  in  2018 
and  remained  broadly  neutral  in  2019.  It  is 
expected to become strongly expansionary in 2020 
due  to  the  measures  directed  at  countering  the 
impact  of 
the  COVID-19-induced  crisis  and 
contractionary  in  2021  as  a  substantial  part  of 
measures are expected to be unwound. 

left 

Monetary  policy,  conducted  within  an  inflation 
targeting  framework  (45),  has  overall  remained 
expansionary,  but  policy  rates  have 
the 
negative  territory  in  the  period  covered  by  the 
report.  The  Riksbank  raised  the  policy  rate  by  25 
basis  points  to  -0.25%  in  December  2018,  and 
further 
the 
assessment that conditions were good for inflation 
to remain close to the target over the period ahead. 
Moreover, the assessment considered the necessity 
of  more  analysis  of  the  impact  of  a  prolonged 
period of negative interest rates. 

in  December  2019,  on 

to  0% 

(45)  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). 

8.2.3.  Underlying  factors  and  sustainability  of 

inflation 

Macroeconomic  policy  mix  and  cyclical 
stance 

is  experiencing  an 
The  Swedish  economy 
unprecedented  slowdown  in  the  wake  of  the 
impact  of  COVID-19,  after  a  long  period  of 
economic expansion. Following a relatively strong 
performance  in  2018,  with  real  GDP  growing  by 
2.2%,  economic  growth  moderated  to  1.2%  in 
2019.  The  slowdown  in  2019  was  largely  driven 
by weaker domestic demand, in particular a slump 
in  housing  investment,  whereas  net  exports  held 
up.  In  the  wake  of  the  abrupt  fall  in  economic 
activity  due  to  the  COVID-19  induced  crisis,  real 
GDP is expected to fall sharply by 6.1% in 2020, 
with  the  output  gap  falling  abruptly  from  positive 
in  2019  to  strongly  negative  in  2020.  GDP  is 
expected  to  rebound  by  4.3%  in  2021.  A  strong 
recovery  in  particularly  private  consumption  and 

102 

-2024201420152016201720182019SwedenEuro areaGraph 8.2: Sweden -HICP inflation(y-o-y percentage change)Source: Eurostat.Table 8.1:weights  Sweden - Components of inflation(percentage change)1)in total   201420152016201720182019Mar-202020HICP0.20.71.11.92.01.71.61000Non-energy industrial goods-0.40.31.10.00.00.30.3293Energy-2.0-4.71.05.39.62.9-0.587Unprocessed food 0.04.12.62.04.52.32.336Processed food1.02.10.52.01.82.82.8163Services0.91.31.32.31.82.02.4421HICP excl. energy and unproc. food0.51.11.11.51.21.61.7877HICP at constant tax rates 0.20.51.01.71.81.61.51000Administered prices HICP1.71.30.92.11.32.02.01471) 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 2020 - Technical annex 

Chapter 8 - Sweden 

collateral  and  subsequently  temporarily  enlarged 
the  circle  of  monetary  policy  counterparties.  The 
Riksbank's total  holdings of  domestic  government 
bonds  amounted  to  a  cumulative  SEK  340  billion 
in January 2020 about one third  of the outstanding 
stock of central  government  debt instruments .  At 
its latest  meeting in  April 2020, the Riksbank left 
its policy rate unchanged. 

 Wages and labour costs 

the 
Employment  recovered  quickly  following 
financial crisis and expanded at a brisk pace, with 
growth at 1.6% in 2018 before slowing appreciably 
to  0.6%  in  2019  in  the  wake  of  the  economic 
slowdown.  The  rise  in  employment  was  driven 
the  public  sector  (in 
primarily  by  services, 
particular  health  care,  education,  and 
local 
government),  and  construction,  while  the  number 
of employed persons in manufacturing and energy 
sectors decreased.  

in 

In  the  past  few  years,  strong  employment  growth 
led  to  a  progressively  tightening  labour  market 
with  increasing  skills  shortages.  However,  the 
decline 
the  unemployment  rate  remained 
moderate,  due  to  the  relatively  strong  growth  of 
the  working  age  population.  In  particular,  in  past 
years  many  migrants  joined  the  labour  force. 
Having fallen to 6.3% in 2018, the unemployment 
rate  increased  to  6.8%  in  2019  and  is  expected  to 

103 

in  view  of 

The  Riksbank  considered  monetary  policy  to 
remain  expansionary,  also 
the 
Riksbank’s  extensive  purchases  of  government 
bonds. In December 2017, the Executive Board of 
the  Riksbank  decided  to  halt  the  asset  purchase 
programme  started  in  2015,  but  to  continuously 
reinvest  redemptions  and  coupon  payments  in  the 
government  bond  portfolio.  In  April  2019  the 
Riksbank  decided  to  extend  the  purchase  of 
government  bonds  for  a  nominal  value  of  45 
billion Swedish krona from July 2019 to December 
2020.  In  order  to  limit  the  impact  of  the  COVID-
19-induced  crisis,  the  Riksbank  in  March  2020 
took  a  series  of  measures  in  subsequent  monetary 
policy  meetings:  i)  further  purchases  of  securities 
by  up  to  SEK  315  billion  in  2020,  including 
government,  municipal  and  mortgage  bonds;  ii) 
reduction in the lending rate for overnight loans to 
banks  from  0.75  to  0.20  percentage  points  above 
the  repo  rate;  iii)  allowing  banks  to  borrow 
unlimited  amounts  on  a  weekly  basis  against 
collateral  at  three  months’  maturity  at  an  interest 
rate of 0.20 percentage points above the repo rate; 
iv)  start  purchasing  commercial  paper  issued  in 
Swedish  kronor  by  Swedish  non-financial 
corporations;  and  v)  offering  loans  in  dollars 
thanks to the swap arrangement of up to 60 billion 
USD that the Riksbank agreed with the US Federal 
the 
Reserve.  The  Riksbank  also 
flexibility  of  the  collateral  framework,  giving 
banks  more  scope  to  use  mortgage  bonds  as 

increased 

Table 8.2:Sweden - Other inflation and cost indicators(annual percentage change)20142015201620172018201920201)20211)HICP inflationSweden0.20.71.11.92.01.70.41.1Euro area0.40.20.21.51.81.20.21.1Private consumption deflatorSweden0.91.10.91.82.21.90.31.0Euro area0.50.30.41.31.41.20.31.2Nominal compensation per employeeSweden2.32.62.62.13.93.0-1.35.6Euro area1.41.31.21.72.22.11.10.4Labour productivitySweden1.32.90.60.00.60.7-3.63.2Euro area0.81.00.51.00.40.1-3.22.4Nominal unit labour costsSweden1.0-0.32.02.13.32.42.42.3Euro area0.60.50.70.71.82.14.3-1.9Imports of goods deflatorSweden1.20.0-2.24.66.72.3-2.6-0.4Euro area-2.4-3.3-3.33.42.7-0.6-3.61.11) Commission services' Spring 2020 Forecast.Source: Eurostat, Commission services. 
 
    
 
 
rise sharply to close to 10% in 2020 in the wake of 
COVID-19  pandemic,  and  to  fall  slightly  in  the 
following year is.  

The  growth 
in  nominal  compensation  per 
employee reached 3.9% in 2018. Despite the tight 
labour  market,  nominal  gains  moderated  to  3.0% 
on  average  in  2019.  In  the  first  half  of  2020, 
negotiations  between  social  partners  were  due  to 
determine  benchmark  wage  increases  for  the 
coming years. In Sweden, social partners typically 
first  negotiate  a  benchmark  agreement 
for 
exporting  sectors  aimed  at  maintaining  cost 
competitiveness  vis-a-vis  major  trading  partners; 
other sectors tend to follow this benchmark rather 
closely.  However,  against  the  backdrop  of  the 
COVID-19  induced  crisis,  social  partners  have 
deferred negotiations on a new multi-annual wage 
agreement  and  overall  compensation  growth  is 
expected  to  remain  muted.  This  should  feed  into 
moderate  underlying  inflation  of  close  to  1%  in 
both 2020 and 2021.  

in 

imply 

Sweden had sluggish labour productivity growth in 
recent  years.  Strong  cyclical  swings  in  economic 
that  forecast 
activity  and  employment 
aggregate  measures  of  changes 
labour 
productivity  for  2020  and  2021  are  severely 
distorted.  Given  relatively  modest  expected  wage 
increases,  the  underlying  rise  in  nominal  unit 
labour  costs  (ULC),  is  projected  to  stabilize  at 
around  2½%  over  the  forecast  period,  suggesting 
that the impact from labour costs on core inflation 
are expected to remain contained. Overall, Sweden 
should  not  experience  major  changes  in  cost 
competitiveness. 

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

to 

the 

role  in  domestic  price  formation.  Import  price 
growth  (measured  by  the  deflator  of  imports  of 
goods)  has  fluctuated  significantly  over  the  past 
years.  In  2018,  the  import  deflator  increased 
sharply  by  6.7%  due  to  higher  commodity  prices, 
amplified  by  the  krona  depreciation.  Its  growth 
eased  in  2019  to  just  above  2%  but  stayed  well 
above  the  rate  registered  in  the  euro  area,  partly 
due 
lagged  effect  of  exchange  rate 
depreciation.  The  impact  of  changes  in  import 
prices  on  consumer  price  inflation  is  difficult  to 
gauge,  as  there  is  evidence  that  the  pass-through 
has  been  weakening  in  recent  years.  Explanations 
provided  in  the  literature  relate,  for  instance,  to 
changes  in  competitive  conditions  and  the  rise  of 
global  value  chains.(46)  For  the  first  part  of  2020, 
the sharp drop in energy prices in the wake of the  
pandemic  will  have  a  strong  negative  impact  on 
consumer  prices.  However,  the  effect  over  the 
entire  forecast  horizon  to  2021  is  difficult  to 
gauge,  given  uncertainties 
the 
recovery path. 

surrounding 

The real effective exchange rate (measured against 
a  group  of  36  trading  partners)  fell  markedly  in 
2018 and 2019, largely due to the weakening in the 
nominal  exchange  rate  of  the  krona.  In  2018  and 
2019,  there  were  no  major  discrepancies  between 
the  growth  in  domestic  prices  and  the  growth  in 
domestic prices of Sweden’s main trading partners. 
For  2020  and  2021,  major  discrepancies  are  not 
to  occur.  Overall,  Swedish  cost 
expected 
developments  do  not  pose  major  challenges  to 
competitiveness. 

Administered prices and taxes 

The  share  of  administered  prices in  the  Swedish 
HICP  basket  amounts  to  just  above  12%,  a  value 
around the euro-area average. The most important 
item  in  the  administrated  price  basket  is  rents.  In 
contrast  to  2018,  administrative  price  inflation 
outpaced  total  HICP  inflation  in  2019,  increasing 
from 1.3% in 2018 to 2.0% in 2019. This is largely 
accounted  for  by  a  marked  increase  in  fully 
administered prices. 

Tax  changes  also  contributed  somewhat  to  higher 
headline  inflation  as  the  pace  at  which  HICP  at 
constant  taxes  increased  over  the  past  two  years 
was slightly lower than for HICP. 

External factors 

Given  the  openness  of  the  Swedish  economy, 
developments  in  import  prices  play  an  important 

(46)  For evidence on the pass-through see  
https://www.riksbank.se/globalassets/media/rapporter/rpp/engel
ska/2019/the-significance-of-the-krona-for-inflation-
article-in-account-of-monetary-policy-2018.pdf.  

104 

-4-20246820142015201620172018201920202021Productivity (real GDP per person employed)Nominal compensation per employeeNominal unit labour costsHICP inflationGraph 8.3: Sweden -Inflation, productivity and wage trends(y-o-y % change)Source: Eurostat, Commission services'Spring 2020 Forecast.         
                                                           
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

markets  expectations  appear  not  to  attach  a  high 
likelihood 
in  krona 
valuation. 

substantial  changes 

to 

The level of consumer prices in Sweden relative to 
the euro area has gradually increased since Sweden 
joined the EU in 1995. In 2018, the Swedish price 
level  stood  at  116%  of  the  euro-area  average.  At 
the  same  time,  the  relative  real  GDP  per  capita 
level  in  Sweden  has  slightly  declined  since  2012, 
reaching  about  122%  of  the  euro-area  average  in 
PPS terms in 2018.  

In the medium term, inflation could gradually rise 
should  a  marked  economic  recovery  occur,  given 
weak  productivity  trends  and  the  reported  skill 
shortages.  However,  as  resource  utilisation  is 
expected  to  abate  somewhat,  there  is  uncertainty 
on how resource pressure will feed into inflation in 
the  current  low  interest  rate  environment.  In 
particular, should low  wage expectations continue 
weighing on disposable income, there would be no 
reason to believe that consumer price inflation will 
receive a large push. 

105 

Medium-term prospects 

HICP  inflation  is  expected  to  fall  from  1.7%  in 
2019  to  0.4%  in  2020,  mainly  due  to  lower 
contributions  from  energy  prices,  before  moving 
somewhat higher to 1.1% in 2021, as core inflation 
would remain muted. These data have to be taken 
with  a  pinch  of  salt,  as  in  the  near  term,  price 
measurement  is  likely  to  be  distorted.(47)  This  is 
partly  due  to  missing  observations  or  low  sample 
sizes  as  the  consumption  of  certain  categories  of 
goods  and  services 
is  affected  by  physical 
restrictions due to measures to combat COVID-19. 
Some 
food  products,  may 
experience  some  upward  impact  on  prices  due  to 
bottlenecks  in  supply  and  distribution.  Overall, 
the 
inflation 
Riksbank’s target, reflecting subdued prices in line 
with an economy operating below its potential. 

items,  such  as 

remain  below 

is  expected 

to 

Risks to the inflation outlook are difficult to gauge 
in the current uncertain economic environment but 
appear to be balanced. While it is hard to interpret 
surveys  on  inflation  expectations  at  this  juncture 

(47)  See 

a 

recent 

paper 

from 

Statistics 

Sweden:  

https://www.scb.se/contentassets/1b48f2064ebd46a78eda4
d68d51c0403/8-pm---hantering_av_effekter_av_corona-
pandemin_i_kpi_och_hikp.pdf 

Table 8.3:Sweden - Budgetary developments and projections (as % of GDP unless indicated otherwise)Outturn and forecast 1)20142015201620172018201920202021General government balance-1.50.01.01.40.80.5-5.6-2.2- Total revenues49.349.550.750.750.649.849.549.8- Total expenditure50.949.549.749.349.849.355.152.0   of which: - Interest expenditure0.70.60.50.50.50.40.30.3p.m.: Tax burden42.943.344.644.744.443.642.943.3Primary balance-0.80.61.51.91.30.9-5.3-1.8Cyclically-adjusted balance 2)-0.6-0.30.50.80.00.1-2.1-0.2One-off and temporary measures 3)0.00.00.00.00.00.00.00.0Structural balance 2)4)-0.6-0.30.50.80.00.1-2.1-0.2Government gross debt45.143.942.240.838.835.142.642.5p.m: Real GDP growth (%)2.74.42.42.42.21.2-6.14.3p.m: Output gap 2)-1.70.60.91.11.40.8-6.3-3.71) Commission services’ Spring 2020 Forecast.2) Due to the COVID-19 pandemic, these estimates are surrounded by an unusually high level of uncertainty.3) COVID-19-related measures were not classified as one-offs in the Commission services’ Spring 2020 Forecast,due to the activation of the general escape clause of the SGP.4) Cyclically-adjusted balance excluding one-off and other temporary measures. Source: Commission services.                                                           
 
 
    
 
 
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

8.3. 

PUBLIC FINANCES 

8.3.1.  Recent fiscal developments 

Sweden’s  general  government  surplus  decreased 
from  0.8%  of  GDP  in  2018  to  0.5%  of  GDP  in 
2019. This mainly reflected weaker revenue as real 
GDP growth slowed. By contrast, the expenditure 
ratio  remained  stable,  as  expenditure  of  local 
government 
on 
outlays 
increased  while 
immigration and integration continued to fall. 

The  expenditure-to-GDP  ratio  decreased  from 
49.8%  of  GDP  in  2018  to  49.3%  in  2019.  The 
revenues-to-GDP  ratio  decreased  from  50.6%  to 
49.8% of GDP between 2018 and 2019. 

The  2019  general  government  surplus  was 
marginally lower than the surplus of 0.6% of GDP 
targeted  in  the  2019  Convergence  Programme.  At 
0.1%,  the  structural  balance  remained  broadly 
unchanged with respect to 2018. 

The  government  debt-to-GDP  ratio  decreased  to 
35.1%  in  2019,  as  fiscal  management  remained 
prudent in the face of slower growth. The marked 
decrease  of  the  debt  ratio  by  almost  4  percentage 
points in 2019 is largely attributable to a reduction 
in  loan-financed  foreign  currency  reserves  by  the 
Riksbank. In March 2019, the Riksbank decided to 
reduce  the  size  of  the  foreign  currency  reserve, 
implying  that  the  outstanding  foreign  currency 
loans maturing in 2019 did not need be refinanced. 
Consequently, the Debt Office did not raise further 
loans  on  behalf  of  the  Riksbank  in  2019,  which 
translated  into  a  lower  general  government  debt 
ratio. 

8.3.2.  Medium-term prospect. 

foresaw  a 

slightly 
The  2020  budget  bill 
expansionary  stance,  mainly  due  to  several  tax 
cuts, which are being implemented. These include 
the abolition of the 5% ‘austerity tax’ levied on the 
portion  of  individual  incomes  exceeding  SEK 
689,300  per  year  (removing  the  top  layer  of 
progressivity), and a reduction in income tax rates 
for income above SEK 17,000 /month for the over-
65s. The aim of the measure is to address the gap 
between  taxation  of  employment  income  and 
pension  income.  Moreover,  the  budget  includes 
new spending on security and a commitment to use 
SEK  3.2 billion  to  promote  the  transition  to  a 
fossil-free economy. 

106 

The  supplementary  Spring  budget  contained  a 
broad  range  of  measures  aimed  at  cushioning  the 
economic  impact  of  the  COVID-19  crisis.  In 
particular, the Swedish authorities responded to the 
COVID-19  crisis  with  a  series  of  coordinated 
fiscal,  monetary  and  financial  support  measures 
successively  scaled  up  as  the  pandemic  spread. 
Fiscal  measures  in  the  supplementary  Spring 
budget are estimated to amount to around 2½% of 
GDP.  These  include  extra  outlays  on  health  care, 
education and social protection, as well as support 
for the regions and local authorities responsible for 
the health care system. The government has further 
taken  steps 
that,  while  not  having  a  direct 
budgetary  impact,  limit  crisis-related  costs  to  the 
corporate  sector,  employees,  self-employed  and 
small  businesses.  These  include  taking  over  sick 
pay  costs,  funding  of  temporary  unemployment, 
reductions 
contributions, 
lowering  requirements  to  receive  unemployment 
benefits, contributing to rent reductions, extending 
of 
the 
postponement and reimbursement of tax and VAT 
payments to support corporate liquidity, as well as 
different kinds of loan guarantees.  

guarantees 

allowing 

security 

social 

credit 

and 

in 

Against  this  backdrop,  the  Commission  services' 
Spring  2020  Forecast,  which  is  based  on  a  no-
policy-change  assumption,  projects  the  general 
government balance to deteriorate sharply in 2020. 
The balance is set to swing from a surplus in 2019 
to a  deficit of around 5 ½ % of GDP in 2020, but 
should  improve  markedly  in  2021  assuming  that 
the  measures  adopted  to  fight  the  pandemic  are 
limited  to  2020.  The  structural  balance  is  set  to 
worsen  by  around  2  percentage  points  in  2020 
before 
in  2021  as  growth 
rebounds,  nominal  government  deficit  falls,  and 
the  output  gap  is  set  to  narrow.  The  revenue-to-
GDP  ratio  is  expected  to  stabilise  at  just  below 
50%  of  GDP  in  2021  while  expenditures  are 
forecast to reach around 52% of GDP.  

improving  again 

Gross  government  debt  is  well  below  the  60%  of 
GDP Treaty reference value and this is expected to 
stay so, reaching around 42% of GDP in 2020 and 
2021, despite the marked increase in the debt ratio 
due to the impact of the COVID-19 pandemic. The 
stabilization of the debt ratio mirrors the projected 
economic 
rate 
in  a 
environment.  

recovery 

interest 

low 

Building  on  a  strong  institutional  set-up  and  a 
robust 
fiscal 
track-record,  a 
framework  came  into  force  in  Sweden  in  2019. 

revised 

fiscal 

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

The  main  changes  are  the  introduction  of  a  debt 
anchor  set  at  35%  of  GDP,  with  a  5  percentage 
point  tolerance  margin,  and  a  lower  net  lending 
surplus  target  over  the  cycle  to  0.33%  of  GDP, 
from  the  previous  1%  of  GDP.  The  revised  fiscal 
framework  kept  the  expenditure  ceiling  and  a 
balanced  budget  requirement  for  local  authorities. 
The  fulfilment  of  the  surplus  target  will  be 
assessed  based  on  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.  This  should  ensure  adequate  safety 
margins for economic fluctuations. 

February,  the  krona  started  depreciating  at  a  fast 
rate  reaching  a  peak  of  11.2  on  18  March.  In  the 
following days, the euro started losing some value 
and,  while  remaining  above  the  threshold  of  the 
10.9  SEK/EUR  since  then,  brought  the  krona 
exchange  rate  at  a  value  of  10.88  SEK/EUR  on 
average  in  March  2020.  Short-term  interest  rate 
spreads vis-à-vis the euro area have come back to 
positive  territory  since  December  2018.  This 
follows a long negative period starting in February 
introduced  a 
the  Riksbank  had 
2015,  when 
negative policy rate, cutting its repo rate to minus 
0.1% and started its asset purchase programme. 

In  addition,  the  new  fiscal  framework  entails  a 
strengthened mandate for the Fiscal Policy Council 
(Finanspolitiska  rådet),  which  has  functioned 
since 2007 to monitor fiscal rules and evaluate the 
official  macro-forecasts. The  selection process  for 
members  of  the  Council  was  changed  on  1  July 
2018  to  one  steered  by  a  nomination  committee 
which  includes,  among  others,  the  Chair  and 
the  Riksdag’s  Finance 
Deputy  Chair  of 
Committee.    The  change  was  motivated  by  the 
desire  to  give  the  independent  fiscal  body  more 
its 
democratic 
increase 
the 
responsibilities  and  diversity.  Some  of 
elements  in  the  fiscal  framework  contribute  to 
bringing  the  Swedish  national  provisions  in  line 
with  provisions  in  the  Budgetary  Frameworks 
Directive, (48)  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. 

legitimacy 

and 

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  long-term  trend  of  the  krona  depreciating 
against  the  euro  that  started  in  2013  continues, 
with a cumulated depreciation of more than 26% in 
early  2020  compared  to  the  2013  peak.  In  2018, 
the krona depreciated by 6% against the euro, and 
by  further  3%  in  2019,  when  it  reached  a  peak  at 
10.80  SEK/EUR  in  October  2019,  before  slightly 
appreciating 
the  range  10.5-10.6  between 
December  2019  and  February  2020.  Since  mid-

to 

(48)  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: 

to  April  and  August 

The increases  in  the  monetary policy rate  decided 
by the Riksbank in December 2018 and 2019 (see 
above)  seem  to  have  been  the  main  driver  of  the 
increase  of  the  3-months  STIBOR-EURIBOR 
spread.  The  spread  averaged  -7  basis  points  in 
2018  and  33  in  2019,  with  two  periods  of  rapid 
increases,  January 
to 
December,  when  it  reached  47  basis  points,  only 
temporarily  interrupted  in  September  2019.  The 
spread continued increasing in 2020 and inn March 
2020  it  stood  at  around  65  basis  points.  The 
depreciation  of  the  Swedish  krona  in  2018  and 
2019, therefore, does not seem to be accounted for 
by  monetary  policy  actions,  contrary  to  the  one 
during 2014-2016. As indicated in the next section, 
the  uncovered  interest  parity  relation  does-  not 
hold  on  average  in  2018  and  2019  also  if  one 
measures it using the spread between the curve of 
the  yields  of  Swedish  government  bonds  with 
respect to German government bonds. 

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 foreign currency 
reserves  decreased  by  more  than  10%  in  krona 
(almost  4%  in  US  dollars)  between  December 
2017  and  December  2018  and  by  almost  17% 

107 

8.08.59.09.510.010.511.011.5201420152016201720182019Graph 8.4: Sweden -SEK/EUR exchange rate(monthly averages)Source: ECB.                                                           
         
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

Looking  at  monthly  data,  long-term  interest  rates 
recorded  a  new  all-time  low  in  August  2019,  at  -
0.36, within the first period ever of negative rates, 
between  June  and  October  2019.  Long-term  rates 
after recovering and turning positive in November 
2019  turned  negative  again  in  February  2020  to 
reach  -0.17%  in  March  2020.The  compression  of 
Swedish  long-term  interest  rates  reflected  the 
continuation  of  the  non-standard  monetary  policy 
measures,  with  continued  acquisition  and/or 
repurchase of governments bonds as a response to 
the  low  domestic  inflation  environment,  and  its 
safe-haven  premium.  The  yields  of  the  Swedish 
benchmark  government  bond  remained  relatively 
well connected to the German benchmark bond, in 
line  with 
the  safe-haven  status  of  Swedish 
government bonds. Long-term interest spreads vis-
à-vis  the  German  benchmark  bond  remained 
relatively low. Spreads started increasing to touch 
42 basis points in January 2020, having decreased 
during 2018 to reach 20 basis points in May 2019. 
In March 2020, they were at 37 basis points. (49) 

(12% in US dollars) between December 2018 and 
December 2019, when it stood at around SEK 480 
billion.  In  the  beginning  of  2020,  international 
reserves stood below the level of SEK 470 billion 
(45  billion  US  dollars),  or  around  9%  of  GDP. 
These  changes  reflect  Riksbank  decisions 
to 
somewhat  lower  the  level  of  foreign  exchange 
reserves,  which  had  been  increased  substantially 
after  the  global  financial  crisis,  financed  by  loans 
from  the  Swedish  National  Debt  Office.  The 
change in foreign reserves therefore, does not bear 
a direct relation to changes in the exchange rate.  

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 around ten years.  

The Swedish 12-month average long-term interest 
rate,  relevant  for  the  assessment  of  the  Treaty 
criterion was well below the reference value at the 
time  of  the  2020  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  declining  trajectory  since  June  2018, 
when  they  were  at  0.7%,  and  went  below  0.1% 
since  November  2019  and  in  negative  territory 
since  February  2020.    In  March  2020,  the  latest 
month  for  which  data  are  available,  the  reference 
value,  given  by  the  average  of  long-term  interest 
rates  in  Portugal,  Cyprus,  and  Italy  plus  2 
percentage  points,  stood  at  2.9%.  In  that  month, 
the  12-month  moving  average  of  the  yield  on  the 
Swedish  benchmark  bond  stood  at  -0.1%,  i.e.  3.0 
percentage points below the reference value. 

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

108 

-40-20020406080201420152016201720182019Graph 8.5: Sweden -3-M Stibor spread to 3-M Euribor(basis points, monthly values)Source: Eurostat and EBF (European Banking Federation).-202468Jan-14Jan-15Jan-16Jan-17Jan-18Jan-19Jan-20SwedenReference valueGraph 8.6: Sweden -Long-term interest rate criterion(percent, 12-month moving average)Source: Commission services.-10123201420152016201720182019SwedenGermanyGraph 8.7: Sweden -Long-term interest rates(percent, monthly values)Source: Eurostat.   
      
   
                                                           
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, 
financial 
market integration – gives an important indication 
of  a  Member  State's  ability  to  integrate  into  the 
euro area without difficulties. 

labour  and 

to 

In  December  2019,  the  Commission  published  its 
ninth Alert Mechanism Report (AMR 2020) under 
the  Macroeconomic  Imbalance  Procedure  (MIP  - 
see  also  Box  1.6),  which  concluded  that  an  In-
Depth  Review  (IDR)  was  warranted  for  Sweden. 
In  February  2020,  the  Commission  published  its 
annual  country  report  on  Sweden,  including  an 
IDR. This report led to the conclusion that Sweden 
continues 
experience  macroeconomic 
imbalances. Overvalued house price levels coupled 
with a continued rise in household debt poses risks 
of a disorderly correction. While household debt as 
a  share  of  GDP  and  disposable  income  has 
stabilised  recently, 
it  remains  high.  After  a 
correction  and  stabilization  of  house  prices  over 
2017-2018,  prices  have  gradually  recovered  and 
remain  close  to  historically  high  levels.  Although 
the  banking  sector  appears  adequately  capitalised, 
a disorderly correction would negatively affect the 
to 
financial  sector  given 
household  mortgages.  In  such  a  case,  there  could 
to  neighbouring 
also  be  negative  spill-overs 
countries 
financial 
given 
interlinkages.  Some  policy  measures  have  been 
taken  in  recent  years  to  address  rising  household 
debt, especially through macro-prudential policies. 
However, important policy gaps remain in the area 
of  housing-related 
taxation,  boosting  housing 
supply and the rental market. 

large  exposure 

systemic 

the 

its 

8.6.1.  Developments  of 

the  balance  of 

payments 

According to Balance of Payments data, Sweden's 
current  account  continued  its  gradual  decline  to 
reach  1.7%  of  GDP  in  2018  as  the  economy 
experienced  a  strong  expansion  fuelled  by  solid 
gains  in  domestic  demand.  A  decline  in  the 
balance  of  trade  for  both  goods  and  services 
contributed  to  the  lower  current  account  surplus, 
only  partially  compensated  for  by  the  increase  in 
the primary income balance from 2015 onwards. In 
2019,  the  current  account  balance  rebounded  to 
reach  3.9%,  as  the  goods  and  services  balances 

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

substantial  gains.  The 

posted 
solid  export 
performance  in goods  was  supported by terms-of-
trade  effects  and  by  the  composition  of  trade  in  a 
mature  phase  of  the  cyclical  expansion,  while 
improvements  in  services  exports  was  probably 
owing  to  some  special  non-recurrent  factors,  such 
as  transfers  of  intellectual  property.  By  contrast, 
current  transfers have delivered a negative impact 
on the current account balance, 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. 

According  to  National  Accounts  data,  Sweden's 
large savings-investment surplus persisted in 2018 
and  2019,  reflecting  a  combination  of  high  and 
increasing  net  savings  by  the  private  sector, 
compounded  by  fiscal  surpluses.  High  private 
sector  savings  reflect  a  combination  of  factors 
including  a  pension  regime  with  substantial 
mandatory contributions in presence of decreasing 
expected pension payments, precautionary savings, 
and  high  profitability  of  enterprises,  which  is 
supported  by  moderate  increases  in  wage  costs. 
Strong  corporate  profitability  in  combination  with 
relatively  subdued  business  investment  translated 
in  corporate  savings  boosting  those  of  the  private 
sector.  Total  gross  capital  formation  peaked  at 
around 26.8% of GDP in 2018 and this is share is 
expected  to  decline  somewhat  over  the  forecast 
period as the economy is cooling. 

Sweden's  export  market  share  has  been  declining 
overall  since  the  early  2000s,  a  phenomenon 
shared  with  several  high-income  countries.  The 
export  performance  of  the  Swedish  economy 
slightly  deteriorated  in  2018  but  rebounded  in 
2019.  Short-term  fluctuations  in  export  shares 
appear  to  reflect  cyclical  composition  effects  of 
in 
export  specialisation  rather 
structural features. The trend decline in the export 
market  shares  is  linked  to  changing  global  trade 

than  changes 

109 

010203040201420152016201720182019Gross national savingGross capital formation at current prices; total economyGraph 8.8: Sweden -Saving and investment(in percent of GDP at market prices)Source: Eurostat, Commission services.   
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

positions.  External  reserves  remained  constant  in 
2018  and  2019.  External  debt  has  been  on  a 
declining  trend,  and  decreased  by  more  than  20 
percentage  points  between  2014  and  2019,  to 
166.5%  of  GDP.  The  strong  fiscal  position  with 
the  concurrent  decline  in  gross  government  debt 
has been a key factor behind this decline. 

patterns,  which  affect  most  mature,  industrialised 
economies  with  a  similar  focus  on  high-value-
added  exports.  This  downward  trend,  therefore, 
does  not  suggest  any  underlying  competitiveness 
issues per se. 

in 

developments 

This  benign  conclusion  on  competitiveness  is 
the 
buttressed 
cost 
by 
indicators.  The  real  effective 
competitiveness 
exchange  rate  weakened  from  the  second  half  of 
2017 onwards, mainly due to a fall in the nominal 
effective  exchange  rate  of  the  krona.  Given  the 
advanced  stage  of  the  cycle,  unit  labour  costs 
(ULC)  have  been  growing  fairly  moderately  over 
the  same  period,  broadly  in  line  with  Sweden's 
main trading partners.  

the 

Sweden's  net  international  investment  position 
improved markedly to around 8% of GDP in 2018, 
and  deteriorated  again 
following  year. 
Sweden's  financial  account  shows  relatively  large 
fluctuations  over  time.  However,  seen  over  a 
longer period, the financial account balance mainly 
reflects Sweden's role as a net FDI investor abroad. 
By  contrast,  the  balance  of  portfolio  investments 
fluctuated  appreciably  year  to  year,  mirroring  the 
interplay  of  financial  market  conditions  and 
perceptions,  exchange  rates  and  relative  cyclical 

According  to  the  Commission  services'  Spring 
2018  Forecast,  which 
is  based  on  National 
Accounts  data,  net  exports  are  expected  to  drag 
down real GDP growth in 2020 in view of sharply 
falling world trade and disruptions in production of 
exporting  manufacturers.  The  net  contribution  of 

110 

8090100110201420152016201720182019Graph 8.9: Sweden -Effective exchange ratesNEERREER, HICP deflatedREER, ULC deflated(vs. 36 trading partners;  monthly averages;index numbers, 2014 = 100)Source: Commission services.Table 8.4:Sweden - Balance of payments(percentage of GDP)201420152016201720182019Current account4.54.13.53.11.73.9of which: Balance of trade in goods3.02.82.12.11.53.0                 Balance of trade in services1.32.22.10.80.10.3                 Primary income balance 1.90.70.61.71.72.5                 Secondary income balance-1.8-1.6-1.3-1.5-1.7-1.9Capital account-0.1-0.2-0.1-0.10.00.0External balance 1)4.43.93.43.01.73.9Financial account 2.71.4-4.93.91.33.4of which: Direct investment0.90.9-2.82.12.40.4                Portfolio investment4.0-2.61.20.5-1.82.1                Other investment 2)-2.22.9-4.21.20.82.1                Change in reserves0.00.30.80.1-0.1-1.2Financial account without reserves2.71.2-5.83.81.44.6Errors and omissions-1.6-2.5-8.40.9-0.4-0.5Gross capital formation23.724.424.725.826.825.8Gross saving27.627.727.629.229.430.3Gross external debt188.5179.7175.1176.0170.7166.5International investment position-2.2-5.3-1.91.38.021.21) The combined current and capital account.2) Including financial derivatives.Sources: Eurostat, Statistics Sweden, Commission services.    
 
 
     
 
 
Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

Competitiveness Index. Sweden also tops rankings 
in public administration performance according to 
the  World  Bank's  Worldwide  Governance 
Indicators. Sweden's deficit in the transposition of 
EU  directives  in  2018  and  2019  was  at  0.3%  and 
0.1%, below the EU average and the 0.5% target as 
proposed  by  the  European  Commission  in  the 
Single Market Act (2011).  

The  4th  Anti-Money  Laundering  Directive 
imposed  transposition  by  26  June  2017  and  from 
2017  to  2020  Sweden  has  communicated  to  the 
Commission  the  adoption  of  several  transposition 
measures,  which  ensure  a  complete  transposition 
of the Directive. The Commission is completing its 
analysis of whether the notified measures conform 
to  the  Directive.  As  regards  the  5th  Anti-Money 
Laundering  Directive,  whose 
transposition 
deadline elapsed on 10 January 2020, Sweden has 
transposition  measures  and 
notified  national 
transposition. 
declared 
The 
a 
the  communicated 
Commission 
their  completeness  and 
measures 
conformity with the directive.  

complete 
is  analysing 

to  assess 

the 

allegations  of 

transposition  of 

the  Directive, 
Beyond 
suspected  money 
persistent 
laundering have affected the reputation of Swedish 
banks.  Effective  supervision  requires  increased 
resources  and  appropriate  procedures  to  apply  the 
in  place.  Sweden  has 
risk-based  approach 
strengthened 
its  Financial 
the  capacity  of 
Supervisory Authority, but the agency’s capacity is 

111 

growth would turn positive in 2021, on the back of 
the  projected  recovery.  The  current  account 
surplus is expected to fall somewhat in 2020. It is 
projected to slightly rise again in 2021, to 4.0% of 
GDP, in National Account terms. 

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  been  high, 
at  40%  or  more  every  year  since  2005,  with  an 
increase  by  more  than  3  points  of  GDP  over  the 
last five years to reach 44.3% in 2019. Trade with 
the  EU  has  represented  more  than  40%  of  all 
Swedish trade since 2005 and more than 45% over 
the period 2018-2019. The main euro-area trading 
partners  are  Germany, 
the  Netherlands  and 
Finland,  while  among  non-euro-area  countries 
Norway and Denmark are the main trade partners.  

The  stock  of  inward  FDI  has  remained  stable 
relative  to  GDP  in  recent  years  (64%  of  GDP  in 
2018).  In  2018,  76%  of  the  total  FDI  stock 
originated  from the EU,  with the  Netherlands, the 
UK,  Luxembourg,  Germany 
and  Finland 
accounting for 62% of this total. 

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 

Table 8.5:Sweden - Market integration201420152016201720182019Trade openness 1) (%)40.841.040.041.643.544.3Trade with EA in goods & services 2)+3) (%)17.417.417.418.319.019.1Export performance (% change) 4)0.52.7-0.5-0.5-0.21.7World Bank's Ease of Doing Business Index rankings 5)999101210WEF's Global Competitiveness Index rankings 6)1096798Internal Market Transposition Deficit 7) (%)0.30.20.41.40.30.1Real house price index 8)89.4100.0107.3112.4109.0109.6Residential investment 9) (%)4.24.75.35.75.45.0 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 2020 - Technical annex 

Chapter 8 - Sweden 

at 

average 

euro-area 

increasing from 9.4% in 2017 to 17.8%, surpassing 
the 
15.8%.  Bank 
concentration  as  measured  by  the  market  share  of 
the  largest  five  credit  institutions  in  total  assets 
remained  high  at  54%,  significantly  above  the 
euro-area average, which was 50.6% at the end of 
2018. 

of 

the 

had 

level 

highest 

The capital adequacy ratio of Swedish banks is just 
above  the  euro  area  average.  It  stood  at  20.6%  in 
the  third  quarter  of  2019,  compared  to  the  euro 
area average  of 18.1%.  At the beginning of 2020, 
Sweden 
the 
Countercyclical Capital Buffer in the EU, as it had 
been  raised  from  2%  to  2.5%  on  19  September 
2019.  On  13  March  2020,  the  Swedish  Financial 
Supervisory  Authority  (Finansinspektionen,  FSA) 
reduced  the  Countercyclical  Capital  Buffer  to  0% 
(50) to support credit provision and help counter the 
impact of the COVID-19 induced crisis. The FSA 
further temporarily allows banks to  fall below the 
liquidity  coverage  ratio  (LCR)  for  individual 
currencies and total currencies. This comes on top 
of  the  measures  taken  by  the  Riksbank  described 
previously. 

At the end of 2018, the FSA revised the calculation 
method  for  the  risk-weight-floor  imposed  on 
residential  mortgages  exposures  of  banks  using 
internal  risk  models,  enhancing  the  international 
comparability  of  reported  capital  ratios.  This 
the  Capital 
measure  under  Article  458  of 
Requirements  Regulation  (51)  led  to  a  drop  in 
reported  bank  capitalisation  as  a  ratio  of  risk-
weighted  assets  and  moved  it  closer  to  the  EU 
average.  Improved  comparability  implies  that  the 
fall in the reported capital ratio for Swedish banks 
vis-à-vis EU peers is probably overestimated. The 
leverage  ratio  remains  between  4%  and  5%  for 
most Swedish banks, which is among the lowest in 
the  EU.  The  phasing  in  of  changes  in  capital 
requirements  agreed  by  the  Basel  Committee  on 
Banking  Supervision  may  lead  to  higher  capital 
buffers  for  Swedish  banks  going  towards  full 
implementation on 1 January 2027. 

The  ratio  of  non-performing  loans  (0.8%  in  the 
third quarter 2019) has stayed low in recent  years 
and  among  the  lowest  in  the  EU  and  also  

(50)  See https://fi.se/en/published/coronavirus/ 
(51)  In  line  with  Article  458  of  the  Capital  Requirement 
Regulation,  Finansinspektionen  replaced  the  method  used 
to  apply  the  risk  weight  floor  of  25%  for  Swedish 
mortgages  for  Interal  Ratings  Based  with  a  (credit 
institution-specific) minimum level of 25% for the average 
risk weight on Swedish housing loans. 

still  low  compared  to  the  size  of  the  Swedish 
financial sector. 

The  Swedish  labour  market,  largely  governed  by 
negotiations  between  social  partners  at  sectorial 
level,  is  characterised  by  high  employment  rates. 
Low  nominal  wage increases in recent  years  have 
been  a  factor  behind  muted  underlying  inflation. 
Sweden has one of the lowest wage dispersions in 
the EU, with high entry wages and relatively little 
wage  progression.  According  to  the  2015  OECD 
employment  protection  indicator,  the  employment 
protection  of  permanent  workers  is  rather  high 
compared  to  that  of  temporary  workers.  The 
dispersion  of  regional  unemployment  rates  is 
relatively  low,  but  persistent  imbalances  in  the 
housing  market  and  high  costs  of  housing  in  the 
larger  cities  pose  challenges  to  labour  mobility. 
The  integration  of  low-skilled  workers  and  those 
born outside the EU remain a key challenge for the 
Swedish labour market, though, as the employment 
rate  of  both  groups  is  significantly  below  the 
overall  employment  rate.  Skills  shortages  are 
pronounced in education, health care, social work, 
information 
technology, 
industry and construction. 

communication 

and 

sector, 

financial 

especially 

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  large  market  shares  in  Lithuania, 
Latvia  and  Estonia.  They  also  have  substantial 
market shares in Denmark and Norway. At the end 
of  2017,  Nordea  moved 
to 
Finland. This move significantly reduced the asset-
to-GDP  ratio  of  the  Swedish  domestic  banking 
sector  from  269%  of  GDP  in  2017  to  225%  of 
GDP in 2019. 

its  headquarters 

Moreover,  in  the  wake  of  the  move  of  Nordea’s 
headquarters, the share of foreign ownership in the 
Swedish financial market almost doubled in 2018, 

112 

010203040506070SE, 2014SE, 2018EA, 2014EA, 2018Concentration 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.   
                                                           
significantly  lower  than  the  euro  area  average, 
which  remains  just  below  3%.  High  asset  quality, 
the 
cost-efficiency,  market  concentration  and 
ability  to  earn  a  positive  interest  margin  (52)  –
which  allows  to  cover  the  large  external  funding 
gap  faced  by  Swedish  banks  –  support  the 
profitability  of  the  banks.  The  latter  is  among  the 
highest  in  Europe.  The  sector's  average  return  on 
equity  (ROE),  which  was  high  and  increasing  in 
2018  (13.1%  in  Q4  2018),  stood  at  almost  7%  in 
the  third  quarter  of  2019,  above  the  euro  area 
average of slightly above 5%. 

Real house prices have more than tripled over the 
past  two  decades,  significantly  outpacing  income 
growth.  The  increase  has  been  paired  with  an 
increase  in  household  debt.  At  the  beginning  of 
2020,  house  prices  had  recovered  to  around  the 
peak  level  of  August  2017.  First  available  data 
suggest a price decline as of mid-March however, 
as  the  economy  started  to  contract.  In  2018,  the 
high  household  debt  ratio  was  mirrored,  together 
with  high  debt  of  non-financial  corporations,  in  a 
consolidated  private  debt-to-GDP  ratio  of  above 
200%,  well  above  the  135%  figure  of  the  euro 
area.  The  consolidated  private  debt-to-GDP  ratio 
slightly increased in 2019, reaching 205% of GDP. 

Housing  construction  activity  has 
increased 
significantly  over  the  past  years,  reaching  an 
average  growth  of  5.4%  between  2016  and  2019. 
However,  since  2019  housing  construction  has 
started  to  fall.  In  the  current  situation  of  sharp 
economic 
slowdown  with  high  uncertainty, 
strongly  valued  house  prices  coupled  with  a  high 
household  debt  ratio  continue  to  entail  risks  of  a 
disorderly deleveraging process, potentially with a 
significant  broader  impact  on  the  real  economy 
and in an extreme scenario the banking sector. In a 
more  structural  sense,  housing  shortages  and  an 

(52)  The  interest  margin  refers  to  the  difference  between 
interest paid by banks on their funding and interest earned 
by banks from their activity.  

Convergence Report 2020 - Technical annex 

Chapter 8 - Sweden 

sub-optimally  functioning  housing  market  have 
negative  knock-on  effects  on  labour  mobility, 
income  and  wealth  inequality  as  well  as  social 
equality.  

in  Sweden  are  very  well 
Capital  markets 
the  euro  area.  The 
to 
developed  compared 
capitalization index, measuring the ratio to GDP of 
the  value  of  the  stock  of  quoted  shares  issued  by 
Swedish enterprises stood at about 115% at the end 
of  2018,  just  below  the  level  of  the  end  of  2014. 
This 
the  euro-area 
capitalization  index  of  60.8%  in  2019  (59.6%  in 
2018). 

roughly 

times 

four 

is 

The  total  amount  of  outstanding  debt  securities 
stood  in  2019  at  155%  of  GDP,  more  than  10 
points below the value of 2014. Outstanding bank 
credit  to  non-financial  companies  and  households 
stood in 2019 at about 133% of GDP. This level is 
above the  value of 2014 (122%), with an increase 
of the share given to households from 61% in 2014 
to almost 70% in 2019.  

113 

0510152025SE, 2014SE, Q3-19EA, 2014EA, Q3-19Return on equityCapital adequacyNon performing loansGraph 8.11: Sweden -Selected banking sector soundness indicators%Source: ECB, EC calculations.Note: Q3-19 Return on equity is calculatedover the last four quarters.020406080100120140160180SE, 2014SE, 2019EA, 2014EA, 2019Debt 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.