Implementation of the Euro in the Czech Republic

Home , Czechoslovak koruna, Czech koruna, Slovak koruna

Thesis by Nguyen Le Zuzana

Submitted in Partial Fulfillment of the Requirements for the Degree of Bachelor of Science in Business Administration

State University of New York Empire State College 2016

Reader: Tanweer Ali

I, Zuzana Nguyen Le, hereby declare that the material contained in this submission is original work performed by me under the guidance and advice of my mentor, Tanweer Ali. Any contribution made to the research by others is explicitly acknowledged in the thesis. I also declare that this work has not previously been submitted in any form for a degree or diploma in any university. Zuzana Nguyen Le, 24.4.2016

Acknowledgement

I would like to express my deepest gratitude to my mentor, Mr. Tanweer Ali, for his precise guidance and his patience.

I also want to thank all of my close friends who had to listen to my complaints during this stressful period. Especially, I am most grateful for my Thesis-writing-buddy, Dinh

Huyen Trang, without whom I would have spent much more time writing the thesis.

Our sessions full of food and concentration gave me the needed motivation to finish the work. So thank you.

Last but not least, I owe my big thank to my family that supported me and gave me the most possible comfort environment to concentrate.

Table of Contents

Introduction ...... 1

History ...... 2 Motives Leading to the European Economic Integration ...... 2 Stages of European Economic Integration ...... 4 Free Trade Zone ...... 4 Customs Union (CU) ...... 6 The Common Market ...... 7 Economic and monetary union ...... 7 Political union ...... 8

The Czech Republic Becoming a Member of the European Union ...... 10

The Euro ...... 12 Maastricht Convergence Criteria ...... 14 Fulfillment of the Convergence Criteria in the Czech Republic ...... 16

Impacts of Implementing the Euro in the Czech Republic ...... 22 Direct Benefits from Implementing the Euro ...... 24 Direct Costs from Implementing the Euro ...... 27 Indirect Benefits and Costs ...... 31

Impacts of Financial Crisis on the Euro Introdution in the Czech Republic ... 36 The Mortgage Crisis in the US ...... 38 Impacts of the Global Financial Crisis on the Czech Republic ...... 39

Comparison between the Czech Republic and Slovakia ...... 41 The Introduction of the Euro in Slovakia ...... 41 The economic comparison between Slovakia and the Czech Republic ...... 44 Gross Domestic Product ...... 44 Foreign Direct Investment (FDI) ...... 45 The Overall Financial Situation ...... 46 Inflation rate ...... 47 Unemployment rate ...... 48

Conclusion ...... 50

Abstract

The Czech Republic is a member of the European Union since 2004 and yet is not a member of the Eurozone. Until recently, the date of the euro adoption was not fixed, however, from 2014 the Czech government declared an active support for creating conditions for the euro adoption. How will adoption of the euro affect the Czech

Republic? Will it help or harm the Czech’s economy? This thesis aims to analyse the issue of the euro adoption in the Czech Republic. There is no doubt that implementing the new currency is a huge change that will effect the country a lot, thus, there are a lot of arguments for and against the project. Another aspect will be a comparison with

Slovakia, as a country that already entered the Eurozone, because these two countries are quite similar, there is a shared tradition, therefore, the experience of Slovakia with the euro can be useful for the Czech Republic. The differences between the countries’ economy are shown on the statistical tables. To obtain required information to support my work I mostly read academic journals, books from various libraries, and some credible sources on the Internet. In my opinion, this topic is a current issue and it concerns a lot of people and their lives. There is no certain result yet but it will definitely affect the country in many ways.

Introduction

Economic and monetary union together make the fourth phase of the economic integration of the European Union. These two terms are different, but they complement each other. The economic union has a status of coordinated cooperation in the field of trade, economic, monetary, fiscal, social, and structural policy. On the other hand, monetary policy is a form of cooperation developing a free movement of capitals. The aim of this cooperation is a creation of fixed rates, providing for full convertibility of the members’ currencies, followed by replacement of national currencies by the common currency – the euro.

Euro has become a significant player in the world monetary system right after the dollar and the yen. Currently, there are already 19 countries using the euro as their currency out of the 28 member states of the European Union.

The aim of this work is to help with the question, when is the convenient time for the

Czech Republic to adopt the euro. There will be also a mention about the impacts of the global financial crisis on the Czech Republic. Furthermore, information about the advantages and disadvantages of membership in the monetary union will be provided as well as the comparison between the Czech and Slovak economy because experiences of Slovakia with the single European currency can be useful for the Czech Republic.

History

Motives Leading to the European Economic Integration

The beginnings of modern European integration are fit into the fifties of the twentieth century. However, the unification efforts of various European countries can be found much earlier in history. Mostly it was rather because of the rulers’ desire to own larger territory than to get the nations closer and economic cooperation.

From history, there was already a ruler, the first Holy Roman Emperor - Charlemagne, who tried to unite territories. Charlemagne, also known as Charles the Great or Charles I, was King of the Franks. Around the year 800, he initiated an attempt at recreating the Roman

Empire. This empire included today's France, Belgium, Luxembourg, Switzerland, West

Germany, and Netherlands, which are (except Switzerland) five out of six founding members of the current European Community, only Italy missing. Charles I also introduced a single currency in his empire, which came in the form of euro after 1200 years. (Dinan, 2007)

George of Podebrady was King of Bohemia and leader of the Hussites. Around 1462, he suggested to create the European confederation of the states, which would face together against the Turks.

Under the reign of Napoleon Bonaparte, the French empire expanded on Belgium,

Netherlands, and part of Italy. There was also an effort of a single currency and a single right.

World War I was from 1914 to 1918. The National Revival in Europe led to belief that every nation has to have its own state. After signing the Treaty of Versailles, new ordering of

Europe was created which the Germans did not like. (BERGER, 2013)

In 1940, Winston Churchill, the Prime Minister of the United Kingdom, and Jean Monnet,

French political economist and diplomat, proposed creation of Anglo-French Union. The

proposal represented a common defense policy against war, a common foreign policy, policy of finance and economy. After the German army occupied France, French government rejected the proposal.

In 1939, Germany launched World War II, which lasted until 1945 when Germany was defeated. Europe felt the need of connecting nations in order to prevent future wars. (Dinan,

2007)

In 1947, Winston Churchill became a Chairman of the movement for a united Europe. At the conference in Hague, the provisions of the Council of Europe were created and the

Charter of Human Rights and Freedoms was adopted. In the documents, there were incorporated ideas about free movement of persons, goods, freedom of thinking, assembly and expression, and about the Court of Justice. (Dinan, 2007)

After WWII in 1945, the whole Europe ended up in the crisis. The United States came with help in the form of Marshall Plan. George Marshall, state secretary of the US, presented his plan in June 1947. (Dinan, 2007) The aid was against hunger, poverty, desperation, and chaos; the aid was offered to all European countries affected by WWII. By this aid the US wanted to achieve its economic benefit as well. Thanks to that American companies gained access to the European market where they had no strong competition. The USA benefits from the created sales and distribution network to this day and its aid returned in the form of firms’ profits, securing sales, and employment of American citizens.

The United States also wanted to act against the danger of Soviet expansion. SSSR declared that they will not join the program of helping Europe. Central and eastern states did not accept the aid because they were under the pressure, which caused the split of Europe to

East and West part. Besides the financial aid, the Marshall Plan had another goal – creating a

European federation. In 1948, the Organisation for European Economic Co-operation

(OEEC) came into being, which organized and distributed aid from the US. Thanks to

OEEC, close cooperation among the European countries started and it led to a creation of federal structure and degradation of trade barriers in Europe. The aid that was provided by the Marshall Plan was for 17 Member states in the amount of 12.5 billion dollars. The drawing states were: Belgium, Denmark, Austria, France, Greece, Island, Ireland, Italy,

Luxembourg, Netherlands, Norway, Portugal, Sweden, Switzerland, Turkey, United

Kingdom, and the Federal Republic of Germany. (BERGER, 2013)

As can be seen from the events, attempts to unify Europe were here long time ago. They could be considered as causes and motives leading to the formation of integration steps in

Europe.

Stages of European Economic Integration

The term „integration“ means unification, combining parts into a unit. An economic integration is a process of linking national economies and removing barriers to mutual trade.

An economic theory distinguishes several stages of economic integration. For the first time, the individual stages were defined by the professor Bela Ballasa in his article „The Theory of

Economic Integration“. The stages of integration processes are known as follows: free trade zone (FTZ), customs union (CU), single internal market, economic and monetary union, and political union.

Free Trade Zone

The free trade zone is the lowest stage of the economic integration. The principle of this stage is on agreement of the free trade zone countries – to eliminate tariffs, quotas, or other restrictions on certain products. At first, it was about coal and steel products. ("free-trade zone", 2016)

In 1950 French Foreign Minister, Robert Schuman, proposed France and Germany and any other European country that they can join the market of coal and steel resources. (Dinan,

2007) This idea originally came from the Schuman’s friend, Jean Monet. That is why they are considered to be founders of the European Union. The Schuman Declaration was the first step of the European integration and it lead to creation of the European Coal and Steel

Community (ECSC). This plan of economic integration aimed to improve relationship between France and Germany and to ensure there will be no wars in Europe. (Dinan, 2007)

During the WWII, the weapons were made from steel and the coal was the main energy material, which was important for producing the steel. Control of the strategic materials – coal and steel – was ensured by the subordination of the coal mining and steel production of the member states to the unitary authority. Based on the comparison of coal mining and steel production, now to the previous years, the secret manufacture of weapons can be easily revealed. It was, so far, a limited area of cooperation, however, the opening of non- discriminatory market for coal and steel for all participating states was a germ for the creation of a single market for all industrial products. Robert Schuman offered the membership to all European states, who would be interested in it. Besides Germany and

France; Italy, Belgium, Netherlands, and Luxembourg also joined to the common creation of coal and steel market. (BERGER, 2013) In 1951, the Treaties of Paris were signed by the six states, which created the ECSC, the predecessor of the EU. The treaty came into force on 23

July 1952 with effect for 50 years, which means until 2002. Then based on the Treaty of

Nice, the ECSC was transferred to the European Community. (BERGER, 2013)

The ECSC was the first step, which was to demonstrate the ability of peaceful cooperation and which was to create basis for further and deeper integration.

Customs Union (CU)

Benelux countries (Belgium, Netherlands, Luxembourg) proposed to convene a conference to deepen integration and the development of joint contracts in the area of transport, energetics,, and atomic energy. On 27 March 1957, two treaties were signed in

Rome; the first one was the Treaties of Rome, which contributed to establishment of the

European Economic Community (EEC), and the second one was the European Atomic

Energy Community (Euratom).

Both treaties came into force on 1 January 1958. ("customs union", 2016)

In the Framework of the ECC, the member states decided to transfer part of decision- making at the national level in certain areas. Uniform rules of functioning and decision were set up for the following areas: common agricultural policy and fisheries policy, common transport policy, competition policy, tax provisions, approximation of laws, economic and social policy. (Dinan, 2007)

The goal of EURATOM was to secure the control of Member States in the peaceful uses of atomic energy. There was spotted a new energy source of tomorrow in nuclear energy, as well as the threat of the production of nuclear weapons.

In comparison with the free trade zone, the custom union is qualitatively a higher form of economic integration. The Member States already agreed on elimination of tariffs, quotas, and other restrictions on all types of goods among themselves, and they also enforce common customs tariff towards Third countries.

In 1965, the Member States agreed on merging of three existing communities (ECSC,

Euratom, and EEC) with a Merger Treaty (or Brussels Treaty) into a single institutional structure, which came into force on 1 July 1967, hereinafter referred to as the European

Community.

The completion of the custom union was on 1 July 1968. (Dinan, 2007)

The Common Market

The common market is the third stage of the economic integration. The Member States removed all customs duties and quotas between themselves, they use common customs tariff towards Third countries, and also there is free movement of not only goods but also services, labor, and capital among them. ("common market", 2016)

On 1 January 1973, there was a first wave of expansion of the European Community with new members: United Kingdom, Ireland, and Denmark.

In 1978, French official Jacques Dellors prepared a concept of common market, which was signed by the Member States as a Single European Act in 1986. The goal was to reach these four freedoms: free movement of goods, services, capital, and labor force.

On 1 January 1981, Greece joined.

On 14 June 1985, the integration deepened with the Schengen Treaty. The Member States agreed on a common goal – to abolish the checks on persons at internal borders including airports and ports, alignment of visa and asylum policy, and establishment of a common searcher and information computer system to help against crime and drugs.

The controls at the external boarders with the Third countries remained the same.

On 1 January 1986, there was a third expansion in the EC – Portugal and Spain.

(Dinan 2007)

Economic and monetary union

Member States‘ economies are already fully involved in the single internal market (the common market) and they are transferring some of their powers to supranational institutions.

These institutions can, for instance, have co-decision on trade policy, social sphere, or budget deficits of member countries. The aim of the monetary union is to create a system of fixed

currency exchange rates and to ensure full convertibility of Member States‘ currencies. There is an effort of Member States for introducing the common currency as a legal tender.

On 7 February 1992, The Maastricht Treaty was signed by the members of the European

Community in Maastricht, Netherlands. The Treaty came into force on 1 November 1993 and it created the European Union and led to the creation of the single European currency, the euro. The European Union (the EU) is a grouping of the previous three communities.

("Economic and Monetary Union.", 2015)

The EU Treaty also defines the Maastricht convergence criteria, also known as the euro convergence criteria, which must be fulfilled by the Member States of the EU in order to enter the Economic and monetary union and for the subsequent introduction of a common currency.

Political union

This stage is not an economic aspect, however, the political integration cannot be completely separated from the economic integration because both processes closely intersect. The political union is considered as the highest stage of the integration process.

In October 1997, the Amsterdam Treaty was signed and it came into force in May

1999. This treaty has incorporated the Schengen agreement to the legal system of the

EU. ("What Is Political Union? Definition and Meaning." )

The three EU pillars were confirmed and defined in Maastricht:

1) Cooperation in areas of economy, foreign trade, and finance.

2) Common foreign policy and internal security.

3) Jurisdiction – the European primary law is superior to the national law.

In February 2001, the Treaty of Nice was signed and it came into force in February

2003. The treaty changed the system of decision-making in the EU. In many areas, they began voting by qualified majority instead of unanimity. Further, the double majority system was introduced, which supposed to represent at least 65% of the EU citizens.

The Treaty of Nice also contained a draft of the European Constitution that would fill the fifth stage of integration, the political union. However, the draft of the European

Constitution was refused. (Dinan, 2007)

In May 2004, there was the fifth EU enlargement to the states: the Czech Republic,

Estonia, Cyprus, Poland, Hungary, Latvia, Lithuania, Cyprus, Malta, Slovenia, and

Slovakia.

In December 2007, the Lisbon Treaty was signed and it came into force in December

2009. The treaty includes a modified draft of the European Constitution that has an influence on limitation of national sovereignty in favour of the political union. (Dinan,

2007)

The Czech Republic Becoming a Member of the European Union

The Czech Republic’s journey into the Europaen Union resulted from the fall of the communist régime and the disintegration of the Soviet Union. In December 1991, there was signed the so-called European (association) agreement between the EC and the

Czech and the Slovak Federal Republic. Because the Federation fell apart on the 31st

December 1992, the agreement had to be signed again in 1993, but this time seperately for the Czech Republic and for the Slovak Republic. The aim of the agreement was, within 10 years from the acquisition date (from February 1995), to introduce the free trade zone and establish political dialogue between the Czech Republic and the

European Union. ("The Czech Republic’s Integration into the EU – Monetary and

Economic Policy.")

Meanwhile, there was adopted the Copenhagen criteria during the European Council session in Copenhagen (October 1993). The Copenhagen criteria was for determining the requirements for any states applying for entry into the EU. The Czech Republic applied for the membership on the 17th January 1996. In March 1998, the Czech

Republic’s accession proces to the EU was officially launched. On the 16th April 2003, the Accession Treaty was signed in Athens and then it came into force on th 1st of May

2004 – on this date, the Czech Republic became a member of the European Union.

("The Czech Republic’s Integration into the EU – Monetary and Economic Policy.")

By entering the EU, the Czech Republic committed itself to meet the Maastricht criteria to join the eurozone and the common currency, the euro. The question is not whether to adopt euro or not, but the appropriateness of the timing of this moment. The

Czech Republic does not have a binding deadline for adopting the euro yet, rather it depends on the readiness of the country.

Readiness and capability of the country to adopt the euro is characterized by the term

„zero-cost level“. This is a situation where benefits of adopting the euro will be at least equal to or greater than the costs associated with this step. Evaluation is focused on evaluating the nature of the economy in terms of minimizing potential risks and expenses, which could be brought by the adoption of the common currency. ("The

Czech Republic’s Integration into the EU – Monetary and Economic Policy.")

The principal risk is associated with the fact that by adopting the common currency the new Member State will lose the possibility to conduct its own national monetary policy, as well as the ability to influence domestic interest rates and manage the exchange rate. By entering the eurozone, the Czech Republic would lose the possibility of carrying out foreign Exchange intervention by the CNB under the existing system of managed floating exchange rate and also the end of the conduct of monetary policy on inflation targeting regime with possibility of domestic interest rates. The Czech

Republic would become a member of the national central banks within the euro area and it would be left with only some of its national powers, such as, bank supervision, regulation of the domestic financial market, and so forth. The important indicators, that assess a country’s readiness to join the eurozone, are the Maastricht criteria. The economic stability and readiness of the candidate country is tested for at least two years, which is based on the conditions defined by the Maastricht criteria as well. After this period, the candidate country can apply for the entry into the eurozone. The final word in evaluating a country’s readiness to adopt the euro have the European Central Bank and the European Commission.

The Euro

The euro is the single currency which is currently used by the 19 Member States of the

European Union which together form the euro area. In 1999, the euro was introduced and it was a major step towards deepening of the European integration. It is also one of its major successes because approximately 338 million of EU citizens now use the euro as their currency and enjoy its benefits which will be further expanded with the way the other EU countries will adopt the euro.

When the euro was introduced on 1 January 1999, it became the new official currency of

11 Member States which repplaced the former national currency, for instance, the

Deutschmark and the French franc in two phases. In the first phase, the euro was introduced as a virtual currency for non-cash payments and for accounting purposes, while the former currency continued to be use for cash payments and it was considered to be „sub-unit“ of the euro. On 1 January 2002, the euro was introduced in the formo f banknotes and coins.

(„Euro“, 2016)

The euro is not the currency of all Member States. Two countries, Denmark and the

United Kingdom, negotiated the exception in the Treaty that allows them to use their national currencies, while the remaining countries (many of the newer members of the EU and

Sweden) have not yet met the condition for adopting the single currency. Once the conditions are fulfilled, their national currency will be replaced by the euro.

Figure 1:

(„Euro“, 2016)

At the time when the euro was created, the independent European Central Bank

(ECB) and the National Central Banks of the Member States, that have adopted the euro, became responsible for monetary policy. The ECB was set up for this purpose.

These banks together form the so-called Eurosystem.

Fiscal policy (taxes and expenses) remains in the hands of national governments, which are binding to adhere the commonly agreed rules on public finances, collectively known as the „Stability and Growth pact“. They also retain full responsibility for their own structural policies (labor markets, pension markets, and capital markets). However, they agreed on their coordination in order to achieve the common objectives in the field of stability, growth, and employment. („Euro, 2016“)

Besides of the easier travel, the single currency has a great economic and political significance. A framework, in which the euro is managed, ensuring that the euro is a stable currency with low inflation and low interest rates and encourages sound public

finances. The single currency is also a logical complement to the single market to

ensure its greater efficiency. Using the single currency increases price transparency,

eliminates exchange fees, streamlining the functioning of the European economy,

facilitates international trade, and strengthens the EU’s voice in the world. Thanks to

the size and strength of the euro area, the euro is better protected against external

economic shocks, for instance, an unexpected rise in oil prices and turbulence in the

currency markets.

Finally, the euro is a tangible symbol of European identity for EU citizens, to which

they can be increasingly proud as the euro area expands and multiplies these benefits for

its current and future members.

Maastricht Convergence Criteria

The EU legislation clearly determines the process of euro adoption. It occurs in three

stages. The first phase is full membership in the EU, the second is membership in the

European Exchange mechanism ERM II, and the last stage is the fulfillment of the

Maastricht criteria.

Each Member State should fulfill the five Maastricht criteria to be ale to join the

European Monetary Union (EMU) and to adopt EU’s single currency, the euro. The five

criteria are:

• Price stability

• Government budget deficit

• Government debt-to-GDP ratio

• Exchange rate

• Long-term interest rates

The price stablity, the government budget deficit, and the government debt-to-GDP ratio are

designed to maintain monetary and exchange stability. And the last two, the Exchange rate

and the long-term interest rates should ensure the stability of the euro through protection

from inflationary pressures caused by excessive budget deficits.

The price stability – an average annual inflation rate of a state shall not exceed by more than

1.5% the average annual inflation rates of three Member States with the lowest inflation

rates.

(„Maastricht criteria, 2016)

The government budget deficit – the ratio of the annual general government deficit to the

GDP at market prices must not exceed 3% at the end of the preceding fiscal year.

(„Maastricht criteria, 2016)

The government debt-to-GDP ratio - the ratio of gross government debt shall not exceed the

60% limit of the gross domestic product at the end of the preceding fiscal year.

(„Maastricht criteria, 2016)

The exchange rate – the applicant countries should have joined the ERM/ERM II under the

EMU and shall have succeeded to keep its monetary exchange-rate within a +/- 15% range

from an unchanged central rate during the last two years. („Maastricht criteria“, 2016)

The long-term interest rates (average yields for 10-year government bonds in the past year)

– shall be no more than 2% higher than the unweighted arithmetic average of the similar 10- year government bond yields in the 3 EU countries with the lowest HICP inflation.

(„Maastricht criteria“, 2016)

Fulfillment of the Convergence Criteria in the Czech Republic

Criterion on Price Stability

The Czech Republic has been compliant with this criterion since 2013. The reasons why it was not compliant in 2012 were because of the increase in indirect taxes and adverse supply shocks in the form of high prices of oil and food.

The Czech’s domestic economy had an anti-inflationary effect in 2012-2014. Its average inflation rate was 0,4% in 2014, because in the end of 2013, the CNB started to use the Exchange rate as an additional monetary policy instrument aiming to maintain price stability in line with its inflation target. Furthermore, the low inflation was also caused by the lower electricity prices. In comparison with other EU countries in that year, the Czech Republic was samowhere in the middle of the set of EU countries.

Some of them were even in deflation (see Figure 2). "Assessment of the Fulfilment of the Maastricht Convergence Criteria and the Degree of Economic Alignment of the

Czech Republic with the Euro Area - 2015.")

Figure 2: Average HICP inflation rate in 2014

(in %)

With a sharp decline in oil prices on global market, the inflation forecast for 2015 remained the same as inflation in 2014. In 2016-2018, inflation in the Czech Republic will be scaled down by the assumed exit from the CNB’s exchange rate commitment and a subsequent increase in nominal interest rates. A slight recovery in inflation is predicted for the EU so the criterion should meanwhile increase. Therefore, the criterion should be also fulfilled in 2016-2018 by a sufficient margin.

Table 1: Harmonised index of consumer prices

(average for last 12 months vs. average for previous 12 months as of end of period; growth in

2012 2013 2014 2015 2016 2017 2018 Average0for030EU0countries0with0lowest0inflation 1,6 0,3 &0,2 &0,5 0,9 1,2 1,4 Reference0value 3,1 1,8 1,3 1,0 2,4 2,7 2,9 Czech0Republic 3,5 1,4 0,4 0,4 1,0 1,9 1,9

Criterion on the Government Financial Position

There was an implementation of budgetary consolidation programme by the government in 2012-2013, which cost a gradual fall of the general government deficit.

The only exception was a widening of the deficit in 2012 reflecting strong one-off effects, notably financial compensation relating to property settlement between the religious societies, the churches, and the state. In June 2014, the excessive deficit procedure against the Czech Republic, running since 2009, was discounted. Due to a one-off additional shortfall in excise duty, change in the definition of general government, and a sizeable rise in investment, the general government deficit increased to 1,9% of GDP in 2014. ("Assessment of the Fulfilment of the Maastricht Convergence

Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro

Area - 2015.")

The Czech Ministry of Finance estimates that the general government balance should by degrees improve to -0,5% of GDP in 2018. Thus, the criterion is expected to be fulfilled as well. Furthermore, it is also necessary for the Czech Republic to meet the medium-term objective of achieving a structural general government deficit no more than 1.0% of GDP. 2012 2013 2014 2015 2016 2017 2018 Average0for030EU0countries0with0lowest0inflation 1,6 0,3 &0,2 &0,5 0,9 1,2 1,4 Reference0value 3,1 1,8 1,3 1,0 2,4 2,7 2,9 TableCzech0Republic 2: General government balance3,5 1,4 0,4 0,4 1,0 1,9 1,9 (in % ofGDP)

2012 2013 2014 2015 2016 2017 2018 Reference0value &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 Czech0Republic &4,0 &1,3 &1,9 &1,9 &1,2 &0,8 &0,5

As to the general government debt, the Czech Republic’s low initial level of gevernment debt it has had no problem fulfilling this criterion. Due to the global financial and economic crisis, the debt increased significantly in 2009-2012 from less

than 30% to aroung 45% of GDP in 2013 (see Table 3). It resulted from low nominal

GDP growth and higher general government deficits. The significant increase in debt in

2012 was a result from the creation of a deficit financing and debt refinancing reserve which led to a decline in the debt ratio in 2014. With respect to the fiscal policy stance and economic growth, the debt-to-GDP2012 ratio2013 should2014 fall further,2015 coming2016 up 2017to 40% 2018of Average0for030EU0countries0with0lowest0inflation 1,6 0,3 &0,2 &0,5 0,9 1,2 1,4 GDPReference0value in 2018. In comparison with the3,1 EU average,1,8 the1,3 total general1,0 government2,4 2,7 debt 2,9is Czech0Republic 3,5 1,4 0,4 0,4 1,0 1,9 1,9 still low, however, the criterion will very probably be fulfilled in the following years.

2012 2013 2014 2015 2016 2017 2018 Reference0value &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 TableCzech0Republic 3: General government debt&4,0 &1,3 &1,9 &1,9 &1,2 &0,8 &0,5 (in % of GDP)

2012 2013 2014 2015 2016 2017 2018 Reference0value 60,0 60,0 60,0 60,0 60,0 60,0 60,0 Czech0Republic 44,7 45,2 42,7 40,9 40,9 49,7 40,1

Criterion on the Convergence of Interest Rates

Annual average long-term interests rate in the Czech Republic dropped sharply in

2012-2015 for convergence purposes. The Czech Republic traditionally performs without problems in terms of fulfilling the interest rate criterion and the same will probably apply according to outlook to 2018.

Figure 3: Long-term interest rates (August 2015; average for the last 12 months; in %)

19 2012 2013 2014 2015 2016 2017 2018 Average0for030EU0countries0with0lowest0inflation 1,6 0,3 &0,2 &0,5 0,9 1,2 1,4 Reference0value 3,1 1,8 1,3 1,0 2,4 2,7 2,9 Czech0Republic 3,5 1,4 0,4 0,4 1,0 1,9 1,9

2012 2013 2014 2015 2016 2017 2018 Reference0value &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 &3,0 Czech0Republic &4,0 &1,3 &1,9 &1,9 &1,2 &0,8 &0,5

2012 2013 2014 2015 2016 2017 2018 Reference0value 60,0 60,0 60,0 60,0 60,0 60,0 60,0 TableCzech0Republic 4: Long-term interest rates 44,7for convergence45,2 42,7 purposes40,9 40,9 49,7 40,1 (12-month average; in%)

2012 2013 2014 2015 2016 2017 2018 Average0for030EU0countries0with0lowest0inflation 3,1 4,4 1,8 1,6 1 1,3 1,3 Reference0value 5,1 6,4 3,8 3,6 3 3,3 3,3 Czech0Republic 2,8 2,1 1,6 0,7 1,2 1,5 1,8

Criterion on Participation in the Exchange Rate Mechanism

The Czech Republic has to join the ERM II so the formal fulfillment of the criterion on exchange rate stability can be possible. That is why the assessment of the Czech

Republic’s fulfillment can be made only at an analytical level. The hypothetical

CZK/EUR central parity is set as the average exchange rate in 2013 Q1. This parity’s aid enables monitoring whether the Czech Republic would have fulfilled the Exchange rate stability criterion in the given period of time. ("Assessment of the Fulfilment of the

Maastricht Convergence Criteria and the Degree of Economic Alignment of the Czech

Republic with the Euro Area - 2015.")

As can be seen form table 7, the exchange rate did not leave the band of ±15% around the hypothetical central parity in the restricted period of time. In November

2013, the CNB started to use the exchange rate as an additional monetary policy instrument in order to ease the monetary conditions after the lower bound on interes rates had been reached. The value of the koruna went significantly down to approximately CZK 27 to the euro on the day the exchange rate commitment was announced. The Exchange rate remained stable for quite some time at about CZK 27.5 to the euro without further foreign exchange interventions. Due to the favourable

economic growth, the koruna’s exchange rate started to appreciate towards CZK 27 to the euro in 2015 Q2. The CNB maintained it just above this level in Q3 using further interventions despite continued appreciation pressures. „The foreign exchange commitment will apply until conditions are created for sustainable fulfillment of the inflation target at 2%.“ ("Assessment of the Fulfilment of the Maastricht Convergence

Criteria and the Degree of Economic Alignment of the Czech Republic with the Euro

Area - 2015.")

The Czech Republic’s September 2003 Euro-area Accession Strategy and its August

2007 update state that the Government and the CNB agree on staying in ERM II for the minimun required period only, meaning that the Czech Republic ought to enter the

ERM II only after it has achieved a high degree of economic alignment and after established conditions so it can introduce the euro right after the assessment of the exchange rate criterion.

Figure 4: Nominal CZK/EUR exchange rate

Impacts of Implementing the Euro in the Czech Republic

In this chapter, the arguments for and against the adoption of the common European currency for the Czech Republic will be demonstrated to illustrate examples of preparedness of the Czech economy and its possible impacts on benefits and costs for

Czech’s economy. Moreover, it will describe functioning of the monetary policy, as a tool that belongs to the Czech National Bank (CNB) competency that can influence

Czech’s economy and then its loss of usage in the national economy and transfer competencies to the supranational level with the enter into the Eurozone.

Implementation of the common currency can have positive but also negative impacts on the country’s economy. The impacts can be divided into four groups: direct, indirect, one-time, and permanent. Direct impacts are immediately caused by the implementation of the euro, or right before the date of adoption. Indirect impacts cause using direct ones and implementing the common currency is one of the factors affecting the final value of the followed quantity. They appear in the medium-term or the long-term horizon after adopting the common currency. One-time impacts occur only once, on the other hand, the permanent ones can be observed in the economy over a long period.

We can see the categorization of the impacts in the Table 5 below. (The medium- term horizon is meant by period up to five years after the adoption, the long-term horizon is meant by the period beginning with the sixth year after the adoption.)

Table 5: Categorization of Impacts of the Implementation of the Common

Currency

Direct Impacts Indirect Impacts

Benefits Benefits

- growth in foreign trade (permanent, - limited exchange rate risk (permanent, medium-term/long-term horizon, after immediate, after implementation) implementation)

- decrease of transaction costs - inflow of foreign investments

(permanent, immediate, after (permanent, medium-term/long-term implementation) horizon, after implementation)

- lower costs to procure capital - stabilization of public finance

(permanent, medium-term/long-term (permanent, medium-term/long-term horizon, after implementation) horizon, before and after implementation)

- higher transparency of prices

(permanent, medium-term/long-term horizon, after implementation)

Costs Costs

- loss of autonomous monetary policy and - long-term growth of price level exchange rate policy (permanent, (permanent, immediate, after immediate, before and after implementation) implementation)

- immediate growth of price level (one- time, immediate, after implementation)

- administrative and technical costs of transition to euro (one-time, immediate, before and after implementation)

- specific costs of the bank sector (one- time and permanent, immediate, before and after implementation)

(LACINA, 2008)

Direct Benefits from Implementing the Euro

Direct benefit (positive impact) on national economy represents the limitation of exchange risk, reduction of transaction costs, lower costs to procure capital, and higher transparency of prices.

Limitation of Exchange Risk

The volatility of the exchange rates affects the companies participating in the foreign trade, the investors and the public sector in the settlement of financial transactions in euro, and also the citizens who exchange crowns for euros when travelling to the countries of the Eurozone.

The companies are influenced by the change of exchange rate in the international trade. However, the firms can prevent themselves with various ways. The companies

can take out supplementary insurance against the exchange rate difference, or they can use some of the tools of the financial market, for instance, currency options. It considerably increases their transaction costs. (LACINA, 2008)

A Czech citizen when travelling abroad is subjected to both exchange fee

(transaction cost) as well as any changes in the exchange rate CZK/EUR. Appreciation of the Czech koruna will mean a loss for the citizen because at the beginning of the journey the euro had higher value than the Czech koruna and in the end it was the opposite.

Ex. If a married couple exchange 10 000 CZK for the Euro (exchange rate in 2009 –

28 CZK/EUR) they will go abroad with 357,14 EUR. They spend only 300 EUR and the rest they take home and keep for the next holiday. If the Czech koruna will be appreciated, during the following years, to 27 CZK/EUR then the value of the 57,14

EUR will be only 1542,78 CZK instead of 1599,92 CZK. Thus, the married couple will lose out on this. (LACINA, 2008)

The volatility of exchange rates also affects investors and the public sector in the moment of implementation of euro financial operations. We can use an example of drawing the European Structural Fund and the Cohesion Fund. (LACINA, 2008)

Elimination of exchange rate risk towards euro represents a permanent and immediate benefit for the national economy. Limitation of exchange rate risk is one of the main factors that set off series of indirect benefits. We can expect growth in foreign trade, capital inflows into the country, deeper integration of financial markets and the stabilization of public finances. By raising foreign trade the higher employment rate can be expected, and living standards in the Czech Republic will be increased as well.

(LACINA, 2008)

Reduction of Transaction Costs

Another permanent and immediate benefit for the Czech Republic after adopting the euro is transaction cost savings. There will be a reduction of the financial costs that are connected to exchange fees as well as administrative transaction costs. The administrative transaction costs mainly include the cost of managing accounting systems to process data in multiple currencies, management of foreign exchange, personal expenses for employees in charge of foreign exchange operations, and so forth.

Transaction costs cannot be completely eliminated, since many of the entities will continue realize their financial transactions in multiple currencies. Great importance, however, will have transaction cost savings primarily for businesses that deal only with the countries of the Eurozone. (LACINA, 2008)

Lower costs to procure capital

Expenses on procuring capital relate to the prices of financial products that are available on the financial markets. An indicator of these expenses is the interest rate. A condition for being a member of the Eurozone is to adopt the common monetary policy, which tries to ensure the price stability with an aim to keep the inflation under 2 percent in the medium-term horizon. With the low inflation, the European Central Bank (ECB) can keep the interest rates low. When the Czech Republic enters the Eurozone, there is an expectation of low interest rates that will enable easier access to the capital.

(LACINA, 2008)

The Czech Republic had a long-term lower interest rates than the European Central

Bank. However, the interest rates in the commercial banks are higher than the interest rates in the Eurozone. It is due to the higher margins between the borrowed and loaned

rates. Entering the Eurozone comes with the integration of financial markets, and thus, the competition will be bigger, which can lower the margins. It will also be easier to have access to new products of financial markets, which will lead to the reduction of the costs to procure capital for businesses. Lowering costs to procure capital can have permanent benefits for the Czech’s economy, which will occur in the medium-term horizon and the competition will increase on the Czech financial market. (LACINA,

2008)

Higher Transparency of Prices

Prices of goods and services in the Eurozone are easy to compare. Consumers do not have to recalculate the prices and they can choose the most affordable product offered by the sellers in any Member State of the EU. This fact will lead to a positive impact on the competition in the single internal market of the EU leading to a convergence or an alignment of prices of goods and services. An effect of bigger transparency of prices can be expected in the long-term horizon. For the Czech Republic’s economy is greater transparency in prices lasting. (LACINA, 2008)

Direct Costs from Implementing the Euro

Direct costs are the negative impacts on the economy after implementing the common currency. Possible direct costs can be: a loss of autonomous monetary policy and exchange rate policy, an immediate growth of price level, administrative and technical costs of transition to the euro, and specific costs of the bank sector. (LACINA,

2008)

Loss of Autonomous Monetary Policy and Exchange Rate Policy

The Czech National Bank uses a variety of tools of monetary and price-fixing policy to keep the stability of the Czech economy. During the adverse development of economic cycle, in the time of recession, the CNB accepts the expansionary policy in order to increase the amount of money in the cycle so the economy can be revived. To achieve it, the CNB lowers the reserve requirements, interest rates, purchase of securities and bonds. By lowering the reserve requirements (the commercial banks must have these reserve requirements deposited in the central bank), the amount of money in the cycle will increase. Thus, the commercial banks will have more money to lend to clients. For the clients, this money is cheaper and also easier to access, so they can afford to invest in businesses, to buy machines for production, and so forth; therefore, the economy will slowly get out of the recession. (LACINA, 2008)

The capital is cheaper when the interest rates are lower, and the money in the cycle increases. The commercial banks will buy the cheap capital from the central bank and then the clients from the commercial banks.

In addition, the CNB also executes the exchange rate policy in order to stabilize the macroeconomic environment of the country. The CBN can strengthen the Czech koruna by buying it on the foreign exchange markets. The Czech koruna will be more valuable and more expensive abroad. The crown will appreciate. On the contrary, when the CNB will be selling the Czech koruna and buy another currency, the Czech currency will depreciate. In the short-term, depreciation will strengthen the competitiveness of domestic exporters, because their products will be cheaper than the price of products in other currencies. If the export rises, then there is an expansionary policy. There is a real product growth as well as inflation growth. (LACINA, 2008)

Instruments of monetary and exchange rate policies represents, in the short period of time, the important factors in maintaining or restoring macroeconomic stability. By entering into the Eurozone, the Czech Republic would lose the opportunity to use these tools as it will have to accept the exchange rate and monetary policy of the euro system, the CNB will be only one member of the decision-making mechanism, which comprises the ECB and the national central banks of all EU Member States that have adopted the euro.

The loss of monetary and exchange rate policy reduces the importance that the

Czech National Bank is not the only player who can significantly affect the amount of money in the economy or the exchange rate level. There is also the important role played by fiscal, or budget, state policy when using the system of public budgets leading to the mass redistribution of money, and thus, leading to the influence of the economic growth, employment, and the price level stability. (LACINA, 2008)

Immediate Growth of Price Level

With adopting the Euro, the citizens are most worried about the price growth. There was a survey in March 2007, done by the European Commission, and it showed that

79% of the Czech respondents expressed their concerns of price increase due to the

Euro adoption.

Conversion of the national currency to the euro is performed with the conversion coefficient, which is in the national legislation and it is committed. It is expressed as a national currency per Euro and it is determined to six valid digits (e.g. 1.9558

DEM/EUR). Rounding takes place on the nearest (euro) cent, thus, the conversion would not lead to a significant price level growth. (LACINA, 2008)

An exception could be traders, who will round the prices up or down for the marketing purposes, so they have more attractive prices.

The immediate growth of price level would mean an instantaneous one-time cost that will be reflected half year before up to one year after the introduction of the Euro.

Administrative and Technical Costs of Transition to Euro

Various economic subjects will be facing the administrative and technical costs of transition to Euro. Those subjects will mainly be: businessmen, financial institutions or institutions of the public sector. Up to 60% of costs will be the IT expenses. The necessary thing to do is to adjust software programs for accounting, tax returns, invoicing, financial management, and so forth, so these programs will be able to work with two currencies at once. This is mostly significant for the half year before the adoption of the Euro and one year after the adoption. Subsequently, they will work only with one currency, with the Euro. All prizes in stores, catalogues, on the internet, invoices, payslips, account statements, etc. will be displayed in both currencies, the

Czech koruna and the Euro, according to the conversion coefficient.

Another technical costs will increase for the businessmen or the municipal authorities during the fourteen-day period of dual circulation, which will pose greater demands on their handling and storage. (LACINA, 2008)

Another costs will be for the training of employees, who receive and issue money at work. They will be trained on how to use the Euro, how to recognize the real elements on the Euro, and how to work with the software programs.

It is also essential to spread the information about the implementation of the Euro and it also costs something. The government will have to realize a huge informational campaign related to the lots of topics providing the accurate date of the Euro adoption,

period of the dual circulation of both currencies, look of the euro coins and the bank notes, conversion coefficient between the Czech koruna and the Euro, etc.

The administrative and technical costs of transition to Euro will mean one-time costs for the Czech Republic. (LACINA, 2008)

It is important to point out, that there already were similar arrangements in 1992 when there was a transition from the Czechoslovak koruna to the Czech koruna.

Specific Costs of the Bank Sector

A bank sector will also face the specific costs. CNB will carry the costs related to the production and distribution of the Euro bank notes and coins. The pulling off the Czech koruna from the cycle and its liquidation goes with another costs. The commercial banks will have to adjust their software so they can display figures in euros, the cash machines for issuing the Euro, the exchanging the Czech koruna for Euro for free, etc.

All of these aspects are one-time costs. (LACINA, 2008)

With the transition to a common currency, the banks will have permanent costs in the form of limiting the intake of the foreign exchange transactions.

On one hand, foreign exchange transactions represent the income of banks. On the other hand it represents costs for the subjects, thus, it there will not be any costs for the economy as a whole.

Indirect Benefits and Costs

After implementing the euro, the direct benefits and costs immediately induce further indirect benefits and costs. (LACINA, 2008)

Affected inflation

The introduction of the euro can bring, for instance, inflation. As mentioned earlier, the Czech National Bank is responsible for the inflationary policy. By entering into the

Eurozone, its powers will go to the European Central Bank. If inflationary pressures affect only our country and the surrounding regions, but do not affect the majority of the euro area, in this case, the ECB will not actively intervene. This task belongs to individual governments, which must adopt some fiscal measures in case of inflationary threat. One of the measures can be, for instance, restriction of government spending.

(LACINA, 2008)

The aim of the ECB is price stability expressed by 2% of inflation rate. When estimating the potential future development of inflation in the Czech Republic, it is necessary to learn from the development of inflation in the current Member States in the period before and after the introduction of the euro. The average inflation in the second half of 2008 was closer to the objective imposed by ECB (value of 2%). Due to the global economic crisis, the values of inflation in some EU countries were even negative.

(LACINA, 2008)

Some economists argue that the inflation can be largely created by its own economy.

It can be caused by the population’s expectations. If, for some reason, the population has a pessimistic expectations resulting perhaps from the bad experiences from the past and the central bank will not convince them about the contrary, their expectations may be reflected in their actions. Tenants will rise the rents, banks will increase the interest rates, the unions will want to enforce higher wages and so forth. Hence, inflation expectations will result in a real inflation. If the adoption of the euro would raise pessimistic expectations for the population, it could realistically occur after the implementation of the euro. Therefore, the population should be properly informed

about the whole issue concerning the euro in order to avoid any possible concerns and speculations of the future development. (LACINA, 2008)

Influence on the economic growth

One of the main motives for introducing the euro is its positive impact on the economic growth. We consider the growth of gross domestic product (GDP) as the indicator of the economic growth. The GDP provides information about the performance of the economy, and secondly, in the long-term it reflects on the standard of living.

The long-term positive economic growth has an impact on increasing the income of the population, which are directly proportional to the quality of their lives. Citizens of the Czech Republic, in comparison with other EU Member States, have a lower median income, which is why the introduction of the euro seems to be right move. (LACINA,

2008)

It cannot be accurately determined whether the adoption of the euro will have a positive or negative effect on the long-term economic growth in the country. The analysis of the future can be based on logical considerations and economic theories or experience with the introduction of the euro in other countries of the Eurozone.

The economic growth can positively affect the process of deepening international cooperation and the elimination of foreign trade barriers. The introduction of the single currency will bring benefits in the form of reduction in transaction costs, increased price transparency, and to minimize foreign exchange risks. (LACINA, 2008)

The small economies showing a higher degree of openness, including the Czech

Republic, have greater benefit from involvement in international trade. According to the

Stuart Mill’s theory of reciprocal demand, exports from the small economy have far

greater chance of finding its consumers abroad than the major economies. The reason is that the foreign market is bigger, and hence, the demand is higher compared to the domestic market. Removing barriers of foreign trade comes with the offer of foreign goods as well. However, the demand for foreign goods in the Czech Republic is small in comparison with the large foreign “menu”. Thus, the export earnings will grow and the import costs will decrease, resulting in increased net exports. Growth in net exports is one of the positive factors affecting the economic growth. Therefore, the conclusion can be that the adoption of the common currency and the removal of barriers to foreign trade, the Czech Republic will have benefits in terms of growth in net exports, which positively affects economic growth. (LACINA, 2008)

Influence on the purchasing power of the population

The Czech Republic is a country that has a less advanced economy compared to the other countries in the Eurozone. The Czech economy is characterized by lower levels of product formed per capita and lower price levels. Examples can be seen when comparing the domestic and foreign prices of products, especially services, which are not subject to international competition, such as a marketable product. However, with the development of our economy, there is an increase in labor productivity, increasing disposable income of the population, the growth of prices of goods and the gradual alignment of price levels between economies. This phenomenon occurs in the longer horizon. (LACINA, 2008)

Transferring the Czech koruna to the euro will take place at the conversion rate, the amount of which should accurately reflect the market equilibrium condition. In compliance with the set rules, there should not be a reach of disposable devaluation of savings and pensions of people during the conversion.

The purchasing power of the population may continue to be threatened by the unserious behaviour of traders who would not respect the rules of rounding currency and they would take advantage from the transition to increase the prices. This would increase the citizens’ spending at the current income. This risk should be avoided by approving a series of measures, such as a Code of Ethics, or other tools that were used by the Eurozone members.

Finally, the risk of reduced purchasing power of citizens can cause a rapid rise in the price level after entering the Eurozone. It is a risk, which is reflected in the long-term and which resulted from the very characteristic of the Czech economy as a country converging to the maturity of the Eurozone countries. (LACINA, 2008)

Impacts of Financial Crisis on the Euro Introdution in the Czech Republic

The global financial crisis has had a significant impact on euro adoption strategies in

Central Europe, in this case, the euro adoption in the Czech Republic. It had reached to the widened public finance deficit and to slow catching up with the euro zone price level. The financial crisis and the recession have made the euro adoption more complicated and it have also delayed the adoption. In the aftermath of the recession, the fulfillment of both the criterions has improved. The government‘s last rejecting standpoints on the date of the euro adoption is reasoned with impacts of the vanishing financial crisis and economic recession.

To be more specific, with the domestic economic problems, such as: interruption of convergence of the domestic price level with prices in the euro area, worsening condition of the public finance, not improving structural characteristics of the labour markets. (Helísek,

2011) Another standpoint is the fiscal problems of a number of the euro area countries leading to uncertainty in international financial markets, investors‘ fear, potential reveals in flows of short-term capital, and endangered stability of the crown if incorporated into ERM

II. (Svetlosakova, 2016)

When the international financial crisis hit Central Europe in October 2008, the CNB cut rates to 2.75%, at that time it was the lowest rate in the EU and created new facility to provide more liquidity by extending two-week loans in exchange for state bonds as collateral. The money and currency markets were scarcely affected by the crisis. As the aversion of risk to the region intensified, yields increased and the bond market in the Czech

Republic experienced some liquidity problems. The Czech sinancial system was claimed to be less vulnerable than the neighbor countries, however, the interest rates were cut significantly. The Czech Republic was affected by the financial crisis by indirect effects, such as: dependency on exports, foreign bank ownership, strong links with the eurozone,

and integration into the global market – these four aspects are rhather channels of

instability. As the EU demand diminished, exports fell and the trade deficit increased. The

decline in external demand also corresponded with the domestic decline in consumption

that resulted in diminished wages and production and increased unemployment. From the

industrial perspective, the most affected industry in Central Europe were automobiles,

especially in the Czech Republic.

„The common currency has acted as a valuable shield from exchange rate turbulences for

those Member States whise currency is the euro“. (Commission of the EC, 2010)

The stabilizing impact of the euro by empiric evidence can be documented by assessment

of volatility of exchange rates. There will be an assessment of : (Helísek, 2011)

• exchange rate CZK/EUR which has the crucial influence on the foreign trade of the Czech

Republic

•

• exchange rate USD/EUR which is the decisive exchange rate for the euro area countries

The table below illustrates the standard deviation of the exchange rates in individual

months of the specific period of time (in currency units) and the variation coefficient (in

%).

Table 6: Volatility of exchange rates CZK/EUR ans USD/EUR

(Helísek, 2011)

As can be seen from the Table 6, there are three examined periods. Firstly, it is 12 months of the pre-crisis period from September 2007 to August 2008. Secondly, it is the crisis period from September 2008 to the end of 2009 (16 months). And thirdly, the following 12-month period of 2010. The table presents various volatility of exchange rates in individual periods. Surprisingly, during the crisis, the rates did not have the highest volatility. Moreover, there can be seen almost double volatility measured by the variation coefficient of CZK/EUR (4.34%) compared to USD/EUR (7.24%) for the whole monitored period, except the pre-crisis period. The euro area members’ foreign trade with third countries (rate USD/EUR) was therefore subject to a higher instability than the foreign trade of the Czech Republic with the euro area countries.

The Mortgage Crisis in the US

The U.S. subprime mortgage crisis in 2007 is considered to be the first cause of the global economic crisis which gradually spread to the global financial crisis. This situation was enhaced by the high price of the crude oil in the first half of the year 2008 which was

caused by the weak dollar and by the high demand in China before the Olympics. In the fall

2008, financial crisis fully erupted which led to lowering the price of the crude oil, fall in equity markets, and financial problems also affected the world’s big banks. It led to bankruptcy of many banks as well as financial institutions, such as: Lehman Brothers,

Bearn Stearns, AIG (American Insurance Group), Indy Mac, and so forth. In the history of the US, it is considered to be the worst economic crisis since the Great Depression (1929-

1933). Due to the strong US economy and its interconnected markets, the crisis hit the whole world. (Smith, 2011)

Impacts of the Global Financial Crisis on the Czech Republic

The global financial crisis hit the Czech Republic during the year 2008. It appeared predominantly on collective redundancies in industries, tightening conditions for mortgages and finance for developmet projects, reducing exports, and reducing consumer spending.

Czech banks have been more careful in lending since then. Czech government tried to help especially entrepreneurs and investors. Ministry of finance of the Czech Republic sought to lower VAT rate for restaurants and hairdressers. The biggest impact, that the global economic crisis caused, was on the Czech’s industry. Many firms were fighting with diminishing numbers of contracts and they had a negative view about the further development. The reason why companies were afraid of doing some business as usually was that they did not expect turnover until 2010.

On the other hand, the Czech Republic was maybe in a slightly better position for different reasons in comparison to other countries. For instance, it did not suffer from expensive exports. Or when it comes to the banks in the Czech Republic, in 2009, they „recorded sound profit: return on equity amounted 26.4 percent, and the return of assets tood at 1.5 percent.

This resilience reflected timely policy actions, a sound regulatory system, and prudent bank lending.“ („Crisis-proofing financial integration: Czech Republic“)

Czech Republic’s banking sector has learned from the previous financial difficulties during a smaller crisis in the 1990s and that is why Czech banks survived.

Comparison between the Czech Republic and Slovakia

The Introduction of the Euro in Slovakia

The Czech and Slovak nations lived in a common country from 1918 to 1992. In May

2004, the Czech Republic and Slovakia became the EU countries together, nevertheless since then, the two countries went different ways towards the Eurozone. While the Czech Republic has not yet chosen a specific date to enter the Eurozone, Slovakia became the 16th Member

State of the Eurozone on the 1st January 2009. It was the first country from the former

Warsaw Treaty Organization to join the Eurozone. Moreover, it was the second country among the new Member States after Slovenia.

Already in Slovakia’s negotiations to join the EU, it committed to become a member of the Economic and Monetary Union, and after fulfilling the criterias it would adopt the euro.

The National Bank of Slovakia together with the Minister of Finance SR already approved the euro adoption stratégy in 2003. The main objective was the introduction of the euro as soon as possible after meeting the Maastricht criteria. In 2005, the National Bank of Slovakia with the Minister of Finance SR developed a plan for adopting the euro, eith whom the actual preparations started, which resulted in the subsequent euro adoption.

Slovakia failed to meet the Maastricht criteria when joining the EU, except the criterion of long-term interest rates. However, gradually with the right setting of the economy policy,

Slovakia managed to fulfill all the criteria. It was necessary to implement a number of significant structural reforms. It was especially the public finance reform, harmonization of the tax system, the pension system reform, changes in the field of education, health, social policy, and the labor market. The adopted measures led to an increase in long-term stability of the economy and the long-term sustainability of the public finance. In line with the price

stability, it was still needed to complete the pricing deregulation, which could create additional pressures on inflation. The Maastricht criteria were not fulfilled individuallly because their values influenced each other. As indicated in the convergence reports of the

European Central Bank and the European Commission, the criterion of long-term interest rate was already fulfilled when Slovakia joined the EU, the criterion of inflation and exchange rate stability was fulfilled from December 2007, and the fiscal criteria of public deficit and public debt was fulfilled in may 2008. The date of the entry into the Eurozone was first established in 2009. However, Slovakia already fulfilled all these criteria before the expected date with a great reserve. Meeting all the criteria was confirmed by the convergence reports of the ECB and the European Commission from May 2008. On the 1st January 2009, the euro became the official currency in Slovakia. Experience with the euro adoption in

Slovakia can be valuable and inspiring for the Czech Republic.

The introduction of the new currency was carried out according to the „big bang scenario“, when the dual circulation of the Slovak koruna and the euro was defined for only two weeks. Thanks to proper preparations, this two-week period occured as sufficient prove for a smooth transition to the new currency. In order for Slovakia to avoid concerns about the rising prices, it has taken a number of measures. The so-called Code of Conduct was introduced as well as the frequent inspections of Slovak Trade Inspection, and the price action committees or activities of consumer associations.

The Code of Conduct represented a voluntary commitment of traders to fully respect the rules for conversion of prices from the national currency to the euro and not to abuse this transition to increase proces. The Slovak Trade Inspection controlled the correctness of the dual pricing. Failure to comply the conditions resulted in punishment by sanctions. The

development of prices were also monitored by the government through the established

Monetary Affairs.

The European Commission has evaluated the adoption of the euro in Slovakia positively.

Objectively, it was not associated with any inflationary impact. The well managed information campaign, focusing on all kinds of subjects, also contributed to the smooth running.

The outbreak of the financial and economic crisis complicated the assessment of benefits of the new currency for the Slovak economy. Moreover, the use of the euro was still too short for its effects to occur. The influence of the euro adoption in Slovakia can be estimated by comparing the development of similar economies that haven’t adopted the euro. The so- called Visegrad group countries can be taken into consideration.

The Visegrad group (V4) is an alliance of four Central European countries which closely cooperated on their path towards European integration. On the 15th February 1991, it was founded as a Visegrad Triangle. The countries of the Visegrad Triangle were: Hungary,

Poland, and the Czech and Slovak Federal Republic. The fall of the communist regime was a need for close cooperation; it was essential to their transition from a totalitarian regime to a free democratic society. After the dissolution of Czechoslovakia the alliance became the

Visegrag Group. The foreign policy cooperation between these countries was even greater after joining the EU on the 1st May 2004.

The economic comparison between Slovakia and the Czech Republic

The Czech economy is more advanced compared to the Slovak economy. Economic maturity of the Czech Republic in 2006 was around 77% of the average of the EU-25 countries, while the economic level of the Slovak Republic was only 58%. Thus, it can be expected that the process of price settlement will develop faster in the Czech Republic than in Slovakia.

Gross Domestic Product

Adopting the euro in the period of economic crisis and the high exchange rate were very bad for Slovak exporters. Moreover, they could not devaluate their national currency in order to avoid the „hit“ of recession like in the Czech Republic, thus, as can be seen from the table below, the degree of recession of the Slovak economy was larger than that of the Czech

Republic in 2009. (Li, 2016)

The Czech economy was affected by the global financial crisis less thanks to its healthier financial system and better macroeconomic situation, higher economic growht, low inflation, more balanced international payments, small proportion of foreign currency debt, and so forth.

Table 7: Comparative Czech and Slovak real GDP growth rates during 2008-2014 (%)

However, as the impact of the global financial crisis gradually subsided, the Slovak economy has recovered and the recovery was even stronger than that in the Czech Republic.

(Li, 2016) As the table shows, Slovakia has maintained a positive growth trend from 2010 to the present. Furthermore, according to the European Commission’s report, the economic growth rate of Slovakia will significantly exceed the EU average in 2016 and in the same year the economic growth rate of Slovakia i salso expected to bet he second best in the EU.

("Economic Workshop: Slovakia's Growth Model.", 2016)

From 2012-2013, the Czech economy fell by 2 percentage points because of the influence of the Eurozone debt crisis and the stringend fiscal austerity measures. At the end of 2013, the new government took a series of measures to help economic growth, there were series of interventions in the foreign exchange market executed by the CNB, the strong growth of the automotive industry also helped the economy. Thanks to these aspects the Czech economy began to expand.

Foreign Direct Investment (FDI)

Slovakia wanted to attract more foreign direct investment through the euro adoption.

There were two reasons: firstly, exchange rate risks and transaction costs would be lower; secondly, sovereign credit rating would be raised. (Li, 2016) In 2009, the FDI in both countries declined because of the global financial crisis. In 2010, due to better coping with the global financial crisis and low level of foreign debt, the Czech Republic was the most successful in attracting foreign direct investment in comparison with other countries from

Central and Eaastern Europe. Czech’s total FDI accounted for 4% of GDP, while in Slovakia it was only 1% of GDP. (Li, 2016) In 2011, the FDI in Slovakia was 4 times higher than in

2010. Due to the Eurozone debt crisis, the Czech Republic attracted less FDI, which fell by

26% compared to 2010. (Li, 2016) In 2012, Slovakia managed to avoid the second wave of recesion thanks to the expansion of the foreign investors who were especially interested in the automotive industry. The euro introduction was the main reason for the investors to invest in Slovakia.

However, the Czech Republic attracted much higher FDI per capacita than Slovakia from

2009 to 2013 (except 2011). So the conclusion of this section is that the euro adoption failed to help Slovakia to attract more FDI than in the Czech Republic. (Li, 2016)

The Overall Financial Situation

In the Maastricht criteria, the public debt-to-GDP ratio is predetermined as below 60%.

("Who Can Join and When?", 2015) As we can see from the table, the Czech public debt-to-

GDP ratio was 28.7% and the Slovak public debt-toGDP ratio was 28.2% so both countries were well below the reference value. Even though the numbers were increasing in the following years, they also stayed well below. Nevertheless, in 2014 the public debt-to-GDP ratio started to decline in both countries.

Table 8: Comparative Czech and Slovak public debt-to-GDP ratio during 2008-2014

(%)

The reference value specified in the Maastricht convergence criteria for the government budget deficit is less than 3%. ("Who Can Join and When?" , 2015) So we can see (Table 9) that in 2008, both countries were below. However, in the following

year, the government budget deficit in both countries increased dramatically, reaching

5.5% and 7.9%. In order to reduce the goverment budget deficit, both governments adopted state budget austerity plans. As a result, both contries are below the reference value.

Table 9: Comparative Czech and Slovak budget deficit to GDP ratio during 2008- 2014 (%)

After the crisis, the Czech Republic implemented a fiscal consolidation policy faster and earlier than Slovakia, thus, Czech public finance was improved more quickly. (Li,

2016)

Inflation rate

Thanks to the weakening of the global economic activity and the consumer demand impact on the prices in Slovakia, it had no problems with the increase of the inflation after adopting the euro.

Table 10: Comparative Czech and Slovak harmonised index of consumer prices (HICP) during 2009-2014 (%)

Between 2009 and 2010, the inflation rate in Slovakia was quite low, owing mainly to weak domestic activity. However, it sharply increased in 2011 and 2012 due to increases in indirect taxes and food prices and higher oil prices. Then the inflation rate declined due to the weaker domestic demand and food and fiel prices on global markets continued to be moderate. During those years, the inflation rate in the Czech Republic was quite similar to the Slovak inflation rate.

Unemployment rate

After joining the EU, the Czech unemployment rate decreased, with the expansion of the labour market, from 8.3% to 4.4% (2004-2008). Slovakia had more difficulties with the unemployment, especially after splitting up in 1993. (Li, 2016) As can be seen from the Table 11, the unemployment rate of Slovakia is twice the level of that of the Czech

Republic.

Table 11: Comparative Czech and Slovak unemployment rate during 2009-2014

(% of the labout force)

The euro adoption was not helpful to the Slovakia’s unemployment reduction.

After gaining independence from the Czech Republic, Slovakia was a bit behind the

Czech Republic in terms of political and economic changes and integration into the

European economy. After joining the EU, both countries committed to the adoption of the single currency, however, they choose different path to achieve that committment.

In order to fulfill the Maastricht convergence criteria, Slovakia implemented reforms in related fields very early and it was successful. On the other hand, the Czech Republic’s government was replaced in 2006 so the set date, years 2009-2010, to join the Eurozone was also delayed and the new date for euro adoption hasn’t been announced yet.

Moreover, the euro adoption was even less „attractive“ for the Czech Republic with the

Eurozone debt crisis in the end of the 2009.

The benefits of Slovak’s implementation of the euro has not yet been fully displayed in seven years because of the difficulties from the beginning when facing the global financial crisis followed by the Eurozone debt crisis. Thus, it is difficult for other

European countries to state whether the introduction of the euro will boost their economic status and growth potential or not.

Nevertheless, the Czech Republic’s overall economic performance is better than

Slovak’s.

Conclusion

The attempts to unite Europe had already been there since time immemorial. However, in the past, the desire of various rulers predominated over larger territories and power. After the WWII, the modern European integration began in terms of bringing nations together and economic cooperation. As a result of this long process, Europe has become an important player on the global key economies. The efforts to unite Europe also resulted in the creation of monetary union and a common currency, which has already been adopted by

19 Member States out of 28.

The common currency represents a number of advantages to the European countries. From the outside view, the national economies are more attractive and credible thanks to the euro.

Moreover, it helps to increase their competitiveness. The single currency clearly contributes to the effective functioning of the common European market. There is elimination of transaction costs of currency conversion, elimination of exchange rate risks associated with currency fluctuations, there is greater transparency in prices, the growth of foreign trade and investment.

A possible disadvantage from euro adoption appears to be the loss of independent monetary policy, which will subsequently be transerred to the supranational level. The problem can occur during periods of high volatility of economic cycles in the euro area.

The Eurozone countries can no longer use their own monetary policy to influence the unfavorable economic development. The loss of independent monetary policy in the Czech

Republic reduces the importance that the CNB is not the only player who can influence the state of economy. In small open economies, such as the Czech Republic, the investment inflows and outflows can have far greater impacts on the economy than the CNB

interventions. From this perspective, the advantages outweigh the disadvantages of the euro adoption in the Czech Republic.

For the Czech economy, it will be interesting and inspiring to observe the development of the Slovak economy, which is in its structure very similar to the Czech economy and it is already a part of the Eurozone. However, the assessment of the advantages of a common currency is complicated because of the global financial crisis and the Eurozone debt crisis which affected Slovakia a lot at tht time. The economic growth after the crisis showed a faster pace in the euro area compared to countries that are not part of it.

So the question is not whether the Czech Republic should adopt the common European currency or not, since the accession to the EU has already committed it to this step. The question is when is the right timing. This relates not only to the fulfillment of compulsory

Maastricht convergence criteria, but also to the sufficient alignment with the business cycle with the euro area. Economists forecast the introduction of the euro in the Czech Republic around 2020. The final word in this issue will have government because the euro is not only an economic project, but also political. The euro adoption in the Czech Republic hasn’t been a strong political priority so far. We will see how the „new“ government will face this problem.

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