sign in sign up
<<
Home , Belgian franc, European Monetary System, Luxembourg franc

E UROPEAN M ONETARY I NSTITUTE

CONVERGENCE REPORT Report required by Article 109j of the Treaty establishing the European Community

March 1998 © European Monetary Institute, 1998 Postfach 16 03 19, D-60066 Frankfurt am Main

All rights reserved. Photocopying for educational and non-commercial purposes permitted provided that the source is acknowledged.

ISBN 92-9166-057-4

Printed by Kern & Birner GmbH + Co., D-60486 Frankfurt am Main

II Contents

Introduction and summary 1

1 Convergence criteria 1.1 Framework for analysis 3 1.2 The state of convergence 4

2 Compatibility of national legislation with the Treaty 2.1 Introduction 11 2.2 Independence of NCBs 12 2.3 The legal integration of NCBs in the ESCB 13 2.4 Legislation other than the statutes of NCBs 13 2.5 Compatibility of national legislation with the Treaty and the Statute 13

3 Summaries country by country 14 14 15 Greece 16 Spain 16 17 18 19 19 20 Austria 21 Portugal 21 Finland 22 Sweden 23 23

Chapter I Convergence criteria

1 Key aspects of the examination of economic convergence in 1998 32

2 Examination of the key aspects of convergence in 1998 # 40 Belgium 40 Denmark 57 Germany 73 Greece 89 Spain 107 France 123 Ireland 138 Italy 153

# Each country sub-section deals in turn with: price developments; fiscal developments; exchange rate developments; long-term interest rate developments; and ends with a concluding summary.

III 2 Examination of the key aspects of convergence in 1998 (continued)

Luxembourg 171 Netherlands 183 Austria 199 Portugal 215 Finland 231 Sweden 246 United Kingdom 262

Annex 1 Developments in the private ECU markets 278

Annex 2 Statistical methodology on convergence indicators 282

Chapter II Compatibility of national legislation with the Treaty

1 General observations 1.1 Introduction 288 1.2 Scope of adaptation 288 1.3 Member States with a derogation, Denmark and the United Kingdom 290

2 Independence of NCBs 2.1 General remarks 291 2.2 Institutional independence 292 2.3 Personal independence 293 2.4 Financial independence 295

3 Legal integration of NCBs in the ESCB 3.1 Statutory objectives 296 3.2 Tasks 296 3.3 Instruments 296 3.4 Organisation 296 3.5 Financial provisions 296 3.6 Miscellaneous 297

4 Legislation other than the statutes of NCBs 4.1 297 4.2 Coins 297 4.3 Foreign reserve management 297 4.4 Exchange rate policy 298 4.5 Miscellaneous 298

IV 5 Country assessments Belgium 298 Denmark 299 Germany 299 Greece 299 Spain 300 France 300 Ireland 300 Italy 301 Luxembourg 301 Netherlands 302 Austria 303 Portugal 303 Finland 303 Sweden 304 United Kingdom 304

Annex Compatibility of national legislation, including the statutes of national central banks (NCBs), with the Treaty/Statute, with particular emphasis on adaptations under Article 108 of the Treaty in view of Stage Three 305

Glossary 353

V

Introduction and summary Introduction and summary

This Report examines the achievement of a adoption of a single and high degree of sustainable convergence (see recommend its findings to the Council, Chapter I) as well as compliance with the meeting in the composition of the Heads statutory requirements to be fulfilled for of State or Government; national central banks (NCBs) to become an integral part of the European System of the European Parliament shall be consulted Central Banks (ESCB), with particular and forward its opinion to the Council, emphasis on independence (see meeting in the composition of the Heads Chapter II). In producing this Report, the EMI of State or Government; and, finally, fulfils the requirement of Article 109j (1) of the Treaty establishing the European the Council, meeting in the composition Community (the Treaty) to report to the of the Heads of State or Government, EU Council on the progress made in the shall (on 2 May 1998) confirm which fulfilment by the Member States of their Member States fulfil the necessary obligations regarding the achievement of conditions for the adoption of a single economic and monetary union. The same currency, acting by a qualified majority and mandate has been given to the European on the basis of the recommendations of Commission and the two reports have been the EU Council, and taking into account submitted to the EU Council in parallel. Both the two reports and the opinion of the reports represent the starting-point of the European Parliament. procedure according to Article 109j (2) and (4), which will entail the following additional Denmark, in accordance with the terms of steps: Protocol No. 12 of the Treaty, has given notification that it will not participate in Stage the European Commission shall submit to Three of Economic and Monetary Union. the EU Council a recommendation, for The United Kingdom, in accordance with the each Member State, on whether it fulfils terms of Protocol No. 11, has also notified the necessary conditions for the adoption the EU Council that it does not intend to of a single currency; move to the third stage in 1999. As a consequence, neither Member State will the EU Council, acting by a qualified participate in the single currency at the start majority on that recommendation, shall of Stage Three. Nevertheless, both countries assess, for each Member State, whether it progress towards convergence is examined fulfils the necessary conditions for the in detail in this Report.

2 I Convergence criteria

1.1 Framework for analysis is equally important that, when the criteria are applied in early 1998, they are applied In this years Report under Article 109j (1), with a view to ensuring that government the EMI makes use of a common framework financial positions in particular are sustainable for analysis and examines the state of and not affected by measures of temporary convergence on a country-by-country basis. effect.

The common framework for analysis is This Report builds on principles set out in outlined in Chapter I of the Report (under previous reports published by the EMI, Key aspects of the examination of especially the first EMI report prepared under convergence in 1998). It is based, first, on the Article 109j (1), entitled Progress Towards Treaty provisions and their application by the Convergence 1996, which was issued in EMI with regard to the developments of November 1996, and the November 1995 prices, fiscal deficit and debt ratios, exchange report prepared under Article 7 of the EMI rates and long-term interest rates, also taking Statute, entitled Progress Towards into account other factors; and, second, on a Convergence. In particular, a number of range of additional backward and forward- guiding principles are used by the EMI in the looking economic indicators which are application of the convergence criteria. considered to be useful for examining the Quoting from the 1995 and 1996 reports: sustainability of convergence in greater detail. First, the individual criteria are interpreted and applied in a strict manner. The rationale The common framework is subsequently behind this principle ... is that the main applied individually to all fifteen Member purpose of the criteria is to ensure that only States. These country reports, which focus those Member States which have economic on each Member States performance, should conditions that are conducive to the be considered separately, in line with the maintenance of price stability and the viability provisions of Article 109j. of the European currency area should participate in it. Second, the convergence In this Report and the ensuing interpretation criteria constitute a coherent and integrated of the convergence criteria the EMI has to package and they must all be satisfied; the take into account the principles laid down by Treaty lists the criteria on an equal footing the . The Council has and does not suggest a hierarchy. Third, the emphasised many times the need for a high convergence criteria have to be met on the degree of sustainable convergence and, in basis of current data. Fourth, the application that context, the need for a strict interpretation of the convergence criteria should be of the convergence criteria to make EMU consistent, transparent and simple. Moreover, work. In December 1996 the European it is emphasised again that compliance with Council meeting in Dublin stated in respect the convergence criteria is essential, not only of its decision to be taken under Treaty at a specific point in time, but also on a Article 109j (4): The Council takes this sustained basis. In this vein, the country opportunity to stress that the four criteria of reports elaborate on the sustainability of sustainable convergence and the requirement convergence. of central bank independence must be strictly applied. This is essential if the coming The statistical data used in the application of completion of monetary union is to have the the convergence criteria have been provided essential quality of stability and the is to by the Commission (see also Annex 2). be assured of its status as a strong currency. It Convergence data on price and long-term

3 interest rate developments are presented up 1996 bilateral exchange rate levels, although to the period ending in January 1998, the to differing degrees. In addition, in 1997 latest month for which data on Harmonised significant reductions have been achieved in Indices of Consumer Prices (HICPs) were fiscal deficits across the Union, and in a few available. For exchange rates, the period countries budgetary positions were in surplus. considered in this Report ends in February The EU-wide fiscal deficit ratio has fallen to 1998, the latest full month before the 2.4% of GDP, which represents a decline of examination by the EMI was concluded.1 1.8 percentage points compared with 1996. Data for fiscal positions cover the period up Furthermore, for the first time during the to 1997. These data were judged by 1990s, the debt-to-GDP ratio for the EU as a EUROSTAT to be in accordance with the whole declined in 1997. Overall conditions rules laid down in the European System of necessary to maintain an environment Integrated Economic Accounts (ESA, second conducive to non-inflationary growth have edition). However, this does not prejudge thus improved. However, the average debt the assessment of whether fiscal positions are ratio still stands at 72.1% of GDP and is much to be regarded as sustainable. Account is also higher in three Member States. In addition, taken of the latest Commission projections the decline in deficit ratios below the reference for 1998, together with national budgets for value and the fall in debt ratios in many 1998 and the most recent Convergence countries have only recently been realised. Programmes, as well as other information Furthermore, the recent reductions in deficit which is considered to be relevant in the and debt ratios have partly been related to context of forward-looking considerations one-off measures. concerning the sustainability of convergence. Within the context of a single monetary policy, the adjustments seen over the recent 1.2 The state of convergence past need to be carried substantively further. Indeed, decisive and sustained corrective Since publication of the EMIs report entitled policies of a structural nature are warranted Progress Towards Convergence 1996 in in most countries. These requirements for November 1996, major improvements in lasting policy adjustment result from the terms of convergence have been seen in the combined burden arising from (i) high and Union. Between the last quarter of 1996 and persistent unemployment, which according January 1998 the EU average rate of HICP to the analysis conducted by the EMI and inflation has fallen from 2.2% to 1.3%; all other international organisations is largely of a Member States with the exception of Greece structural nature; (ii) demographic trends, recorded rates of HICP inflation of around which are expected to place a heavy burden 2% or less in January 1998, and the standard on future public expenditure; and (iii) the deviation, as a measure of convergence, has high level of public debt, which will weigh on decreased from 1.6% in the last quarter of current budgets of many Member States until 1996 to 0.9% in January 1998. In parallel, debt levels are reduced. long-term interest rates have been falling throughout the Union to reach low EU- average levels of around 5‰% at the end of the reference period and differentials between 1 On 14 March 1998, i.e. after the reference period most EU countries bond yields have been applied in this Report, the previous bilateral central virtually eliminated. Over the two-year rates of the against the other reference period up to February 1998, bilateral of the exchange rate mechanism were revalued by ERM exchange rates have in general remained 3%. On the same day, the was incorporated in the exchange rate mechanism of broadly stable. Countries outside the ERM the EMS. Both measures were effective from have tended to trade above average March 16 March 1998.

4 Clearly, as regards developments in labour stabilisers to work during periods of weak markets, it will be crucial to strengthen economic activity. national policies which enhance their functioning by means of reducing structural Evidently, in order to ensure sustainable fiscal impediments. This will be paramount in consolidation, it is not sufficient to have reducing high levels of unemployment, which recourse to measures with a temporary cannot be regarded as sustainable over the effect. In 1997 such measures were used to long term. Such policies would also contribute varying degrees in a number of Member to increasing the ability of Member States States, which has complicated the assessment economies to respond quickly and effectively of the structural stance of fiscal policy. They to country-specific developments in Stage need to be replaced by durable measures in Three, as well as to ensure competitiveness. order to avoid an increase in net borrowing requirements in 1998, or in subsequent years Insufficient progress in structural adjustment if they have given rise to future expenditure will severely complicate sustainable fiscal obligations or future shortfalls in revenues. consolidation, which is needed in order to be Evidence available so far suggests that policies able to cope effectively with the other main have been moving in the right direction, challenges which need to be addressed - the generally reducing the impact of temporary ageing of the population and high debt ratios. measures on public finances in 1998, a year Against this background, it is emphasised that for which budget outcomes are expected to further consolidation is required in most be better than those recorded in 1997 in Member States in order to reduce high ratios nearly all countries, and in a number of of general government debt relative to GDP Member States more favourable than planned and bring them down to 60% within an in medium-term Convergence Programmes. appropriate period of time. The need for stronger fiscal positions contrasts with Consistent with the aim of fostering sustainable substantial actual deficits in many countries. economic growth, fiscal consolidation in recent Progress is also required with respect to the years does appear to have been increasingly Stability and Growth Pact effective from based on bringing down expenditure ratios, 1999 onwards. A forceful debt reduction thereby counteracting the upward trend which within an appropriate period of time is had been observed in the early 1990s. warranted, first, in order to diminish However, as a result of falling interest rates, vulnerability to changes in interest rates, many countries have also benefited from which is aggravated if a larger share of debt lower interest payments relative to GDP and matures within the short term, and, second, consolidation was focused in part on reducing to make it easier to cope with future budgetary investment expenditure. In the future, more challenges, such as the increasing fiscal burden emphasis needs to be placed on lowering arising from the ageing of the population, in current expenditure items. In addition, in a particular in the context of unfunded public number of countries revenue ratios have pension systems, as well as the medium-term approached levels which are detrimental to challenges arising from the need to reform economic growth. unprofitable public enterprises and reduce structural unemployment. Third, reducing budgetary imbalances is necessary to re- The criterion on price stability establish a degree of flexibility for fiscal policies which enables countries to respond Focusing on the performance of individual to adverse cyclical developments, i.e. low countries, over the twelve-month reference fiscal deficits or surpluses are needed under period ending January 1998 fourteen Member normal circumstances to allow automatic States (Belgium, Denmark, Germany, Spain,

5 France, Ireland, Italy, Luxembourg, the Looking ahead to the near future, in most Netherlands, Austria, Portugal, Finland, countries recent trends and forecasts for Sweden and the United Kingdom) had average inflation tend to indicate that there is little or HICP inflation rates of below the reference no sign of immediate upward pressure on value. This reference value was calculated by inflation. The risks for price stability are often using the unweighted arithmetic average of associated with a narrowing of the output the rate of HICP inflation in the three gap, a tightening of labour market conditions countries with the lowest inflation rates, plus and increases in administered prices or indirect 1.5 percentage points. These three countries taxes; in several countries, for the most part inflation rates were 1.1% for Austria, 1.2% for those which are further ahead in the current France and 1.2% for Ireland, and, adding 1.5 cyclical upturn, the rate of inflation is generally percentage points to the average of 1.2%, the forecast to rise to somewhat above 2% reference value is 2.7%. HICP inflation in during the period 1998-99. This applies to Greece was 5.2%, considerably lower than in Denmark, Spain, Ireland, the Netherlands, previous years, but still well above the Portugal, Finland and the United Kingdom. reference value (see Table A and Chart A). These Member States need to exercise firm control over domestic price pressures with Looking back over the period from 1990 to regard to, inter alia, wage and unit labour 1997, the convergence of inflation rates can costs. Support is also required from fiscal be explained by a variety of common factors. policies, which need to react flexibly to the In the first place, as is indicated for each domestic price environment. individual Member State, it reflects a number of important policy choices, most notably the orientation of monetary policy towards price The criterion on the government budgetary stability and the increasing support received position from other policy areas, such as fiscal policies and the development of wages and unit With regard to the performance of individual labour costs. In addition, in most Member Member States in 1997, three countries have States the macroeconomic environment, in recorded fiscal surpluses (Denmark, Ireland particular during the period following the and Luxembourg) and eleven Member States cyclical downturn of 1993, has contributed to have achieved or maintained deficits at or the easing of upward pressure on prices. below the 3% reference value specified in the Finally, in many Member States broadly stable Treaty (Belgium, Germany, Spain, France, exchange rates and subdued import price Italy, the Netherlands, Austria, Portugal, developments have helped to dampen Finland, Sweden and the United Kingdom). inflation. At the level of individual countries, it Only Greece recorded a deficit of 4.0%, is apparent that a group of Member States which is still above the reference value. For recorded relatively similar inflation rates for 1998, fiscal surpluses or further reductions in most of the 1990s, while several others made deficit ratios are projected by the Commission particularly rapid progress in 1996-97. Among for nearly all Member States. The Greek the latter, annual CPI inflation in Spain, Italy deficit is expected to fall to 2.2% of GDP (see and Portugal fell from 4-5‰% in 1995 to Table A and Chart B). around 2% in 1997. These three Member States have had twelve-month average HICP As regards government debt, in the three inflation rates of below the reference value Member States with debt-to-GDP ratios of since mid-1997. In Greece, HICP inflation fell above 100%, debt has continued to decline in from 7.9% in 1996 to 5.4% in 1997, while relation to GDP. In Belgium the debt ratio in remaining considerably above the reference 1997 was 122.2%, i.e. 13.0 percentage points value (see Chart A). lower than the peak in 1993; in Greece the debt ratio in 1997 stood at 108.7%, i.e. 2.9

6 percentage points below the latest peak in as has been pointed out above, in a number 1996; and in Italy the debt ratio was 121.6%, of Member States measures with a temporary i.e. 3.3 percentage points below the peak of effect have played a role in reducing deficits. 1994. In the seven countries which in 1996 On the basis of the evidence available to the had debt ratios significantly above 60% but EMI, the effects of such measures have been below 80% of GDP, debt ratios also declined. quantified at between 0.1 and 1 percentage This was particularly the case in Denmark, point, with the level varying by country. To Ireland and the Netherlands, where debt the extent that evidence is available, the ratios in 1997 were 16.5, 30.0 and 9.1 magnitude of temporary measures in 1998 percentage points respectively below their budgets has generally been reduced; in peak levels of 1993, and stood at 65.1%, addition, as mentioned above, forecasts for 66.3% and 72.1% of GDP respectively; in 1998 suggest in most cases a further decline Spain the debt ratio in 1997 declined by 1.3 in deficit ratios. Reductions in debt ratios percentage points from its peak level of 1996 have benefited in part from a number of to reach 68.8% of GDP; in Austria the financial operations and transactions, such as corresponding reduction amounted to 3.4 privatisation, which are reflected in the so- percentage points, taking the debt ratio to called stock-flow adjustment item as reported 66.1% of GDP. In Portugal the debt ratio was in the main body of the Report. Such 3.9 percentage points below its 1995 level, transactions are expected to continue to play bringing the debt ratio to 62.0% of GDP. a role in several Member States. Finally, in Sweden the debt ratio was 2.4 percentage points below its peak level of Notwithstanding recent achievements, further 1994, reaching 76.6% of GDP in 1997. In substantial consolidation is warranted in most Germany, which in 1996 had a debt ratio of Member States in order to achieve lasting just above the 60% reference value, the debt compliance with the fiscal criteria and the ratio continued its upward trend and in 1997 medium-term objective of having a budgetary was 19.8 percentage points higher than in position that is close to balance or in surplus, 1991, standing at 61.3% of GDP. In 1997 four as required by the Stability and Growth Pact, countries continued to have debt ratios of effective from 1999 onwards. This applies in below the 60% reference value (France, particular to Belgium, Germany, Greece, Spain, Luxembourg, Finland and the United France, Italy, the Netherlands, Austria and Kingdom). In France the debt ratio continued Portugal, where deficits in 1998 are forecast its upward trend to reach 58.0% of GDP in to be between 1.6 and 2.9% of GDP. For 1997 (see Table A and Chart B). most of these countries, these consolidation requirements also apply when comparing the For 1998 further reductions in debt-to-GDP fiscal deficit ratios as projected in the ratios are projected by the Commission for Convergence Programmes for 1999-2000 all Member States which had debt ratios of with the medium-term objective of the Stability above 60% in 1997. In the cases of Denmark, and Growth Pact. Ireland and Portugal, a reduction to a level at or below the reference value is forecast. As Taking a broader view on the sustainability of regards countries with debt ratios of 50-60% fiscal developments, the case for sustained of GDP in 1997, Finland and the United consolidation over an extended period of Kingdom are anticipated to reduce their debt time, requiring substantial fiscal surpluses, is ratios further below 60%, whereas in France particularly strong for those countries with the debt ratio is expected to increase debt ratios of above 100% (Belgium, Greece marginally. and Italy). This compares with significant overall deficits in 1997 and the years before. Overall, progress in reducing fiscal deficit and In countries with debt ratios of significantly debt ratios has generally accelerated. However, above 60% but below 80% of GDP, keeping

7 the deficit ratio at current levels would not November 1996 respectively. Three bring down the debt ratio to below 60% currencies remained outside the ERM during within an appropriate period of time, which the reference period referred to in this indicates the need for further, in some cases Report, namely the Greek drachma2 , the substantial, consolidation. Instead, realising and the . the fiscal positions forecast for 1998 by the European Commission and maintaining a Each of the ten ERM currencies mentioned balanced budget from 1999 onwards would above, with the exception of the Irish pound, reduce the debt ratio to below 60% over has normally traded close to its unchanged appropriate periods (Spain, the Netherlands central rates against other ERM currencies, and and Austria). Sweden could achieve the same some currencies (the Belgian/Luxembourg result by realising the surplus position forecast , the , the for 1998 and maintaining it for several years and the ) virtually moved as a thereafter. In Germany the debt ratio is bloc. On occasion, several currencies traded forecast to be just above 60% of GDP in outside a range close to their central rates. 1998, which could allow it to be reduced to However, the maximum deviation, on the below the reference value as early as 1999 if basis of 10 business day moving averages, was a balanced budget were achieved in that year. limited to 3.5%, abstracting from the In Denmark, Ireland and Portugal current and development of the Irish pound. In addition, forecast fiscal balances would allow the debt the deviations were only temporary and mainly ratio to be reduced to a level equal to or just reflected transient movements of the Spanish below 60% as early as 1998. Finally, in France, peseta and the (in early 1996), where the debt ratio is just below 60% of the (at end-1996/early GDP, complying with the Stability and Growth 1997) as well as the (in early Pact from 1999 onwards would also ensure and mid-1997) vis--vis other ERM currencies. that the debt ratio does not exceed the An examination of exchange rate volatility and reference value. short-term interest rate differentials suggests the persistence of relatively calm conditions It should be noted that in assessing budgetary throughout the reference period. positions of EU Member States, the impact on national budgets of transfers to and from The Irish pound has normally traded the EC budget is not taken into account by significantly above its unchanged central rates the EMI. against other ERM currencies; at the end of the reference period the Irish pound stood just over 3% above its central rates.3 In The exchange rate criterion parallel, the degree of exchange rate volatility vis--vis the Deutsche Mark increased until During the two-year reference period from mid-1997 and short-term interest rate March 1996 to February 1998 ten currencies differentials against those EU countries with (the Belgian/, the Danish the lowest short-term interest rates widened krone, the Deutsche Mark, the , over the same period. More recently, the the French franc, the Irish pound, the Dutch guilder, the Austrian schilling and the Portuguese escudo) have been participating in the ERM for at least two years before this 2 As noted above, the Greek drachma was incorporated examination, as stated by the Treaty. The in the exchange rate mechanism of the EMS, periods of membership for the Finnish markka effective from 16 March 1998. 3 As noted above, the previous bilateral central rates and the were shorter, as these of the Irish pound against other currencies of the currencies joined and rejoined the exchange exchange rate mechanism were revalued by 3%, rate mechanism in October 1996 and effective from 16 March 1998.

8 former decreased and the latter narrowed short-term interest rates remained wide in somewhat while remaining relatively high. Greece, having narrowed until mid-1997 and widened significantly since November 1997, In the case of the Italian lira, at the beginning whereas they have narrowed significantly in of the reference period, before rejoining the Sweden. In the case of the pound sterling the ERM, it initially experienced a small and short-term interest rate differential tended to temporary setback in its previous strengthening widen. trend, reaching a maximum downward deviation of 7.6% below its future central rate against one ERM currency in March 1996. The long-term interest rate criterion Thereafter, it resumed its appreciation and tended towards its later central parities, Over the twelve-month reference period moving for most of the time within a narrow ending January 1998, fourteen Member States range. In the case of the Finnish markka, also (Belgium, Denmark, Germany, Spain, France, at the beginning of the reference period, Ireland, Italy, Luxembourg, the Netherlands, before joining the ERM, it initially continued Austria, Portugal, Finland, Sweden and the its weakening movement apparent over the United Kingdom) had average long-term previous few months - which had interrupted interest rates of below the reference value. the longer-term upward movement since This reference value was calculated by using 1993 - reaching a maximum downward the unweighted arithmetic average of the deviation of 6.5% below its future central rate long-term interest rates in the three countries against one ERM currency in April 1996. with the lowest rates of HICP inflation, plus 2 Thereafter, it appreciated and generally traded percentage points. These three countries within a narrow range around its later central long-term interest rates were 5.6% for Austria, parities. Since joining and rejoining the ERM in 5.5% for France and 6.2% for Ireland, and, October and November 1996 respectively, adding 2 percentage points to the average of both the Finnish markka and the Italian lira 5.8%, the reference value is 7.8%. have normally traded close to their unchanged Representative long-term interest rates in central rates against other ERM currencies. Greece, which have been comparable with As was the case for other ERM currencies, on yields in other countries since June 1997, occasion the Italian lira and the Finnish markka were 9.8% and thus stood well above the traded outside a range close to their central reference value (see Table A and Chart C). rates, but such deviations were limited and temporary. In both cases the relatively high Looking back over the period from 1990 to degree of exchange rate volatility against the 1997, long-term interest rates were broadly Deutsche Mark observed in earlier periods similar in a number of countries when declined to low levels over the reference considered over the period as a whole. This period and short-term interest rate differentials applies to Belgium, Germany, France, against those EU countries with the lowest Luxembourg, the Netherlands and Austria. In short-term interest rates narrowed steadily in Denmark and Ireland long-term rates were the case of the Italian lira and were insignificant also relatively close to those in the above- in the case of the Finnish markka. mentioned countries for most of the period. In Finland and Sweden the process of yield The three currencies remaining outside the convergence accelerated from 1994-95 ERM, namely the Greek drachma, the Swedish onwards and both countries have recorded krona and the pound sterling, have normally limited differentials since around 1996. In traded above their March 1996 average Spain, Italy and Portugal, where yields were bilateral exchange rates against other EU significantly higher for most of the 1990s, currencies. Short-term interest rate differentials long-term interest rates declined steeply from against those EU countries with the lowest 1995 onwards and moved below the

9 reference value in either late 1996 or early Austria and Finland nominal unit labour costs 1997. A significant reduction was also seen in over the period 1996-97 either were broadly Greece. In the case of the United Kingdom, stable or declined, while in several other reflecting a different position in the cycle vis- cases (Denmark, Spain, France, Luxembourg, -vis continental European countries, a broad Portugal and the United Kingdom) increases trend has been observed since the early were clearly positive but for the most part 1990s of, first, convergence with, and later moderate. The main exception was Greece, divergence from the long-term interest rates where, despite a significant deceleration during prevailing in the countries with the lowest the 1990s, the increase in nominal unit labour bond yields, although long-term interest rate costs was 7.5% in 1997. In Italy and Sweden differentials have narrowed more recently. the increase in unit labour costs picked up in 1996 to close to 5%, before slowing in 1997 The broad patterns observed in member to 3.1% in Italy and 1.2% in Sweden. countries are closely related to the developments in inflation rates (see above), As regards the other relevant price indices which have facilitated a general reduction in considered in this Report, these generally long-term interest rates and a particularly confirm the trend observed in HICPs. In marked decline in the case of the formerly some countries one or more other measures high-yielding currencies. Other factors of inflation are somewhat above the level of underlying this trend were the stability of HICP inflation. exchange rates in most cases and the improvement in countries fiscal positions, Recent figures for EU countries current thereby reducing risk premia. These underlying account positions point to surpluses in eleven developments were seen by the markets as countries in 1997. Among these, in Spain, improving the prospects for participation in France, Italy, Finland and Sweden deficits Stage Three of EMU - an element which may were recorded in the early 1990s but have in turn have played an independent role in subsequently been eliminated; in the United accelerating the narrowing of yield differentials, Kingdom a small surplus emerged in 1997. In both directly and by further improving the others, surpluses have been maintained prospects for price and exchange rate stability. throughout the 1990s. Belgium and the Netherlands, in particular, have built up sizable net asset positions. In the remaining four Other factors Member States (Germany, Greece, Austria and Portugal) current account deficits have In addition to the convergence criteria been more persistent, although in the case of mentioned above, the Report also takes Germany the deficit in 1997 was small. account of a number of other factors which are referred to explicitly in Article 109j (1) of With regard to the integration of markets, the Treaty: the development of the ECU; the European Commission figures on the state of results of the integration of markets; the implementation of internal market directives situation and development of the balances of (as of February 1998) show that the average payments on current account and an transposition rate in the Union is examination of unit labour costs and other approximately 94%. In a breakdown by sector, price indices (see Table B). the Commission identifies public procurement as the sector in which the most technical The growth of nominal unit labour costs has barriers remain. Considering trade flows in generally decelerated in the course of the goods and services, the share of intra-EU 1990s to levels consistent with low rates of trade as a percentage of total trade is inflation. In a number of countries, namely significant for all EU countries. In 1996 intra- Belgium, Germany, Ireland, the Netherlands, EU exports as a proportion of total exports

10 ranged from 52% in the United Kingdom to general, residents and non-residents are over 80% in Portugal. The average for all EU treated differently. No comprehensive Member States is 61%. For intra-EU imports measures have yet been taken to harmonise the corresponding figures range from 54% in capital income taxation in order to promote Ireland to 76% in Portugal, while the average the integration of financial markets. for all EU countries is approximately 61%. The overall private ECU market contracted As regards taxation issues, indirect taxation further in 1997, reflecting declines in bank and capital income taxation are of particular assets and liabilities and international bonds importance to the integration of markets. outstanding. This contraction took place There continue to be significant differences despite some favourable developments in between EU countries both in terms of the 1997. In particular, some legal uncertainties indirect taxation of goods and services and, were resolved and, partly in response to this, for the taxation of capital income, in terms of the spread between market and basket ECU the rates applied and their precise application. exchange rates narrowed further between The tax treatment of interest payments is an end-December 1996 and end-December example: in some EU countries there is a 1997 from around 90 basis points to par; it withholding tax, whereby the tax is levied on was even at a premium for a short period residents, while in others the paying agent is towards the end of 1997. required to inform the tax authorities and, in

2 Compatibility of national legislation with the Treaty

2.1 Introduction and that all further steps, for example promulgation, have been accomplished. This Article 108 of the Treaty states that Member applies to all legislation under Article 108. States shall ensure, at the latest at the date of However, the above distinction between the establishment of the ESCB, that their different areas of legislation is important national legislation, including the statutes of when it comes to determining the date on their NCBs, is compatible with the Treaty which legislation must enter into force. Many and the Statute (legal convergence). This decisions which the Governing Council of the does not require the harmonisation of NCBs ECB and the NCBs will take between the statutes, but it implies that national legislation date of the ESCBs establishment and the and statutes of NCBs need to be adjusted in end of 1998 will predetermine the single order to make them compatible with the monetary policy and its implementation within Treaty and the Statute. For the purpose of the euro area. Therefore, adaptations which identifying those areas where the adaptation relate to the independence of an NCB need of national legislation is necessary, a distinction to become effective at the latest at the date may be made between the independence of of the ESCBs establishment. Other statutory NCBs, the legal integration of NCBs in the requirements relating to the legal integration ESCB and legislation other than statutes of of NCBs in the ESCB need only enter into NCBs. force at the moment that the integration of an NCB in the ESCB becomes effective, i.e. Compatibility requires that the legislative the starting date of Stage Three or, in the process be completed, i.e. that the respective case of a Member State with a derogation or act has been adopted by the national legislator a special status, the date on which it adopts

11 the single currency. The entry into force of between features of an institutional, personal adaptations of legislation other than statutes and financial nature.4 of NCBs which are required to ensure compatibility with the Treaty and the Statute As regards institutional independence, rights is dependent on the content of such legislation of third parties (e.g. government and and therefore needs to be assessed on a parliament) to: case-by-case basis. give instructions to NCBs or their decision- This Report provides, inter alia, an assessment making bodies; on a country-by-country basis of the compatibility of national legislation with the approve, suspend, annul or defer decisions Treaty and the Statute. of NCBs;

censor an NCBs decisions on legal 2.2 Independence of NCBs grounds;

Central bank independence is essential for participate in the decision-making bodies the credibility of the move to Monetary of an NCB with a right to vote; or Union and, thus, a prerequisite of Monetary Union. The institutional aspects of Monetary be consulted (ex ante) on an NCBs Union require monetary powers, currently decisions held by Member States, to be exercised in a new system, the ESCB. This would not be are incompatible with the Treaty and/or the acceptable if Member States could influence Statute and, thus, require adaptation. the decisions taken by the governing bodies of the ESCB. With respect to personal independence, statutes of NCBs should ensure that: The Statute contemplates an important role for governors of NCBs (via their membership governors of NCBs have a minimum term of the Governing Council of the ECB) with of office of five years; regard to the formulation of monetary policy and for the NCBs with regard to the execution a governor of an NCB may not be of the operations of the ESCB (see Article dismissed for reasons other than those 12.1 of the Statute, last paragraph). Thus, it mentioned in Article 14.2 of the Statute will be essential for the NCBs to be (i.e. if he/she no longer fulfils the conditions independent in the performance of their required for the performance of his/her ESCB-related tasks vis--vis external bodies. duties or if he/she has been guilty of serious misconduct); The principle of the independence of NCBs is expressly referred to in Article 107 of the other members of the decision-making Treaty and Article 14.2 of the Statute. Article bodies of NCBs involved in the 107 contains a prohibition on attempts to performance of ESCB-related tasks have influence the ECB, NCBs or the members of the same security of tenure as governors; their decision-making bodies, and Article 14.2 provides for security of tenure for such members. 4 There is also a criterion of functional independence, but as NCBs will in Stage Three be integrated in the The EMI has established a list of features of ESCB, this is being dealt with in the framework of central bank independence, distinguishing the legal integration of NCBs in the ESCB (see paragraph 2.3 below).

12 no conflicts of interest will arise between 2.4 Legislation other than the the duties of members of the decision- statutes of NCBs making bodies of NCBs vis--vis their respective NCB (and, additionally, of The obligation of legal convergence under governors vis--vis the ECB) and other Article 108 of the Treaty, which is incorporated functions which members of the decision- in a Chapter entitled Monetary Policy, applies making bodies involved in the performance to those areas of legislation which are affected of ESCB-related tasks may perform and by the transition from Stage Two to Stage which may jeopardise their personal Three. The EMIs assessment of the independence. compatibility of national legislation with the Treaty and the Statute focuses in this respect Financial independence requires that NCBs on laws with an impact on an NCBs can avail themselves of the appropriate means performance of ESCB-related tasks and laws to fulfil their mandate. Statutory constraints in in the monetary field. Relevant legislation this field must be accompanied by a safeguard requiring adaptation is in particular found in clause to ensure that ESCB-related tasks can the following areas: banknotes, coins, foreign be properly fulfilled. reserve management, exchange rate policy and confidentiality.

2.3 The legal integration of NCBs in the ESCB 2.5 Compatibility of national legislation with the Treaty and The full participation of NCBs in the ESCB the Statute necessitates measures in addition to those designed to ensure independence. In particular, All Member States except Denmark, whose such measures may be necessary to enable legislation does not require adaptation, have NCBs to execute tasks as members of the introduced, or are in an advanced process of ESCB and in accordance with decisions taken introducing, changes in the statutes of their by the ECB. The main areas of attention are NCBs, following the criteria laid down in the those where statutory provisions may form EMIs Reports and in the EMIs opinions. The an obstacle to an NCB complying with the United Kingdom, which is exempt from the requirements of the ESCB or to a governor obligations under Article 108 of the Treaty, is fulfilling his/her duties as a member of the in the process of introducing a new statute of Governing Council of the ECB, or where its NCB which, while providing a greater level statutory provisions do not respect the of operational central bank independence, is prerogatives of the ECB. Thus the EMIs not expressly intended to achieve the legal assessment of the compatibility of the convergence as required by the EMI for full statutes of NCBs with the Treaty and the compliance with the Treaty and the Statute. Statute focuses on the following areas: Throughout the European Union legislators, statutory objectives, tasks, instruments, with the above exceptions, have undertaken organisation, financial provisions and a legislative process intended to prepare miscellaneous issues. NCBs for Stage Three of EMU.

13 3 Summaries country by country

3.1 Belgium in 1997, as well as the forecast deficit of 1.7% in 1998. The Stability and Growth Pact also Over the reference period Belgium has requires, as a medium-term objective, a achieved a rate of HICP inflation of 1.4%, budgetary position that is close to balance or which is well below the reference value in surplus. stipulated by the Treaty. The increase in unit labour costs was subdued and low rates of With regard to other factors, in 1996 and inflation were also apparent in terms of other 1997 the deficit ratio exceeded the ratio of relevant price indices. Looking ahead, there public investment to GDP, while Belgium has are no signs of immediate upward pressure maintained large current account surpluses on inflation; forecasts project inflation to be and a strong net external asset position. around 1‰% in 1998 and 1999. The has been participating in the ERM for The statute of the much longer than two years. Over the was amended with Law No. 1061/12-96/97. reference period it remained broadly stable, Assuming that specific provisions thereof, for generally close to its unchanged central parities which progressive adaptation is envisaged, without the need for measures to support will enter into force on time, the Banks the exchange rate. The level of long-term statute will be compatible with Treaty and interest rates was 5.7%, i.e. well below the Statute requirements for Stage Three. The respective reference value. EMI takes note that adaptations of various other laws are envisaged. In 1997 Belgium achieved a fiscal deficit ratio of 2.1% of GDP, i.e. below the reference value, and the outlook is for a further decline 3.2 Denmark to 1.7% in 1998. The debt-to-GDP ratio is far above the 60% reference value. After having Denmark, in accordance with the terms of reached a peak in 1993, it declined by 13.0 Protocol No. 12 of the Treaty, has given percentage points to stand at 122.2% in notification to the EU Council that it will not 1997; the outlook is for a further decline to participate in Stage Three of EMU. 118.1% of GDP in 1998. Notwithstanding the Nevertheless, its progress towards efforts and the substantial progress made convergence is examined in detail. towards improving the current fiscal situation, there is an evident ongoing concern as to Over the reference period Denmark has whether the ratio of government debt to achieved a rate of HICP inflation of 1.9%, GDP will be sufficiently diminishing and which is well below the reference value approaching the reference value at a stipulated by the Treaty. The increase in unit satisfactory pace and whether sustainability labour costs has picked up recently and some of the fiscal position has been achieved; other relevant indicators of inflation exceeded addressing this issue will have to remain a key 2% in 1997. Looking ahead, there are no signs priority for the Belgian authorities. The of immediate upward pressure on inflation; maintenance of a primary surplus of at least forecasts project inflation will rise to somewhat 6% of GDP per year and the achievement of above 2% in 1998 and slightly higher in 1999. growing and sizable overall fiscal surpluses are The has been participating in needed in order to be able to forcefully the ERM for much longer than two years. reduce the debt ratio to 60% within an Over the reference period it remained broadly appropriate period of time. This compares stable, generally close to its unchanged central with a recorded fiscal deficit of 2.1% of GDP parities, without the need for measures to

14 support the exchange rate. The level of long- Looking ahead, there are no signs of immediate term interest rates was 6.2%, i.e. below the upward pressure on inflation; forecasts project respective reference value. inflation will stand at around 2% in 1998 and 1999. The Deutsche Mark has been In 1997 Denmark achieved a general participating in the ERM for much longer than government surplus of 0.7% of GDP, thus two years. Over the reference period it comfortably meeting the reference value, and remained broadly stable, generally close to its the outlook is for a surplus of 1.1% in 1998. unchanged central parities, without the need The debt-to-GDP ratio is above the 60% for measures to support the exchange rate.The reference value. After having reached a peak level of long-term interest rates was 5.6%, i.e. in 1993, the ratio declined by 16.5 percentage well below the respective reference value. points to stand at 65.1% in 1997. Regarding the sustainability of fiscal developments, the In 1997 Germany achieved a fiscal deficit outlook is for a decrease in the debt ratio to ratio of 2.7% of GDP, i.e. below the reference 59.5% of GDP in 1998 i.e. just below the value, and the outlook is for a further decline reference value. Looking further ahead, if to 2.5% in 1998. The debt-to-GDP ratio is current fiscal surpluses are maintained, just above the 60% reference value. As of Denmark should comply with the medium- 1991, the first year after German unification, term objective of the Stability and Growth the ratio increased by 19.8 percentage points Pact, effective from 1999 onwards, of having to stand at 61.3% in 1997, reflecting to a large a budgetary position that is close to balance extent the fiscal burden relating to unification. or in surplus, and the debt ratio would fall Regarding the sustainability of fiscal further below 60%. developments,,, the outlook is for a marginal decline in the debt ratio to 61.2% of GDP in With regard to other factors, in 1996 the 1998. Keeping the deficit ratio at current deficit ratio was below the ratio of public levels would not be sufficient to bring the investment to GDP. Moreover, Denmark has debt ratio down to 60% of GDP within an recorded current account surpluses, while appropriate period of time, thus pointing to continuing to have a net external liability the need for further substantial progress in position. In the context of the ageing of the consolidation. The Stability and Growth Pact population, Denmark benefits from a rapidly also requires as a medium-term objective a expanding private pension sector. budgetary position that is close to balance or in surplus. Given the current debt ratio of just The statute of Danmarks Nationalbank does above 60% of GDP, achieving the fiscal not contain incompatibilities in the area of position forecast for 1998 and realising a central bank independence. The legal balanced budget thereafter would reduce the integration of the Bank in the ESCB does not debt ratio to below 60% as early as 1999. need to be provided for and other legislation does not need to be adapted as long as With regard to other factors, in 1996 and Denmark does not adopt the single currency. 1997 the deficit ratio exceeded the ratio of public investment to GDP, and Germany recorded current account deficits as a 3.3 Germany consequence of unification, while maintaining a net external asset position. Over the reference period Germany has achieved a rate of HICP inflation of 1.4%, The statute of the which is well below the reference value was amended with the Sixth Act amending stipulated by the Treaty. Unit labour costs fell the Deutsche Bundesbank Act dated and low rates of inflation were also apparent 22 December 1997, which made the Banks in terms of other relevant price indices. statute compatible with Treaty and Statute

15 requirements for Stage Three. The EMI takes fiscal situation, there must be an ongoing note that adaptation of the Act on Coins is concern as to whether the ratio of government envisaged. debt to GDP will be sufficiently diminishing and approaching the reference value at a satisfactory pace and whether sustainability 3.4 Greece of the fiscal position has been achieved; addressing this issue will have to remain a key A clear trend towards lower inflation has priority for the Greek authorities. Substantial been discernible in Greece, with the CPI rate primary surpluses and persistent, sizable overall falling from above 20% in 1990 to 5‰% in fiscal surpluses will be needed to be able to 1997. HICP inflation was 5.2% over the reduce the debt ratio to 60% within an reference period. At the same time, the appropriate period of time. This compares increase in unit labour costs decelerated to with a recorded fiscal deficit of 4.0% of GDP 7‰% in 1997, and the reduction in inflationary in 1997, as well as the deficit forecast of 2.2% tendencies is also indicated by other relevant in 1998. The Stability and Growth Pact also measures of inflation. Looking ahead, forecasts requires, as a medium-term objective, a suggest a fall in inflation to 4‰% in 1998 and budgetary position that is close to balance or to 3‰% in 1999. Long-term interest rates in surplus. have been on a broadly declining trend during the 1990s, with the exception of 1997; With regard to other factors, in 1996 and they averaged 9.8% over the reference period. 1997 the deficit ratio exceeded the ratio of Overall, notwithstanding the progress made, public investment to GDP, Greece recorded Greece has not achieved a rate of HICP current account deficits and had a net external inflation or a level of long-term interest rates liability position. In the context of the ageing which are below the respective reference of the population, Greece benefits from a values stipulated by the Treaty. partly funded pension system.

Greece did not participate in the ERM during The statute of the Bank of Greece was the reference period referred to in this amended with Law 2548 dated 12 December Report.5 Over the reference period, the 1997. As a result, there are no remaining Greek drachma traded above its March 1996 incompatibilities with Treaty and Statute average bilateral exchange rates against most requirements for Stage Three in the Banks other EU currencies, which are used as a statute. There are, however, two imperfections benchmark for illustrative purposes in the which still require adaptation before Greece absence of central rates. adopts the single currency. The EMI is not aware of any other statutory provisions which Since 1993 the fiscal deficit ratio has been would require adaptation under Article 108 reduced by a total of 9.8 percentage points to of the Treaty. stand at 4.0% of GDP in 1997, above the reference value stipulated in the Treaty; the outlook for 1998, is for a decline in the deficit 3.5 Spain ratio to 2.2%, i.e. a level below the reference value. The debt-to-GDP ratio is far above the Over the reference period Spain has achieved 60% reference value. After having reached a a rate of HICP inflation of 1.8%, which is well peak in 1993, the ratio broadly stabilised, below the reference value stipulated by the before decreasing by 2.9 percentage points Treaty. The increase in unit labour costs was to 108.7% in 1997; the outlook for 1998 is for a decline in the debt ratio to 107.7% of GDP. 5 As noted above the Greek drachma was incorporated Notwithstanding the efforts and the substantial in the exchange rate mechanism of the EMS, progress made towards improving the current effective from 16 March 1998.

16 subdued and a general trend towards low independence with Law 66/1997 of 30 rates of inflation was also apparent in terms December 1997. The Banks statute is in the of other relevant price indices. Looking ahead, process of being amended in the area of the there is little sign of immediate upward Banks integration in the ESCB. Assuming that pressure on inflation; forecasts project inflation a draft law to this effect is adopted as it stood will rise to somewhat above 2% in 1998 and on 24 March 1998 and that it will enter into 1999. The Spanish peseta has been force on time, the Banks statute will be participating in the ERM for considerably compatible with Treaty and Statute longer than two years. Over the reference requirements for Stage Three. The EMI takes period it remained broadly stable, generally note that further adaptation of Law 10/1975 close to its unchanged central parities, without of 12 March 1975 on Coinage is envisaged. the need for measures to support the exchange rate. The level of long-term interest rates was 6.3%, i.e. below the respective 3.6 France reference value. Over the reference period France has achieved In 1997 Spain achieved a fiscal deficit ratio of a rate of HICP inflation of 1.2%, which is well 2.6%, i.e. below the reference value, and the below the reference value stipulated by the outlook is for a further decline to 2.2% in Treaty and one of the three lowest inflation 1998. The debt-to-GDP ratio is above the rates in the Union. The increase in unit labour 60% reference value. After having reached a costs was subdued and low rates of inflation peak in 1996, the ratio declined by 1.3 were also apparent in terms of other relevant percentage points to stand at 68.8% in 1997. price indices. Looking ahead, there are no Regarding the sustainability of fiscal signs of immediate upward pressure on developments, the outlook is for a decrease inflation; forecasts project inflation will stand in the debt ratio to 67.4% of GDP in 1998. at well below 2% in 1998 and 1999. The Given the current debt ratio of somewhat French franc has been participating in the below 70% of GDP, achieving the fiscal ERM for much longer than two years. Over balance forecast for 1998 and a balanced the reference period it remained broadly budget thereafter would reduce the debt stable, generally close to its unchanged central ratio to below 60% in 2001. Instead, keeping parities, without the need for measures to the 1998 overall or primary balances constant support the exchange rate. The level of long- in the following years would bring the debt term interest rates was 5.5%, i.e. well below ratio down to 60% of GDP not before 2007 the respective reference value. and 2004 respectively, thus pointing to the need for further substantial progress in In 1997 France achieved a fiscal deficit ratio of consolidation. The Stability and Growth Pact 3.0% of GDP, i.e. a level equal to the also requires as a medium-term objective a reference value, and the outlook is for virtually budgetary position that is close to balance or no further improvement in 1998 (a decrease in surplus. to 2.9%) in spite of the favourable conjunctural situation. In addition, the fiscal debt ratio, With regard to other factors, in 1996 the though increasing to 58.0% of GDP in 1997, fiscal deficit ratio exceeded the ratio of public remained just below the 60% reference investment to GDP, but it fell below that level value; the outlook is for a marginal increase to in 1997. Furthermore, Spain has recorded 58.1% in 1998. Regarding the sustainability of current account surpluses, while continuing fiscal developments, keeping the deficit ratio to have a net external liability position. at current levels would not be sufficient to keep the debt ratio below 60% of GDP, thus The statute of the Banco de Espaæa was pointing to a need for further substantial amended in the area of central bank progress in consolidation. The Stability and

17 Growth Pact also requires as a medium-term declined more recently as the Irish pound has objective a budgetary position that is close to moved closer to its bilateral central rates balance or in surplus. This would also imply a against other ERM currencies.6 reduction in the debt ratio to further below 60% of GDP. In 1997 Ireland achieved a general government surplus of 0.9% of GDP, thereby comfortably With regard to other factors, in 1996 and meeting the 3% reference value, and the 1997 the deficit ratio exceeded the ratio of outlook is for a surplus of 1.1% of GDP in public investment expenditure to GDP. 1998. The debt-to-GDP ratio is above the Furthermore, France has recorded current 60% reference value. After having reached a account surpluses and a net external liability peak in 1993, the ratio declined by 30.0 position. percentage points to stand at 66.3% in 1997, reflecting inter alia very strong real GDP The statute of the Banque de France is growth. Regarding the sustainability of fiscal currently being adapted. Assuming that a developments, the outlook is for a decline in draft law to this effect is adopted as it stood the debt ratio to 59.5% of GDP in 1998, i.e. on 24 March 1998 and that it will enter into just below the reference value. Looking further force on time, the Banks statute will be ahead, if current fiscal surpluses are maintained compatible with Treaty and Statute Ireland should comply with the medium-term requirements for Stage Three. The EMI takes objective of the Stability and Growth Pact, note that adaptations of various other laws effective from 1999 onwards, of having a are envisaged. budgetary position that is close to balance or in surplus, and the debt ratio would fall further below 60%. 3.7 Ireland With regard to other factors, in 1996 the Over the reference period Ireland has deficit position did not exceed the ratio of achieved a rate of HICP inflation of 1.2%, public investment to GDP. Moreover, Ireland which is well below the reference value has maintained current account surpluses. In stipulated by the Treaty and one of the three the context of a relatively favourable lowest inflation rates in the Union. Unit demographic situation, the pension system labour costs declined, and low rates of relies on funded private pensions and inflation were also apparent in terms of other unfunded social security pensions play a relevant price indices. Looking ahead, there relatively minor role. are some signs of immediate upward pressure on inflation, which may rise towards 3% over The statute of the the next two years. The level of long-term was amended by the Central Bank Act 1998. interest rates was 6.2%, i.e. below the With the adoption and entry into force of respective reference value. this Act, and assuming that specific provisions thereof (for which progressive adaptation The Irish pound has been participating in the through ministerial orders is envisaged) will ERM for much longer than two years. During enter into force on time, there will be no the reference period it has normally traded remaining incompatibilities with Treaty and significantly above its unchanged central rates Statute requirements for Stage Three in the against other ERM currencies, reflecting an Banks statute. There are, however, two autonomous upward trend of the currency in the light of buoyant domestic economic 6 With effect from 16 March 1998, i.e. after the conditions. This is also mirrored in relatively reference period referred to in this Report, the high exchange rate volatility and short-term bilateral central rates of the Irish pound against the interest rate differentials, both of which have other ERM currencies were revalued by 3%.

18 imperfections, which will not jeopardise the and approaching the reference value at a overall functioning of the ESCB at the start of satisfactory pace and whether sustainability Stage Three and which will be addressed in of the fiscal position has been achieved; the context of forthcoming legislative changes. addressing this issue will have to remain a key The EMI takes note that the Decimal Currency priority for the Italian authorities. Significant Act has also been adapted. and persistent overall fiscal surpluses are rapidly needed to be able to forcefully reduce the debt ratio to 60% of GDP within an 3.8 Italy appropriate period of time. This compares with a recorded fiscal deficit of 2.7% of GDP Over the reference period Italy has achieved in 1997 as well as the deficit forecast for 1998 a rate of HICP inflation of 1.8%, which is well of 2.5%. The Stability and Growth Pact also below the reference value stipulated by the requires, as a medium-term objective, a Treaty. The growth of unit labour costs budgetary position that is close to balance or picked up in 1996, before slowing to 3.1% in in surplus. 1997, and a general trend towards low rates of inflation was also apparent in terms of With regard to other factors, in 1996 and other relevant price indices. Looking ahead, 1997 the deficit ratio exceeded the ratio of there is little sign of immediate upward public investment to GDP, while Italy has pressure on inflation; the most recent forecast recorded sizable and increasing current projects inflation to stand slightly below 2% in account surpluses which brought the net 1998 and around 2% in 1999. The level of external liability position near to balance. long-term interest rates was 6.7%, i.e. below the respective reference value. The statutory provisions governing the Banca dItalia, which are contained in various laws The Italian lira has been participating in the and decrees, have been amended. Assuming ERM for around 15 months, i.e. for less than that the amendments to the Banks By-Laws two years prior to the examination by the adopted by the General Meeting of EMI. On the basis of the evidence reviewed Shareholders are approved by a Presidential in the Report, in an ex post assessment, the Decree and that they will enter into force on lira has been broadly stable over the reference time, and assuming that the provisions referred period as a whole. Within the ERM it has to in Article 11.1 of Legislative Decree No. remained generally close to its unchanged 43 dated 10 March 1998 will enter into force central parities, without the need for measures on the date of the establishment of the ESCB to support the exchange rate. at the latest, the Banks statute will be compatible with Treaty and Statute In 1997 Italy achieved a fiscal deficit ratio of requirements for Stage Three. The EMI is not 2.7% of GDP, i.e. below the reference value, aware of any other statutory provisions which and the outlook is for a further decrease to would require adaptation under Article 108 2.5% in 1998. The debt-to-GDP ratio is far of the Treaty. above the 60% reference value. After having reached a peak in 1994, the ratio declined by 3.3 percentage points to stand at 121.6% in 3.9 Luxembourg 1997. The outlook is for a decline in the debt ratio to 118.1% of GDP in 1998. Over the reference period Luxembourg has Notwithstanding the efforts and the substantial achieved a rate of HICP inflation of 1.4%, progress made towards improving the current which is well below the reference value fiscal situation, there must be an ongoing stipulated by the Treaty. The increase in unit concern as to whether the ratio of government labour costs was subdued and low rates of debt to GDP will be sufficiently diminishing inflation were also apparent in terms of other

19 relevant price indices. Looking ahead, there is 3.10 Netherlands little sign of immediate upward pressure on inflation; forecasts project inflation will stand Over the reference period the Netherlands at 1‰-2% in 1998 and 1999. The Luxembourg has achieved a rate of HICP inflation of 1.8% franc, which is in a monetary association with which is well below the reference value the Belgian franc, has been participating in the stipulated by the Treaty. The increase in unit ERM for much longer than two years. Over labour costs was subdued and generally low the reference period it remained broadly rates of inflation were also apparent in terms stable, generally close to its unchanged central of other relevant price indices. Looking ahead, parities without the need for measures to there are some signs of immediate upward support the exchange rate. The level of long- pressure on inflation; forecasts project inflation term interest rates was 5.6%, i.e. well below will rise to around 2‰% in 1998 and 1999. the respective reference value. The Dutch guilder has been participating in the ERM for much longer than two years. Luxembourg achieved a general government Over the reference period it remained broadly surplus of 1.7% of GDP in 1997, thereby stable, generally close to its unchanged central comfortably meeting the 3% reference value, parities, without the need for measures to and the outlook is for a surplus of 1.0% in support the exchange rate. The level of long- 1998. In addition, the fiscal debt ratio was term interest rates was 5.5%, i.e. well below virtually stable at 6.7% of GDP in 1997, i.e. the respective reference value. remaining far below the 60% reference value, and the outlook is for an increase to 7.1% in In 1997 the Netherlands achieved a fiscal 1998. With regard to the sustainability of deficit ratio of 1.4% of GDP, i.e. well below fiscal developments, looking ahead, if current the reference value, and the outlook is for an fiscal surpluses are maintained for 1998, increase to 1.6% in 1998. The debt-to-GDP Luxembourg should comply with the medium- ratio is above the 60% reference value. After term objective of the Stability and Growth having reached a peak in 1993, the ratio Pact, effective from 1999 onwards, of having declined by 9.1 percentage points to stand at a budgetary position that is close to balance 72.1% in 1997. Regarding the sustainability of or in surplus. fiscal developments, the outlook is for a decrease in the debt ratio to 70.0% of GDP With regard to other factors, Luxembourg in 1998. Looking further ahead, keeping the has maintained large current account surpluses. deficit ratio at current levels would not be sufficient to bring the debt ratio down to 60% The Law of 20 May 1983 establishing the of GDP within an appropriate period of time, Institut MonØtaire Luxembourgeois as thus pointing to the need for further substantial amended and the Law of 15 March 1979 on progress in consolidation. The Stability and the monetary status of Luxembourg are Growth Pact also requires as a medium-term currently being amended with Law No. 3862. objective a budgetary position that is close to Assuming that this law is adopted as it stood balance or in surplus. Given the current debt on 24 March 1998 and that it will enter into ratio of above 70% of GDP, achieving the force on time, there will be no remaining fiscal position forecast for 1998 and realising a incompatibilities with Treaty and Statute balanced budget thereafter would reduce the requirements in the IMLs statute, although debt ratio to below 60% in 2002. there are various imperfections, which will, however, not jeopardise the overall functioning With regard to other factors, in 1996 and of the ESCB at the start of Stage Three. Two 1997 the deficit ratio did not exceed the ratio of these imperfections should be corrected of public investment to GDP, and the urgently. Netherlands maintained large current account surpluses as well as a net external asset

20 position. In the context of the ageing of the ahead, keeping the deficit ratio at current population, the Netherlands benefits from a levels would not be sufficient to bring the sizable funded occupational pension system. debt ratio down to 60% of GDP within an appropriate period of time, thus pointing to The statute of De Nederlandsche Bank is the need for further substantial progress in currently being amended. Assuming that a consolidation. The Stability and Growth Pact draft law to this effect is adopted as it stood also requires as a medium-term objective a on 24 March 1998 and that it will enter into budgetary position that is close to balance or force on time, there will be no remaining in surplus. Given the current debt ratio of incompatibilities with Treaty and Statute above 65% of GDP, achieving the fiscal requirements for Stage Three in the Banks position forecast for 1998 and realising a statute, although there is one imperfection, balanced budget thereafter would reduce the which will, however, not jeopardise the overall debt ratio to below 60% as early as the year functioning of the ESCB at the start of Stage 2000. Three. The EMI takes note that adaptations of various other laws are envisaged. With regard to other factors, in 1996 the deficit ratio exceeded the ratio of public investment to GDP, while in 1997 the 3.11 Austria difference was close to zero. Austria has maintained current account deficits as well as Over the reference period Austria has a net external liability position. achieved a rate of HICP inflation of 1.1%, which is well below the reference value The statute of the Oesterreichische stipulated by the Treaty and one of the three Nationalbank is currently being adapted. lowest inflation rates in the Union. Unit Assuming that a draft law to this effect is labour costs were broadly stable over the adopted as it stood on 24 March 1998 and reference period (having decreased in 1996) that it will enter into force on time, the Banks and low rates of inflation were also apparent statute will be compatible with Treaty and in terms of other relevant price indices. Statute requirements for Stage Three. The Looking ahead, there are some signs of EMI takes note that adaptation of the Foreign upward pressure on inflation. The Austrian Exchange Act is envisaged. schilling has been participating in the ERM for longer than two years. Over the reference period it remained broadly stable, generally 3.12 Portugal close to its unchanged central parities, without the need for measures to support the Over the reference period Portugal has exchange rate. The level of long-term interest achieved a rate of HICP inflation of 1.8%, rates was 5.6%, i.e. well below the respective which is well below the reference value reference value. stipulated by the Treaty. The increase in unit labour costs has decelerated markedly over In 1997 Austria achieved a fiscal deficit ratio the 1990s and the general trend towards low of 2.5%, i.e. below the reference value, and rates of inflation was also apparent in terms the outlook is for a decrease to 2.3% in 1998. of other relevant price indices. Looking ahead, The debt-to-GDP ratio is above the 60% there are no signs of immediate upward reference value. After having reached a peak pressure on inflation; forecasts project inflation in 1996, it declined by 3.4 percentage points to stand somewhat above 2% in 1998 and to stand at 66.1% in 1997. Regarding the 1999. The Portuguese escudo has been sustainability of fiscal developments, the participating in the ERM for considerably outlook is for a decrease in the debt ratio to longer than two years. Over the reference 64.7% of GDP in 1998. Looking further period it remained broadly stable, generally

21 close to its unchanged central parities, without price indices. Looking ahead, there are some the need for measures to support the signs of immediate upward pressure on exchange rate. The level of long-term interest inflation; forecasts suggest a rate of 2-2‰% in rates was 6.2%, i.e. below the respective 1998 and 1999. The level of long-term reference value. interest rates was 5.9%, i.e. below the respective reference value. In 1997 Portugal achieved a fiscal deficit ratio of 2.5%, i.e. below the reference value, and The Finnish markka has been participating in the outlook is for a decrease to 2.2% in 1998. the ERM for around 16 months, i.e. for less The debt-to-GDP ratio is just above the 60% than two years prior to the examination by reference value. After reaching a peak in the EMI. On the basis of the evidence 1995 the ratio declined by 3.9 percentage reviewed in the Report, in an ex post points to stand at 62.0% in 1997. Regarding assessment, the Finnish markka has been the sustainability of fiscal developments, the broadly stable over the reference period as a outlook is for a decrease in the debt ratio to whole. Within the ERM, it has remained 60.0% of GDP in 1998, i.e. a level equal to the generally close to its unchanged central parities reference value. Looking further ahead, current without the need for measures to support fiscal deficit ratios exceed the medium-term the exchange rate. objective of the Stability and Growth Pact, effective from 1999 onwards, of having a In 1997 Finland achieved a fiscal deficit ratio budgetary position that is close to balance or of 0.9% of GDP, i.e. well below the reference in surplus, thus pointing to a need for further value, and the outlook is for a surplus of 0.3% substantial consolidation. This would also in 1998. In addition, the fiscal debt ratio imply a reduction in the debt ratio to below declined to 55.8% of GDP in 1997, thus 60%. remaining below the 60% reference value. Regarding the sustainability of fiscal With regard to other factors, in 1996 and developments, the outlook is for a further 1997 the deficit ratio did not exceed the ratio decline to 53.6% in 1998. Against this of public investment to GDP, and Portugal background, Finland should comply with the has recorded current account deficits and a medium-term objective of the Stability and net external asset position. Growth Pact, effective from 1999 onwards, of having a budgetary position that is close to The statute of the Banco de Portugal was balance or in surplus, and the debt ratio amended by means of the Constitutional Law would fall further below 60%. 1/97 of 20 September 1997 and Law No. 5/ 98 of 31 January 1998, which made the With regard to other factors, Finland has Banks statute compatible with Treaty and recorded sizable current account surpluses Statute requirements for Stage Three. The while continuing to have a net foreign liability EMI takes note that adaptations of various position. In the context of the ageing of the other laws are envisaged. population, Finland benefits from a partly funded pension system.

3.13 Finland The statute of Suomen Pankki was amended by means of a revised Act on the Bank of Over the reference period Finland has Finland. The revised law has, again, been achieved a rate of HICP inflation of 1.3%, adapted through a new law (the new law in which is well below the reference value order to bring the Banks statute fully into line stipulated by the Treaty. Unit labour costs with the Treaty and the Statute. With the declined in 1997 and low rates of inflation adoption of the new law, the Banks statute were also apparent in terms of other relevant will be compatible with Treaty and Statute

22 requirements for Stage Three. The EMI takes With regard to other factors, the deficit ratio note that adaptations of the Currency Act exceeded the ratio of public investment to and the Act on Coins have been completed. GDP in 1996, while falling below that level in 1997. In addition, Sweden recorded current account surpluses, while maintaining a net 3.14 Sweden external liability position. In the context of the ageing of the population, Sweden benefits Over the reference period Sweden has from a partly funded pension system. achieved a rate of HICP inflation of 1.9%, which is well below the reference value The Constitution Act, the Riksdag Act and stipulated by the Treaty. The increase in unit the Sveriges Riksbank Act are currently being labour costs was subdued in 1997 and low amended to meet Treaty and Statute rates of inflation were also apparent in terms requirements for the independence of Sveriges of other relevant price indices. Looking ahead, Riksbank. Assuming that the draft law to this there is little sign of immediate upward effect is adopted as it stood on 24 March pressure on inflation; forecasts project inflation 1998, there will be two remaining will stand at 1‰%-2% in 1998 and 2% in 1999. incompatibilities with Treaty and Statute The level of long-term interest rates was requirements for Stage Three in the Banks 6.5%, i.e. below the respective reference statute. value.

Sweden does not participate in the ERM. 3.15 United Kingdom Over the reference period, the Swedish krona traded above its March 1996 average The United Kingdom, in accordance with the bilateral exchange rates against most other terms of Protocol No. 11 of the Treaty, has EU currencies, which are used as a benchmark notified the EU Council that it does not for illustrative purposes in the absence of intend to move to the third stage in 1999. As central rates. a consequence, it will not participate in the single currency at the start of Stage Three. In 1997 Sweden achieved a fiscal deficit ratio Nevertheless, its progress towards of 0.8% of GDP, i.e. well below the reference convergence is examined in detail. value, and the outlook is for a surplus of 0.5% in 1998. The debt-to-GDP ratio is above the Over the reference period the United 60% reference value. After having reached a Kingdom has achieved a rate of HICP inflation peak in 1994, the ratio declined by 2.4 of 1.8%, which is well below the reference percentage points to stand at 76.6% in 1997. value stipulated by the Treaty. The increase in Regarding the sustainability of fiscal unit labour costs was subdued and a general developments, the outlook is for a decline in tendency towards low rates of inflation was the debt ratio to 74.1% of GDP in 1998. also apparent in terms of other relevant price Against the background of recent trends in indices. Looking ahead, forecasts project the deficit ratio, Sweden should comply with inflation at 2-2‰% in 1998 and 1999. The the medium-term objective of the Stability level of long-term interest rates was 7.0%, i.e. and Growth Pact, effective from 1999 below the respective reference value. onwards, of having a budgetary position that is close to balance or in surplus. Given the The United Kingdom does not participate in current debt ratio of above 75% of GDP, the ERM. Over the reference period, the achieving the overall surplus forecast for currency appreciated against other EU 1998 and maintaining it in subsequent years currencies, partly reflecting the differing would reduce the debt ratio to below 60% of position in the cycle and the associated GDP in 2003. monetary policy stance.

23 In 1997 the United Kingdom achieved a fiscal With regard to other factors, the United deficit ratio of 1.9% of GDP, i.e. a level well Kingdom has recorded a small current account below the reference value, and the outlook is surplus in 1997, and has a net foreign asset for a further decline to 0.6% in 1998. In position. In the context of the ageing of the addition, the fiscal debt ratio decreased to population, the United Kingdom benefits 53.4% of GDP in 1997, thus remaining below from a pension system which is heavily reliant the 60% reference value and the outlook is on funded private pensions. for a further decline to 52.3% in 1998. Regarding the sustainability of fiscal Since the United Kingdom has notified the developments, looking ahead, with fiscal Council that it does not intend to adopt the balances as projected, the United Kingdom single currency, there is no current legal should comply with the medium-term requirement to ensure that national legislation objective of the Stability and Growth Pact, is compatible with the Treaty and the Statute. effective from 1999 onwards, of having a budgetary position that is close to balance or in surplus, and the debt ratio would fall further below 60%.

24 Table A Economic indicators and the convergence criteria (excluding the exchange rate criterion)

HICP Long-term General government General government inflation(a) interest rate(b) surplus (+) or deficit (-)(c) gross debt(c) Belgium 1996 1.8 6.5 -3.2 126.9 1997 1.5 5.8 # -2.1 122.2 1998(d) 1.4 5.7 # -1.7 118.1 Denmark(e) 1996 2.1 7.2 # -0.7 70.6 1997 1.9 6.3 # 0.7 65.1 1998(d) 1.9 6.2 # 1.1 # 59.5 Germany 1996 1.2 6.2 -3.4 60.4 1997 1.5 5.6 # -2.7 61.3 1998(d) 1.4 5.6 # -2.5 61.2 Greece 1996 7.9 14.4 -7.5 111.6 1997 5.4 9.9 -4.0 108.7 1998(d) 5.2 9.8 # -2.2 107.7 Spain 1996 3.6 8.7 -4.6 70.1 1997 1.9 6.4 # -2.6 68.8 1998(d) 1.8 6.3 # -2.2 67.4 France 1996 2.1 6.3 -4.1 # 55.7 1997 1.3 5.6 # -3.0 # 58.0 1998(d) ** 1.2 ** 5.5 # -2.9 # 58.1 Ireland 1996 2.2 7.3 # -0.4 72.7 1997 *** 1.2 *** 6.3 # 0.9 66.3 1998(d) *** 1.2 *** 6.2 # 1.1 # 59.5 Italy 1996 4.0 9.4 -6.7 124.0 1997 1.9 6.9 # -2.7 121.6 1998(d) 1.8 6.7 # -2.5 118.1 Luxembourg 1996 *** 1.2 *** 6.3 # 2.5 # 6.6 1997 1.4 5.6 # 1.7 # 6.7 1998(d) 1.4 5.6 # 1.0 # 7.1 Netherlands 1996 1.4 6.2 # -2.3 77.2 1997 1.9 5.6 # -1.4 72.1 1998(d) 1.8 5.5 # -1.6 70.0 Austria 1996 1.8 6.3 -4.0 69.5 1997 * 1.2 * 5.7 # -2.5 66.1 1998(d) * 1.1 * 5.6 # -2.3 64.7 Portugal 1996 2.9 8.6 -3.2 65.0 1997 1.9 6.4 # -2.5 62.0 1998(d) 1.8 6.2 # -2.2 # 60.0 Finland 1996 ** 1.1 ** 7.1 -3.3 # 57.6 1997 ** 1.2 ** 6.0 # -0.9 # 55.8 1998(d) 1.3 5.9 # 0.3 # 53.6 Sweden 1996 * 0.8 * 8.0 -3.5 76.7 1997 1.8 6.6 # -0.8 76.6 1998(d) 1.9 6.5 # 0.5 74.1 United 1996 2.5 7.9 -4.8 # 54.7 Kingdom 1997 1.8 7.1 # -1.9 # 53.4 1998(d) 1.8 7.0 # -0.6 # 52.3

Source: European Commission. *,**,*** = first, second and third best performer in terms of price stability. # = General government deficit not exceeding 3% of GDP; general government gross debt not exceeding 60% of GDP. (a) Annual percentage changes. (b) In percentages. For further explanation of the Greek data, see note in Table 12 for Greece. (c) As a percentage of GDP. (d) Twelve-month period ending January 1998 for HICP inflation and long-term interest rate; European Commission (spring 1998 forecasts) projections for general government surplus or deficit and general government gross debt. (e) See footnote (c) in Table 4 for Denmark.

25 Table B CPI inflation, unit labour costs and current account balance (annual percentage changes, unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Belgium Consumer price index 3.4 3.2 2.4 2.8 2.4 1.5 2.1 1.6 Unit labour costs 3.8 6.8 4.0 5.7 0.3 1.2 -0.2 0.5 Current account balance(b) 1.8 2.3 2.8 5.0 5.1 4.2 4.2 4.7 Denmark Consumer price index 2.6 2.4 2.1 1.2 2.0 2.1 2.1 2.2 Unit labour costs 2.0 1.9 1.9 -0.7 0.0 2.0 0.9 3.0 Current account balance(b) 1.0 1.5 2.8 3.4 1.8 1.1 1.7 0.6 Germany(c) Consumer price index 2.7 3.6 5.1 4.5 2.7 1.8 1.5 1.8 Unit labour costs 2.0 3.3 6.2 3.7 0.2 1.6 -0.2 -1.8 Current account balance(b) 3.2 -1.1 -1.0 -0.7 -1.0 -1.0 -0.6 -0.1 Greece Consumer price index 20.4 19.4 15.9 14.4 10.9 8.9 8.2 5.5 Unit labour costs 19.5 9.3 12.6 12.7 11.7 11.3 9.9 7.5 Current account balance(b) -4.3 -1.7 -2.1 -0.8 -0.1 -2.5 -3.7 -3.8 Spain Consumer price index 6.7 5.9 5.9 4.6 4.7 4.7 3.6 2.0 Unit labour costs 9.3 8.1 8.0 4.9 0.0 1.9 2.9 1.9 Current account balance(b) -3.4 -3.0 -3.0 -0.4 -0.8 1.2 1.3 1.4 France Consumer price index 3.4 3.2 2.4 2.1 1.7 1.8 2.0 1.2 Unit labour costs 4.1 3.6 2.7 3.1 -0.3 1.8 1.4 1.3 Current account balance(b) -0.8 -0.5 0.4 0.9 0.6 0.7 1.3 2.9 Ireland Consumer price index 3.4 3.2 3.0 1.5 2.4 2.5 1.6 1.5 Unit labour costs 0.0 2.2 3.1 3.8 -1.7 -4.1 -2.6 -1.3 Current account balance(b) 0.0 2.1 2.6 5.5 3.6 4.1 3.2 2.8 Italy Consumer price index 6.1 6.4 5.4 4.2 3.9 5.4 3.9 1.7 Unit labour costs 9.3 8.5 3.7 1.4 -0.4 1.8 4.9 3.1 Current account balance(b) -1.5 -2.1 -2.4 1.0 1.4 2.5 3.4 3.1 Luxembourg Consumer price index 3.7 3.1 3.2 3.6 2.2 1.9 1.4 1.4 Unit labour costs 6.6 3.5 4.0 -2.2 1.4 2.2 0.7 1.1 Current account balance(b) 17.0 13.5 15.4 13.7 14.0 18.1 15.9 15.9 Netherlands Consumer price index 2.4 3.1 3.2 2.6 2.8 1.9 2.0 2.2 Unit labour costs(d) 1.7 3.9 3.1 2.2 -1.3 1.2 0.2 0.1 Current account balance(b) 3.2 2.6 2.3 4.4 5.3 5.9 5.2 7.3 Austria Consumer price index 3.3 3.3 4.1 3.6 3.0 2.2 1.9 1.3 Unit labour costs 2.8 4.5 4.8 3.5 0.8 1.1 -0.5 0.0 Current account balance(b) 0.8 0.0 -0.1 -0.4 -0.9 -2.0 -1.8 -1.8 Portugal Consumer price index 13.4 11.4 8.9 6.5 5.2 4.1 3.1 2.2 Unit labour costs 15.7 15.1 13.3 6.5 4.2 2.0 2.9 2.8 Current account balance(b) -0.3 -0.9 -0.1 0.1 -2.5 -0.2 -1.4 -2.0 Finland Consumer price index 6.2 4.3 2.9 2.2 1.1 1.0 0.6 1.2 Unit labour costs 8.8 7.7 -1.8 -4.7 -2.2 0.7 0.6 -2.4 Current account balance(b) -5.1 -5.5 -4.6 -1.3 1.3 4.1 3.8 5.3 Sweden Consumer price index 10.4 9.7 2.6 4.7 2.4 2.8 0.8 0.9 Unit labour costs 10.6 6.4 0.4 1.9 0.5 0.0 4.6 1.2 Current account balance(b) -2.9 -2.0 -3.4 -2.0 0.3 2.2 2.3 2.7 United Consumer price index 8.1 6.7 4.7 3.0 2.3 2.9 3.0 2.8 Kingdom Unit labour costs 10.1 7.1 3.2 0.4 -0.4 1.4 2.1 1.9 Current account balance(b) -3.4 -1.4 -1.7 -1.6 -0.2 -0.5 -0.3 0.4

Source: National data; for explanatory notes see Table Measures of inflation and related indicators and Table External devel opments. (a) Partly estimated. (b) As a percentage of GDP. (c) Unified Germany from 1992 onwards; current account balance from 1991 onwards. (d) 1997: market economy.

26 Chart A Reference value and Harmonised Indices of Consumer Prices (12-month moving average of annual percentage changes) Belgium Greece Reference value* Spain Italy Reference value* Denmark Germany 3 best performers** France Ireland 3 best performers**

8 8

7 7

6 6

5 5

4 4

3 3

2 2

1 1

0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1997 1998 1997 1998

Luxembourg Portugal Reference value* Finland Reference value* Netherlands Austria 3 best performers** Sweden United Kingdom 3 best performers**

8 8

7 7

6 6

5 5

4 4

3 3

2 2

1 1

0 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1997 1998 1997 1998

Source: European Commission. * Unweighted arithmetic average of the three best-performing countries according to the price criterion plus 1.5 percentage points. ** Unweighted arithmetic average of the three best-performing countries according to the price criterion.

27 Chart B Performance in relation to Maastricht Treaty fiscal reference values (as a percentage of GDP) (a) General government surplus (+) / deficit (-) 1996 1997 1998 (a)

3

0

-3

-6

-9 BE DK DE GR ES FR IE IT LU NL AT PT FI SE UK

(b) General government gross debt

140 120 100 80 60 40 20 0 BE DK(b) DE GR ES FR IE IT LU NL AT PT FI SE UK

Source: European Commission (spring 1998 forecasts). (a) Projections. (b) See footnote (c) in Table 4 for Denmark.

28 Chart C Reference value and long-term interest rates (12-month moving average in percentages) Belgium Greece (a) Reference value* Spain Italy Reference value* Denmark Germany 3 best performers** France Ireland 3 best performers**

14 14

13 13

12 12

11 11

10 10

9 9

8 8

7 7

6 6

5 5 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1997 1998 1997 1998

Luxembourg Portugal Reference value* Finland Reference value* Netherlands Austria 3 best performers** Sweden United Kingdom 3 best performers**

14 14

13 13

12 12

11 11

10 10

9 9

8 8

7 7

6 6

5 5 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 1997 1998 1997 1998

Source: European Commission. (a) For further explanation of the data used see Table 12 for Greece. * Unweighted arithmetic average of the long-term interest rates of the three best-performing countries according to the price criterio plus 2.0 percentage points. ** Unweighted arithmetic average of the long-term interest rates of the three best-performing countries according to the price criterion.

29 30 Chapter I

Convergence criteria 1 Key aspects of the examination of economic convergence in 1998

This chapter aims at summarising, country perspective; this should help to better by country, the evidence which is available determine whether current achievements from a comprehensive examination of are primarily the result of genuine structural economic convergence, referring to a adjustments. Second, and to the extent number of economic criteria related to the appropriate, a forward-looking perspective development of prices, government financial is adopted. In this context it is highlighted positions, exchange rates and long-term that the sustainability of favourable interest rates, and taking into account developments hinges critically on other factors. In the following text, Boxes appropriate and lasting policy responses to 1-4 briefly recall the provisions of the existing and future challenges. Overall, it is Treaty and provide methodological details emphasised that ensuring sustainability which outline the application of these depends both on the achievement of a provisions by the EMI. Furthermore, the sound starting position and on the policies main text describes in greater detail the pursued after the start of Stage Three of range of indicators which are considered Economic and Monetary Union. for examining the sustainability of developments, most of which have already As regards price developments, the Treaty appeared in previous reports. First, the provisions and their application by the EMI evidence of the period 1990 to 1997 is are outlined in Box 1. reviewed from a backward-looking

BOX 1 Price developments

1. Treaty provisions Treaty Article 109j (1) requires:

the achie vement 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 Protocol No. 6 on the convergence criteria referred to in Article 109j (1) of the Treaty, stipulates:

The criterion on price stability refer red to in the first indent of Article 109j (1) of this Treaty 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‰ 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.

2. Application of Treaty provisions - First, with regard to an av erage rate of inflation, observed over a period of one year before the examination, the inflation rate has been calculated using the increase in the latest a vailable twelve- month average of the Harmonised Indices of Consumer Prices (HICP) over the previous twelve- month average. Hence, with respect to the rate of inflation, the reference period considered in this Report is February 1997 to January 1998.

32 - Second, the notion of at most, the three best-performing Member States in ter ms of price stability which is used for the definition of the reference value has been applied by using the unweighted arithmetic average of the rate of inflation in the three countries with the lowest inflation rates, given that these rates are compatible with price stability and there are no outliers. At the time this Report was finalised, the three countries with the lowest HICP inflation rates observed over the reference period were Austria (1.1%), France (1.2%) and Ireland (1.2%); as a result, the average rate is 1.2% and, adding 1‰ percentage points, the reference value is 2.7%.

Inflation has been measured on the basis of the data from HICPs, which were developed for the purpose of assessing convergence in terms of price stability on a comparable basis (see Annex 2 to this chapter).

To allow a more detailed examination of the labour costs and import prices. Finally, price sustainability of price developments, the trends across other relevant price indices average rate of HICP inflation achieved over (including the national CPI, the private the twelve-month reference period from consumption deflator, the GDP deflator and February 1997 to January 1998 is reviewed in producer prices) are taken into account. the light of the performance during the From a forward-looking perspective, a view is 1990s in terms of price stability. In this provided on prospective inflationary connection, attention is drawn to the developments in the immediate future, orientation of monetary policy, in particular including forecasts by major international whether the focus of the monetary authorities organisations, and structural aspects are has been primarily on achieving and mentioned which are relevant for maintaining maintaining price stability, as well as to the an environment conducive to price stability contribution of other areas of economic after the start of Stage Three of Economic policy. Moreover, the implications of the and Monetary Union. macroeconomic environment for the achievement of price stability are taken into Concerning fiscal developments, the Treaty account. Price developments are examined provisions and their application by the EMI in the light of demand and supply conditions, as well as procedural issues are outlined in focusing inter alia on factors influencing unit Box 2.

BOX 2 Fiscal developments

1. Treaty provisions Treaty Article 109j (1) requires:

the sustainability of the go vernment 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 104c (6). Article 2 of Protocol No. 6 stipulates that this criterion shall mean that at the time of the examination the Member State is not the subject of a Council decision under Article 104c (6) of this Treaty that an excessive deficit exists.

33 Article 104c sets out the excessive deficit procedure. According to Article 104c (2) and (3) the Commission shall prepare a report if a Member State does not fulfil the requirements for fiscal discipline, in particular if

a) the ratio of the planned or actual government deficit to gross domestic product exceeds a reference value (defined in the Protocol as 3% of GDP), unless: either the ratio has declined substantially and continuously and reached a level that comes close to the reference value; or, alternatively, the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value;

b) the ratio of government debt to gross domestic product exceeds a reference value (defined in the Protocol as 60% of GDP), unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace.

In addition, the report prepared by the Commission shall take into account whether the government deficit exceeds government investment expenditure and all other relevant factors, including the medium- term economic and budgetary position of the Member State. The Commission may also prepare a report if, notwithstanding the fulfilment of the requirements under the criteria, it is of the opinion that there is a risk of an excessive deficit in a Member State. The Monetary Committee shall formulate an opinion on the report of the Commission. Finally, according to Article 104c (6), the EU Council, on the basis of the recommendation from the Commission, shall, acting by qualified majority, decide, after an overall assessment, whether an excessive deficit exists in a Member State.

2. Procedural issues and application of Treaty provisions - First, with regard to the provision of Protocol No. 6, Article 2, that the criterion on the go vernment budgetary position... shall mean that at the time of the examination the Member State is not the subject of a Council decision under Article 104c (6) of this Treaty that an excessive deficit exists, it should be noted that the EU Council (ECOFIN) will officially revise the list of countries having an excessi ve deficit onl y after publication of this Report, on the basis of a recommendation of the Commission. Since it will be these forthcoming decisions by the EU Council which will precede the final decisions to be taken by the Heads of State or Government, the EMI Report does not comment further on the earlier decisions taken in June 1997. *

- Second, with regard to Article 104c, the EMI, in contrast to the Commission, has no formal role in the excessive deficit procedure.

- Third, for the purpose of examining convergence, and in advance of the decisions to be taken by Ministers in the excessive deficit procedure, the EMI expresses its view on fiscal developments. With regard to sustainability, the EMI examines key indicators of fiscal developments from 1990 to 1997, considers the outlook and challenges for public finances and focuses on the links between deficit and debt developments.

- Fourth: (a) in cases where a deficit ratio is considered by the EMI to have declined both substantiall y and continuously, it pro vides its view with regard to the Treaty provision of the ratio having reached a level that comes close to the reference v alue.

* According to the decisions of the EU Council in June 1997, all EU Member States currently have excessive deficits except Denmark, Ireland, Luxembourg, the Netherlands and Finland.

34 (b) with regard to the Treaty provision that the excess over the reference value is only e xceptional and temporary and the ratio remains close to the reference value, the EMI refers to the agreement reached in the Stability and Growth Pact.

- Fifth, with regard to the Treaty provision that a debt ratio of above 60% of GDP should be suf ficiently diminishing and approaching the reference value at a satisfactory pace, the EMI e xamines past and current trends, and, for countries in which the ratio exceeds the reference value, it provides a number of illustrative calculations. For countries with debt ratios of between 60% and 80% of GDP, these refer to the potential future paths of the debt ratio on various assumptions. For countries with debt ratios of above 100% of GDP, in addition to the above calculations, the overall and primary fiscal balances are shown which are consistent with a reduction of the debt ratio to 60% of GDP over five, ten and fifteen years, i.e. by 2002, 2007 and 2012 respectively.

The examination of fiscal developments is based on comparable data compiled on a National Accounts basis, in compliance with the European System of Integrated Economic Accounts (ESA 2nd edition; see Annex 2 to this chapter). The main figures presented in this Report became available from the Commission in March 1998 and include government financial positions in 1996 and 1997 as well as Commission estimates for 1998. Also, the relationship between the deficit ratio and government investment expenditure is reported for 1996 and 1997.

Concerning the closer examination of the In a further step, the evolution of the sustainability of fiscal developments, the deficit ratio is investigated. In this respect it outcome in the reference year, 1997, is is considered useful to keep in mind that reviewed in the light of the performance the change in a countrys annual deficit during the 1990s. As a starting-point, the ratio is typically influenced by a variety of evolution observed in the debt ratio over underlying forces. These influences are the past is considered, and the factors often sub-divided into cyclical effects on underlying this evolution are examined, i.e. the one hand, which reflect the reaction of the difference between nominal GDP deficits to changes in the output gap, and growth and interest rates, the primary non-cyclical effects on the other hand, balance, and the stock-flow adjustments. which are often taken to reflect structural Such a perspective can offer further or permanent adjustments to fiscal policies. information on the extent to which the However, such non-cyclical effects, as macroeconomic environment, in particular quantified in the Report on the basis of the combination of growth and interest Commission estimates, cannot necessarily rates, has affected the dynamics of debt; on be seen as entirely reflecting a structural the contribution of fiscal consolidation change to fiscal positions, because they will efforts as reflected in the primary balance; also include any measures and other factors and on the role played by special factors as with only temporary effects on the included in the stock-flow item. In addition, budgetary balance. While complete and the structure of debt is considered, by fully comparable data on such measures focusing in particular on the share of debt with a temporary effect do not exist, the with a short-term residual maturity and available information for 1996-98 is foreign currency debt, as well as their provided when these measures have evolution. By linking these shares with the contributed to a reduction in deficit ratios. current level of the debt ratio, the sensitivity To the extent possible, a distinction is of fiscal balances to changes in exchange made between measures which improve rates and interest rates is highlighted. the budgetary outcome in one year only

35 and therefore require compensation in the presented (see Box 2). In respect of these following year (one-off measures), and calculations, a link between deficit measures which have the same implication developments and the prospective path of in the short run but in addition lead to the debt ratio can be established, as well as extra borrowing in later years, thereby first a link to the objectives of the Stability and improving and later burdening the budget Growth Pact applicable from 1999 onward, (self-reversing measures). of having a budgetary position close to balance or in surplus. Finally, long-term Past public expenditure and revenue trends challenges to the sustainability of budgetary are also considered in more detail. In the positions are emphasised, particularly those light of past trends, a view is put forward, related to the issue of unfunded public inter alia, of the broad areas on which pension systems in connection with aspects necessary future consolidation may need of demographic change. to focus. With regard to exchange rate developments, Turning to a forward-looking perspective, the Treaty provisions and their application 1998 budget plans and recent forecasts are by the EMI are outlined in Box 3. For the recalled and account is taken of the currencies of Member States not medium-term fiscal strategy as reflected in participating in the ERM, performance is Convergence Programmes. Thereafter, a shown against each of the EU member number of illustrative calculations are currencies over the past two years.

BOX 3 Exchange rate developments

1. Treaty provisions Treaty Article 109j (1) requires:

the obser vance of the normal fluctuation margins provided for by the exchange-rate mechanism of the , for at least two years, without devaluing against the currency of any other Member State.

Article 3 of Protocol No. 6 on the convergence criteria referred to in Article 109j (1) of the Treaty stipulates:

The criterion on par ticipation in the exchange-rate mechanism of the European Monetary System referred to in the third indent of Article 109j (1) of this Treaty 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 currencys bilateral central rate against any other Member States currency on its own initiative for the same period.

36 2. Application of Treaty provisions*

The Treaty refers to the criterion on participation in the Exchange Rate Mechanism (ERM) of the European Monetary System.

- First, the EMI examines if the country has participated in the ERM for at least the last tw o years before the examination, as stated in the Treaty. In individual cases of a shorter period of participation, the EMI describes exchange rate developments over the full two-year reference period up to February 1998, the last full month before the EMIs report was adopted.

- Second, with regard to the definition of nor mal fluctuation margins, the EMI recalls the for mal opinion that was put forward by the EMI Council in October 1994 and its statements in the November 1995 Report on Pro gress towards convergence:

In the EMI Councils opinion of October 1994 it was stated that ...the wider band has helped to achieve a sustainable degree of exchange rate stability in the ERM..., that ...the EMI Council considers it advisable to maintain the present arrangements..., and that ...member countries should continue to aim at avoiding significant exchange rate fluctuations by gearing their policies to the achievement of price stability and the reduction of fiscal deficits, thereby contributing to the fulfilment of the requirements set out in Article 109j (1) of the Treaty and the relevant Protocol.

In the November 1995 Convergence Report it was recognised by the EMI that w hen the Treaty was conceived, the normal fluctuation margins were –2.25% around bilateral central rates, whereas a –6% band was a derogation from the rule. In August 1993 the decision was taken to widen the fluctuation margins to –15%, and the interpretation of the criterion, in particular of the concept of normal fluctuation margins, became less straightforward. It w as then also proposed that account would need to be taken of the par ticular evolution of exchange rates in the EMS since 1993 in forming an ex post judgement.

Against this background, in the assessment of exchange rate developments the emphasis is placed on exchange rates being close to the central rates. When examining exchange rate developments within the ERM, reference is made to the currencys deviation from all bilateral central rates in the system as a neutral and transparent way of presentation.

- Third, the issue of se vere tensions is generall y addressed by examining the degree of deviation of exchange rates from ERM central parities, and by using such indicators as exchange rate volatility vis--vis the Deutsche Mark and its trend, as well as short-term interest rate differentials vis--vis the group of countries with the lowest money market rates and their evolution.

All bilateral exchange rates for the reference period from March 1996 to February 1998 are derived from ECU exchange rates which are quoted daily and published in the Official Journal of the European Communities (see Annex 2 to this chapter).

* In the opinion of two members of the Council, the EMI should not base its Report on a particular interpretation of ERM participation, but should submit a thorough Report for the EU Council to assess de facto sustained exchange rate stability in the context of the economic fundamentals in all Member States. These members underline that the exchange rate criterion can no longer be applied straightforwardly because the form of the ERM which existed when the Treaty was prepared came to an end in August 1993 with the decision to widen the permitted fluctuation margins from ±2.25% to ±15%.

37 With regard to a more detailed well as the current account of the balance examination, apart from reviewing the of payments, the degree of openness of performance of nominal exchange rates the Member State and the destination of over the reference period from March trade (i.e. the share of intra-EU trade), and 1996 to February 1998, evidence relevant net foreign asset positions. to the sustainability of current exchange rates derived from real exchange rate With regard to long-term interest rate patterns vis--vis ERM participating developments, the Treaty provisions and countries is briefly reviewed (for non-ERM their application by the EMI are outlined in members reference is made to real Box 4. exchange rates against EU currencies), as

BOX 4 Long-term interest rate developments

1. Treaty provisions Treaty Article 109j (1) requires:

the durability of con vergence achieved by the Member State and of its participation in the exchange- rate mechanism of the European Monetary System being reflected in the long-term interest-rate levels.

Article 4 of Protocol No. 6 of the Treaty stipulates:

The criterion on the con vergence of interest rates referred to in the fourth indent of Article 109j (1) of this Treaty 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 2 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, taking into account differences in national definitions.

2. Application of Treaty provisions - First, with regard to an a verage nominal long-term interest rate observ ed over a period of one y ear before the examination, the long-term interest rate has been calculated as an arithmetic a verage over the latest twelve months for which data on HICPs were available. Hence, the reference period considered in this Report is February 1997 to January 1998.

- Second, the notion of at most, the three best-performing Member States in ter ms of price stability which is used for the definition of the reference value has been applied by using the unweighted arithmetic average of the long-term interest rates of the three countries with the lowest inflation rates (see Box 1). At the time this Report was finalised, the long-term interest rates of these three countries observed over the reference period were 5.6% (Austria), 5.5% (France) and 6.2% (Ireland); as a result, the average rate is 5.8% and, adding 2 percentage points, the reference value is 7.8%.

Interest rates have been measured on the basis of harmonised long-term interest rates, which were developed for the purpose of assessing convergence (see Annex 2 to this chapter).

38 As mentioned above, the Treaty makes several other factors, namely the explicit reference to the durability of development of the ECU, the results of the convergence being reflected in the level of integration of markets, the situation and long-term interest rates. Therefore, development of the balances of payments developments over the reference period on current account and an examination of from February 1997 to January 1998 are the development of unit labour costs and reviewed in the context of the path of other price indices. These factors are long-term interest rates during the 1990s reviewed in the country chapters under and the main factors underlying differentials the individual criteria listed above, while vis--vis those prevailing in the EU countries the development of the ECU is discussed with the lowest long-term interest rates. separately in Annex 1 to this chapter.

Finally, Article 109j (1) of the Treaty Each country chapter concludes with a requires the Report to take account of summary.

39 2 Examination of the key aspects of convergence in 1998

BELGIUM thereafter. Control over inflation has benefited from falling or broadly stable import prices during most of the 1990s, Price developments although growth in import prices accelerated in 1997. Low rates of inflation Over the reference period from February are also apparent when it is measured in 1997 to January 1998 the average rate of terms of other relevant price indices (see HICP inflation in Belgium was 1.4%, i.e. well Table 2). below the reference value of 2.7%. This was also the case in 1997 as a whole. In Looking at recent trends and forecasts, 1996 average HICP inflation was 1.8% (see current outturns for consumer price Table 1). Seen over the past two years, inflation (measured as a percentage change HICP inflation in Belgium has been at levels over the corresponding month a year which are generally considered to be earlier) have been decreasing to around consistent with price stability. ‰% and there are no signs of immediate upward pressure on the basis of the Looking back, consumer price inflation in measures shown in Table 3a. Most forecasts Belgium, as measured on the basis of the of inflation suggest rates of around 1‰% CPI, has followed a downward trend since for 1998 and 1999 (see Table 3b). the beginning of the 1990s (see Chart 1). This experience of declining rates of inflation Looking further ahead, maintaining an reflects a number of important policy environment conducive to price stability choices, most notably the orientation of relates in Belgium to, inter alia, the conduct monetary policy towards price stability of fiscal policies over the medium to long from the mid-1980s onwards. Since 1990 term; it will be equally important to this policy has been formalised in the strengthen national policies aimed at objective of seeking to maintain a close link improving the functioning of labour markets between the Belgian franc and the Deutsche against the background of the current high Mark within the framework of the ERM. rate of unemployment in Belgium. The general orientation has been supported by, inter alia, the introduction of legislation limiting wage rises to those obtaining in Fiscal developments Belgiums most important trading partners as well as by a reduction in employers In the reference year 1997 the general social security contributions. In addition, government deficit ratio was 2.1%, i.e. below the macroeconomic environment has the 3% reference value, and the debt ratio contributed to containing upward pressure was 122.2%, i.e. far above the 60% reference on prices. In particular, a negative output value. Compared with the previous year, the gap emerged in the context of the 1993 deficit ratio has been reduced by 1.1 recession (see Table 2). The output gap percentage points and the debt ratio by 4.7 has remained sizable in subsequent years, percentage points. In 1998 the deficit ratio is despite a recovery in GDP growth. Against forecast to decrease to 1.7% of GDP, while this background, growth in compensation the debt ratio is projected to decline to per employee has gradually decreased, 118.1%. In 1996 and 1997 the deficit ratio with growth in unit labour costs falling to exceeded the ratio of public investment almost zero in 1994 and remaining low expenditure to GDP by 2.0 percentage

40 points and 0.7 percentage point, respectively outturns can be observed in the deficit-to- (see Table 4). GDP ratio. Starting from a ratio of 5.5% in 1990, fiscal imbalances reached 7.1% of Looking back over the years 1990 to 1997, GDP in 1993; since then, the deficit has the Belgian debt-to-GDP ratio declined by declined year by year to stand at 2.1% of 3.5 percentage points; initially the ratio GDP in 1997 (see Chart 3a). As is shown tended to rise, from 125.7% in 1990 to in greater detail in Chart 3b, which focuses reach 135.2% in 1993, whereas it declined on changes in deficits, cyclical factors played steadily year by year thereafter to reach a major role only in 1993, increasing the 122.2% in 1997 (see Chart 2a), i.e. a deficit. However, the non-cyclical decline of 13.0 percentage points over improvements could reflect a lasting, four years. As is shown in greater detail in structural move towards more balanced Chart 2b, the declining primary surpluses fiscal policies and/or a variety of measures during the early 1990s were not sufficient with temporary effects. Evidence available to outweigh the sizable debt-increasing suggests that such measures with a effects of a negative growth/interest rate temporary effect reduced the deficit ratio differential. By contrast, after 1993 higher by 0.3 percentage point in 1997, compared primary balances more than compensated with 0.4 percentage point in 1996. They for the adverse influence of the growth/ were mainly of a one-off nature. This interest rate differential, with the latter implies that the compensating measures factor having started to recede in 1997. In already included in the 1998 budget will addition, stock-flow adjustments need to yield their expected results in contributed to a reduction in gross debt in 1998 in order to keep fiscal balances on 1996, mainly reflecting the impact of the planned path. financial operations (sales of assets by the government and the central bank). The Moving on to examine trends in other patterns observed in the early 1990s may fiscal indicators, it can be seen from Chart be seen as indicative of the risks which can 4 that the general government total arise for public finances when expenditure ratio rose steadily between macroeconomic conditions deteriorate and 1990 and 1993. Against the background of the buffer in terms of the primary surplus is high and rising unemployment, current insufficient to counterbalance such effects. transfers to households as well as public In this context, it may be noted that the consumption increased in particular (see share of debt with a short-term residual Table 6). In subsequent years the ratio of maturity has been decreasing from the high total expenditure to GDP declined, mainly levels of the early 1990s, and in parallel the reflecting a reduction in interest payments average maturity has increased (see Table and to a lesser extent in current transfers 5). With regard to 1997, the proportion of relative to GDP. The expenditure ratio in debt with a short-term residual maturity is 1997 was lower than at the beginning of still relatively high, and, taking into account the 1990s, due primarily to a reduction in the current level of the debt ratio, fiscal interest payments. While some further balances are highly sensitive to changes in reduction in the ratio of interest payments interest rates. On the other hand, the to GDP can be expected as the debt ratio proportion of foreign currency denominated is reduced further, a continuation of the debt in Belgium is low and fiscal balances downward trend of total expenditure to are relatively insensitive to changes in GDP would appear to require additional exchange rates. adjustments in expenditure items other than investment, which is already low. During the 1990s a similar pattern of first Government revenue in relation to GDP deteriorating and subsequently improving tended to increase continuously up to

41 1994, remaining broadly unchanged horizons. As an illustration, focusing on the thereafter, and may have approached a period of ten years, i.e. reducing the debt level which is detrimental to growth. ratio to 60% by 2007, would imply realising from 1999 onwards an overall surplus of According to the Belgian medium-term fiscal 2.7% of GDP per year (see Table 7a) or policy strategy, as presented in the realising from 1999 onwards a primary Convergence Programme for 1997-2000 surplus of 8.0% of GDP per year (see issued in December 1996, a declining trend Table 7b). This compares with an overall in deficit and debt ratios is projected to deficit ratio of 1.7% and a primary surplus continue in 1998. The budget for 1998 is ratio of 6.0% projected for 1998, i.e. the well ahead of the programme. It foresees a difference is 4.4 and 2.0 percentage points further reduction in the overall deficit ratio respectively. to 1.7% of GDP, which reflects the planned increase in the primary surplus-to-GDP A second exercise, as detailed in Chart 5, ratio (to 6.0%) and a further fall in interest shows that maintaining the 1998 overall payments. The total revenue ratio of the fiscal balance of -1.7% of GDP over the federal government and social security subsequent years would only reduce the system is projected to decrease by 0.5 debt ratio to 93.4% in ten years; the 60% percentage point, in line with the envisaged reference value would then be reached in reduction in the primary expenditure-to- 2031. Maintaining the 1998 primary surplus GDP ratio. Measures with a temporary of 6.0% of GDP would reduce the debt-to- effect have been further reduced in the GDP ratio to 79.6% in ten years; in this 1998 budget to 0.2% of GDP. According case, the 60% level would be reached in to current plans, and if assumptions 2012. Finally, realising balanced budgets regarding economic growth are fulfilled, in annually from 1999 onwards would bring the year 2000 the overall deficit-to-GDP the debt ratio down to 80.7% in ten years, ratio is expected to stand at 1.0% and the and the 60% reference value would be debt ratio at 111.0%, depending on reached in 2015. economic developments. Compared with fiscal balances projected in the Convergence Such calculations are based on the Programme for 1999-2000, further normative assumption of a constant nominal substantial fiscal consolidation is needed in rate of interest of 6% (average real cost of order to comply with the medium-term public debt outstanding of 4% and 2% objective of the Stability and Growth Pact, inflation) and the assumption of a constant effective from 1999 onwards, of having a real GDP growth rate of 2.3%, as estimated budgetary position that is close to balance by the Commission for real trend GDP or in surplus. growth in 1998. Stock-flow adjustments are not taken into account. While these With regard to the future horizon for calculations are purely illustrative, and can reducing the debt ratio to the 60% by no means be seen as forecasts, they do reference value in countries with a debt provide an illustration of why consolidation ratio of above 100% of GDP, two different efforts need to be all the more resolute kinds of calculations are presented. On the and lasting the higher the initial stock of assumption that fiscal balances and debt debt, in order to forcefully reduce the ratios as projected by the European debt-to-GDP ratio to 60% or below within Commission for 1998 are achieved, the an appropriate period of time. first exercise, as detailed in Table 7, shows the fiscal balances which would be Stressing the need for sustained consistent with convergence of the debt consolidation over an extended period of ratio to 60% of GDP over different time time resulting in the achievement of growing

42 and sizable overall fiscal surpluses is indeed pound (see Table 9a). The episodes in critical in the case of Belgium, since the which such deviations occurred were current high level of debt would otherwise temporary, the degree of exchange rate impose a continuous burden on fiscal policy volatility vis--vis the Deutsche Mark was and the economy as a whole. As has been continuously very low (see Table 9b) and seen in the past, high levels of debt increase short-term interest rate differentials against the vulnerability of fiscal positions to those EU countries with the lowest short- unexpected shocks, thus heightening the term interest rates were insignificant. During risk of a sudden worsening of public the reference period Belgium has not finances. In addition, as is highlighted in devalued its currencys bilateral central Table 8, from around 2010 onwards a rate against any other Member States marked ageing of the population is expected currency. and, in the context of an unfunded pension system, public pension expenditure is In a longer-term context, measures of the projected to increase in terms of GDP, real effective exchange rate of the Belgian particularly if policies regarding benefits franc vis--vis the currencies of ERM continue unchanged. Alleviation of the participating Member States depicted in overall burden of population ageing will Table 10 suggest that current levels are only be feasible if public finances have close to historical values. As regards other created sufficient room for manoeuvre external developments, Belgium has before entering the period during which maintained large current account surpluses, the demographic situation worsens. a situation which has been reflected in a steady improvement in the net external asset position (see Table 11). It may also Exchange rate developments be recalled that Belgium is a small open economy with, according to the most The Belgian franc has been participating in recent data available, a ratio of foreign the ERM since its inception on 13 March trade to GDP of 84% for exports and 79% 1979, i.e. for much longer than two years for imports, and with a share of intra-EU prior to the examination (see Table 9a). As trade of 70% for exports and 74% for mentioned above, Belgian monetary policy imports. has focused on the objective of seeking to maintain a close link between the Belgian franc and the Deutsche Mark within the Long-term interest rate developments context of the ERM. Focusing on the reference period from March 1996 to Over the reference period from February February 1998, the currency has normally 1997 to January 1998 long-term interest traded close to its central rates against rates in Belgium were 5.7% on average, and other ERM currencies and very close to thus stood well below the reference value those vis--vis the Deutsche Mark, the for the interest rate criterion of 7.8% set Dutch guilder and the Austrian schilling on the basis of the three best-performing (see Chart 6 and Table 9a). On occasion Member States in terms of price stability. the Belgian franc traded outside a range This was also the case for 1997 as a whole, close to its central rates vis--vis several as well as for 1996 (see Table 12). partner currencies. The maximum upward and downward deviations from central Long-term interest rates have been on a rates, on the basis of 10 business day broadly declining trend since the early moving averages, were 2.5% and -3.0% 1990s (see Chart 7a). At the same time, a respectively, abstracting from the relatively close convergence of Belgian autonomous upward trend of the Irish long-term interest rates with those

43 prevailing in the EU countries with the In 1997 Belgium achieved a fiscal deficit lowest bond yields has been observed ratio of 2.1% of GDP, i.e. below the since the beginning of the 1990s; over the reference value, and the outlook is for a past two years the differential has declined further decline to 1.7% in 1998. The debt- to almost zero (see Chart 7b). The main to-GDP ratio is far above the 60% reference factors underlying this trend were value. After having reached a peak in 1993, favourable developments in rates of it declined by 13.0 percentage points to inflation, the relative stability of the Belgian stand at 122.2% in 1997; the outlook is for francs exchange rate, the pursuit of a a further decline to 118.1% of GDP in similar monetary policy stance to that 1998. Notwithstanding the efforts and the followed in the above-mentioned countries, substantial progress made towards the reduction in fiscal deficits and the improving the current fiscal situation, there improvement in the current account of the is an evident ongoing concern as to whether balance of payments. the ratio of government debt to GDP will be sufficiently diminishing and approaching the reference value at a satisfactory pace Concluding summary and whether sustainability of the fiscal position has been achieved; addressing this Over the reference period Belgium has issue will have to remain a key priority for achieved a rate of HICP inflation of 1.4%, the Belgian authorities. The maintenance which is well below the reference value of a primary surplus of at least 6% of GDP stipulated by the Treaty. The increase in per year and the achievement of growing unit labour costs was subdued and low and sizable overall fiscal surpluses are rates of inflation were also apparent in needed in order to be able to forcefully terms of other relevant price indices. reduce the debt ratio to 60% within an Looking ahead, there are no signs of appropriate period of time. This compares immediate upward pressure on inflation; with a recorded fiscal deficit of 2.1% of forecasts project inflation to be around GDP in 1997, as well as the forecast deficit 1‰% in 1998 and 1999. The Belgian franc of 1.7% in 1998. The Stability and Growth has been participating in the ERM for much Pact also requires, as a medium-term longer than two years. Over the reference objective, a budgetary position that is close period it remained broadly stable, generally to balance or in surplus. close to its unchanged central parities without the need for measures to support With regard to other factors, in 1996 and the exchange rate. The level of long-term 1997 the deficit ratio exceeded the ratio of interest rates was 5.7%, i.e. well below the public investment to GDP, while Belgium respective reference value. has maintained large current account surpluses and a strong net external asset position.

44 List of Tables and Charts*

BELGIUM

I Price developments Table 1 Belgium: HICP inflation Chart 1 Belgium: Price developments Table 2 Belgium: Measures of inflation and related indicators Table 3 Belgium: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Belgium: General government financial position Chart 2 Belgium: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Belgium: General government gross debt structural features Chart 3 Belgium: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Belgium: General government expenditure and receipts Table 6 Belgium: General government budgetary position Table 7 Belgium: Debt convergence calculations (a) On the basis of overall fiscal balances (b) On the basis of primary fiscal balances Chart 5 Belgium: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 8 Belgium: Projections of elderly dependency ratio

III Exchange rate developments Table 9 (a) Belgium: Exchange rate stability (b) Key indicators of exchange rate pressure for the Belgian franc Chart 6 Belgian franc: Deviations from ERM bilateral central rates Table 10 Belgian franc: Measures of the real effective exchange rate vis--vis ERM Member States Table 11 Belgium: External developments

IV Long-term interest rate developments Table 12 Belgium: Long-term interest rates Chart 7 (a) Belgium: Long-term interest rate (b) Belgium: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

45 1 Price developments

Table 1 Belgium: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.8 1.5 1.3 0.9 0.5 1.4 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Belgium: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

8

6

4

2

0

-2

-4 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

46 Table 2 Belgium: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 3.4 3.2 2.4 2.8 2.4 1.5 2.1 1.6 CPI excluding changes in net indirect taxes(b) 3.1 3.1 2.3 2.4 1.6 1.5 1.5 1.4 Private consumption deflator 3.3 3.3 2.3 3.5 2.8 1.7 2.3 1.6 GDP deflator 3.1 3.2 3.6 4.2 2.3 1.7 1.6 1.4 Producer prices 0.0 -1.0 -0.0 -1.5 1.7 2.3 0.7 1.9 Related indicators Real GDP growth 3.0 1.6 1.5 -1.5 2.4 2.1 1.5 2.7 Output gap (p.pts) 2.9 2.4 2.0 -1.4 -1.0 -0.9 -1.5 -1.0 Unemployment rate (%) 6.7 6.6 7.3 8.8 10.0 9.9 9.8 9.5 Unit labour costs, whole economy 3.8 6.8 4.0 5.7 0.3 1.2 -0.2 0.5 Compensation per employee, whole economy 6.1 7.9 5.9 5.1 3.6 3.2 1.1 2.8 Labour productivity, whole economy 2.3 1.1 1.8 -0.6 3.4 2.0 1.3 2.3 Import price deflator -1.5 -0.6 -2.9 -2.6 0.9 1.0 2.0 4.5 Exchange rate appreciation(c) 4.9 -0.2 2.0 1.0 1.6 4.2 -1.9 -4.0 Broad monetary aggregate (M3H)(d) 10.2 5.9 4.4 9.2 7.6 -6.0 6.8 6.4 Stock prices -8.2 -7.6 -1.5 10.5 11.5 -2.2 20.5 33.9 House prices 9.2 6.6 9.1 6.6 7.7 4.6 4.5 3.5

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Belgium: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.6 1.3 1.4 1.2 0.4 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 2.4 1.6 1.2 1.0 0.6 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 1.1 1.2 1.4 1.4 1.4 Source: National non-harmonised data.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 1.3 1.5 OECD (December 1997), private consumption deflator 1.6 1.6 IMF (October 1997), CPI 1.9 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

47 II Fiscal developments

Table 4 Belgium: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -3.2 -2.1 -1.7 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -2.0 -0.7 . General government gross debt 126.9 122.2 118.1 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Belgium: General government gross debt (as a percentage of GDP)

(a) Levels

140

135

130

125

120 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

15 10 5 0 -5 -10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

48 Table 5 Belgium: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 125.7 127.5 129.0 135.2 133.5 131.3 126.9 122.2 Composition by currency (% of total) In domestic currency 86.2 87.3 89.1 84.9 87.0 89.7 93.0 92.7 In foreign currencies 13.8 12.7 10.9 15.1 13.0 10.3 7.0 7.3 Domestic ownership (% of total) 80.3 76.6 77.6 75.7 77.9 77.7 78.2 . Average maturity(a) (years) . 3.4 3.9 4.5 4.6 4.8 4.5 4.3 Composition by maturity(a) (% of total) Short-term(b) (< 1 year) 39.3 33.6 31.6 34.3 30.7 24.9 23.6 24.6 Medium-term (1-5 years) 31.8 37.1 36.9 30.5 31.0 33.1 37.3 35.7 Long-term (> 5 years) 28.9 29.3 31.5 35.2 38.3 42.0 39.1 39.7

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Treasury debt only. (b) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Belgium: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-2

-4

-6

-8 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

3 2 1 0 -1 -2 -3 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

49 Chart 4 Belgium: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

60

55

50

45 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Belgium: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 47.8 48.0 48.0 48.7 49.5 49.6 49.7 49.9 Taxes 28.9 28.5 28.4 28.7 30.3 30.4 30.7 31.3 Social security contributions 17.0 17.6 17.8 18.2 17.7 17.7 17.4 17.2 Other current receipts 1.8 1.9 1.8 1.8 1.5 1.5 1.6 1.4 Total expenditure 53.2 54.2 54.9 55.8 54.4 53.5 52.9 52.0 Current transfers 27.0 28.0 28.0 28.4 28.0 27.9 28.2 27.8 Actual interest payments 10.5 10.1 10.7 10.7 10.0 9.0 8.5 7.9 Public consumption 14.0 14.4 14.2 14.7 14.6 14.7 14.5 14.5 Net capital expenditure 1.8 1.8 2.0 2.1 1.8 1.9 1.7 1.8 Surplus (+) or deficit (-) -5.5 -6.3 -6.9 -7.1 -4.9 -3.9 -3.2 -2.1 Primary balance 5.0 3.8 3.8 3.6 5.1 5.1 5.3 5.8 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -5.6 -3.3 -2.5 -2.0 -0.7

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

50 Table 7 Belgium: Debt convergence calculations

(a) On the basis of overall fiscal balances (as a percentage of GDP)

Total gross debt Overall fiscal balance Overall fiscal balance consistent with reduction (deficit: (-); surplus (+)) of debt level to 60% of GDP in(a) 1997 1998 1997 1998 2002 2007 2012 122.2 118.1 -2.1 -1.7 10.6 2.7 0.5

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the overall fiscal balance for 1998 is as forecast and the overall fiscal balances were maintained at 10.6%, 2.7% and 0.5% of GDP respectively, from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 2.3% in 1998, as estimated by the Commission, and an inflation rate of 2%. Stock-flow adjustments are disregarded.

(b) On the basis of primary fiscal balances (as a percentage of GDP)

Total gross debt Primary fiscal balance Primary fiscal balance consistent with reduction of debt level to 60% of GDP in(a) 1997 1998 1997 1998 2002 2007 2012 122.2 118.1 5.8 6.0 16.2 8.0 5.7

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the primary fiscal balance for 1998 is as forecast and the primary fiscal balances were maintained at 16.2%, 8.0% and 5.7% of GDP respectively, from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 2.3% in 1998, as estimated by the Commission, an inflation rate of 2% and a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Chart 5 Belgium: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

125

100

75

50 19981999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 118.1% of GDP for 1998 is as forecast and that the 1998 overall balance of -1.7% of GDP or the primary balance of 6.0% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 2.3% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

51 Table 8 Belgium: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 22.4 25.1 25.6 31.9 41.1 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

52 III Exchange rate developments

Table 9 (a) Belgium: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Danish krone 1.6 -0.3 Deutsche Mark 0.4 -0.1 Spanish peseta 0.2 -2.0 French franc 2.5 -0.3 Irish pound 4.2 -10.6 Italian lira 1.1 -1.9 Dutch guilder 0.1 -0.5 Austrian schilling 0.4 -0.1 Portuguese escudo 1.4 -2.7 Finnish markka -0.2 -3.0

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b)Key indicators of exchange rate pressure for the Belgian franc

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 0.2 0.2 0.2 0.3 0.1 0.1 0.2 0.1 Short-term interest rate differentials(b) -0.2 -0.2 -0.2 -0.1 0.0 0.2 0.2 0.0

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

53 Chart 6 Belgian franc: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) BEF/DKK BEF/DEM BEF/ESP BEF/FRF BEF/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

BEF/ITL BEF/NLG BEF/ATS BEF/PTE BEF/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 10 Belgian franc: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -2.9 -0.3 -0.4 PPI/WPI-based -8.6 0.5 0.9 Memo item: Nominal effective exchange rate 3.2 2.3 5.6

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

54 Table 11 Belgium: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account (b) 1.8 2.3 2.8 5.0 5.1 4.2 4.2 4.7 Net foreign assets (+) or liabilities (-)(c) 4.2 7.8 10.4 15.1 15.5 16.2 17.9 21.9 Exports (goods and services)(d) 68.2 69.2 70.6 71.2 76.1 79.6 81.0 83.6 Imports (goods and services)(e) 65.9 66.7 68.5 69.0 72.9 75.8 76.8 78.9

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current acco unt in previous editions of the Manual. Data up to and including 1994 include Luxembourg. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in BLEU national exports of goods was 70.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in BLEU national imports of goods was 73.6%; Direction of Trade Statistics Yearbook 1997, IMF.

55 IV Long-term interest rate developments

Table 12 Belgium: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb. 97- Jan 98

Long-term interest rate 6.5 5.8 5.7 5.5 5.2 5.7 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Belgium: Long-term interest rate (monthly averages; in percentages)

11

10

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Belgium: Long-term interest rate and CPI inflation differentials against EUcountries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

2

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

56 DENMARK

Price developments indirect taxes has risen steadily since 1993 and exceeded 2% in 1997 (see Table 2). Over the reference period from February 1997 to January 1998 the average rate of Looking at recent trends and forecasts, HICP inflation in Denmark was 1.9%, i.e. current outturns for consumer price well below the reference value of 2.7%. inflation (measured as a percentage change This was also the case in 1997 as a whole. over the corresponding month a year In 1996 average HICP inflation was 2.1% earlier) have been decreasing to below 2% (see Table 1). Seen over the past two and there are no signs of immediate upward years, HICP inflation in Denmark has been pressure on the basis of the measures at levels which are generally considered to shown in Table 3a. Forecasts of inflation be consistent with price stability. suggest a rise over the next two years to somewhat above 2% in 1998 and slightly Looking back, consumer price inflation in higher in 1999 (see Table 3b). Risks for Denmark, as measured on the basis of the price stability over this period are associated CPI, has remained steady at around 2% with a narrowing of the output gap, tight since 1992 (see Chart 1). This experience labour market conditions and trends in of generally low inflation reflects a number asset prices. of important policy choices, most notably the orientation of monetary policy towards Looking further ahead, although Denmark keeping the exchange rate of the Danish does not intend to participate in the single krone stable vis--vis the strongest ERM monetary policy, its close exchange rate currencies. Moreover, in recent years fiscal and economic links with other EU countries policy has contributed to reducing the risks are likely to warrant national monetary and to inflation. The stabilisation of inflation at economic policies which are aligned closely a low level has also been supported by, with those of the euro area, with the inter alia, labour market reforms in both pursuit of price stability via stable exchange the 1980s and the 1990s. Until 1993 the rates providing the most appropriate policy macroeconomic environment contributed objective. The environment of low domestic to containing upward pressure on prices, inflation also needs to be supported by the as GDP grew at relatively low, albeit conduct of appropriate fiscal policies as continuously positive rates (see Table 2). well as by measures aimed at further Although Denmark was less affected by enhancing competition in product markets the 1993 recession than other Member and further reducing rigidities in the labour States, the negative output gap widened in market. 1992-93. However, since 1994 a robust recovery has been under way, accompanied by a closing of the output gap. Control Fiscal developments over inflation has benefited from modest growth in unit labour costs and falling or In the reference year 1997 the general broadly stable import prices during most of government budget balance showed a the 1990s. However, in 1997 growth in surplus of 0.7% of GDP, hence the 3% both unit labour costs and import prices reference value for the deficit ratio was accelerated. Low rates of inflation are also comfortably met, while the debt ratio was apparent when it is measured in terms of 65.1%, i.e. above the 60% reference value. other relevant indicators of inflation, Compared with the previous year, the although the CPI excluding changes in net fiscal balance has improved by 1.4

57 percentage points, moving into surplus, interest rates. In addition, the proportion while the debt ratio has fallen by 5.5 of foreign currency debt in Denmark has percentage points. In 1998 the surplus is declined to levels which make fiscal balances forecast to increase to 1.1% of GDP, while relatively insensitive to changes in exchange the debt ratio is projected to decline to rates. 59.5% i.e. just below the reference value. In 1996 the deficit ratio was below the ratio During the 1990s a pattern of first of public investment expenditure to GDP deteriorating and subsequently improving (see Table 4). results can be observed in the deficit-to- GDP ratio, whereby the ratio remained Looking back over the years 1990 to 1997, consistently below the 3% reference value. the Danish debt-to-GDP ratio increased by Starting from a ratio of 1.5% in 1990, the 4.3 percentage points; initially the ratio deficit reached 2.8% in 1993; since then, rose, from 60.8% of GDP in 1990 to 81.6% the deficit has declined year by year and of GDP in 1993; thereafter it declined became a surplus of 0.7% in 1997 (see steadily year by year to stand at 65.1% in Chart 3a). As is shown in greater detail in 1997 (see Chart 2a), i.e. a decline of Chart 3b, which focuses on changes in 16.5 percentage points over four years. As deficits, cyclical factors contributed is shown in greater detail in Chart 2b, in considerably to the increase in the deficit the early 1990s the primary surplus was until 1993, as well as to its reduction in close to outweighing the sizable debt- 1994, but played a minor role thereafter. increasing effects of a negative growth/ The non-cyclical improvements could reflect interest rate differential. However, there a lasting, structural move towards more was a strong upward effect on the debt balanced fiscal policies and/or a variety of ratio as a result of stock-flow adjustments, measures with temporary effects. However, most notably in 1993. These upward evidence available suggests that measures adjustments reflected, inter alia, the creation with a temporary effect did not improve of sizable deposits at the central bank to fiscal balances in 1997 by more than 0.1% boost foreign exchange reserves. After of GDP. 1993 a growth rate of above 3%, and later an improvement in the budget, contributed Moving on to examine trends in other to reducing the debt ratio. Furthermore, fiscal indicators, it can be seen from Chart stock-flow adjustments, (redemption of 4 that the general government total foreign debt and portfolio shifts of expenditure ratio rose between 1990 and government funds) have also caused a 1994. Against the background of high and decline in the debt ratio. The patterns rising unemployment, current transfers to observed in the early 1990s may be seen households increased, accounting for most as indicative of the risks which can arise of the increase in total expenditure, while from an unforeseen deterioration in the the interest payments ratio diminished economic environment, including pressure slightly (see Table 6). After 1994 the ratio on the currency, when such effects are not of total expenditure to GDP declined, counterbalanced by a sufficiently high reflecting a reduction in transfers to primary surplus. In this context, it may be households, interest payments and public noted that the share of debt with a short- consumption relative to GDP. On balance, term residual maturity has been low over the expenditure ratio in 1997 was lower the 1990s, and the average maturity has than at the beginning of the 1990s, while tended to increase (see Table 5). transfer payments have increased. A Accordingly, also taking into account the continuation of the downward trend would current level of the debt ratio, fiscal balances seem to require the main emphasis to be are relatively insensitive to changes in placed on both current transfers and public

58 consumption. Government revenue in in 1998, for rapidly reducing the debt ratio. relation to GDP was 1.6 percentage points Stressing the benefits of a surplus position higher in 1997 than in 1990 and it may be in public finances and of a substantial at a level which is detrimental to economic further reduction in the debt ratio is indeed growth. appropriate in the case of Denmark. As has been seen in the past, unexpected shocks Looking at the Danish medium-term fiscal can substantially increase the debt ratio. policy strategy, as presented in the Moreover, the Danish Social Pension Fund Convergence Programme updated in May (which does not have pension liabilities 1997, a broadly stable general government and is run by the government) invests most surplus of somewhat less than 1% of GDP of its assets in government paper, thereby is expected in 1998, and the debt ratio is reducing the consolidated general projected to decline to 64% of GDP. The government gross debt. The unlikely event budget plan for 1998 shows a larger surplus of a change in this investment policy would in the financial balance than envisaged in affect the debt ratio (but not, however, the the programme. It foresees both a reduced interest burden). In addition, as is highlighted expenditure ratio (as a result of cuts in all in Table 8, from around 2010 onwards a spending categories in relation to GDP and marked ageing of the population is the postponement of investments) and a expected. While Denmark benefits from a decreased revenue ratio (mostly due to rapidly expanding private pension sector, income and wealth tax reductions, while unfunded social security pensions remain social security contributions in particular substantial and public sector pension are projected to increase). Currently, there expenditure is projected to increase in is no evidence of significant measures with terms of GDP, particularly if policies a temporary effect in the 1998 budget. By regarding benefits continue unchanged. the year 2000 a further increase in the Alleviation of the overall burden of budget surplus is planned. These projections population ageing will be facilitated if public show a slower improvement in the general finances have created sufficient room for government budget balance position than manoeuvre before entering the period envisaged in the previous programme, during which the demographic situation although the new target for the budget worsens. balance in 1998 is somewhat more ambitious and a more favourable development of the debt ratio is now Exchange rate developments expected. If fiscal balances turn out as projected in the Convergence Programme The Danish krone has been participating in for 1999-2000, Denmark would comply the ERM since its inception on 13 March with the medium-term objective of the 1979, i.e. for much longer than two years Stability and Growth Pact, effective from prior to the examination (see Table 8a). As 1999 onwards, of having a budgetary mentioned above, the orientation of position that is close to balance or in monetary policy has been to keep the surplus. Danish krone stable vis--vis the strongest ERM currencies. Focusing on the reference With regard to the potential future course period from March 1996 to February 1998, of the debt ratio, the EMIs Report does the currency has normally traded close to not consider this issue in detail for countries its central rates against other ERM forecast to have a debt ratio of below 60% currencies (see Chart 5 and Table 8a). On of GDP in 1998. Projected developments occasion the Danish krone traded outside underline the benefits of the surplus position a range close to its central rates vis--vis achieved in 1997, and forecast to increase several partner currencies. The maximum

59 upward and downward deviations from Long-term interest rates have been on a central rates, on the basis of 10 business broadly declining trend since the early day moving averages, were 1.2% and -3.4% 1990s (see Chart 6a). At the same time, a respectively, abstracting from the comparatively close convergence of Danish autonomous upward trend of the Irish long-term interest rates with those pound (see Table 8a). The episodes in prevailing in the EU countries with the which such deviations occurred were lowest bond yields has been observed temporary, the degree of exchange rate since the early 1990s, although long-term volatility vis--vis the Deutsche Mark was interest rates have not converged continuously very low and decreasing (see completely towards the lowest levels Table 8b) and short-term interest rate observed in the Union (see Chart 6b). The differentials against those EU countries main factors underlying this trend were the with the lowest short-term interest rates comparatively low rates of inflation, the were small. During the reference period relative stability of the Danish krones Denmark has not devalued its currencys exchange rate and the improvement in the bilateral central rate against any other fiscal position. Member States currency.

In a longer-term context, measures of the Concluding summary real effective exchange rate of the Danish krone vis--vis the currencies of ERM Denmark, in accordance with the terms of participating Member States depicted in Protocol No. 12 of the Treaty, has given Table 9 suggest that current levels are notification to the EU Council that it will close to historical values. As regards other not participate in Stage Three of EMU. external developments, Denmark has Nevertheless, its progress towards maintained current account surpluses over convergence is examined in detail. the 1990s, a situation which has been reflected in a reduction in the net external Over the reference period Denmark has liability position (see Table 10). It may also achieved a rate of HICP inflation of 1.9%, be recalled that Denmark is a small open which is well below the reference value economy with, according to the most stipulated by the Treaty. The increase in recent data available, a ratio of foreign unit labour costs has picked up recently trade to GDP of 39% for exports and 35% and some other relevant indicators of for imports, and a share of intra-EU trade inflation exceeded 2% in 1997. Looking of 64% for exports and 69% for imports. ahead, there are no signs of immediate upward pressure on inflation; forecasts project inflation will rise to somewhat Long-term interest rate developments above 2% in 1998 and slightly higher in 1999. The Danish krone has been Over the reference period from February participating in the ERM for much longer 1997 to January 1998 long-term interest than two years. Over the reference period rates in Denmark were 6.2% on average, it remained broadly stable, generally close and thus stood below the reference value to its unchanged central parities, without for the interest rate criterion of 7.8% set the need for measures to support the on the basis of the three best-performing exchange rate. The level of long-term Member States in terms of price stability. interest rates was 6.2%, i.e. below the This was also the case for 1997 as a whole, respective reference value. as well as for 1996 (see Table 11).

60 In 1997 Denmark achieved a general and Growth Pact, effective from 1999 government surplus of 0.7% of GDP, thus onwards, of having a budgetary position comfortably meeting the reference value, that is close to balance or in surplus, and and the outlook is for a surplus of 1.1% in the debt ratio would fall further below 1998. The debt-to-GDP ratio is above the 60%. 60% reference value. After having reached a peak in 1993, the ratio declined by 16.5 With regard to other factors, in 1996 the percentage points to stand at 65.1% in deficit ratio was below the ratio of public 1997. Regarding the sustainability of fiscal investment to GDP. Moreover, Denmark developments, the outlook is for a decrease has recorded current account surpluses, in the debt ratio to 59.5% of GDP in 1998, while continuing to have a net external i.e. just below the reference value. Looking liability position. In the context of the further ahead, if current fiscal surpluses are ageing of the population, Denmark benefits maintained, Denmark should comply with from a rapidly expanding private pension the medium-term objective of the Stability sector.

61 List of Tables and Charts*

DENMARK

I Price developments Table 1 Denmark: HICP inflation Chart 1 Denmark: Price developments Table 2 Denmark: Measures of inflation and related indicators Table 3 Denmark: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Denmark: General government financial position Chart 2 Denmark: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Denmark: General government gross debt - structural features Chart 3 Denmark: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Denmark: General government expenditure and receipts Table 6 Denmark: General government budgetary position Table 7 Denmark: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Denmark: Exchange rate stability (b) Key indicators of exchange rate pressure for the Danish krone Chart 5 Danish krone: Deviations from ERM bilateral central rates Table 9 Danish krone: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Denmark: External developments

IV Long-term interest rate developments Table 11 Denmark: Long-term interest rates Chart 6 (a) Denmark: Long-term interest rate (b) Denmark: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

62 1 Price developments

Table 1 Denmark: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 2.1 1.9 1.6 1.6 1.7 1.9 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Denmark: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

4

3

2

1

0

-1

-2

-3

-4 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

63 Table 2 Denmark: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 2.6 2.4 2.1 1.2 2.0 2.1 2.1 2.2 CPI excluding changes in net indirect taxes(b) 3.1 2.6 2.1 1.4 1.6 1.9 2.0 2.2 Private consumption deflator 2.7 2.7 1.2 0.4 2.6 2.1 2.5 2.1 GDP deflator 3.4 2.5 2.2 0.8 2.4 2.1 1.9 1.9 Producer prices 3.8 2.4 0.2 1.2 1.3 3.4 1.4 1.3 Related indicators Real GDP growth 1.4 1.3 0.2 1.5 4.2 2.6 2.7 2.9 Output gap (p.pts) -0.1 -0.6 -2.2 -2.7 -0.7 -0.4 -0.2 0.1 Unemployment rate (%) 9.6 10.5 11.2 12.3 12.2 10.3 8.7 7.8 Unit labour costs, whole economy 2.0 1.9 1.9 -0.7 0.0 2.0 0.9 3.0 Compensation per employee, whole economy 4.1 3.9 4.2 1.9 3.8 3.5 3.1 4.0 Labour productivity, whole economy 2.0 2.0 2.2 2.7 3.8 1.5 2.1 1.0 Import price deflator -0.9 1.9 -1.3 -3.0 -0.5 -1.1 -0.5 3.0 Exchange rate appreciation(c) 6.6 -1.5 2.5 2.8 -0.0 4.3 -1.0 -3.0 Broad monetary aggregate (M3H)(d) 6.0 8.3 1.8 4.3 4.1 -2.0 7.2 4.8 Stock prices 12.1 -1.6 -12.8 0.8 18.7 -3.7 16.2 42.3 House prices -7.5 1.3 -1.6 -0.9 12.1 7.6 10.8 9.0

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: A positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Denmark: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 2.3 2.2 2.1 2.1 1.7 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 3.5 2.7 1.8 1.4 1.1 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 2.2 2.5 2.6 2.6 2.5

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 2.1 2.2 OECD (December 1997), private consumption deflator 2.6 2.9 IMF (October 1997), CPI 2.6 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

64 II Fiscal developments

Table 4 Denmark: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -0.7 0.7 1.1 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) 1.4 2.5 . General government gross debt(c) 70.6 65.1 59.5 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure. (c) General government gross debt figures are not adjusted for the assets held by the Danish Social Pension Fund against sectors outside general government, nor for government deposits at the central bank for the management of foreign exchange reserves. According to statements 5 and 6 relating to Council Regulation (EC) No. 3605/93 of 22 November 1993, the Council and the Commission agree that, for Denmark, these items shall be specified in the presentation of general government gross debt. They totalled 9.6% of GDP in 1996 and 8.0% of GDP in 1997. In addition, the data are not adjusted for the amounts outstanding in the government debt from the financing of public undertakings, which, according to statement 3 relating to the aforementioned Regulation, will be subject to a separate presentation for the Member States. In Denmark this item amounted to 5.2% of GDP in 1996 and 4.9% of GDP in 1997.

65 Chart 2 Denmark: General government gross debt (as a percentage of GDP)

(a) Levels

85 80 75 70 65 60 1990 1991 1992 1993 1994 1995 1996 1997

Note: See footnote (c) in Table 4.

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

20 15 10 5 0 -5 -10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

Table 5 Denmark: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt(a) (as a percentage of GDP) 60.8 65.5 69.7 81.6 78.1 73.3 70.6 65.1 Composition by currency (% of total) In domestic currency 77.5 83.6 83.2 77.4 82.6 86.2 87.0 87.0 In foreign currencies 22.5 16.4 16.8 22.6 17.4 13.8 13.0 13.0 Domestic ownership(b) (% of total) . . 67.0 55.0 72.0 68.0 65.0 59.3 Average maturity(c) (years) 4.4 3.6 4.2 4.2 4.4 5.0 5.3 5.3 Composition by maturity(d) (% of total) Short-term(e) (< 1 year) 9.2 9.3 12.0 11.2 7.6 7.8 8.1 8.1 Medium and long-term (Ն 1 year) 90.8 90.7 88.0 88.8 92.4 92.2 91.9 91.9

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) See footnote (c) in Table 4. (b) Central government domestic debt only (market value), including debt held by the Social Pension Fund. For 1992 data refer to the third quarter only. (c) Residual maturity. Central government domestic debt only. (d) Residual maturity. (e) Including short-term debt and debt linked to short-term interest rates.

66 Chart 3 Denmark: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 Denmark: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

64

62

60

58

56 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

67 Table 6 Denmark: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 57.0 56.6 58.2 60.1 60.9 58.8 59.3 58.6 Taxes 47.9 47.7 47.9 49.3 51.1 50.3 50.5 50.5 Social security contributions 2.6 2.6 2.7 2.9 3.0 2.8 2.8 2.8 Other current receipts 6.5 6.2 7.6 8.0 6.8 5.7 6.0 5.4 Total expenditure 58.6 58.7 60.3 63.0 63.7 61.1 59.9 57.9 Current transfers 23.4 24.0 25.2 26.0 27.8 26.9 26.3 25.0 Actual interest payments 7.5 7.5 6.9 7.9 7.3 6.7 6.2 5.8 Public consumption 25.9 25.9 25.9 26.8 26.3 25.5 25.4 25.4 Net capital expenditure 1.9 1.3 2.3 2.4 2.3 2.0 2.1 1.8 Surplus (+) or deficit (-) -1.5 -2.1 -2.1 -2.8 -2.8 -2.4 -0.7 0.7 Primary balance 5.9 5.3 4.9 5.0 4.5 4.3 5.5 6.5 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -0.9 -0.9 -0.4 1.4 2.5

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 Denmark: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 22.7 21.6 24.9 31.7 37.7 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

68 III Exchange rate developments

Table 8 (a) Denmark: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 0.3 -1.6 Deutsche Mark 0.2 -1.4 Spanish peseta -0.2 -3.4 French franc 0.9 -0.4 Irish pound 2.6 -10.4 Italian lira 1.2 -1.7 Dutch guilder 0.3 -2.0 Austrian schilling 0.3 -1.4 Portuguese escudo -0.0 -2.7 Finnish markka -0.1 -2.7

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Danish krone

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 0.5 0.6 0.8 0.9 0.5 0.4 0.2 0.2 Short-term interest rate differentials(b) 0.4 0.3 0.4 0.3 0.3 0.3 0.2 0.3

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

69 Chart 5 Danish krone: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) DKR/BEF DKR/DEM DKR/ESP DKR/FRF DKR/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

DKR/ITL DKR/NLG DKR/ATS DKR/PTE DKR/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Danish krone: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 3.3 1.0 1.2 PPI/WPI-based 3.5 4.5 7.9 Memo item: Nominal effective exchange rate 0.3 3.9 5.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

70 Table 10 Denmark: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 1.0 1.5 2.8 3.4 1.8 1.1 1.7 0.6 Net foreign assets (+) or liabilities (-)(c) -41.9 -38.7 -35.1 -32.1 -26.9 -26.3 -23.7 -23.9 Exports (goods and services)(d) 35.5 37.7 38.1 37.3 38.7 38.9 38.8 39.4 Imports (goods and services)(e) 30.1 30.9 31.1 29.7 32.2 33.7 33.5 35.2

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 64.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 68.9%; Direction of Trade Statistics Yearbook 1997, IMF.

71 IV Long-term interest rate developments

Table 11 Denmark: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 7.2 6.3 6.1 5.7 5.4 6.2 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) Denmark: Long-term interest rate (monthly averages; in percentages)

12

10

8

6

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Denmark: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

3

2

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

72 GERMANY

Price developments 1990s. Until 1996 control over inflation also benefited from broadly stable import Over the reference period from February prices, whereas a marked acceleration was 1997 to January 1998 the average rate of seen in 1997. Low rates of inflation are HICP inflation in Germany was 1.4%, i.e. also apparent when it is measured in terms well below the reference value of 2.7%. of other relevant price indices (see This was also the case in 1997 as a whole. Table 2). In 1996 average HICP inflation was 1.2% (see Table 1). Seen over the past two Looking at recent trends and forecasts, years, HICP inflation in Germany has been current outturns for consumer price at levels which are generally considered to inflation (measured as a percentage change be consistent with price stability. over the corresponding month a year earlier) have been decreasing to around Looking back, consumer price 1% and there are no signs of immediate developments in Germany, as measured upward pressure on the basis of the on the basis of the CPI, were adversely measures shown in Table 3a. Forecasts of affected by the economic consequences of inflation suggest a rate of around 2% for unification in the early 1990s. Consumer 1998 and 1999 (see Table 3b). Risks for price inflation reached a peak of 5.1% in price stability over this period are associated 1992 (the first year for which CPI statistics with higher administered prices and an for unified Germany are available). In increase in value added taxes. subsequent years inflation in Germany has followed a downward trend, falling to just Looking further ahead, maintaining an below 2% in 1995 and thereafter (see environment conducive to price stability Chart 1). This experience of successful relates in Germany to, inter alia, the conduct stabilisation following an inflationary shock of fiscal policies over the medium to long to the economy reflects the continued term; it will be equally important to pursuit of stability-oriented policies. strengthen national policies aimed at Notably, monetary policy has been enhancing competition in product markets consistently geared towards price stability and improving the functioning of labour through the pursuit of an intermediate markets against the background of the target for monetary growth. Some attempts current high rate of unemployment in have also been made to increase the Germany. flexibility of the economy, including the labour markets. In addition, the macroeconomic environment has Fiscal developments contributed to containing upward pressure on prices. Following the slowdown in the In the reference year 1997 the general economy in 1993, when output declined government deficit ratio was 2.7%, i.e. by over 1%, economic growth recovered, below the 3% reference value, and the but not sufficiently to prevent the debt ratio was 61.3%, i.e. just above the emergence of a negative output gap (see 60% reference value. Compared with the Table 2). Against this background, since previous year, the deficit ratio has been the mid-1990s wage moderation and reduced by 0.7 percentage point and the consistent productivity growth have helped debt ratio increased by 0.9 percentage to contain the rise in unit labour costs, point. In 1998 the deficit ratio is forecast to which had increased sharply in the early decrease to 2.5% of GDP, while the debt

73 ratio is projected to decline marginally to noticeable, and, taking into account the 61.2%. In 1996 and 1997 the deficit ratio current level of the debt ratio, fiscal balances exceeded the ratio of public investment are relatively sensitive to changes in interest expenditure to GDP (see Table 4). rates. However, given the fact that the debt is refinanced at long maturities, this Looking back over the years 1991 (the first sensitivity relates particularly to long-term year for which fiscal data for unified interest rates. On the other hand, the Germany are available) to 1997, the proportion of foreign currency debt is German debt-to-GDP ratio increased by negligible and fiscal balances are insensitive 19.8 percentage points. During the first to changes in exchange rates. years considered the ratio increased steadily, from 41.5% of GDP in 1991 to 50.2% in During the 1990s a relatively trendless 1994, while in 1995 it jumped to 58.0%. In pattern can be observed in the deficit-to- 1996 the ratio exceeded the 60% reference GDP ratio, with outturns of around 3% of value for the first time and in 1997 it GDP (see Chart 3a). Compared with the increased further to reach 61.3% of GDP period immediately prior to unification, (see Chart 2a). As is shown in greater this represented a deterioration in fiscal detail in Chart 2b, primary surpluses were balances, which had been slightly in surplus generally small and thus not sufficient to in 1989. As is shown in greater detail in outweigh the debt-increasing effects of a Chart 3b, which focuses on changes in negative growth/interest rate differential. deficits, cyclical factors made a large negative However, until 1995, the most important contribution in 1993 following a strong underlying factors were stock-flow boom mainly triggered by excessive demand adjustment items, including in particular in the wake of unification; a smaller negative unification-related debt assumptions by the contribution was seen in 1996. In general, Federal Government. The strongest impact such cyclical factors were mostly offset by was recorded in 1995, mainly reflecting the other measures, thereby limiting their assumption by general government of the impact on the overall deficit. However, the debt of the Treuhand agency, which will be non-cyclical improvements could reflect a a lasting burden on fiscal policy. The patterns lasting, structural move towards more observed during the 1990s, which continue balanced fiscal policies and/or a variety of to be affected by the additional strain measures with temporary effects. Evidence placed on public finances by German available suggests that measures with a unification, may be seen as indicative of the temporary effect played a role in improving need to adopt early corrective measures the fiscal balance in 1996 and 1997, but to deal with the budgetary consequences that the impact did not exceed 0.2% of of adverse shocks, even when initial GDP per annum. As these measures were budgetary imbalances are not excessive. mainly of a one-off nature, compensating They also reflect the need to provide a measures already introduced in 1998 buffer of a primary surplus as a precaution budgets will need to yield their expected against deteriorating macroeconomic results in 1998 in order to keep fiscal conditions, even when the structure of the balances on the planned path. general government debt is relatively favourable. In this context, it may be noted Moving on to examine trends in other that the share of debt with a short-term fiscal indicators, it can be seen from Chart residual maturity has been increasing during 4 that between 1991 and 1995 the total the 1990s, while the average maturity has expenditure ratio rose, with all expenditure remained broadly stable (see Table 5). items increasing, except for net capital With regard to 1996, the proportion of expenditure (see Table 6). After 1995 debt with a short-term residual maturity is expenditures declined, due to lower ratios

74 of all major expenditure items. On balance, Currently, there is no evidence of significant the expenditure ratio in 1997, at 48%, had measures with a temporary effect in the been brought back very close to the level 1998 budget. For the year 2000, the seen in 1991 but it remains markedly Convergence Programme targets a deficit higher than just before unification, when it of 1‰% of GDP but the debt ratio is had been close to 45%. As the burden of projected to remain above 60% of GDP interest payments has increased in line for the rest of the decade. The intention is with a rising debt ratio, and capital to reduce the share of government expenditure has been cut back, bringing expenditure in GDP to the pre-unification down expenditure ratios would appear to level by the end of the decade. The require the fiscal authorities to focus mainly intentions regarding deficit and debt on transfer payments and public reductions are somewhat less ambitious consumption. Government revenue in than those contained in previous relation to GDP reached a peak in 1994 programmes. Compared with fiscal balances before returning close to the level of 1991. projected in the Convergence Programme The current level of around 45% of GDP is for 1999-2000, further substantial fiscal also very close to that observed before consolidation is required in order to both unification, but this is partly due to the compensate for the tax shortfalls not yet erosion of the tax base. Additionally, from reflected in the Convergence Programme 1996 onwards, this ratio as well as the and to comply with the medium-term expenditure ratio was reduced by an objective of the Stability and Growth Pact, amount equivalent to ‰% of GDP owing effective from 1999 onwards, of having a to the new treatment of child benefits. budgetary position that is close to balance or in surplus. According to the German medium-term fiscal policy strategy, as presented in the With regard to the reduction of the debt Convergence Programme for 1997-2000 ratio to the 60% reference value for those dated December 1996, a reduction in the countries in which this ratio is currently deficit ratio to 2‰% of GDP and a broad exceeded only marginally, the EMI stabilisation of the debt ratio is to be emphasises that debt can be brought down achieved in 1998. The budget plan for in relation to GDP within a short period of 1998 forecasts the general government time. As may be seen from Chart 5, in the deficit to stand at 2% of GDP and the case of Germany, achieving overall fiscal debt ratio to stabilise at around 62% of positions and debt ratios forecast by the GDP while Commission forecasts are European Commission for 1998 and slightly more favourable. The 1998 budget realising a balanced budget in 1999 would shows a combination of expenditure reduce the debt ratio to below 60% of restraint and only moderate revenue GDP in the same year, while maintaining increases. The increase in tax revenue is fiscal balances over subsequent years at expected to be lower than nominal GDP the levels forecast for 1998 would not be growth. Value added tax will be increased sufficient to bring the debt ratio down to from April 1998, with the proceeds to be 60% of GDP within an appropriate period transferred to the pension system, but the of time. Such calculations are based on the solidarity tax surcharge has been reduced normative assumption of a constant nominal and the structural decoupling of tax rate of interest of 6% (average real cost of revenue from economic growth may public debt outstanding of 4% and 2% continue. Furthermore, the tax on business inflation) and the assumption of a constant capital has been abolished, but the loss of real GDP growth rate of 2.3%, as estimated receipts is to be compensated by the by the Commission for real trend GDP reduction of enterprise tax privileges. growth in 1998. Stock-flow adjustments

75 are not taken into account. While they are central rates, on the basis of 10 business purely illustrative, and can by no means be day moving averages, were 2.2% and -2.9% regarded as forecasts, these calculations respectively, abstracting from the provide an illustration of the need for autonomous upward trend of the Irish further substantial progress in consolidation pound (see Table 8a). The episodes in in order to reduce the debt ratio to 60% of which such deviations occurred were GDP or below within an appropriate period temporary and short-term interest rate of time. differentials against those EU countries with the lowest short-term interest rates Stressing the need for considerable were insignificant. During the reference improvement in the deficit ratio and to period Germany has not devalued its sustain consolidation over time is indeed currencys bilateral central rate against any warranted in the case of Germany, since other Member States currency. additional room for manoeuvre is necessary in order to be able to address future In a longer-term context, measures of the budgetary challenges. As is highlighted in real effective exchange rate of the Deutsche Table 8, from around 2010 onwards a Mark vis--vis the currencies of ERM marked ageing of the population is expected participating Member States depicted in and, in the context of an unfunded pension Table 9 suggest that current levels are system, public pension expenditure is close to historical values. Current account projected to increase in terms of GDP, deficits emerged as a consequence of particularly if policies regarding benefits are unification; these have narrowed more not tightened further. The overall burden recently, thus slowing the rate of of population ageing will become more deterioration in the net external asset manageable the better the state of public position (see Table 10). It may also be finances when the demographic situation recalled that Germany has, according to worsens. There must, however, be further the most recent data available, a ratio of retrenchment efforts in pension payments, foreign trade to GDP of 30% for exports which is underlined by the fact that the and 29% for imports, and a share of intra- burden of levies in Germany has reached a EU trade of 56% for exports and 55% for relatively high level. imports.

Exchange rate developments Long-term interest rate developments

The Deutsche Mark has been participating Over the reference period from February in the ERM since its inception on 13 March 1997 to January 1998 long-term interest 1979, i.e. for much longer than two years rates in Germany were 5.6% on average, prior to the examination (see Table 8a). and thus stood well below the reference Focusing on the reference period from value for the interest rate criterion of 7.8% March 1996 to February 1998, the currency set on the basis of the three best-performing has normally traded close to its central Member States in terms of price stability. rates against other ERM currencies and This was also the case for 1997 as a whole, very close to those vis--vis the Belgian as well as for 1996 (see Table 11). franc, the Dutch guilder and the Austrian schilling (see Chart 6 and Table 8a). On Long-term interest rates have been on a occasion the Deutsche Mark traded outside broadly declining trend since the early a range close to its central rates vis--vis 1990s (see Chart 7a). For most of the several partner currencies. The maximum period since the beginning of the 1990s, a upward and downward deviations from relatively narrow and typically negative gap

76 between German long-term interest rates In 1997 Germany achieved a fiscal deficit and those prevailing in the EU countries ratio of 2.7% of GDP, i.e. below the with the lowest bond yields has been reference value, and the outlook is for a observed (see Chart 7b). The main factors further decline to 2.5% in 1998. The debt- underlying this trend of relatively low long- to-GDP ratio is just above the 60% term interest rates were that the inflationary reference value. As of 1991, the first year impulse following German unification was after German unification, the ratio increased contained and that inflation returned to a by 19.8 percentage points to stand at comparatively low rate. 61.3% in 1997, reflecting to a large extent the fiscal burden relating to unification. Regarding the sustainability of fiscal Concluding summary developments,,, the outlook is for a marginal decline in the debt ratio to 61.2% of GDP Over the reference period Germany has in 1998. Keeping the deficit ratio at current achieved a rate of HICP inflation of 1.4%, levels would not be sufficient to bring the which is well below the reference value debt ratio down to 60% of GDP within an stipulated by the Treaty. Unit labour costs appropriate period of time, thus pointing fell and low rates of inflation were also to the need for further substantial progress apparent in terms of other relevant price in consolidation. The Stability and Growth indices. Looking ahead, there are no signs Pact also requires as a medium-term of immediate upward pressure on inflation; objective a budgetary position that is close forecasts project inflation will stand at to balance or in surplus. Given the current around 2% in 1998 and 1999. The Deutsche debt ratio of just above 60% of GDP, Mark has been participating in the ERM for achieving the fiscal position forecast for much longer than two years. Over the 1998 and realising a balanced budget reference period it remained broadly stable, thereafter would reduce the debt ratio to generally close to its unchanged central below 60% as early as 1999. parities, without the need for measures to support the exchange rate.The level of With regard to other factors, in 1996 and long-term interest rates was 5.6%, i.e. well 1997 the deficit ratio exceeded the ratio of below the respective reference value. public investment to GDP, and Germany recorded current account deficits as a consequence of unification, while maintaining a net external asset position.

77 List of Tables and Charts*

GERMANY

I Price developments Table 1 Germany: HICP inflation Chart 1 Germany: Price developments Table 2 Germany: Measures of inflation and related indicators Table 3 Germany: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Germany: General government financial position Chart 2 Germany: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Germany: General government gross debt - structural features Chart 3 Germany: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Germany: General government expenditure and receipts Table 6 Germany: General government budgetary position Chart 5 Germany: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 7 Germany: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Germany: Exchange rate stability (b) Key indicators of exchange rate pressure for the Deutsche Mark Chart 6 Deutsche Mark: Deviations from ERM bilateral central rates Table 9 Deutsche Mark: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Germany: External developments

IV Long-term interest rate developments Table 11 Germany: Long-term interest rates Chart 7 (a) Germany: Long-term interest rate (b) Germany: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

78 1 Price developments

Table 1 Germany: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.2 1.5 1.4 1.4 0.8 1.4 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Germany: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

7

6

5

4

3

2

1

0

-1

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

79 Table 2 Germany*: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997 Measures of inflation

Consumer price index (CPI) 2.7 3.6 5.1 4.5 2.7 1.8 1.5 1.8 CPI excluding changes in net indirect taxes(a) 2.7 3.3 3.6 3.6 2.3 1.8 1.5 1.8 Private consumption deflator 2.7 3.7 4.7 4.1 3.0 1.7 2.0 1.9 GDP deflator 3.2 3.9 5.6 4.0 2.4 2.1 1.0 0.6 Producer prices 1.5 2.1 1.6 0.1 0.7 2.2 0.1 0.8 Related indicators Real GDP growth 5.7 5.0 2.2 -1.2 2.7 1.8 1.4 2.2 Output gap (p.pts) 2.4 4.9 3.9 0.1 0.4 -0.1 -1.0 -1.1 Unemployment rate (%) 6.4 5.7 7.7 8.9 9.6 9.4 10.4 11.4 Unit labour costs, whole economy 2.0 3.3 6.2 3.7 0.2 1.6 -0.2 -1.8 Compensation per employee, whole economy 4.7 5.9 10.6 4.3 3.6 3.9 2.5 1.8 Labour productivity, whole economy 2.7 2.5 4.1 0.6 3.4 2.2 2.7 3.7 Import price deflator -0.7 2.2 -1.5 -1.4 0.5 0.6 0.7 3.0 Exchange rate appreciation(b) 5.5 -1.1 3.1 2.8 0.2 5.6 -2.3 -4.6 Broad monetary aggregate (M3H)(c) 5.0 20.0 8.6 8.2 8.3 -0.1 7.1 5.8 Stock prices 17.1 -8.1 3.6 10.3 17.5 0.8 20.2 44.5 House prices(d) ...... -0.1 .

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). * Refers to unified Germany from 1992 onwards. (a) National estimates, 1990-94 western Germany. (b) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (c) National harmonised data. (d) Prices for new houses.

Table 3 Germany: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.9 1.8 1.9 1.8 1.3 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 2.9 2.2 1.6 1.2 0.9 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 1.9 2.1 2.0 2.0 1.9

Source: National non-harmonised data.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 1.7 1.9 OECD (December 1997), private consumption deflator 1.9 1.9 IMF (October 1997), CPI 2.3 .

Source: European Commission (spring 1998 forecasts), OECD and IMF. 80 II Fiscal developments

Table 4 Germany: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -3.4 -2.7 -2.5 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -1.4 -0.8 . General government gross debt 60.4 61.3 61.2 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Germany: General government gross debt (as a percentage of GDP)

(a) Levels

65 60 55 50 45 40 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

10 8 6 4 2 0 -2 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

81 Table 5 Germany: General government gross debt str uctural features

1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 41.5 44.1 48.0 50.2 58.0 60.4 61.3 Composition by currency (% of total) In domestic currency 100.0 100.0 100.0 100.0 100.0 100.0 100.0 In foreign currencies 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Domestic ownership (% of total) 77.0 75.6 71.0 74.3 71.9 71.1 . Average maturity(a) (years) 4.4 4.4 4.8 4.8 5.3 4.7 . Composition by maturity(b) (% of total) Short-term(c) (≤ 1 year) 13.2 16.1 16.3 18.5 16.8 18.5 . Medium and long-term (> 1 year) 86.8 83.9 83.7 81.5 83.2 81.5 .

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Federal government and its special funds debt only (which represent almost 2/3 of the general government gross debt). (b) Residual maturity. Where data on floating rate debt are not available these items are classified according to their residual maturity. (c) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Germany: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-1

-2

-3

-4 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

82 Chart 4 Germany: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

52

50

48

46

44 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Germany: General government budgetary position (as a percentage of GDP)

1991 1992 1993 1994 1995 1996 1997 Total current receipts 44.8 46.0 46.3 46.7 46.4 45.6 45.2 Taxes 24.2 24.5 24.4 24.4 24.2 23.2 22.6 Social security contributions 18.0 18.3 18.8 19.3 19.5 19.9 20.1 Other current receipts 2.7 3.2 3.1 3.1 2.7 2.6 2.5 Total expenditure 48.1 48.8 49.9 49.3 49.9 49.1 48.0 Current transfers 21.4 21.2 22.4 22.6 22.8 22.6 22.1 Actual interest payments 2.7 3.3 3.3 3.3 3.8 3.7 3.7 Public consumption 19.5 20.0 20.1 19.8 19.8 19.8 19.4 Net capital expenditure 4.6 4.3 4.1 3.6 3.5 3.0 2.7 Surplus (+) or deficit (-) -3.1 -2.6 -3.2 -2.4 -3.3 -3.4 -2.7 Primary balance -0.4 0.6 0.1 1.0 0.5 0.3 1.1 Surplus (+) or deficit (-), net of public investment expenditure(a) . . -0.7 0.0 -1.1 -1.4 -0.8

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

83 Chart 5 Germany: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

65

60

55 1998 1999

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 61.2% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.5% of GDP or the primary balance of 1.2% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 2.3% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 7 Germany: Projections of elderly dependency ratio

1990(a) 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 21.7 23.8 30.3 35.4 49.2 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC. (a) Western Germany.

84 III Exchange rate developments

Table 8 (a) Germany: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 0.1 -0.4 Danish krone 1.4 -0.2 Spanish peseta 0.1 -2.4 French franc 2.2 -0.2 Irish pound 3.9 -10.6 Italian lira 1.2 -1.8 Dutch guilder 0.0 -0.8 Austrian schilling 0.0 -0.1 Portuguese escudo 1.1 -2.8 Finnish markka -0.2 -2.9

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Deutsche Mark

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) ------Short-term interest rate differentials(b) -0.2 -0.2 -0.1 -0.1 -0.1 -0.1 -0.0 -0.0

Source: European Commission, national data and EMI calculations. (a) Not applicable. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

85 Chart 6 Deutsche Mark: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) DEM/BEF DEM/DKK DEM/ESP DEM/FRF DEM/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

DEM/ITL DEM/NLG DEM/ATS DEM/PTE DEM/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Deutsche Mark: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 1.8 3.2 5.7 PPI/WPI-based 4.2 1.2 4.1 Memo item: Nominal effective exchange rate 24.1 4.1 9.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

86 Table 10 Germany: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 3.2 -1.1 -1.0 -0.7 -1.0 -1.0 -0.6 -0.1 Net foreign assets (+) or liabilities (-)(c) 20.7 16.6 13.8 11.2 9.1 4.7 4.1 . Exports (goods and services)(d) 32.1 26.1 25.5 24.5 25.7 26.9 27.7 30.0 Imports (goods and services)(e) 26.3 26.0 25.9 24.7 25.9 27.2 27.4 28.7

Source: National data except exports and imports (European Commission, spring 1998 forecasts). Western Germany up to 1990, unified Germany thereafter. (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 56.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 55.1%; Direction of Trade Statistics Yearbook 1997, IMF.

87 IV Long-term interest rate developments

Table 11 Germany: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 6.2 5.6 5.6 5.3 5.1 5.6 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Germany: Long-term interest rate (monthly averages; in percentages)

10

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Germany: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points) Long-term interest rate differential CPI inflation differential

2

1

0

-1 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

88 GREECE

Price developments growth in unit labour costs decelerated but still grew at over 10% per annum on Over the reference period from February average until 1995; in 1997 growth in unit 1997 to January 1998 the average rate of labour costs was reduced to 7‰%. Increases HICP inflation in Greece was 5.2%, i.e. in import prices have been curbed from considerably above the reference value of above 13% in 1990 to below 3% in 1997. A 2.7%. This was also the case in 1997 as a reduction in inflationary tendencies is also whole. In 1996 average HICP inflation was indicated by other relevant measures of 7.9% (see Table 1). Seen over the past two inflation (see Table 2). years, HICP inflation in Greece has been significantly reduced without, as yet, having Looking at recent trends and forecasts, reached a level generally considered to be current outturns for consumer price consistent with price stability. inflation (measured as a percentage change over the corresponding month a year Looking back, a clear trend towards lower earlier) have been decreasing to 4.4% (see rates of inflation in Greece has been Table 3a). Most forecasts of inflation suggest discernible since the early 1990s. Consumer a rate of around 4‰% for 1998 and 3‰% price inflation, as measured on the basis of for 1999 (see Table 3b). Upside risks over the CPI, decreased steadily from above this period are associated with wage 20% in 1990 to 5‰% in 1997 (see Chart growth.7 1). This experience of disinflation reflects a number of important policy choices, most Looking further ahead, creating an notably the progressive tightening of environment conducive to price stability monetary policy since the turn of the relates in Greece to, inter alia, the conduct decade with a view to reducing rates of of fiscal policies over the medium to long inflation. Initially, policy-makers sought to term; it will be equally important to achieve the inflation target via an exchange strengthen national policies aimed at rate policy which did not fully accommodate enhancing competition in product markets inflation differentials relative to Greeces and improving the functioning of labour main trading partners; since 1995 the markets against the background of the authorities have linked the Greek drachma current high rate of unemployment in closely to the ECU. The reduction in Greece. inflation has been supported both by adjustments in fiscal policy which aim, inter alia, at broadening the tax base and Fiscal developments combating tax evasion, as well as by structural changes in the labour market In the reference year 1997 the general and the liberalisation of financial markets. government deficit ratio was 4.0%, i.e. In addition, the macroeconomic above the 3% reference value, and the environment has contributed to containing debt ratio was 108.7%, i.e. far above the upward pressure on prices. In particular, in 60% reference value. Compared with the the context of the recession in 1993, a previous year, the deficit ratio has been negative output gap emerged (see Table reduced by 3.5 percentage points and the 2). Since 1996 economic growth has recovered and the output gap has narrowed. Against this background, both 7 An adjustment plan which accompanies the entry of the drachma to the ERM effective from 16 March 1998 seeks to growth in compensation per employee and limit any associated inflationary risks.

89 debt ratio by 2.9 percentage points. In be observed in the deficit-to-GDP ratio. 1998 the deficit ratio is forecast to decrease Starting from a ratio of 16.1% of GDP in to 2.2% of GDP, while the debt ratio is 1990, the deficit declined to 11.5% in projected to decline to 107.7%. In 1996 1991, but increased again in the following and 1997 the deficit ratio exceeded the two years to stand at 13.8% in 1993. Since ratio of public investment expenditure to then, the deficit has declined year by year GDP by 4.5 percentage points and 0.7 to stand at 4.0% in 1997 As is shown in percentage point respectively (see Chart 3a, it has been reduced over four Table 4). consecutive years by a total of 9.8 percentage points. Although the deficit Looking back over the years 1990 to 1997, ratio has declined substantially and the Greek debt-to-GDP ratio increased by continuously, it has not reached a level 18.6 percentage points; initially the ratio close to the reference value of 3% of GDP tended to rise continuously, from 90.1% in in 1997. As is shown in greater detail in 1990 to 111.6% in 1993, to broadly stabilise Chart 3b, which focuses on changes in thereafter, decreasing to 108.7% in 1997 deficits, cyclical factors played a major role (see Chart 2a), i.e. a decline of 2.9 percentage only in 1993. However, the non-cyclical points since the latest peak in 1996. As is improvements could reflect a lasting, shown in greater detail in Chart 2b, in the structural move towards more balanced early 1990s the strongest factor underlying fiscal policies and/or a variety of measures the increase in the ratio, notably in 1993, with temporary effects. Evidence available came from the so-called stock-flow suggests that such measures with a adjustment item of public debt, reflecting temporary effect reduced the deficit ratio the adverse effects of the depreciation of the by 0.2 percentage point in 1997, compared Greek drachma and of consolidation with 0.3 percentage point in 1996. As they operations. By contrast, since 1994 the were mainly of a one-off nature, the primary balance has recorded a surplus, thus compensating measures already introduced outweighing the sizable impact of further in the 1998 budget will need to yield their stock-flow adjustments. The patterns expected results in 1998 in order to keep observed in the early 1990s may be seen as fiscal balances on the planned path. indicative of the risks to public finances which can arise when special factors exert upward Moving on to examine trends in other pressures on the debt which are only partly fiscal indicators, it can be seen from Chart compensated by equivalent primary surpluses. 4 that the general government total In this context, it may be noted that the share expenditure ratio, after declining in 1991, of debt with a short-term maturity has been showed an upward movement until 1993, decreasing from the high levels of the early mainly reflecting a steep increase in interest 1990s, which is a development in the right payments (see Table 6) as a result of a direction. With respect to 1997, the surge in debt. Since 1995 a downward proportion of debt with a short-term maturity trend in the total expenditure ratio has is still noticeable, and, taking into account the been discernible, mainly reflecting lower current level of the debt ratio, fiscal balances interest payments and a reduction in net are relatively sensitive to changes in interest capital expenditure. Overall the expenditure rates. In addition, the proportion of foreign ratio in 1997 was more than 6 percentage currency debt in Greece is relatively high and points lower than at the beginning of the fiscal balances are sensitive to changes in 1990s, reflecting in particular a sharp exchange rates. reduction in net capital expenditure and also some reductions in all other main During the 1990s a pattern of first adverse expenditure categories in relation to GDP. and subsequently improving outturns can Given this pattern, a balanced continuation

90 of the downward trend of total expenditure assumption that fiscal balances and debt to GDP would appear to require greater ratios as projected by the European adjustments in expenditure items other Commission for 1998 are achieved, the than capital expenditure. Government first exercise, as detailed in Table 7, shows revenue has tended to increase in relation the fiscal balances which would be to GDP continuously over the period consistent with convergence of the debt considered, and was nearly 6 percentage ratio to 60% of GDP over different time points higher in 1997 than in 1990. horizons. As an illustration, focusing on the period of ten years, i.e. reducing the debt According to the Greek medium-term fiscal ratio to 60% by 2007, would imply realising policy strategy, as presented in the from 1999 onwards an overall surplus of Convergence Programme for 1994-99 1.4% of GDP per year (see Table 7a) or updated in July 1997, the deficit ratio is realising from 1999 onwards a primary expected to decline to 2.4% of GDP in surplus of 6.4% of GDP per year (see 1998, and the debt ratio to 107% of GDP. Table 7b). This compares with an overall The budget plan for 1998 is broadly in line deficit ratio of 2.2% and a primary surplus with the programme. The reduction in the ratio of 6.8% projected for 1998, i.e. the deficit ratio projected for 1998 will mainly difference is 3.6 and -0.4 percentage points be achieved by reducing the share of respectively. current expenditure in GDP and by increasing the share of government revenue A second exercise, as detailed in Chart 5, in GDP. Currently, there is no evidence of shows that maintaining the 1998 overall significant measures with a temporary effect fiscal balance of -2.2% of GDP over the in the 1998 budget. Further improvement subsequent years would only reduce the is projected in 1999, when the deficit ratio debt ratio to 87.5% in ten years; the 60% is planned to reach 2.1% and the debt ratio reference value would be reached in 2034. to stand at 101% of GDP. The planned Maintaining the 1998 primary surplus of development of Greeces public deficit is 6.8% of GDP would reduce the debt-to- broadly in line with previous programmes - GDP ratio to below 60% in ten years. except for 1999, when a less favourable Finally, realising balanced budgets annually outcome is expected. The path of the debt from 1999 onwards would bring the debt ratio is projected to be more favourable ratio down to 70.6% in ten years, and the than previously foreseen. Compared with 60% reference level would be reached in fiscal balances projected in the Convergence 2011. Programme for 1999, further substantial consolidation is required in order to comply Such calculations are based on the with the medium-term objective of the normative assumption of a constant nominal Stability and Growth Pact, effective from rate of interest of 6% (average real cost of 1999 onwards, of having a budgetary public debt outstanding of 4% and 2% position that is close to balance or in inflation), and the assumption of a constant surplus. However, fiscal deficits as projected real GDP growth rate of 2.7%, as estimated in the Convergence Programme for 1998 by the Commission for real trend GDP and 1999 are below the reference value of growth in 1998. Stock-flow adjustments the Treaty. are not taken into account. While these calculations are purely illustrative, and can With regard to the future horizon for by no means be seen as forecasts, they do reducing the debt ratio to the 60% provide an illustration of why consolidation reference value in countries with a debt efforts need to be all the more resolute ratio of above 100% of GDP, two different and lasting the higher the initial stock of kinds of calculations are presented. On the debt, in order to forcefully reduce the

91 debt-to-GDP ratio to 60% or below within closely to the ECU with a view to reducing an appropriate period of time. rates of inflation. Focusing on the reference period, the currency has normally traded Stressing the need for sustained consolidation above its March 1996 average bilateral over an extended period of time resulting in exchange rates against most other EU persistent, sizable overall fiscal surpluses is currencies, which are used as a benchmark indeed critical in the case of Greece, since for illustrative purposes in the absence of the current high level of debt would otherwise central rates (see Chart 6 and Table 9a). impose a continuous burden on fiscal policy The main exceptions were the development and the economy as a whole. As has been against the Irish pound, the pound sterling seen in the past, high levels of debt increase and, to a lesser extent, the Italian lira. In the vulnerability of fiscal positions to parallel with these developments the degree unexpected shocks, thus heightening the risk of volatility of the drachmas exchange rate of a sudden worsening of public finances. In against the Deutsche Mark fluctuated within addition, as is highlighted in Table 8, there are a range of 2-4% (see Table 9b) and short- future budgetary challenges to meet. From term interest rate differentials against those around 2010 onwards a marked ageing of EU countries with the lowest short-term the population is expected and public pension interest rates remained high, having expenditure is projected to increase in relation narrowed until mid-1997 and widened to GDP, particularly if policies regarding significantly since November 1997. benefits continue unchanged. Greece benefits, however, from a partly funded pension system. In a longer-term context, the real effective One aspect of particular relevance in Greece exchange rates of the Greek drachma is that the partly funded pension system against other EU currencies depicted in currently invests a large part of its surpluses Table 10 are above historical average values. in government paper, thereby reducing the This reflects an ongoing and not yet consolidated general government gross debt. completed process of reducing inflation, As a result, any change in this investment based on a policy of not accommodating policy would pose a risk to the gross debt inflation differentials by nominal ratio (but not, however, to the interest depreciation. With regard to other external burden). Moreover, the demographic trend developments, during the 1990s Greece over the next few decades will have an has recorded current account deficits and adverse effect on the current surpluses in the a net external liability position (see Table pension system, thereby making 11). It may also be recalled that, according improvements in the general government to the most recent data available, Greece fiscal balance essential. Alleviation of the has a ratio of foreign trade to GDP of 19% overall burden of population ageing will only for exports and 31% for imports, and a be feasible if public finances have created share of intra-EU trade of 56% for exports sufficient room for manoeuvre before entering and 70% for imports. the period during which the demographic situation worsens. Long-term interest rate developments

Exchange rate developments Over the reference period from February 1997 to January 1998 long-term interest During the reference period from March rates in Greece were 9.8% on average, and 1996 to February 1998 the Greek drachma has not participated in the ERM8 (see Table 9a). Monetary policy has been guided by 8 The Greek drachma was incorporated in the exchange rate an exchange rate target linking the drachma mechanism of the EMS, effective from 16 March 1998.

92 thus stood well above the reference value rates which are below the respective for the interest rate criterion of 7.8% set reference values stipulated by the Treaty. on the basis of the three best-performing Member States in terms of price stability. Greece did not participate in the ERM This was also the case for 1997 as a whole, during the reference period referred to in while in 1996 the rate was considerably this Report.9 Over the reference period, above the reference value (see Table 12). the Greek drachma traded above its March 1996 average bilateral exchange rates Long-term interest rates have been on a against most other EU currencies, which broadly declining trend during the 1990s, are used as a benchmark for illustrative with the exception of 1997 (see Chart 7a). purposes in the absence of central rates. At the same time, a tendency towards a closer convergence of Greek long-term Since 1993 the fiscal deficit ratio has been interest rates with those prevailing in the reduced by a total of 9.8 percentage points EU countries with the lowest bond yields to stand at 4.0% of GDP in 1997, above has been observed since the mid-1990s, the reference value stipulated in the Treaty; although the differential still remains the outlook for 1998 is for a decline in the significantly positive (see Chart 7b). The deficit ratio to 2.2%, i.e. a level below the main factor underlying this trend was the reference value. The debt-to-GDP ratio is significant decline in the inflation differential. far above the 60% reference value. After In addition, the relative stability of the having reached a peak in 1993, the ratio Greek drachmas exchange rate in recent broadly stabilised, before decreasing by 2.9 years against the currencies of the above- percentage points to 108.7% in 1997; the mentioned countries and the recent outlook for 1998 is for a decline in the improvement in the countrys fiscal position debt ratio to 107.7% of GDP. have played a role in the narrowing of the Notwithstanding the efforts and the differential during most of the period substantial progress made towards considered, while more recently the improving the current fiscal situation, there differential has increased. must be an ongoing concern as to whether the ratio of government debt to GDP will be sufficiently diminishing and approaching Concluding summary the reference value at a satisfactory pace and whether sustainability of the fiscal A clear trend towards lower inflation has position has been achieved; addressing this been discernible in Greece, with the CPI rate issue will have to remain a key priority for falling from above 20% in 1990 to 5‰% in the Greek authorities. Substantial primary 1997. HICP inflation was 5.2% over the surpluses and persistent, sizable overall reference period. At the same time, the fiscal surpluses will be needed to be able to increase in unit labour costs decelerated to reduce the debt ratio to 60% within an 7‰% in 1997, and the reduction in inflationary appropriate period of time. This compares tendencies is also indicated by other relevant with a recorded fiscal deficit of 4.0% of measures of inflation. Looking ahead, forecasts GDP in 1997, as well as the deficit forecast suggest a fall in inflation to 4‰% in 1998 and of 2.2% in 1998. The Stability and Growth to 3‰% in 1999. Long-term interest rates Pact also requires, as a medium-term have been on a broadly declining trend objective, a budgetary position that is close during the 1990s, with the exception of to balance or in surplus. 1997; they averaged 9.8% over the reference period. Overall, notwithstanding the progress made, Greece has not achieved a rate of 9 As noted above, the Greek drachma was incorporated in the exchange rate mechanism of the EMS, effective from 16 March HICP inflation or a level of long-term interest 1998.

93 With regard to other factors, in 1996 and external liability position. In the context of 1997 the deficit ratio exceeded the ratio of the ageing of the population, Greece public investment to GDP, Greece recorded benefits from a partly funded pension current account deficits and had a net system.

94 List of Tables and Charts*

GREECE

I Price developments Table 1 Greece: HICP inflation Chart 1 Greece: Price developments Table 2 Greece: Measures of inflation and related indicators Table 3 Greece: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Greece: General government financial position Chart 2 Greece: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Greece: General government gross debt - structural features Chart 3 Greece: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Greece: General government expenditure and receipts Table 6 Greece: General government budgetary position Table 7 Greece: Debt convergence calculations (a) On the basis of overall fiscal balances (b) On the basis of primary fiscal balances Chart 5 Greece: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 8 Greece: Projections of elderly dependency ratio

III Exchange rate developments Table 9 (a) Greece: Exchange rate stability (b) Key indicators of exchange rate pressure for the Greek drachma Chart 6 Greek drachma: Bilateral exchange rates Table 10 Greek drachma: Measures of the real effective exchange rate vis--vis EU Member States Table 11 Greece: External developments

IV Long-term interest rate developments Table 12 Greece: Long-term interest rates Chart 7 (a) Greece: Long-term interest rate (b) Greece: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

95 1 Price developments

Table 1 Greece: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 7.9 5.4 5.0 4.5 4.3 5.2 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Greece: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

22 20 18 16 14 12 10 8 6 4 2 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

96 Table 2 Greece: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 20.4 19.4 15.9 14.4 10.9 8.9 8.2 5.5 CPI excluding changes in net indirect taxes(b) 18.5 17.9 14.9 15.6 10.8 8.9 8.4 4.9 Private consumption deflator 19.9 19.7 15.6 14.2 11.0 8.6 8.5 5.5 GDP deflator 20.6 19.8 14.8 14.5 11.3 9.1 8.5 6.8 Producer prices 13.9 17.0 12.1 11.7 7.4 9.8 8.1 6.9 Related indicators Real GDP growth 0.0 3.1 0.7 -1.6 1.7 1.8 2.6 3.5 Output gap (p.pts) 0.8 2.3 1.3 -2.1 -2.2 -2.5 -2.3 -1.3 Unemployment rate (%) 6.4 7.3 7.6 7.1 7.2 7.1 7.5 7.9 Unit labour costs, whole economy 19.5 9.3 12.6 12.7 11.7 11.3 9.9 7.5 Compensation per employee, whole economy 17.9 15.4 11.8 9.8 11.9 12.6 11.5 10.7 Labour productivity, whole economy -1.3 5.5 -0.7 -2.5 0.1 1.2 1.4 3.0 Import price deflator 13.4 12.1 12.1 7.7 5.7 6.7 3.9 2.7 Exchange rate appreciation(c) -8.5 -11.4 -8.0 -8.6 -6.9 -2.8 -1.3 -1.9 Broad monetary aggregate (M3H)(d) 19.2 10.6 17.3 13.5 11.9 6.4 9.8 14.5 Stock prices 188.8 -2.1 -21.2 2.8 14.7 -3.7 5.4 58.0 House prices ------

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: A positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Greece: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 4.9 4.7 5.1 4.7 4.4 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 4.6 4.4 3.8 4.2 4.3 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 5.1 4.9 4.7 4.6 4.4

Source: National non-harmonised data.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 4.5 3.6 OECD (December 1997), private consumption deflator 4.5 3.5 IMF (October 1997), CPI 4.7 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

97 II Fiscal developments

Table 4 Greece: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -7.5 -4.0 -2.2 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -4.5 -0.7 . General government gross debt 111.6 108.7 107.7 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Greece: General government gross debt (as a percentage of GDP)

(a) Levels

120

110

100

90

80 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

15 10 5 0 -5 -10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

98 Table 5 Greece: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 90.1 92.3 98.8 111.6 109.3 110.1 111.6 108.7 Composition by currency (% of total) In domestic currency 76.8 76.3 76.4 77.8 76.2 77.7 78.3 78.4 In foreign currencies 23.2 23.7 23.6 22.2 23.8 22.3 21.7 21.6 Domestic ownership (% of total) 74.9 75.2 75.5 76.1 74.5 76.6 77.9 76.3 Average maturity (years) ...... Composition by maturity(a) (% of total) Short-term (≤ 1 year) 52.2 41.1 37.9 25.5 26.6 24.2 21.8 13.3 Medium and long-term (> 1 year) 47.8 58.9 62.1 74.5 73.4 75.8 78.2 86.7

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Original maturity.

Chart 3 Greece: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-5

-10

-15

-20 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

5 4 3 2 1 0 -1 -2 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

99 Chart 4 Greece: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

50

40

30 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Greece: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 32.1 32.9 33.7 35.0 36.4 37.2 37.2 37.9 Taxes 18.7 19.4 20.1 19.8 20.6 20.8 21.0 21.9 Social security contributions 11.7 11.2 11.1 12.1 12.0 12.0 11.9 11.6 Other current receipts 1.7 2.2 2.5 3.1 3.8 4.4 4.3 4.3 Total expenditure 48.2 44.4 46.5 48.8 46.4 47.5 44.7 41.9 Current transfers 16.2 15.6 15.2 15.8 15.4 16.0 15.9 15.5 Actual interest payments 10.2 9.4 11.7 12.8 14.1 12.9 11.9 9.6 Public consumption 15.3 14.4 13.9 14.5 13.9 15.4 14.7 14.8 Net capital expenditure 6.6 5.0 5.7 5.7 2.9 3.2 2.2 2.0 Surplus (+) or deficit (-) -16.1 -11.5 -12.8 -13.8 -10.0 -10.3 -7.5 -4.0 Primary balance -6.0 -2.1 -1.1 -1.0 4.1 2.6 4.4 5.6 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -10.6 -7.0 -7.1 -4.5 -0.7

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

100 Table 7 Greece: Debt convergence calculations

(a) On the basis of overall fiscal balances (as a percentage of GDP)

Total gross debt Overall fiscal balance Overall fiscal balance consistent with reduction (deficit: (-); surplus (+)) of debt level to 60% of GDP in(a) 1997 1998 1997 1998 2002 2007 2012 108.7 107.7 -4.0 -2.2 7.8 1.4 -0.4

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the overall fiscal balance for 1998 is as forecast and the overall fiscal balances were maintained at 7.8%, 1.4% and -0.4% of GDP respectively, from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 2.7% in 1998, as estimated by the Commission, and an inflation rate of 2%. Stock-flow adjustments are disregarded.

(b) On the basis of primary fiscal balances (as a percentage of GDP)

Total gross debt Primary fiscal balance Primary fiscal balance consistent with reduction of debt level to 60% of GDP in(a) 1997 1998 1997 1998 2002 2007 2012 108.7 107.7 5.6 6.8 13.0 6.4 4.5

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the primary fiscal balance for 1998 is as forecast and the primary fiscal balances were maintained at 13.0%, 6.4% and 4.5% of GDP, respectively from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 2.7% in 1998, as estimated by the Commission, an inflation rate of 2% and a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Chart 5 Greece: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

120 100 80 60 40 20 19981999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 107.7% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.2% of GDP or the primary balance of 6.8% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 2.7% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

101 Table 8 Greece: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 21.2 25.5 28.8 33.3 40.9 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

102 III Exchange rate developments

Table 9 (a) Greece: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) No Membership since - Devaluation of bilateral central rate on country’s own initiative - Maximum upward (+) and downward (-) deviations from March 1996 average bilateral rates (%) against(a)

ERM currencies: Belgian franc 5.1 -0.1 Danish krone 3.8 -0.1 Deutsche Mark 4.7 -0.1 Spanish peseta 5.2 -0.2 French franc 3.2 -0.1 Irish pound 0.4 -10.2 Italian lira 0.5 -4.6 Dutch guilder 5.3 -0.1 Austrian schilling 4.8 -0.1 Portuguese escudo 3.3 -0.3 Finnish markka 4.2 -1.5 Non-ERM currencies: Swedish krona 3.5 -3.0 Pound sterling 0.8 -22.3

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average.

(b) Key indicators of exchange rate pressure for the Greek drachma

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 2.7 2.6 2.1 4.4 3.1 2.5 3.1 1.6 Short-term interest rate differentials(b) 10.6 10.5 9.9 9.1 7.7 8.2 12.4 13.4

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

103 Chart 6 Greek drachma: Bilateral exchange rates (daily data; average of March 1996=100; 1 March 1996 to 27 February 1998) GRD/BEF GRD/DKK GRD/DEM GRD/ESP GRD/FRF GRD/IEP

110

100

90

80

70 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

GRD/ITL GRD/NLG GRD/ATS GRD/PTE GRD/FIM GRD/SEK GRD/GBP

110

100

90

80

70 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission.

Table 10 Greek drachma: Measures of the real effective exchange rate vis--vis EU Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 12.1 12.3 26.7 PPI/WPI-based 10.9 13.8 26.0 Memo item: Nominal effective exchange rate -71.2 -25.1 -47.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

104 Table 11 Greece: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -4.3 -1.7 -2.1 -0.8 -0.1 -2.5 -3.7 -3.8 Net foreign assets (+) or liabilities (-)(c) -24.3 -23.2 -21.4 -22.7 -21.5 -19.8 -15.5 -19.5 Exports (goods and services)(d) 16.8 16.9 18.6 18.2 19.0 18.9 18.5 18.7 Imports (goods and services)(e) 28.1 28.9 27.9 28.4 28.4 29.6 30.0 30.6

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 56.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 69.5%; Direction of Trade Statistics Yearbook 1997, IMF.

105 IV Long-term interest rate developments

Table 12 Greece: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 14.4 9.9 10.8 10.5 11.0 9.8 Reference value 9.1 8.0 - - - 7.8

Source: European Commission. Note: The harmonised series for Greece starts in mid-1997. Before this, data were based on available best proxies: for the period from March to June 1997, yield data for long-term bonds with shorter maturities than the harmonised series were used; before that period, yields at issue for long-term bonds with shorter maturities than the harmonised series were used.

Chart 7 (a) Greece: Long-term interest rate (monthly averages; in percentages)

30

25

20

15

10

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Greece: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points) Long-term interest rate differential CPI inflation differential

30

20

10

0 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); for further explanation of the data used, see footnote on Table 12; the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

106 SPAIN

Price developments movements. Since 1993 growth rates of import prices have declined gradually before Over the reference period from February picking up again in 1997. Low rates of 1997 to January 1998 the average rate of inflation are also apparent when it is HICP inflation in Spain was 1.8%, i.e. well measured in terms of other relevant price below the reference value of 2.7%. This indices (see Table 2). was also the case in 1997 as a whole. In 1996 average HICP inflation was 3.6% (see Looking at recent trends and forecasts, Table 1). Seen over the past two years, current outturns for consumer price Spain has reduced the rate of HICP inflation inflation (measured as a percentage change to a level which is generally considered to over the corresponding month a year be consistent with price stability. earlier) have been stable at 2% and there is little sign of immediate upward pressure Looking back, consumer price inflation in on the basis of the measures shown in Spain, as measured on the basis of the CPI, Table 3a. Forecasts of inflation suggest has followed a downward trend since the rates of somewhat above 2% for 1998 and early 1990s, when inflation stood at 6.7% 1999 (see Table 3b). Risks for price stability (see Chart 1). This experience of disinflation over this period are associated with the reflects a number of important policy development of wages in the light of a choices, most notably the shift in the strengthening of economic activity. orientation of monetary policy towards the achievement of price stability in the medium Looking further ahead, maintaining an term within the framework of the ERM. environment conducive to price stability Since 1995 this objective has been relates in Spain to, inter alia, the conduct of enshrined in explicit inflation targets, which fiscal policies over the medium to long currently seek to maintain inflation at 2%. term; it will be equally important to The stabilisation of price developments has strengthen national policies aimed at been supported by recent adjustments in enhancing competition in product markets fiscal policy, labour market reforms and and improving the functioning of labour reforms designed to enhance product markets against the background of the market competition. In addition, the current very high, albeit declining, rate of macroeconomic environment has unemployment in Spain. contributed to containing upward pressure on prices. In particular, real GDP growth decelerated markedly in the early 1990s Fiscal developments and the economy entered a recession in 1993, with output declining by over 1% In the reference year 1997 the general (see Table 2). As a result, a negative government deficit ratio was 2.6%, i.e. output gap emerged. Since 1994 economic below the 3% reference value, and the activity has recovered significantly, but the debt ratio was 68.8%, i.e. above the 60% output gap has remained sizable. Against reference value. Compared with the this background, growth in compensation previous year, the deficit ratio has been per employee has been restrained and reduced by 2.0 percentage points and the growth in unit labour costs has come down debt ratio by 1.3 percentage points. In markedly since the early 1990s. Import 1998 the deficit ratio is forecast to decrease price increases varied considerably in the to 2.2% of GDP, while the debt ratio is 1990s, partly as a result of exchange rate projected to decline to 67.4%. In 1996 the

107 deficit ratio exceeded the ratio of public insensitive to changes in exchange rates. investment but it fell below it in 1997 (see Table 4). During the 1990s diverse patterns can be observed in the deficit-to-GDP ratio. Starting Looking back over the years 1990 to 1997, from a ratio of around 4% of GDP in 1990- the Spanish debt-to-GDP ratio increased by 92, fiscal imbalances reached 6.9% of GDP 24.0 percentage points; initially the ratio in 1993 and peaked at 7.3% in 1995; since tended to rise gradually, from 44.8% in then, the deficit ratio has been declining, to 1990 to 48.0% in 1992, whereas there was stand at 2.6% in 1997 (see Chart 3a). As is a steep increase in 1993 to 60.0% of GDP. shown in greater detail in Chart 3b, which In subsequent years the ratio climbed to focuses on changes in deficits, cyclical factors 70.1% in 1996, before declining to 68.8% in contributed substantially to the increase in 1997 (see Chart 2a), i.e. a decline of 1.3 the deficit ratio in 1993, but did not play a percentage points in one year. As is shown major role thereafter. The non-cyclical in greater detail in Chart 2b, until 1995 improvements could reflect a lasting, primary deficits in general contributed to structural move towards more balanced debt growth, adding to a negative growth/ fiscal policies and/or a variety of measures interest rate differential which also had a with temporary effects. However, evidence debt-increasing effect. In addition, an available suggests that measures with a important factor underlying the steep rise temporary effect did not improve the fiscal in the debt ratio has been the impact of balance in 1997 by more than 0.1% of stock-flow adjustments. In particular, in GDP. 1993 a sizable overfunding of the deficit took place in order to build up a deposit of Moving on to examine trends in other the Treasury at the Banco de Espaæa as a fiscal indicators, it can be seen from Chart buffer stock to cover unforeseen liquidity 4 that the general government total needs, and in the same year the depreciation expenditure ratio rose steeply between of the Spanish peseta, which increased the 1990 and 1993. Against the background of peseta value of debt denominated in foreign high and rising unemployment, current currency, had a minor impact. The patterns transfers to households increased sharply, observed thus far during the 1990s may be while the surge in debt led to higher seen as indicative of the risks to public interest payments. Meanwhile, public finances which can arise when consumption also increased relative to macroeconomic conditions deteriorate GDP (see Table 6). In the years following while special factors drive up the debt 1993 the ratio of total expenditure to ratio, particularly in an environment where GDP was on a declining path, mainly the primary surplus is insufficient to reflecting a reduction in transfers to counterbalance these effects. In this context, households and cuts in public consumption it may be noted that the share of debt with and investment. On balance, the a short-term residual maturity has been expenditure ratio has returned to the level decreasing from the high levels of the early observed in 1990, whereby categories like 1990s, and in parallel the average maturity current transfers, interest payments and has increased (see Table 5). With regard public consumption are now higher as a to 1997, the proportion of debt with a percentage of GDP (although interest short-term residual maturity is still high, payments have eased in recent years), and and, taking into account the current level public investment and other capital of the debt ratio, fiscal balances are sensitive expenditures are lower. Given the to changes in interest rates. On the other successive reduction in public investment hand, the proportion of foreign currency and other capital expenditure as a debt is low and fiscal balances are relatively percentage of GDP during the 1990s, a

108 continuation of the downward trend of as projected by the European Commission total expenditure to GDP would appear to for 1998 are achieved, realising a balanced require greater adjustments in other budget from 1999 onwards would reduce expenditure items. In contrast to the swings the debt ratio to below 60% of GDP as in expenditure, government revenue in early as 2001. Instead, maintaining the relation to GDP has tended to fluctuate 1998 overall and primary balance ratios of around 40% over most of the period -2.2% and 2.1% constant in subsequent considered. years would imply a slower path of debt reduction and would generate a debt ratio According to the Spanish medium-term of below 60% of GDP in 2007 and 2004 fiscal policy strategy, as presented in the respectively. Such calculations are based Convergence Programme for 1997-2000 on the normative assumption of a constant updated in April 1997, a declining trend in nominal rate of interest of 6% (average real deficit and debt ratios is targeted for 1998. cost of public debt outstanding of 4% and The budget for 1998 foresees a reduction 2% inflation) and the assumption of a in the general government deficit to 2.4% constant real GDP growth rate of 2.9%, as of GDP, which is slightly more ambitious estimated by the Commission for real than the figure specified in the programme, trend GDP growth in 1998. Stock-flow and Commission forecasts suggest a deficit adjustments are not taken into account. ratio of 2.2%. The improvement in the While they are purely illustrative, and can budget is planned to result from a decline by no means be regarded as forecasts, the in the share of public expenditure in GDP calculations, which indicate that maintaining as a result, in particular, of restraint in 1998 levels for overall deficits would imply personnel spending, a moderate reduction attainment of the 60% reference value not in unemployment benefits and a drop in before 2007, provide an illustration of the interest payments. Currently, there is no need for further substantial progress in evidence of significant measures with a consolidation. temporary effect in the 1998 budget. In the year 2000 deficits are projected to decline Stressing the need for considerable to 1.6% of GDP and the debt ratio to stand improvement in the deficit ratio and to at 65.3%. The 1997 deficit is better than sustain consolidation over time is indeed expected, but the improvement in the warranted in the case of Spain, since debt ratio was somewhat less favourable additional room for manoeuvre is necessary than envisaged earlier. Compared with in order to be able to address future fiscal balances projected in the Convergence budgetary challenges. As is highlighted in Programme for 1999-2000, further Table 7, from around 2010 onwards a substantial fiscal consolidation is required marked ageing of the population is in order to comply with the medium-term expected, and, in the context of an objective of the Stability and Growth Pact, unfunded pension system, public pension effective from 1999 onwards, of having a expenditure is projected to increase in budgetary position that is close to balance relation to GDP, particularly if policies or in surplus. regarding benefits continue unchanged. The overall burden of population ageing will With regard to the future horizon for become more manageable the better the reducing the debt ratio to the 60% state of public finances when the reference value for countries with a debt demographic situation worsens. ratio clearly above 60% but below 80% of GDP, the EMI presents calculations as detailed in Chart 5. On the assumption that overall fiscal positions and debt ratios

109 Exchange rate developments external liability position (see Table 10). It may also be recalled that, according to the The Spanish peseta has been participating most recent data available, Spain has a in the ERM since 19 June 1989, i.e. for ratio of foreign trade to GDP of 30% for considerably longer than two years prior exports and 28% for imports, and a share to the examination (see Table 8a). As of intra-EU trade of 71% for exports and mentioned above, Spanish monetary policy 66% for imports. has focused on the achievement of price stability over the medium term within the context of the ERM. Focusing on the Long-term interest rate developments reference period from March 1996 to February 1998, the currency, benefiting Over the reference period from February from sizable short-term interest rate 1997 to January 1998 long-term interest differentials vis--vis most partner rates in Spain were 6.3% on average, and currencies, has normally traded close to its thus stood below the reference value for central rates against other ERM currencies the interest rate criterion of 7.8% set on (see Chart 6 and Table 8a). On occasion the basis of the three best-performing the Spanish peseta traded outside a range Member States in terms of price stability. close to its central rates vis--vis various This was also the case for 1997 as a whole, partner currencies. The maximum upward as well as for 1996 (see Table 11). Twelve- and downward deviations from central month average long-term interest rates rates, on the basis of 10 business day have been below the reference value since moving averages, were 3.5% and -2.1% November 1996. respectively, abstracting from the autonomous upward trend of the Irish Long-term interest rates have been on a pound (see Table 8a). The episodes in broadly declining trend during the 1990s which such deviations occurred were (see Chart 7a). A broad trend towards the temporary, the degree of exchange rate convergence of Spanish long-term interest volatility vis--vis the Deutsche Mark rates with those prevailing in the EU decreased steadily to a low level (see countries with the lowest bond yields has Table 8b) and short-term interest rate also been observed for most of the period differentials against those EU countries since the early 1990s. Since mid-1995 the with the lowest short-term interest rates process of convergence towards these narrowed significantly over the reference levels has accelerated, and the differential period. During the reference period Spain has now been virtually eliminated (see has not devalued its currencys bilateral Chart 7b). The main factor underlying this central rate against any other Member trend was the significant decline in the States currency. inflation differential vis--vis those countries with the lowest long-term bond yields, In a longer-term context, measures of the which has recently approached zero. The real effective exchange rate of the Spanish relative stability of the Spanish pesetas peseta vis--vis the currencies of ERM exchange rate against the currencies of the participating Member States depicted in above-mentioned countries and an Table 9 suggest that current levels are improvement in the countrys fiscal position close to historical values. As regards other also helped to account for the narrowing external developments, over the 1990s, of the differential. These underlying current account deficits turned into developments were seen by markets as surpluses. This turnaround in the balance improving the prospects for participation of payments has been reflected in a in Stage Three of EMU - an element which tendency towards reductions in the net may in turn have played an independent

110 role in accelerating the narrowing of yield In 1997 Spain achieved a fiscal deficit ratio differentials, both directly and by further of 2.6%, i.e. below the reference value, and improving the prospects for price and the outlook is for a further decline to 2.2% exchange rate stability. in 1998. The debt-to-GDP ratio is above the 60% reference value. After having reached a peak in 1996, the ratio declined Concluding summary by 1.3 percentage points to stand at 68.8% in 1997. Regarding the sustainability of Over the reference period Spain has fiscal developments,,, the outlook is for a achieved a rate of HICP inflation of 1.8%, decrease in the debt ratio to 67.4% of which is well below the reference value GDP in 1998. Given the current debt ratio stipulated by the Treaty. The increase in of somewhat below 70% of GDP, achieving unit labour costs was subdued and a the fiscal balance forecast for 1998 and a general trend towards low rates of inflation balanced budget thereafter would reduce was also apparent in terms of other relevant the debt ratio to below 60% in 2001. price indices. Looking ahead, there is little Instead, keeping the 1998 overall or primary sign of immediate upward pressure on balances constant in the following years inflation; forecasts project inflation will rise would bring the debt ratio down to 60% of to somewhat above 2% in 1998 and 1999. GDP not before 2007 and 2004 The Spanish peseta has been participating respectively, thus pointing to the need for in the ERM for considerably longer than further substantial progress in consolidation. two years. Over the reference period it The Stability and Growth Pact also requires remained broadly stable, generally close to as a medium-term objective a budgetary its unchanged central parities, without the position that is close to balance or in need for measures to support the exchange surplus. rate. The level of long-term interest rates was 6.3%, i.e. below the respective With regard to other factors, in 1996 the reference value. fiscal deficit ratio exceeded the ratio of public investment to GDP, but it fell below that level in 1997. Furthermore, Spain has recorded current account surpluses, while continuing to have a net external liability position.

111 List of Tables and Charts*

SPAIN

I Price developments Table 1 Spain: HICP inflation Chart 1 Spain: Price developments Table 2 Spain: Measures of inflation and related indicators Table 3 Spain: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Spain: General government financial position Chart 2 Spain: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Spain: General government gross debt - structural features Chart 3 Spain: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Spain: General government expenditure and receipts Table 6 Spain: General government budgetary position Chart 5 Spain: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 7 Spain: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Spain: Exchange rate stability (b) Key indicators of exchange rate pressure for the Spanish peseta Chart 6 Spanish peseta: Deviations from ERM bilateral central rates Table 9 Spanish peseta: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Spain: External developments

IV Long-term interest rate developments Table 11 Spain: Long-term interest rates Chart 7 (a) Spain: Long-term interest rate (b) Spain: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

112 1 Price developments

Table 1 Spain: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 3.6 1.9 1.9 1.9 1.9 1.8 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Spain: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

10

8

6

4

2

0

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

113 Table 2 Spain: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 6.7 5.9 5.9 4.6 4.7 4.7 3.6 2.0 CPI excluding changes in net indirect taxes(b) . . . . 4.4 3.7 3.4 1.7 Private consumption deflator 6.5 6.4 6.4 5.6 4.8 4.7 3.4 2.5 GDP deflator 7.3 7.1 6.9 4.3 4.0 4.8 3.1 2.2 Producer prices 2.0 1.3 1.2 2.4 4.5 6.9 1.7 1.3 Related indicators Real GDP growth 3.7 2.3 0.7 -1.2 2.1 2.8 2.3 3.4 Output gap (p.pts) 4.5 4.1 2.2 -1.5 -1.9 -1.7 -2.1 -1.5 Unemployment rate (%) 16.3 16.3 18.4 22.7 24.2 22.9 22.2 20.8 Unit labour costs, whole economy 9.3 8.1 8.0 4.9 0.0 1.9 2.9 1.9 Compensation per employee, whole economy 9.5 9.5 10.4 6.8 2.8 2.9 3.8 2.7 Labour productivity, whole economy 0.1 1.3 2.3 1.8 2.7 1.1 0.8 0.8 Import price deflator -1.2 -0.3 1.3 6.5 5.7 4.7 2.4 4.1 Exchange rate appreciation(c) 4.4 -0.1 -2.1 -12.2 -6.7 -0.0 0.9 -4.5 Broad monetary aggregate (M3H)(d) 13.7 12.4 6.4 7.1 7.5 9.6 7.8 3.0 Stock prices -12.5 0.4 -12.0 14.7 18.5 -6.2 22.1 52.7 House prices 15.6 14.3 -1.3 -0.4 0.7 3.5 1.9 1.3

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Spain: Recent inflation trends and forecasts (annual percentage change unless otherwise stated) (a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 2.0 1.9 2.0 2.0 2.0 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 2.8 2.9 2.8 2.4 2.2 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 1.6 1.8 2.1 2.3 2.4

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 2.1 2.1 OECD (December 1997), private consumption deflator 2.4 2.4 IMF (October 1997), CPI 2.2 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

114 II Fiscal developments

Table 4 Spain: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -4.6 -2.6 -2.2 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -1.7 0.3 . General government gross debt 70.1 68.8 67.4 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Spain: General government gross debt (as a percentage of GDP)

(a) Levels

80

70

60

50

40 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

15

10

5

0

-5 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

115 Table 5 Spain: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 44.8 45.5 48.0 60.0 62.6 65.5 70.1 68.8 Composition by currency (% of total) In domestic currency 96.6 96.0 93.3 91.5 90.8 90.7 91.1 90.4 In foreign currencies 3.4 4.0 6.7 8.5 9.2 9.3 8.9 9.6 Domestic ownership (% of total) 94.1 87.6 86.5 72.0 80.7 78.4 80.0 78.5 Average maturity(a) (years) 1.0 1.4 1.8 3.0 3.0 3.1 3.1 3.7 Composition by maturity(b) (% of total) Short-term(c) (< 1 year) 65.7 62.8 60.5 43.7 41.7 42.1 41.0 30.6 Medium-term (1-5 years) 32.4 31.6 26.4 34.9 33.6 29.6 29.7 37.2 Long-term (> 5 years) 1.9 5.6 13.0 21.5 24.7 28.3 29.3 32.1

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Only those domestic currency securities that are recorded in the centralised book-entry system. (b) Residual maturity. Domestic currency securities that are recorded in the centralised book-entry system, foreign currency securities and assumed debt; overall, these represent between 70% (1992) and 81% (1997) of the total debt. (c) Including short-term debt and debt linked to short-term interest rates.

116 Chart 3 Spain: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-2

-4

-6

-8 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

3 2 1 0 -1 -2 -3 -4 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 Spain: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

50

45

40

35 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

117 Table 6 Spain: General government budgetary position (as a percentage of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 39.6 40.3 42.1 42.3 41.0 39.4 40.2 40.8 Taxes 22.6 22.6 23.5 22.3 22.2 22.1 22.4 22.9 Social security contributions 13.3 13.6 14.5 14.8 14.5 13.5 13.8 13.9 Other current receipts 3.8 4.2 4.1 5.2 4.3 3.8 4.0 4.0 Total expenditure 43.7 44.6 46.0 49.2 47.4 46.7 44.9 43.4 Current transfers 18.3 19.2 20.0 21.4 20.9 19.7 19.7 19.4 Actual interest payments 3.9 3.7 4.1 5.2 4.8 5.5 5.1 4.5 Public consumption 15.5 16.1 17.0 17.4 16.8 16.6 16.4 16.0 Net capital expenditure 6.0 5.6 4.8 5.2 4.8 4.9 3.7 3.5 Surplus (+) or deficit (-) -4.1 -4.2 -3.8 -6.9 -6.3 -7.3 -4.6 -2.6 Primary balance -0.2 -0.5 0.3 -1.7 -1.5 -1.8 0.5 1.9 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -2.9 -2.5 -3.6 -1.7 0.3

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 5 Spain: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

70

60

50 1998 1999 2000 2001

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 67.4% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.2% of GDP or the primary balance of 2.1% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 2.9% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 7 Spain: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 19.8 23.5 25.9 30.7 41.0 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

118 III Exchange rate developments

Table 8 (a) Spain: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 19 June 1989 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 2.0 -0.2 Danish krone 3.5 0.2 Deutsche Mark 2.4 -0.1 French franc 3.3 0.2 Irish pound 5.1 -9.7 Italian lira 1.4 -0.9 Dutch guilder 1.7 -0.5 Austrian schilling 2.4 -0.1 Portuguese escudo 2.4 -1.7 Finnish markka 0.2 -2.1

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Spanish peseta

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 3.7 2.9 1.3 2.2 1.6 1.4 0.8 0.5 Short-term interest rate differentials(b) 4.4 3.8 3.6 2.9 2.3 2.0 1.6 1.1

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

119 Chart 6 Spanish peseta: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) ESP/BEF ESP/DKK ESP/DEM ESP/FRF ESP/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

ESP/ITL ESP/NLG ESP/ATS ESP/PTE ESP/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Spanish peseta: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 0.3 -5.1 3.5 PPI/WPI-based -1.6 -3.8 2.2 Memo item: Nominal effective exchange rate -27.8 -12.1 -12.4

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

120 Table 10 Spain: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -3.4 -3.0 -3.0 -0.4 -0.8 1.2 1.3 1.4 Net foreign assets (+) or liabilities (-)(c) -11.6 -14.4 -17.3 -19.7 -19.8 -18.6 -18.0 . Exports (goods and services)(d) 17.1 18.0 19.2 21.1 24.1 25.4 27.2 29.7 Imports (goods and services)(e) 20.4 21.8 23.1 22.2 24.2 25.6 26.6 28.3

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current acco unt in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in national exports of goods was 71.0%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in national imports of goods was 66.3%; Direction of Trade Statistics Yearbook 1997, IMF.

121 IV Long-term interest rate developments

Table 11 Spain: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 8.7 6.4 6.0 5.6 5.4 6.3 Reference value 9.1 8.0 - - - 7.8 Source: European Commission.

Chart 7 (a) Spain: Long-term interest rate (monthly averages; in percentages)

16

14

12

10

8

6

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Spain: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

6

4

2

0

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

122 FRANCE

Price developments inflation (measured as a percentage change over the corresponding month a year Over the reference period from February earlier) have been decreasing to ‰% and 1997 to January 1998 the average rate of there are no signs of immediate upward HICP inflation in France was 1.2%, i.e. well pressure on the basis of the measures below the reference value of 2.7%. This shown in Table 3a. Forecasts of inflation was also the case in 1997 as a whole. In suggest rates of generally well below 2% 1996 average HICP inflation was 2.1% (see for 1998 and 1999 (see Table 3b). Risks for Table 1). Seen over the past two years, price stability over this period are associated HICP inflation in France has been low and with a narrowing of the output gap. has fallen to a level which is generally considered to be consistent with price Looking further ahead, maintaining an stability. environment conducive to price stability relates in France to, inter alia, the conduct Looking back, consumer price inflation in of fiscal policies over the medium to long France, as measured on the basis of the term; it will be equally important to CPI, has followed a downward trend since strengthen national policies aimed at the early 1990s. Since 1993 inflation has enhancing competition in product markets been close to or below 2% (see Chart 1). and improving the functioning of labour This experience of low inflation reflects a markets against the background of the number of important policy choices, in current high rate of unemployment in particular the continued orientation of France. monetary policy towards exchange rate and price stability within the framework of the ERM. Recent adjustments in fiscal policy, Fiscal developments together with some structural measures aimed at increasing product market In the reference year 1997 the deficit ratio competition, especially in formerly sheltered was 3.0%, i.e. at the level of the 3% sectors, have reinforced the low inflation reference value, and the debt ratio was climate. In addition, the macroeconomic 58.0%, i.e. just below the 60% reference environment has contributed to containing value. Compared with the previous year, upward pressure on prices. Notably, a the deficit ratio has been reduced by 1.1 negative output gap emerged in the context percentage points and the debt ratio has of the 1993 recession (see Table 2). Since increased by 2.3 percentage points. In 1994 economic growth has recovered, but 1998 the deficit ratio is forecast to decrease this has not been sufficient to eliminate the to 2.9% of GDP, while the debt ratio is output gap. Against this background, growth projected to increase marginally to 58.1%. in unit labour costs has been moderate In 1996 and 1997 the deficit ratio exceeded since 1994. Moreover, the broadly stable the ratio of public investment expenditure effective exchange rate during the 1990s to GDP by 1.5 percentage points and 0.2 has helped to keep growth in import prices percentage points respectively (see subdued. Low rates of inflation are also Table 4). apparent when it is measured in terms of other relevant price indices (see Table 2). Looking back over the years 1990 to 1997, the French debt-to-GDP ratio increased by Looking at recent trends and forecasts, 22.5 percentage points (see Chart 2a). As current outturns for consumer price is shown in greater detail in Chart 2b, the

123 main factors underlying the evolution of improvements could reflect a lasting, the debt ratio were, on the one hand, structural move towards more balanced primary deficits recorded in the years fiscal policies and/or a variety of measures 1992-96 and, on the other, the debt- with temporary effects. Evidence available increasing effects of a negative growth/ suggests that measures with a temporary interest rate differential over the whole effect played a deficit-reducing role in period. Stock-flow adjustments played a 1997, amounting to 0.6% of GDP. As they relatively minor role, albeit increasing debt were mainly of a self-reversing nature, in most years. Only in 1997 did the primary compensating measures already included balance again show a small surplus, thereby in the 1998 budget will need to yield their marginally curbing the growth of the debt expected results and, in addition, ratio. The patterns observed thus far during compensating measures will need to be the 1990s may be seen as indicative of the taken in later years when the self-reversing risks to the debt ratio which can arise effects unwind. when the lasting effects of an unfavourable growth/interest rate differential are not Moving on to examine trends in other counteracted by primary surpluses. In this fiscal indicators, it can be seen from Chart context, it may be noted that the share of 4 that the general government total debt with a short-term residual maturity expenditure ratio rose sharply between has remained at relatively high levels since 1990 and 1993. In particular, current the early 1990s (though decreasing), while transfers increased substantially, reflecting the average maturity has remained broadly a marked increase in social spending, stable (see Table 5). With regard to 1997, particularly on pensions, health care and the proportion of debt with a short-term unemployment benefits; but public residual maturity is still relatively high, and, consumption and interest payments as a taking into account the current level of the percentage of GDP also increased (see debt ratio, fiscal balances are relatively Table 6). More recently, the total sensitive to changes in interest rates. On expenditure ratio has been declining, mainly the other hand, the proportion of foreign reflecting a reduction in net capital currency debt in France is low and most is expenditure in relation to GDP, as well as in ECU and may eventually be lower ratios of current transfers and public redenominated in euro; hence, fiscal consumption to GDP. On balance, the balances are relatively insensitive to changes expenditure ratio in 1997 was nearly 3‰ in exchange rates. percentage points higher than at the beginning of the 1990s, reflecting higher During the 1990s a pattern of first ratios to GDP for all major items with the deteriorating and subsequently improving exception of public investment and other outturns was observed in the deficit-to- net capital expenditure. Given this pattern, GDP ratio. Starting from a ratio of 1.6% in a continuation of the downward trend of 1990, the deficit increased sharply to reach total expenditure to GDP would appear to a peak of 5.8% in 1994; since then, the require greater adjustments in items other deficit has declined year by year to stand at than public investment. Government revenue 3.0% in 1997 (see Chart 3a). As is shown in relation to GDP has tended to increase in greater detail in Chart 3b, which focuses since 1994; it was nearly 2 percentage on changes in deficits, cyclical factors played points higher in 1997 than in 1990, and it a dominant role in increasing the deficit may have approached a level which is ratio in 1991 and 1993, and in checking its detrimental to economic growth. increase in 1994. Thereafter, mainly non- cyclical factors contributed to the reduction According to the French medium-term fiscal in deficits. However, these non-cyclical policy strategy, as presented in the

124 Convergence Programme for 1997-2001 challenges. As is highlighted in Table 7, from dated February 1997, the general government around 2010 onwards a marked ageing of deficit is expected to decline to 2.7-2.8% of the population is expected and, in the context GDP and the debt ratio to increase to 58.5- of an unfunded pension system, public pension 59.0% of GDP in 1998, depending on expenditure is forecast to increase in terms economic developments. The budget plan of GDP, particularly if policies regarding for 1998 foresees a somewhat lower debt benefits continue unchanged. The overall ratio and a deficit of 3% of GDP, which is burden of population ageing will become the somewhat higher than envisaged in the more manageable the better the state of updated programme. A marginal reduction in public finances when the demographic the central government deficit ratio is foreseen situation worsens. through a stabilisation of expenditure in real terms. In particular, there are plans to reduce public consumption and social security Exchange rate developments spending. Currently, there is no evidence of significant measures with a temporary effect The French franc has been participating in in the 1998 budget. The deficit ratio is the ERM since its inception on 13 March projected to be cut gradually to less than 1979, i.e. for much longer than two years 1.5% by 2001 and the ratio of government prior to the examination (see Table 8a). As debt to GDP is expected to remain at just mentioned above, French monetary policy under 60% before declining. Compared with has focused on exchange rate and price fiscal balances projected in the Convergence stability within the framework of the ERM. Programme for 1999-2000, further substantial Focusing on the reference period from progress in fiscal consolidation is required in March 1996 to February 1998, the currency order to comply with the medium-term has normally traded close to its central objective of the Stability and Growth Pact, rates against other ERM currencies (see effective from 1999 onwards, of having a Chart 5 and Table 8a). On occasion the budgetary position that is close to balance or French franc traded outside a range close in surplus. to its central rates vis--vis various partner currencies. The maximum upward and With regard to the potential future course of downward deviations from central rates, the debt ratio, the EMIs Report does not on the basis of 10 business day moving consider this issue in detail for those countries averages, were 0.6% and -3.5% respectively, with a debt ratio of below 60% of GDP. It is, abstracting from the autonomous upward however, important to highlight the fact that trend of the Irish pound (see Table 8a). current fiscal positions, in terms of both The episodes in which such deviations overall and primary balances, would not occurred were temporary, the degree of appear to be sufficient to stabilise the debt exchange rate volatility vis--vis the ratio at below 60%, while over time a Deutsche Mark was low and declining (see balanced budget would allow it to be brought Table 8b) and short-term interest rate further below the reference value. In order differentials against those EU countries to allow for a stabilisation of the debt ratio at with the lowest short-term interest rates just below 60% of GDP, a deficit ratio of just were small and narrowing. During the below 2.5% would be required. As noted reference period France has not devalued above, a further reduction in the deficit ratio its currencys bilateral central rate against is necessary in the context of the Stability and any other Member States currency. Growth Pact. Such considerations are also important in the case of France since additional In a longer-term context, measures of the room for manoeuvre will be necessary in real effective exchange rate of the French order to be able to address future budgetary franc vis--vis the currencies of ERM

125 participating Member States depicted in which is well below the reference value Table 9 suggest that current levels are stipulated by the Treaty and one of the close to historical values. As regards other three lowest inflation rates in the Union. external developments, France has The increase in unit labour costs was maintained current account surpluses in subdued and low rates of inflation were recent years, a situation which has been also apparent in terms of other relevant reflected in an improvement in the net price indices. Looking ahead, there are no external liability position (see Table 10). It signs of immediate upward pressure on may also be recalled that, according to the inflation; forecasts project inflation will stand most recent data available, France has a at well below 2% in 1998 and 1999. The ratio of foreign trade to GDP of 29% for French franc has been participating in the exports and 25% for imports, and a share ERM for much longer than two years. Over of intra-EU trade of 63% for exports as the reference period it remained broadly well as for imports. stable, generally close to its unchanged central parities, without the need for measures to support the exchange rate. Long-term interest rate developments The level of long-term interest rates was 5.5%, i.e. well below the respective Over the reference period from February reference value. 1997 to January 1998 long-term interest rates in France were 5.5% on average, and In 1997 France achieved a fiscal deficit thus stood well below the reference value ratio of 3.0% of GDP, i.e. a level equal to for the interest rate criterion of 7.8% set the reference value, and the outlook is for on the basis of the three best-performing virtually no further improvement in 1998 Member States in terms of price stability. (a decrease to 2.9%) in spite of the This was also the case for 1997 as a whole, favourable conjunctural situation. In as well as for 1996 (see Table 11). addition, the fiscal debt ratio, though increasing to 58.0% of GDP in 1997, Long-term interest rates have been on a remained just below the 60% reference broadly declining trend since the early value; the outlook is for a marginal increase 1990s (see Chart 6a). A close convergence to 58.1% in 1998. Regarding the of French long-term interest rates with sustainability of fiscal developments, keeping those prevailing in the EU countries with the deficit ratio at current levels would not the lowest bond yields has been observed be sufficient to keep the debt ratio below throughout most of the 1990s (see Chart 60% of GDP, thus pointing to a need for 6b). The main factors underlying this trend further substantial progress in consolidation. were the comparatively low rate of inflation, The Stability and Growth Pact also requires the relative stability of the French francs as a medium-term objective a budgetary exchange rate, the pursuit of a similar position that is close to balance or in monetary policy stance to that followed in surplus. This would also imply a reduction the above-mentioned countries and, more in the debt ratio to further below 60% of recently, an improvement in the fiscal GDP. position. With regard to other factors, in 1996 and 1997 the deficit ratio exceeded the ratio of Concluding summary public investment expenditure to GDP. Furthermore, France has recorded current Over the reference period France has account surpluses and a net external liability achieved a rate of HICP inflation of 1.2%, position.

126 List of Tables and Charts*

FRANCE

I Price developments Table 1 France: HICP inflation Chart 1 France: Price developments Table 2 France: Measures of inflation and related indicators Table 3 France: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 France: General government financial position Chart 2 France: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 France: General government gross debt - structural features Chart 3 France: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 France: General government expenditure and receipts Table 6 France: General government budgetary position Table 7 France: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) France: Exchange rate stability (b) Key indicators of exchange rate pressure for the French franc Chart 5 French franc: Deviations from ERM bilateral central rates Table 9 French franc: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 France: External developments

IV Long-term interest rate developments Table 11 France: Long-term interest rates Chart 6 (a) France: Long-term interest rate (b) France: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

127 1 Price developments

Table 1 France: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 2.1 1.3 1.4 1.2 0.6 1.2 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 France: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

5

4

3

2

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

128 Table 2 France: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 3.4 3.2 2.4 2.1 1.7 1.8 2.0 1.2 CPI excluding changes in net indirect taxes(b) . 3.9 3.6 2.6 1.5 1.1 1.1 0.8 Private consumption deflator 2.8 3.1 2.4 2.2 2.1 1.5 1.8 1.4 GDP deflator 3.1 3.3 2.1 2.5 1.6 1.6 1.2 1.2 Producer prices(c) 1.4 0.8 -0.3 -0.5 0.8 1.7 -1.1 -0.4 Related indicators Real GDP growth 2.5 0.8 1.2 -1.3 2.8 2.1 1.5 2.4 Output gap (p.pts) 3.2 2.0 1.2 -2.0 -1.1 -1.0 -1.5 -1.2 Unemployment rate (%) 8.9 9.5 10.4 11.7 12.3 11.6 12.3 12.6 Unit labour costs, whole economy 4.1 3.6 2.7 3.1 -0.3 1.8 1.4 1.3 Compensation per employee, whole economy 4.9 4.4 4.3 2.7 2.2 2.7 2.7 3.2 Labour productivity, whole economy 0.8 0.8 1.6 -0.4 2.5 0.9 1.3 1.9 Import price deflator -1.3 0.0 -2.6 -2.5 1.7 1.3 1.1 0.9 Exchange rate appreciation(d) 5.8 -2.1 3.3 2.3 0.7 3.6 0.2 -3.5 Broad monetary aggregate (M3H)(e) 9.1 6.3 4.4 1.5 -2.7 4.1 0.8 -0.7 Stock prices 4.2 -3.9 4.9 8.8 2.1 -9.1 11.2 31.9 House prices 16.7 -0.4 -5.7 1.7 2.8 -4.3 -7.0 -2.0

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Manufacturing sector. (d) Nominal effective exchange rate against 25 industrialised countries. Note: A positive (negative) sign indicates an appreciation (depreciation). (e) National harmonised data.

Table 3 France: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.3 1.0 1.3 1.1 0.5 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 1.7 1.7 1.3 0.9 0.5 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 0.8 0.8 1.0 1.1 1.2

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999

European Commission (spring 1998), HICP 1.0 1.6 OECD (December 1997), private consumption deflator 1.4 1.5 IMF (October 1997), CPI 1.3 .

Source: European Commission (spring 1998 forecasts), OECD and IMF. 129 II Fiscal developments

Table 4 France: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -4.1 -3.0 -2.9 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -1.5 -0.2 . General government gross debt 55.7 58.0 58.1 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 France: General government gross debt (as a percentage of GDP)

(a) Levels

60 55 50 45 40 35 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

6

4

2

0

-2 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

130 Table 5 France: General government gross debt structural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 35.5 35.8 39.8 45.3 48.5 52.7 55.7 58.0 Composition by currency (% of total) In domestic currency 97.7 97.2 97.2 96.9 96.5 96.3 94.2 93.0 In foreign currencies 2.3 2.8 2.8 3.1 3.5 3.7 5.8 7.0 Domestic ownership (% of total) 83.0 81.0 78.6 76.8 83.9 85.0 87.3 86.7 Average maturity(a) (years) 4.6 4.8 5.2 5.3 5.4 5.3 5.3 5.3 Composition by maturity(b) (% of total) Short-term(c) (< 1 year) 33.5 32.6 32.5 31.2 27.1 28.7 30.0 29.4 Medium-term (1-5 years) 34.8 35.4 33.3 32.9 32.5 30.7 28.1 29.5 Long-term (> 5 years) 31.7 32.0 34.2 35.9 40.4 40.6 41.9 41.1

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. (b) Residual maturity. Where residual maturity is less than 5 years, floating rate notes are classified as short-term notes. (c) Including short-term debt and debt linked to short-term interest rates.

131 Chart 3 France: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0 -1 -2 -3 -4 -5 -6 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 France: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

60

55

50

45 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

132 Table 6 France: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 49.0 49.0 48.9 49.6 49.2 49.8 50.9 50.9 Taxes 24.0 24.0 23.5 23.9 24.4 24.7 25.6 26.3 Social security contributions 21.0 21.0 21.3 21.6 21.1 21.3 21.6 21.0 Other current receipts 4.0 4.0 4.1 4.2 3.7 3.8 3.7 3.6 Total expenditure 50.6 51.0 52.9 55.4 55.0 54.7 55.0 54.0 Current transfers 25.6 26.3 27.3 28.7 28.2 28.2 28.5 28.4 Actual interest payments 2.9 2.9 3.2 3.4 3.6 3.7 3.8 3.6 Public consumption 18.0 18.2 18.9 19.9 19.5 19.3 19.5 19.4 Net capital expenditure 4.0 3.5 3.5 3.5 3.7 3.4 3.3 2.6 Surplus (+) or deficit (-) -1.6 -2.1 -3.9 -5.8 -5.8 -4.9 -4.1 -3.0 Primary balance 1.4 0.9 -0.7 -2.4 -2.2 -1.1 -0.3 0.6 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -2.5 -2.6 -1.8 -1.5 -0.2

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 France: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 20.8 23.6 24.6 32.3 39.1 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

133 III Exchange rate developments

Table 8 (a) France: Exchange rate stability (1 March 1996 – 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 0.3 -2.4 Danish krone 0.4 -0.9 Deutsche Mark 0.2 -2.1 Spanish peseta -0.2 -3.2 Irish pound 1.9 -11.1 Italian lira 0.6 -2.4 Dutch guilder 0.3 -2.7 Austrian schilling 0.2 -2.2 Portuguese escudo 0.0 -3.4 Finnish markka -0.1 -3.5

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the French franc

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 1.8 1.5 1.9 1.2 0.9 1.1 0.5 0.3 Short-term interest rate differentials(b) 0.5 0.4 0.3 0.2 0.1 0.1 0.0 0.0

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

134 Chart 5 French franc: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) FRF/BEF FRF/DKK FRF/DEM FRF/ESP FRF/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

FRF/ITL FRF/NLG FRF/ATS FRF/PTE FRF/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 French franc: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods) Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -2.2 0.2 -1.5 PPI/WPI-based -0.8 -0.5 -1.6 Memo item: Nominal effective exchange rate 1.5 6.3 10.1

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

135 Table 10 France: External developments (as a percentage of GDP) 1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -0.8 -0.5 0.4 0.9 0.6 0.7 1.3 2.9 Net foreign assets (+) or liabilities (-)(c) . -8.3 -7.4 -9.1 -4.4 -1.9 -0.4 . Exports (goods and services)(d) 22.6 23.3 24.2 24.4 25.1 26.2 27.0 29.3 Imports (goods and services)(e) 22.6 23.1 23.1 22.6 23.4 24.1 24.4 25.3

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 62.6%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 63.3%; Direction of Trade Statistics Yearbook 1997, IMF.

136 IV Long-term interest rate developments

Table 11 France: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 6.3 5.6 5.6 5.3 5.1 5.5 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) France: Long-term interest rate (monthly averages; in percentags)

11

10

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) France: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

2

1

0

-1

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

137 IRELAND

Price developments terms of other relevant price indices (see Table 2). Over the reference period from February 1997 to January 1998 the average rate of Looking at recent trends and forecasts, the HICP inflation in Ireland was 1.2%, i.e. well latest available outturns for consumer price below the reference value of 2.7%. This inflation (measured as a percentage change was also the case in 1997 as a whole. In over the corresponding month a year 1996 average HICP inflation was 2.2%. earlier) show a rate of inflation of 1.6% but Seen over the past two years, HICP inflation there are some signs of immediate upward in Ireland has been low and has fallen to a pressure on the basis of the measures level which is generally considered to be shown in Table 3a. Forecasts of inflation consistent with price stability. suggest it may rise towards 3% over the next two years (see Table 3b). Risks for Looking back, consumer price inflation in price stability over this period are mainly Ireland, as measured on the basis of the associated with the domestic environment, CPI, has followed a broad downward trend in particular strong money and credit since the early 1990s (see Chart 1). Inflation growth, the procyclical fiscal policy, the fell from 3.4% in 1990 to 1.5% in 1993. development of asset prices, tight labour Thereafter, it rose to around 2.5% in 1994- market conditions and strong GDP growth. 95, before declining again to around 1.5% These risks to inflation are being in 1996-97. This experience of a general exacerbated in the run-up to EMU by the decline in rates of inflation reflects a number expected further decline in short-term of important policy choices, notably a interest rates and, should this materialise, monetary policy stance geared towards by a resulting decline in the effective the primary objective of price stability exchange rate. within the framework of the ERM. The reduction in inflation has also been Looking further ahead, maintaining an supported by other policies, in particular environment conducive to price stability wage moderation. With regard to the relates in Ireland to, inter alia, the conduct macroeconomic environment, it is notable of fiscal policies over the medium to long that lower inflation has been achieved term; it will be equally important to maintain against the background of buoyant real policies aimed at enhancing competition in GDP growth, which stood at over 7% on product markets and improving the average in the eight years to 1997 (see functioning of labour markets against the Table 2). Notwithstanding a tightening of background of the current high, albeit labour market conditions, growth in declining, rate of unemployment in Ireland. compensation per employee was moderate in 1994-96. In 1997 wage increases picked up while remaining moderate in Fiscal developments manufacturing industry. In combination with strong growth in labour productivity, unit In the reference year 1997 Ireland recorded labour costs have declined from 1994 a general government surplus of 0.9% of onwards. Import price increases have varied GDP, thereby comfortably meeting the 3% in recent years, partly as a result of effective reference value, and the debt ratio was exchange rate movements, but were 66.3%, i.e. above the 60% reference value. subdued in 1996-97. Low rates of inflation Compared with the previous year, the are also apparent when it is measured in fiscal balance has improved by 1.3

138 percentage points and the debt ratio has from a ratio of 2.3% in 1990, the deficit decreased by 6.4 percentage points. In remained broadly at that level for several 1998 the fiscal surplus is forecast to increase years. Thereafter, there was a sharp to 1.1% of GDP, while the debt ratio is improvement, beginning in 1996, leading projected to decline to 59.5%, i.e. just to a small deficit in that year and to a below the reference value. In 1996 the surplus of 0.9% in 1997 (see Chart 3a). As deficit ratio did not exceed the ratio of is shown in greater detail in Chart 3b, public investment expenditure to GDP. which focuses on changes in deficits, cyclical factors complicated the stabilisation of the Looking back over the years 1990 to 1997, deficit ratio in the early 1990s and played the Irish debt-to-GDP ratio declined by 29.7 an important role in reducing the deficit percentage points. Initially the ratio ratio later on. In the last two years non- fluctuated around its 1990 level of 96.0%, cyclical factors also contributed to reducing but since 1994 a strong downward trend the deficit. These non-cyclical improvements has been apparent, with a continuous could reflect a lasting, structural move reduction in the debt from 96.3% in 1993 towards more balanced fiscal policies and/ to 66.3% in 1997 (see Chart 2a), i.e. a or a variety of measures with temporary decline of 30.0 percentage points over effects. However, evidence available four years. As is shown in greater detail in suggests that measures with a temporary Chart 2b, the main forces underlying this effect did not play a role in reducing reduction were sizable primary surpluses, deficits in 1996 or 1997. combined with a very favourable growth and interest rate environment since 1994. Moving on to examine trends in other Only in 1993 did significant stock-flow fiscal indicators, it can be seen from Chart adjustments increase the debt ratio, owing 4 that the general government total to a valuation effect on foreign currency expenditure ratio was broadly stable debt of the depreciation of the Irish pound. between 1990 and 1994. Increased transfer The patterns observed thus far during the payments and public consumption were 1990s may be seen as indicative of the compensated for by reduced interest debt-reducing effect of continuous primary payments (see Table 6). After 1994, surpluses, while, on the other hand, these however, the expenditure-to-GDP ratio effects were reinforced by strong growth. declined and, by 1997, had dropped by 4‰ In this context, it may be noted that the percentage points, reflecting reductions share of debt with a short-term residual across all major categories of spending maturity has been low over the 1990s, relative to GDP. On balance, the while the average maturity has decreased expenditure ratio in 1997 was considerably (see Table 5). With regard to 1997, taking lower than at the beginning of the 1990s, into account the current level of the debt particularly on account of the sharp ratio, fiscal balances are relatively insensitive reduction in interest payments as a to changes in interest rates. On the other consequence of lower interest rates and hand, the proportion of foreign currency the reduction in the debt ratio. Government debt is relatively high and fiscal balances revenue in relation to GDP also fell during are relatively sensitive to changes in the 1990s, but this was largely the result of exchange rates. a single drop in 1995 (of 2.5 percentage points) and thereafter the ratio tended to During the 1990s a pattern of initially increase slightly. Overall, reductions in stable and subsequently improving outturns expenditure and revenue ratios in Ireland can be observed in the deficit-to-GDP ratio, have been dominated by very strong GDP whereby the ratio remained consistently growth. below the 3% reference value. Starting

139 According to the Irish medium-term fiscal (see Table 7), the pension systems reliance policy strategy, as stated in the Convergence on funded private pensions and the Programme for 1997-99 updated in relatively minor role of unfunded social December 1997, a somewhat declining security pensions, challenges remain. As a budget surplus and a declining debt ratio small open economy Ireland may need to are expected in 1998. The budget for 1998 have sufficient room for manoeuvre to foresees the maintenance of a surplus in react to country-specific circumstances, and the general government financial balance, it needs to reduce its vulnerability to and a debt ratio which nearly attains the unexpected shocks which could potentially reference value, while Commission forecasts reverse debt trends. As mentioned above, indicate more favourable developments. a decline in growth rates could pose a The 1998 budget contains reductions in further challenge to consolidation. income tax rates and increased spending, but owing to the high economic growth rate both revenue and expenditure ratios Exchange rate developments are expected to decline. Currently, there is no evidence of significant measures with a The Irish pound has been participating in temporary effect in the 1998 budget. For the ERM since its inception on 13 March 1999 the Convergence Programme foresees 1979, i.e. for much longer than two years an increase in the budget surplus to 0.7% prior to the examination (see Table 8a). As of GDP and a debt ratio of 56%. In general, mentioned above, Irish monetary policy Ireland has outperformed the targets of has been geared towards the objective of previous programmes. If fiscal balances price stability within the context of the turn out as projected in the Convergence ERM. Focusing on the reference period from Programme for 1999-2000, or are more March 1996 to February 1998, the currency, favourable, Ireland should comply with the benefiting from sizable interest rate medium-term objective of the Stability and differentials vis--vis most partner Growth Pact, effective from 1999 onwards, currencies, has normally traded significantly of having a budgetary position that is close above its central rates and above a range to balance or in surplus. However, the close to its central rates vis--vis partner fiscal position benefits from a strong currencies (see Chart 5 and Table 8a). The economy, with the structural balance maximum upward and downward probably being in a slight deficit position. deviations from central rates, on the basis Therefore, risks may arise if economic of 10 business day moving averages, were growth slows down. 12.5% and -4.8% respectively (see Table 8a); at the end of the reference period the With regard to the potential future course Irish pound stood just over 3% above its of the debt ratio, the EMIs Report does not central rates vis--vis other ERM currencies. consider this issue in detail for those In parallel with the strength of the Irish countries forecast to have a debt ratio of pound, the degree of exchange rate volatility below 60% of GDP in 1998. Projected vis--vis the Deutsche Mark increased until developments underline the benefits of the mid-1997 (see Table 8b) and short-term surplus position achieved in 1997, and interest rate differentials against those EU forecast to increase in 1998, for rapidly countries with the lowest short-term reducing the debt ratio. However, stressing interest rates widened over the same the need for sound fiscal balances over period. The former has decreased and the time is also evident in the case of Ireland. latter narrowed somewhat in more recent While the issue of public pension cost is months, while remaining relatively high. not a major concern in Ireland, given the During the reference period Ireland has relatively favourable demographic situation not devalued its currencys bilateral central

140 rate against any other Member States Concluding summary currency.10 Over the reference period Ireland has In a longer-term context, measures of the achieved a rate of HICP inflation of 1.2%, real effective exchange rate of the Irish which is well below the reference value pound vis--vis the currencies of ERM stipulated by the Treaty and one of the participating Member States depicted in three lowest inflation rates in the Union. Table 9 suggest that current levels are Unit labour costs declined, and low rates close to historical values. As regards other of inflation were also apparent in terms of external developments, Ireland has other relevant price indices. Looking ahead, maintained large current account surpluses there are some signs of immediate upward in recent years (see Table 10). It may also pressure on inflation, which may rise be recalled that Ireland is a small open towards 3% over the next two years. The economy with, according to the most level of long-term interest rates was 6.2%, recent data available, a ratio of foreign i.e. below the respective reference value. trade to GDP of 84% for exports and 63% for imports, and a share of intra-EU trade The Irish pound has been participating in of 66% for exports and 54% for imports. the ERM for much longer than two years. During the reference period it has normally traded significantly above its unchanged Long-term interest rate developments central rates against other ERM currencies, reflecting an autonomous upward trend of Over the reference period from February the currency in the light of buoyant 1997 to January 1998 long-term interest domestic economic conditions. This is also rates in Ireland were 6.2% on average, and mirrored in relatively high exchange rate thus stood below the reference value for volatility and short-term interest rate the interest rate criterion of 7.8% set on differentials, both of which have declined the basis of the three best-performing more recently as the Irish pound has Member States in terms of price stability. moved closer to its bilateral central rates This was also the case for 1997 as a whole, against other ERM currencies.11 as well as for 1996 (see Table 11). In 1997 Ireland achieved a general Long-term interest rates have been on a government surplus of 0.9% of GDP, broadly declining trend since the early thereby comfortably meeting the 3% 1990s (see Chart 6a). A comparatively reference value, and the outlook is for a close convergence of Irish long-term interest surplus of 1.1% of GDP in 1998. The debt- rates with those prevailing in the EU to-GDP ratio is above the 60% reference countries with the lowest bond yields has value. After having reached a peak in 1993, been observed over most of the period the ratio declined by 30.0 percentage since the beginning of the 1990s, with the points to stand at 66.3% in 1997, reflecting exception of late 1992 and early 1993, the inter alia very strong real GDP growth. period marked by the ERM crisis (see Regarding the sustainability of fiscal Chart 6b). The main factors underlying this developments, the outlook is for a decline trend were the comparatively low rates of inflation and the improvement in the countrys fiscal position. 10 With effect from 16 March 1998, i.e. after the reference period applied in this Report, the bilateral central rates of the Irish pound against other currencies of the ERM were revalued by 3%. 11 With effect from 16 March 1998, i.e. after the reference period referred to in this Report, the bilateral central rates of the Irish pound against other currencies of the ERM were revalued by 3%.

141 in the debt ratio to 59.5% of GDP in 1998, With regard to other factors, in 1996 the i.e. just below the reference value. Looking deficit position did not exceed the ratio of further ahead, if current fiscal surpluses are public investment to GDP. Moreover, maintained, Ireland should comply with the Ireland has maintained current account medium-term objective of the Stability and surpluses. In the context of a relatively Growth Pact, effective from 1999 onwards, favourable demographic situation, the of having a budgetary position that is close pension system relies on funded private to balance or in surplus, and the debt ratio pensions and unfunded social security would fall further below 60%. pensions play a relatively minor role.

142 List of Tables and Charts*

IRELAND

I Price developments Table 1 Ireland: HICP inflation Chart 1 Ireland: Price developments Table 2 Ireland: Measures of inflation and related indicators Table 3 Ireland: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Ireland: General government financial position Chart 2 Ireland: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Ireland: General government gross debt - structural features Chart 3 Ireland: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Ireland: General government expenditure and receipts Table 6 Ireland: General government budgetary position Table 7 Ireland: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Ireland: Exchange rate stability (b) Key indicators of exchange rate pressure for the Irish pound Chart 5 Irish pound: Deviations from ERM bilateral central rates Table 9 Irish pound: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Ireland: External developments

IV Long-term interest rate developments Table 11 Ireland: Long-term interest rates Chart 6 (a) Ireland: Long-term interest rate (b) Ireland: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

143 1 Price developments

Table 1 Ireland: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 2.2 1.2 1.1 1.0 1.2 1.2 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Ireland: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

5 4 3 2 1 0 -1 -2 -3 -4 -5 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

144 Table 2 Ireland: Measures of inflation and related indicators (annual percentage changes unless otherwise stated) 1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 3.4 3.2 3.0 1.5 2.4 2.5 1.6 1.5 CPI excluding changes in net indirect taxes(b) 4.1 3.3 2.7 1.1 2.1 2.4 1.5 1.2 Private consumption deflator 2.0 3.0 2.5 1.9 2.8 2.0 1.2 1.2 GDP deflator -0.8 1.8 2.3 4.2 1.1 0.5 1.1 1.6 Producer prices -1.6 0.8 1.7 4.6 1.1 2.5 0.7 -0.8 Related indicators Real GDP growth 8.5 2.4 4.6 3.6 7.8 11.1 8.6 10.0 Output gap (p.pts) 2.2 -0.8 -2.1 -4.7 -4.0 -0.7 0.1 1.9 Unemployment rate (%) 13.3 14.7 15.5 15.6 14.1 12.2 11.8 10.8 Unit labour costs. whole economy 0.0 2.2 3.1 3.8 -1.7 -4.1 -2.6 -1.3 Compensation per employee, whole economy 5.4 4.6 6.8 5.6 2.3 1.9 2.4 4.0 Labour productivity, whole economy 5.4 2.4 3.6 1.8 4.1 6.3 5.1 5.3 Import price deflator -3.7 2.3 -1.3 4.4 2.7 4.0 -0.7 1.1 Exchange rate appreciation(c) 7.1 -1.6 3.3 -5.9 0.2 1.0 2.3 -0.1 Broad monetary aggregate (M3H)(d) . . . . 9.3 10.7 14.4 21.3 Stock prices -4.4 -11.5 -5.2 20.2 17.6 7.5 25.2 33.7 House prices(e) 12.7 2.1 3.5 0.9 4.1 7.2 11.8 15.1

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data. (e) Prices for new houses.

Table 3 Ireland: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change - - 1.6 - - Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted - - 3.7 - - Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted - - 1.6 - -

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 2.8 3.1 OECD (December 1997), private consumption deflator 2.2 2.4 IMF (October 1997), CPI 2.1 .

Source: European Commission (spring 1998 forecasts), OECD and IMF. 145 II Fiscal developments

Table 4 Ireland: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -0.4 0.9 1.1 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) 1.8 3.2 . General government gross debt 72.7 66.3 59.5 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Ireland: General government gross debt (as a percentage of GDP)

(a) Levels

100

90

80

70

60 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

10

5

0

-5

-10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

146 Table 5 Ireland: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 96.0 95.3 92.3 96.3 89.1 82.3 72.7 66.3 Composition by currency (% of total) In domestic currency 65.9 65.9 60.0 59.0 61.7 65.0 71.6 73.8 In foreign currencies 34.1 34.1 40.0 41.0 38.3 35.0 28.4 26.2 Domestic ownership (% of total) 51.0 50.4 51.4 45.6 49.4 51.1 64.1 . Average maturity(a) (years) . 6.7 6.5 6.7 6.0 5.7 5.3 5.0 Composition by maturity(a) (% of total) Short-term(b) (≤ 1 year) . 9.0 9.7 8.7 10.5 9.1 9.2 8.9 Medium-term (2-5 years) . 41.8 40.0 37.0 38.9 40.4 43.2 44.8 Long-term (> 5 years) . 49.2 50.3 54.2 50.6 50.5 47.6 46.3

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Government bonds and foreign loans only, which represent between 82.4% (1997) and 90.4% (1993) of the total debt. (b) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Ireland: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

2 1 0 -1 -2 -3 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

2

1

0

-1

-2

-3 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

147 Chart 4 Ireland: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

45

40

35 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Ireland: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 37.3 37.9 38.1 37.6 38.2 35.7 35.7 36.3 Taxes 29.8 29.9 30.1 29.7 30.9 28.9 29.3 30.2 Social security contributions 5.2 5.3 5.4 5.4 5.2 4.9 4.5 4.5 Other current receipts 2.3 2.6 2.6 2.5 2.1 1.9 1.8 1.7 Total expenditure 39.6 40.2 40.5 40.3 39.9 37.9 36.1 35.4 Current transfers 15.6 16.0 16.6 16.8 16.4 16.1 15.7 15.2 Actual interest payments 7.7 7.5 6.9 6.4 5.6 5.1 4.5 4.3 Public consumption 14.8 15.6 15.8 15.8 15.5 14.8 14.2 14.3 Net capital expenditure 1.4 1.1 1.2 1.2 2.3 1.9 1.8 1.6 Surplus (+) or deficit (-) -2.3 -2.3 -2.5 -2.7 -1.7 -2.2 -0.4 0.9 Primary balance 5.4 5.1 4.4 3.7 4.0 2.9 4.0 5.2 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -0.6 0.7 -0.0 1.8 3.2

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 Ireland: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 18.4 16.7 18.0 21.7 25.3 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

148 III Exchange rate developments

Table 8 (a) Ireland: Exchange rate stability (1 March 1996 – 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 11.9 -4.1 Danish krone 11.6 -2.5 Deutsche Mark 11.8 -3.7 Spanish peseta 10.7 -4.8 French franc 12.5 -1.8 Italian lira 11.3 2.3 Dutch guilder 11.7 -4.4 Austrian schilling 11.8 -3.8 Portuguese escudo 10.3 -2.9 Finnish markka 10.0 0.6

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Irish pound

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 3.4 4.8 4.7 7.5 8.2 7.3 6.8 6.1 Short-term interest rate differentials(b) 1.6 2.0 2.4 2.6 2.6 2.9 2.6 2.4

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

149 Chart 5 Irish pound: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) IEP/BEF IEP/DKK IEP/DEM IEP/ESP IEP/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

IEP/ITL IEP/NLG IEP/ATS IEP/PTE IEP/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Irish pound: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 0.7 -2.1 -5.4 PPI/WPI-based 0.1 0.7 0.4 Memo item: Nominal effective exchange rate -10.4 0.1 -0.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

150 Table 10 Ireland: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 0.0 2.1 2.6 5.5 3.6 4.1 3.2 2.8 Net foreign assets (+) or liabilities (-)(c) ...... Exports (goods and services)(d) 58.7 60.3 65.5 69.3 73.4 78.9 80.0 83.7 Imports (goods and services)(e) 52.8 52.2 53.4 54.7 57.7 59.6 60.5 62.8

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 66.0%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 53.6%; Direction of Trade Statistics Yearbook 1997, IMF.

151 IV Long-term interest rate developments

Table 11 Ireland: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 7.3 6.3 6.0 5.6 5.4 6.2 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) Ireland: Long-term interest rate (monthly averages; in percentages)

11

10

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Ireland: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

3

2

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria

152 ITALY

Price developments price changes have varied considerably, partly as a result of large effective exchange Over the reference period from February rate movements, which have complicated 1997 to January 1998 the average rate of the task of controlling inflation in some HICP inflation in Italy was 1.8%, i.e. well years. More recently, falling import prices below the reference value of 2.7%. This have improved the price climate. The was also the case in 1997 as a whole. In general trend towards low rates of inflation 1996 average HICP inflation was 4.0% (see is also apparent when it is measured in Table 1). Seen over the past two years, terms of other relevant price indices, while Italy has reduced the rate of HICP inflation some measures exceeded HICP inflation in to a level which is generally considered to 1997 (see Table 2). be consistent with price stability. Looking at recent trends and forecasts, Looking back, consumer price inflation in current outturns for consumer price Italy, as measured on the basis of the CPI, inflation (measured as a percentage change has followed a broad downward trend over the corresponding month a year since the early 1990s (see Chart 1). Inflation earlier) have been broadly stable at around gradually declined from 6.4% in 1991 to 1‰% and there is little sign of immediate 3.9% in 1994. Following an interruption in upward pressure on the basis of the the downward movement in 1995, which measures shown in Table 3a. The most was partly due to the impact of increased recent forecast of inflation suggests a rate VAT rates, it has continued to fall at an of slightly below 2% for 1998 and of accelerated pace. This experience of around 2% for 1999 (see Table 3b). Risks disinflation reflects a number of important for price stability over this period may be policy choices. Most notably, monetary associated with higher administered prices policy has been geared towards the and increases in indirect taxes. achievement of price stability in the medium term, recently again within the framework Looking further ahead, maintaining an of the ERM. The reduction in inflation has environment conducive to price stability been supported by, inter alia, adjustments relates in Italy to, inter alia the conduct of in fiscal policy, enhanced product market fiscal policies over the medium to long competition and labour market reforms term; it will be equally important to such as the abolition of wage indexation. In strengthen national policies aimed at addition, the macroeconomic environment enhancing competition in product markets has contributed to containing upward and improving the functioning of labour pressure on prices. Notably, in the context markets against the background of the of the recession in 1993, a negative output current high rate of unemployment in Italy. gap emerged (see Table 2). The output gap persisted into 1997 as the recovery in economic activity in 1994-95 proved to be Fiscal developments short-lived. Against this background, growth in compensation per employee declined in In the reference year 1997 the general the mid-1990s, which helped to subdue government deficit ratio was 2.7%, i.e. increases in unit labour costs. Wage below the 3% reference value, and the increases were 5.0% over 1995-97 while debt ratio was 121.6%, i.e. far above the over the same period, unit labour costs 60% reference value. Compared with the rose by 3.3% per annum. Meanwhile, import previous year, the deficit ratio has been

153 reduced by 4.0 percentage points and the from the high levels of the early 1990s, and debt ratio by 2.4 percentage points. In in parallel the average maturity has increased 1998 the deficit ratio is forecast to decrease (see Table 5). This is a development in the to 2.5% of GDP, while the debt ratio is right direction. With regard to 1997, the projected to decline to 118.1%. In 1996 proportion of debt with a short-term and 1997 the deficit ratio exceeded the residual maturity is still high, and, taking ratio of public investment expenditure to into account the current level of the debt GDP by 4.4 percentage points and 0.3 ratio, fiscal balances are highly sensitive to percentage point respectively (see changes in interest rates. On the other Table 4). hand, the proportion of foreign currency debt in Italy is low and fiscal balances are Looking back over the years 1990 to 1997, relatively insensitive to changes in exchange the Italian debt-to-GDP ratio increased by rates. 23.6 percentage points; initially the ratio tended to rise steeply, from 98% in 1990 During the 1990s a pattern of continuously to reach 124.9% in 1994, whereas it improving outturns can be observed in the declined year by year thereafter, initially by deficit-to-GDP ratio, with a particularly strong around 0.5% per annum and by 2.4% in deficit reduction in 1997. Starting from a 1997 to reach 121.6% that year (see Chart ratio of 11.1% in 1990, the fiscal imbalance 2a), i.e. a decline of 3.3 percentage points was reduced to 9.2% of GDP in 1994; over three years. As is shown in greater since then, the deficit has declined faster to detail in Chart 2b, for most of the time up stand at 2.7% of GDP in 1997 (see Chart to 1994 growing primary surpluses were 3a). As is shown in greater detail in Chart not sufficient to outweigh the sizable debt- 3b, which focuses on changes in deficits, increasing effects of a negative growth/ cyclical factors tended to hinder the interest rate differential. In addition, a reduction in deficits in the first years of the number of stock-flow adjustments decade and in particular during 1993. contributed to debt growth in these years, Thereafter they have played a limited role. related to, inter alia, the depreciation of However, the non-cyclical improvements the Italian lira in 1992 and the issuance of could reflect a lasting, structural move Treasury bonds in 1993, as a result of a towards more balanced fiscal policies and/ sizable overfunding aimed at building up a or a variety of measures with temporary deposit of the Treasury at the Banca effects. Evidence available suggests that dItalia as a liquidity reserve in the context measures with a temporary effect reduced of the abolition of the Treasurys overdraft the deficit ratio in 1997, with an impact of facility at the central bank, effective in around 1% of GDP, and that they were 1994. After 1994 the primary surplus mostly of a one-off nature. Compensating increased further, and it outweighed the measures have already been included in debt-increasing effects of the the 1998 budget. Additional compensating macroeconomic environment. Moreover, measures will be required when the effects privatisation resulted in a positive stock- of self-reversing measures (amounting to flow adjustment. The patterns observed 0.3% of GDP in 1997) unwind in the during the early 1990s may be seen as future. indicative of the risks to public finances which can arise when macroeconomic Moving on to examine trends in other conditions deteriorate and the primary fiscal indicators, it can be seen from Chart surplus is insufficient to counterbalance 4 that the general government total such effects. In this context, it may be expenditure ratio rose by 3.3 percentage noted that the share of debt with a short- points between 1990 and 1993, in particular term residual maturity has been decreasing on account of increased interest payments

154 (+2.6 percentage points) and current at 1.8% of GDP and the debt ratio to transfers (see Table 6). After 1993 the decrease to 116.3%. The programme is ratio of total expenditure to GDP declined based on the previous medium-term by 6.3 percentage points, mainly reflecting financial plans of the Government dated a decline in interest payments (-2.6 May 1997, which accelerated the percentage points) and capital expenditure consolidation plans previously envisaged. but also due to reductions in current Compared with fiscal balances projected in transfers and public consumption. The the Convergence Programme for 1998- expenditure ratio in 1997 was 3 percentage 2000, further substantial consolidation points lower than at the beginning of the measures are required in order to comply 1990s, primarily due to a reduction in net with the medium-term objective of the capital expenditure and public consumption. Stability and Growth Pact, effective from Given this pattern, also when allowing for a 1999 onwards, of having a budgetary further substantial reduction in interest position that is close to balance or in payments on the basis of unchanged interest surplus. rates, a continuation of the downward trend of primary expenditure to GDP With regard to the future horizon for would appear to require further adjustments reducing the debt ratio to the 60% in expenditure items such as current reference value in countries with a debt transfers. Government revenue in relation to ratio of above 100% of GDP, two different GDP has tended to increase over the kinds of calculations are presented. On the 1990s and is now 5‰ percentage points assumption that fiscal balances and debt higher than in 1990; it may thereby have ratios as projected by the European approached a level which is detrimental to Commission for 1998 are achieved, the economic growth. first exercise, as detailed in Table 7, shows the fiscal balances which would be According to the Italian medium-term fiscal consistent with convergence of the debt policy strategy, as presented in the ratio to 60% of GDP over different time Convergence Programme for 1998-2000 horizons. As an illustration, focusing on the issued in June 1997, the declining trend in period of ten years, i.e. reducing the debt deficit and debt ratios is projected to ratio to 60% by 2007, would imply realising continue in 1998. The budget for 1998 from 1999 onwards an overall surplus of foresees somewhat more favourable 3.1% of GDP per year (see Table 7a) or outcomes than the Convergence realising from 1999 onwards a primary Programme. The reduction in the budget surplus of 8.4% of GDP per year (see deficit will mainly be achieved by Table 7b). This compares with an overall expenditure restraint. Tax revenue as a deficit ratio of 2.5% and a primary surplus percentage of GDP is projected to decline, ratio of 5.5% projected for 1998, i.e. the as the Government has decided not to difference is 5.6 and 2.9 percentage points fully compensate the expiring one-off respectively. revenue measures. Tax-increasing measures enacted with the budget include an increase A second exercise, as detailed in Chart 5, in the rates of value added tax and a shows that maintaining the 1998 overall widening of the bases for income taxes and fiscal balance of -2.5% of GDP over the social security contributions. Currently, subsequent years would only reduce the there is evidence of measures with a debt ratio to 103.4% in ten years; the 60% temporary effect in the 1998 budget reference value would never be reached as amounting to 0.3% of GDP. According to the debt ratio would cease to decline in the Convergence Programme, in the year the long term, to remain at around 67%. 2000 the deficit ratio is projected to stand Maintaining the 1998 primary surplus of

155 5.5% of GDP would reduce the debt-to- vulnerability of fiscal positions in GDP ratio to 88.8% in ten years; in this unfavourable circumstances, thus case, the 60% level would be reached in heightening the risk of a serious worsening 2015. Finally, realising balanced budgets of public finances. In addition, there are annually from 1999 onwards would bring future budgetary challenges to meet the debt ratio down to 84.0% in ten years; concerning budgetary procedures and the the 60% reference value would be reached implications of demographic changes. in 2016. As regards the first issue, new legislation Such calculations are based on the and changes in procedures have been normative assumption of a constant nominal introduced since December 1996 in order rate of interest of 6% (average real cost of to control cash payments and reduce the public debt outstanding of 4% and 2% deposits with the Treasury (conti di inflation) and the assumption of a constant tesoreria) of local authorities and other real GDP growth rate of 1.8%, as estimated public bodies. These deposits, which by the Commission for real trend GDP represent readily available cash balances, growth in 1998. Stock-flow adjustments declined from 7.1% of GDP at the end of are not taken into account. 1996 to 4.1% at the end of 1997, thus reducing risks for expenditure control. This On the alternative assumption of a 2.5% induced an increase in budget expenditure yearly rate of real GDP growth, a growth carryovers (residui passivi) from 7.0 to assumption more in line with that applied 8.7% of GDP. These amounts do not to most other EU countries, the overall represent resources which are freely surplus ratio and the primary surplus ratio available for expenditure, as state budget required to reach the 60% level in ten expenditure on a cash basis cannot exceed years would be 2.5% and 7.8% respectively. the limit set by Parliament to be consistent This means, respectively, a difference in with fiscal targets (for 1998 cash the overall balance ratio projected for authorisations amount to 32.3% of GDP). 1998 of 5.0 and to the primary surplus Tight control of expenditure nevertheless projected for 1998 of 2.3 percentage points. requires further action.

While these calculations are purely Regarding demographic changes, as is illustrative, and can by no means be seen as highlighted in Table 8, from around 2010 forecasts, they do provide an illustration of onwards a marked ageing of the population why consolidation efforts need to be all is expected and, in the context of an the more resolute and lasting the higher unfunded public pension system, public the initial stock of debt, in order to forcefully pension expenditure is projected to increase reduce the debt-to-GDP ratio to 60% or in terms of GDP, on the assumption that below within an appropriate period of policies regarding benefits continue time. unchanged. Alleviation of the overall burden of population ageing will only be feasible if Stressing the need for sustained con- public finances have created sufficient room solidation efforts over an extended period for manoeuvre before entering the period of time resulting in significant and persistent during which the demographic situation overall fiscal surpluses is indeed critical in worsens. the case of Italy, since the current high level of debt would otherwise impose a continuous burden on fiscal policy and the economy as a whole. As has been seen in the past, high levels of debt increase the

156 Exchange rate developments narrowed steadily. Since rejoining the ERM Italy has not devalued its currencys bilateral The Italian lira, which had participated in central rate against any other Member the ERM from its inception on 13 March States currency. 1979 until 17 September 1992, returned to the ERM on 25 November 1996, i.e. it In a longer-term context, when measured has participated in the ERM for around 15 in terms of real effective exchange rates, months of the two-year reference period current exchange rates of the Italian lira (from March 1996 to February 1998) prior against other ERM participating currencies to the examination by the EMI (see Table suggest that current levels are somewhat 9a). As mentioned above, Italian monetary below the average of the year 1987 but policy has been geared towards the primary generally close to historical average values objective of price stability, most recently (see Table 10). As regards other external again within the ERM. developments, Italy has recorded sizable and growing current account surpluses At the beginning of the reference period, since 1993, which have brought the before it rejoined the ERM, the lira initially countrys net external liability position near experienced a small and temporary setback to balance (see Table 11). It may also be in its strengthening trend, reaching a recalled that, according to the most recent maximum downward deviation of 7.6% data available, Italy has a ratio of foreign below its future central rate against one trade to GDP of 28% for exports and 24% ERM currency in March 1996. Thereafter, it for imports, and a share of intra-EU trade resumed its appreciation and tended of 55% for exports and 61% for imports. towards its later central parities, moving for most of the time within a narrow range (see Chart 6). Long-term interest rate developments

Since joining the ERM in November 1996 Over the reference period from February the lira, benefiting from sizable short-term 1997 to January 1998 long-term interest interest rate differentials vis--vis most rates in Italy were 6.7% on average, and partner currencies, has normally traded thus stood below the reference value for close to its central rates against other ERM the interest rate criterion of 7.8% set on currencies (see Chart 6 and Table 9a). On the basis of the three best-performing occasion the Italian lira traded outside a Member States in terms of price stability. range close to its central rates vis--vis While this was also the case for 1997 as a several partner currencies. The maximum whole, twelve-month average long-term upward and downward deviations from interest rates were above the reference central rates, on the basis of 10 business value in 1996 (see Table 12); they have day moving averages, were 2.5% and -3.0% been below the reference value since respectively, abstracting from the February 1997. autonomous upward trend of the Irish pound (see Table 9a). The episodes in Long-term interest rates were broadly which such deviations occurred were stable in the early 1990s, underwent a temporary, the relatively high degree of phase of volatility in 1993-94, and from exchange rate volatility vis--vis the mid-1995 onwards have been on a steeply Deutsche Mark recorded initially declined declining trend (see Chart 7a). In the early to low levels during the reference period 1990s Italian long-term interest rates did (see Table 9b) and short-term interest rate not converge systematically with those differentials against those EU countries prevailing in the EU countries with the with the lowest short-term interest rates lowest bond yields (see Chart 7b).

157 However, since early 1995 the process of the EMI. On the basis of the evidence convergence has accelerated, and the reviewed in the Report, in an ex post differential has now been virtually assessment, the lira has been broadly stable eliminated. The main factors underlying over the reference period as a whole. this trend were the significant decline and Within the ERM it has remained generally ultimate elimination of the inflation close to its unchanged central parities, differential against the EU countries with without the need for measures to support the lowest long-term interest rates and the the exchange rate. recent improvement in the countrys fiscal position. In addition, the recovery of the In 1997 Italy achieved a fiscal deficit ratio exchange rate of the Italian lira in late 1995 of 2.7% of GDP, i.e. below the reference and in the first half of 1996 as well as its value, and the outlook is for a further relative stability more recently in the context decrease to 2.5% in 1998. The debt-to- of the ERM also account for the narrowing GDP ratio is far above the 60% reference of the differential. These underlying value. After having reached a peak in 1994, developments were seen by markets as the ratio declined by 3.3 percentage points improving the prospects for participation to stand at 121.6% in 1997. The outlook is in Stage Three of EMU - an element which for a decline in the debt ratio to 118.1% of may in turn have played an independent GDP in 1998. Notwithstanding the efforts role in accelerating the narrowing of yield and the substantial progress made towards differentials, both directly and by further improving the current fiscal situation, there improving the prospects for price and must be an ongoing concern as to whether exchange rate stability. the ratio of government debt to GDP will be sufficiently diminishing and approaching the reference value at a satisfactory pace Concluding summary and whether sustainability of the fiscal position has been achieved; addressing this Over the reference period Italy has achieved issue will have to remain a key priority for a rate of HICP inflation of 1.8%, which is the Italian authorities. Significant and well below the reference value stipulated persistent overall fiscal surpluses are rapidly by the Treaty. The growth of unit labour needed to be able to forcefully reduce the costs picked up in 1996, before slowing to debt ratio to 60% of GDP within an 3.1% in 1997, and a general trend towards appropriate period of time. This compares low rates of inflation was also apparent in with a recorded fiscal deficit of 2.7% of terms of other relevant price indices. GDP in 1997 as well as the deficit forecast Looking ahead, there is little sign of for 1998 of 2.5%. The Stability and Growth immediate upward pressure on inflation; Pact also requires, as a medium-term the most recent forecast projects inflation objective, a budgetary position that is close to stand slightly below 2% in 1998 and to balance or in surplus. around 2% in 1999. The level of long-term interest rates was 6.7%, i.e. below the With regard to other factors, in 1996 and respective reference value. 1997 the deficit ratio exceeded the ratio of public investment to GDP, while Italy has The Italian lira has been participating in the recorded sizable and increasing current ERM for around 15 months, i.e. for less account surpluses which brought the net than two years prior to the examination by external liability position near to balance.

158 List of Tables and Charts*

ITALY

I Price developments Table 1 Italy: HICP inflation Chart 1 Italy: Price developments Table 2 Italy: Measures of inflation and related indicators Table 3 Italy: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Italy: General government financial position Chart 2 Italy: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Italy: General government gross debt - structural features Chart 3 Italy: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Italy: General government expenditure and receipts Table 6 Italy: General government budgetary position Table 7 Italy: Debt convergence calculations (a) On the basis of overall fiscal balances (b) On the basis of primary fiscal balances Chart 5 Italy: Potential future debt ratios under alternative assumptions for fiscal balance ratios (a) Real GDP growth rate: 1.8% (b) Real GDP growth rate: 2.5% Table 8 Italy: Projections of elderly dependency ratio

III Exchange rate developments Table 9 (a) Italy: Exchange rate stability (b) Key indicators of exchange rate pressure for the Italian lira Chart 6 Italian lira: Deviations from ERM bilateral central rates Table 10 Italian lira: Measures of the real effective exchange rate vis--vis ERM Member States Table 11 Italy: External developments

IV Long-term interest rate developments Table 12 Italy: Long-term interest rates Chart 7 (a) Italy: Long-term interest rate (b) Italy: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

159 1 Price developments

Table 1 Italy: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 4.0 1.9 1.8 1.8 1.9 1.8 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Italy: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

14

12

10

8

6

4

2

0

-2

-4 1990 19911992 1993 1994 1995 1996 1997

Source: National data.

160 Table 2 Italy: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 6.1 6.4 5.4 4.2 3.9 5.4 3.9 1.7 CPI excluding changes in net indirect taxes(b) 5.7 6.0 5.2 4.2 3.6 4.7 3.8 1.7 Private consumption deflator 6.3 6.9 5.6 5.1 4.6 5.7 4.4 2.2 GDP deflator 7.6 7.7 4.7 4.4 3.5 5.1 5.0 2.6 Producer prices 4.1 3.3 1.9 3.8 3.7 7.9 1.9 1.3 Related indicators Real GDP growth 2.2 1.1 0.6 -1.2 2.2 2.9 0.7 1.5 Output gap (p.pts) 2.5 1.9 0.7 -2.0 -1.5 -0.2 -1.2 -1.4 Unemployment rate (%)(c) 9.1 8.6 8.8 10.2 11.3 12.0 12.1 12.3 Unit labour costs, whole economy 9.3 8.5 3.7 1.4 -0.4 1.8 4.9 3.1 Compensation per employee, whole economy 10.7 8.7 5.8 3.7 2.9 4.8 5.5 4.6 Labour productivity, whole economy 1.3 0.2 2.0 2.3 3.4 2.9 0.6 1.5 Import price deflator -0.5 -0.3 1.1 11.6 5.1 12.2 -1.8 -0.1 Exchange rate appreciation(d) 2.6 -1.7 -3.1 -16.4 -4.6 -9.5 9.5 0.7 Broad monetary aggregate (M3H)(e) 6.9 5.7 2.8 3.0 3.5 -2.3 -0.7 9.9 Stock prices 0.7 -15.3 -16.8 18.5 24.7 -8.4 0.6 36.9 House prices ------

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Data prior to 1993 have been adjusted for breaks. (d) Nominal effective exchange rate against 25 industrialised countries. Note: A positive (negative) sign indicates an appreciation (depreciation). (e) National harmonised data.

Table 3 Italy: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.4 1.6 1.6 1.5 1.6 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 1.3 1.4 1.7 1.9 2.1 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 1.4 1.4 1.4 1.5 1.6

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 1.9 2.0 OECD (December 1997), private consumption deflator 2.4 2.2 IMF (October 1997), CPI 2.1 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

161 II Fiscal developments

Table 4 Italy: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -6.7 -2.7 -2.5 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -4.4 -0.3 . General government gross debt 124.0 121.6 118.1 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Italy: General government gross debt (as a percentage of GDP)

(a) Levels

130

120

110

100

90 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

15 10 5 0 -5 -10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

162 Table 5 Italy: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 98.0 101.5 108.7 119.1 124.9 124.2 124.0 121.6 Composition by currency (% of total) In domestic currency 94.0 94.3 93.9 93.0 93.0 92.7 93.4 93.1 In foreign currencies 6.0 5.7 6.1 7.0 7.0 7.3 6.6 6.9 Domestic ownership (% of total) 94.5 93.8 92.8 88.8 86.8 85.4 82.8 79.0 Average maturity(a) (years) 2.4 2.8 2.8 3.0 4.5 4.3 4.3 4.5 Composition by maturity(b) (% of total) Short-term (< 1 year) 67.3 66.9 65.0 60.6 51.7 51.0 51.5 49.4 Medium-term (1-5 years) 21.1 18.2 19.4 23.0 26.8 26.6 25.6 25.8 Long-term (> 5 years) 11.6 15.0 15.6 16.4 21.5 22.4 22.9 24.8

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Domestic debt only. (b) Residual maturity. The short-term component includes all floating rate securities, irrespective of their residual maturities.

Chart 3 Italy: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-4

-8

-12 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

5 4 3 2 1 0 -1 -2 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

163 Chart 4 Italy: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

60

50

40 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Italy: General government budgetary position (as a percentage of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 42.4 43.4 44.3 47.4 45.2 45.0 46.0 47.9 Taxes 25.1 25.6 25.9 28.2 26.7 26.5 27.0 28.1 Social security contributions 14.4 14.7 15.1 15.5 14.9 14.8 15.1 15.5 Other current receipts 2.9 3.1 3.3 3.7 3.7 3.8 3.9 4.3 Total expenditure 53.6 53.5 53.8 56.9 54.4 52.7 52.7 50.6 Current transfers 21.2 21.4 22.3 23.1 22.6 21.5 22.0 22.2 Actual interest payments 9.5 10.2 11.5 12.1 11.0 11.3 10.8 9.5 Public consumption 17.6 17.6 17.7 17.6 17.1 16.1 16.3 16.3 Net capital expenditure 5.3 4.4 2.4 4.1 3.7 3.8 3.5 2.5 Surplus (+) or deficit (-) -11.1 -10.1 -9.6 -9.5 -9.2 -7.7 -6.7 -2.7 Primary balance -1.7 0.1 1.9 2.6 1.8 3.7 4.1 6.8 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -6.8 -6.9 -5.5 -4.4 -0.3

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

164 Table 7 Italy: Debt convergence calculations

(a) On the basis of overall fiscal balances (as a percentage of GDP)

Total gross debt Overall fiscal balance Overall fiscal balance consistent with reduction (deficit: (-); surplus (+)) of debt level to 60% of GDP in 1997 1998 1997 1998 2002 2007 2012 121.6 118.1 -2.7 -2.5 11.0* 3.1* 0.9* 10.4** 2.5** 0.3**

Source: European Commission (spring 1998 forecasts) and EMI calculations. (*) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the overall fiscal balance for 1998 is as forecast and the overall fiscal balances were maintained at 11.0%, 3.1% and 0.9% of GDP respectively, from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 1.8% in 1998, as estimated by the Commission, and an inflation rate of 2%. Stock-flow adjustments are disregarded. (**) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the overall fiscal balance for 1998 is as forecast and the overall fiscal balances were maintained at 10.4%, 2.5% and 0.3% of GDP respectively, from 1999 onwards. The underlying assumptions are a real GDP growth rate of 2.5% and an inflation rate of 2%. Stock-flow adjustments are disregarded.

(b) On the basis of primary fiscal balances (as a percentage of GDP)

Total gross debt Primary fiscal balance Primary fiscal balance consistent with reduction of debt level to 60% of GDP in 1997 1998 1997 1998 2002 2007 2012 121.6 118.1 6.8 5.5 16.6* 8.4* 6.1* 15.9** 7.8** 5.5**

Source: European Commission (spring 1998 forecasts) and EMI calculations. (*) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the primary fiscal balance for 1998 is as forecast and the primary fiscal balances were maintained at 16.6%, 8.4% and 6.1% of GDP respectively, from 1999 onwards. The underlying assumptions are a real trend GDP growth rate of 1.8% in 1998, as estimated by the Commission, an inflation rate of 2% and a nominal interest rate of 6%. Stock-flow adjustments are disregarded. (**) Calculations indicate that the debt ratio would fall to 60% in 2002, 2007 and 2012 respectively, if the primary fiscal balance for 1998 is as forecast and the primary fiscal balances were maintained at 15.9%, 7.8% and 5.5% of GDP respectively, from 1999 onwards. The underlying assumptions are a real GDP growth rate of 2.5%, an inflation rate of 2% and a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

165 Chart 5 Italy: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

(a) Real GDP growth rate: 1.8%

Constant overall balance Constant primary balance Balanced budget

125

100

75

50 19981999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 118.1% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.5% of GDP or the primary balance of 5.5% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 1.8% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

(b) Real GDP growth rate: 2.5%

Constant overall balance Constant primary balance Balanced budget

125

100

75

50 19981999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 118.1% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.5% of GDP or the primary balance of 5.5% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real GDP growth rate of 2.5%; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 8 Italy: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 21.6 26.5 31.2 37.5 48.3 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

166 III Exchange rate developments

Table 9 (a) Italy: Exchange rate stability (25 November 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 25 November 1996 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 1.9 -1.1 Danish krone 1.7 -1.2 Deutsche Mark 1.8 -1.1 Spanish peseta 0.9 -1.3 French franc 2.5 -0.6 Irish pound -2.3 -10.1 Dutch guilder 1.7 -1.3 Austrian schilling 1.8 -1.1 Portuguese escudo 0.7 -3.0 Finnish markka 0.4 -2.9

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average.

(b) Key indicators of exchange rate pressure for the Italian lira

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 6.4 5.5 4.5 4.5 4.1 3.0 2.5 1.1 Short-term interest rate differentials(b) 6.0 5.3 4.7 4.1 3.8 3.6 3.1 2.5

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

167 Chart 6 Italian lira: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) ITL/BEF ITL/DKK ITL/DEM ITL/ESP ITL/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

ITL/IEP ITL/NLG ITL/ATS ITL/PTE ITL/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: The vertical line indicates when Italy rejoined the ERM (25 November 1996). Deviations prior to 25 November 1996 refer to the Italian liras bilateral central rates as established upon ERM re-entry.

Table 10 Italian lira: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -0.2 -4.5 -8.6 PPI/WPI-based -4.4 -3.2 -9.9 Memo item: Nominal effective exchange rate -36.1 -13.0 -25.2

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

168 Table 11 Italy: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -1.5 -2.1 -2.4 1.0 1.4 2.5 3.4 3.1 Net foreign assets (+) or liabilities (-)(c) -7.4 -8.6 -10.9 -9.4 -7.2 -4.8 -3.2 -0.5 Exports (goods and services)(d) 20.0 19.8 21.1 23.4 25.2 27.4 27.0 28.0 Imports (goods and services)(e) 20.0 20.4 21.8 20.1 21.1 22.3 21.6 23.6

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 55.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 60.8%; Direction of Trade Statistics Yearbook 1997, IMF.

169 IV Long-term interest rate developments

Table 12 Italy: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 9.4 6.9 6.1 5.7 5.4 6.7 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Italy: Long-term interest rate (monthly averages; in percentages)

15

10

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Italy: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points) Long-term interest rate differential CPI inflation differential

8

6

4

2

0

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

170 LUXEMBOURG

Price developments there is little sign of immediate upward pressure on the basis of the measures Over the reference period from February shown in Table 3a. Forecasts of inflation 1997 to January 1998 the average rate of suggest rates of between 1‰ and 2% for HICP inflation in Luxembourg was 1.4%, 1998 and 1999 (see Table 3b). Risks for i.e. well below the reference value of 2.7%. price stability over this period are associated This was also the case in 1997 as a whole. with capacity constraints and somewhat In 1996 average HICP inflation was 1.2% accelerating unit labour costs. (see Table 1). Seen over the past two years, HICP inflation in Luxembourg has Looking further ahead, a continuation of been at a level which is generally considered the long-standing economic and fiscal to be consistent with price stability. policies can be seen as being conducive to maintaining price stability. It will also be Looking back, consumer price inflation in important to sustain wage moderation, Luxembourg, as measured on the basis of ensuring that the rate of unemployment in the CPI, has followed a broad downward Luxembourg remains low. trend since the early 1990s (see Chart 1). This experience of declining rates of inflation reflects a number of important policy Fiscal developments choices, most notably an exchange rate policy which links the Luxembourg franc to In the reference year 1997 the general the Belgian franc in a monetary association. government budget balance showed a The general orientation has also been surplus of 1.7% of GDP, hence the 3% supported by prudent fiscal policies. The reference value for the deficit ratio was reduction in inflation during the 1990s has comfortably met. The debt ratio was 6.7%, been achieved within the context of a i.e. far below the 60% reference value. relatively buoyant macroeconomic Compared with the previous year, the environment, although growth decelerated fiscal surplus has decreased by 0.8 between 1993 and 1996 from around 9% percentage point, while the debt ratio has to 3% (see Table 2). Against this increased marginally. In 1998 the surplus is background, growth in compensation per forecast to decrease to 1.0% of GDP, while employee has been restrained in recent the debt ratio is projected to increase to years. In 1997 an acceleration took place. 7.1% (see Table 4). Reflecting the absence of significant effective exchange rate movements, import price Looking back over the years 1990 to 1997, increases in the 1990s have been subdued Luxembourgs debt-to-GDP ratio gradually or negative, thus contributing to the curbing increased by 2.0 percentage points (see of inflationary pressures. Low rates of Chart 2a). As is shown in greater detail in inflation are also apparent when it is Chart 2b, the typical pattern is that primary measured in terms of other relevant price surpluses partly compensated for the debt- indices (see Table 2). increasing effects resulting from the stock- flow adjustment item. In Luxembourg these Looking at recent trends and forecasts, adjustments are due to the fact that the current outturns for consumer price government sector is building up reserves inflation (measured as a percentage change for the pension scheme accumulated in over the corresponding month a year special funds, annual transfer payments to earlier) have been decreasing to 1‰% and which are not recorded in the general

171 government surplus. Owing to the low Exchange rate developments level of debt, practically no effect on the debt ratio during the 1990s is attributable As Luxembourg is in a monetary association to the growth and interest rate with Belgium, the development of the environment. In this context it may be Luxembourg franc is largely identical to noted that Luxembourgs general that of the Belgian franc. Therefore, the government gross debt is almost entirely following paragraph virtually restates the denominated in domestic currency and the text on exchange rate developments in the share of debt with a short-term residual chapter on Belgium. maturity is negligible (see Table 5). The Luxembourg franc has been During the 1990s a similarly sound pattern participating in the ERM since its inception has been observed in annual fiscal balances, on 13 March 1979, i.e. for much longer which have always been in surplus (see than two years prior to the examination Chart 3 and Table 6). However, the overall (see Table 8a). Focusing on the reference fiscal surplus decreased rapidly during the period from March 1996 to February 1998, early 1990s, dropping from 5.0% in 1990 the currency has normally traded close to to 0.8% in 1992. It broadly stabilised at its central rates against other ERM around 2% thereafter, to reach a level of currencies and very close to those vis--vis 1.7% in 1997. Against this background, a the Deutsche Mark, the Dutch guilder and closer examination of Luxembourgs the Austrian schilling (see Chart 4 and performance in terms of the deficit ratio is Table 8a). On occasion the Luxembourg not considered necessary. franc traded outside a range close to its central rates vis--vis several partner Luxembourgs medium-term fiscal policy currencies. The maximum upward and strategy aims at balancing government downward deviations from central rates, finances, thereby complying with the on the basis of 10 business day moving respective provision of the Stability and averages, were 2.5% and -3.0% respectively, Growth Pact, and linking expenditure to abstracting from the autonomous upward GDP growth, thus preventing an increase trend of the Irish pound (see Table 8a). in the public sectors expenditure ratio. The episodes in which such deviations occurred were temporary, the degree of With regard to the potential future course exchange rate volatility vis--vis the of the debt ratio, the EMIs Report does not Deutsche Mark was continuously very low consider this issue in detail for those (see Table 8b) and short-term interest rate countries with a debt ratio of below 60% differentials against those EU countries of GDP. As regards longer-term challenges with the lowest short-term interest rates to public finances, Luxembourg appears to were insignificant. During the reference be in a favourable position, notably by period Luxembourg has not devalued its having maintained low debt ratios. currencys bilateral central rate against any However, the longer-term fiscal position other Member States currency. might be challenged by developments in the pension system stemming from the Luxembourg has traditionally maintained marked ageing of the population, which is large current account surpluses (see Table expected to accelerate from around 2010 9). As regards other external developments, onwards (see Table 7). it may be recalled that Luxembourg is a small open economy with, according to the

172 most recent data available, a ratio of rates of inflation were also apparent in foreign trade to GDP of 95% for exports terms of other relevant price indices. and 86% for imports, and a share of intra- Looking ahead, there is little sign of EU trade of 70% for exports and 74% for immediate upward pressure on inflation; imports. forecasts project inflation will stand at 1‰- 2% in 1998 and 1999. The Luxembourg franc, which is in a monetary association Long-term interest rate developments with the Belgian franc, has been participating in the ERM for much longer than two Over the reference period from February years. Over the reference period it 1997 to January 1998 long-term interest remained broadly stable, generally close to rates in Luxembourg were 5.6% on average, its unchanged central parities without the and thus stood well below the reference need for measures to support the exchange value for the interest rate criterion of 7.8% rate. The level of long-term interest rates set on the basis of the three best-performing was 5.6%, i.e. well below the respective Member States in terms of price stability. reference value. This was also the case for 1997 as a whole, as well as for 1996 (see Table 10). Luxembourg achieved a general government surplus of 1.7% of GDP in Long-term interest rates have been on a 1997, thereby comfortably meeting the 3% broadly declining trend since the early reference value, and the outlook is for a 1990s (see Chart 5a). A close convergence surplus of 1.0% in 1998. In addition, the of Luxembourgs long-term interest rates fiscal debt ratio was virtually stable at 6.7% with those prevailing in the EU countries of GDP in 1997, i.e. remaining far below with the lowest bond yields has been the 60% reference value, and the outlook observed for most of the period since the is for an increase to 7.1% in 1998. With early 1990s (see Chart 5b). The main regard to the sustainability of fiscal factors underlying this trend were the developments, looking ahead, if current comparatively low rate of inflation and fiscal surpluses are maintained for 1998, sound fiscal policies. Luxembourg should comply with the medium-term objective of the Stability and Growth Pact, effective from 1999 onwards, Concluding summary of having a budgetary position that is close to balance or in surplus. Over the reference period Luxembourg has achieved a rate of HICP inflation of With regard to other factors, Luxembourg 1.4%, which is well below the reference has maintained large current account value stipulated by the Treaty. The increase surpluses. in unit labour costs was subdued and low

173 List of Tables and Charts*

LUXEMBOURG

I Price developments Table 1 Luxembourg: HICP inflation Chart 1 Luxembourg: Price developments Table 2 Luxembourg: Measures of inflation and related indicators Table 3 Luxembourg: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Luxembourg: General government financial position Chart 2 Luxembourg: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Luxembourg: General government gross debt - structural features Chart 3 Luxembourg: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Table 6 Luxembourg: General government budgetary position Table 7 Luxembourg: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Luxembourg: Exchange rate stability (b) Key indicators of exchange rate pressure for the Luxembourg franc Chart 4 Luxembourg franc: Deviations from ERM bilateral central rates Table 9 Luxembourg: External developments

IV Long-term interest rate developments Table 10 Luxembourg: Long-term interest rates Chart 5 (a) Luxembourg: Long-term interest rate (b) Luxembourg: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

174 1 Price developments

Table 1 Luxembourg: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.2 1.4 1.5 1.5 1.5 1.4 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Luxembourg: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

7 6 5 4 3 2 1 0 -1 -2 -3 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

175 Table 2 Luxembourg: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 3.7 3.1 3.2 3.6 2.2 1.9 1.4 1.4 CPI excluding changes in net indirect taxes(b) 3.7 3.1 3.1 2.9 2.1 1.8 1.4 1.4 Private consumption deflator 4.0 2.9 3.9 3.8 2.1 1.8 1.4 1.2 GDP deflator 3.4 1.3 5.1 0.5 4.9 1.8 1.1 1.7 Producer prices -2.0 -2.5 -2.1 -1.7 0.5 3.7 -3.1 1.2 Related indicators Real GDP growth 2.2 6.1 4.5 8.7 4.2 3.8 3.0 4.1 Output gap (p.pts) 1.0 1.5 0.4 3.6 2.7 1.7 0.1 -0.2 Unemployment rate (%) 1.3 1.4 1.6 2.1 2.7 3.0 3.3 3.6 Unit labour costs, whole economy 6.6 3.5 4.0 -2.2 1.4 2.2 0.7 1.1 Compensation per employee, whole economy 5.5 6.4 5.3 5.1 4.0 2.2 1.8 2.7 Labour productivity, whole economy -1.0 2.7 1.2 7.4 2.6 0.1 1.1 1.6 Import price deflator 2.5 1.9 0.0 -0.5 1.4 0.1 -0.9 0.9 Exchange rate appreciation(c) 1.7 0.3 0.6 -0.5 1.0 1.2 -0.7 -2.0 Broad monetary aggregate (M3H)(d) 25.1 2.1 10.5 13.6 -7.8 -1.3 1.3 4.9 Stock prices -15.7 3.3 -10.0 121.1 -9.1 0.6 30.0 24.7 House prices(e) 5.2 4.8 6.9 1.4 1.2 1.8 0.9 1.5

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 11 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data. (e) Construction prices for residential and semi-residential buildings.

Table 3 Luxembourg: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI=HICP) Annual percentage change 1.7 1.7 1.5 1.5 1.5 Change in the average of latest 3 months from previous 3 months, annualised rate(a) 1.4 1.6 1.9 2.0 1.7 Change in the average of latest 6 months from previous 6 months, annualised rate(a) 1.3 1.4 1.5 1.5 1.6

Source: European Commission. (a) HICP excluding seasonal items.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 1.6 1.7 OECD (December 1997), private consumption deflator 1.5 1.5 IMF (October 1997), CPI 2.0 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

176 II Fiscal developments

Table 4 Luxembourg: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) 2.5 1.7 1.0 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) 7.2 6.6 . General government gross debt 6.6 6.7 7.1 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Luxembourg: General government gross debt (as a percentage of GDP)

(a) Levels

7

6

5

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

4

2

0

-2

-4 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

177 Table 5 Luxembourg: General government gross debt - structural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 4.7 4.2 5.1 6.1 5.7 5.9 6.6 6.7 Composition by currency (% of total) In domestic currency 96.6 97.7 98.8 99.3 99.4 99.6 99.7 99.8 In foreign currencies 3.4 2.3 1.2 0.7 0.6 0.5 0.3 0.2 Domestic ownership (% of total) 92.0 93.2 95.6 85.2 84.9 84.5 85.4 85.1 Average maturity(a) (years) . . . . . 7.8 7.5 7.2 Composition by maturity(a) (% of total) Short-term(b) (< 1 year) 5.5 6.9 5.8 3.3 6.4 0.8 3.6 0.1 Medium-term (1-5 years) 63.0 66.6 53.8 30.7 15.0 8.3 1.4 10.1 Long-term (> 5 years) 31.4 26.5 40.5 66.1 78.7 90.9 95.0 89.9

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Central government debt only. (b) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Luxembourg: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

6 5 4 3 2 1 0 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

2 1 0 -1 -2 -3 -4 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

178 Table 6 Luxembourg: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts ...... 49.0 47.6 Taxes ...... 32.7 31.7 Social security contributions ...... 11.9 11.6 Other current receipts ...... 4.44.3 Total expenditure ...... 46.5 45.9 Current transfers ...... 27.3 26.7 Actual interest payments 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.3 Public consumption 13.4 13.3 13.1 12.9 12.5 13.2 13.6 13.3 Net capital expenditure ...... 5.35.5 Surplus (+) or deficit (-) 5.0 1.9 0.8 1.7 2.8 1.9 2.5 1.7 Primary balance 5.5 2.3 1.1 2.0 3.1 2.2 2.8 2.1 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . 7.0 7.2 6.5 7.2 6.6

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 Luxembourg: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 19.9 21.9 25.9 33.2 44.2 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

179 III Exchange rate developments

Table 8 (a) Luxembourg: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Danish krone 1.6 -0.3 Deutsche Mark 0.4 -0.1 Spanish peseta 0.2 -2.0 French franc 2.5 -0.3 Irish pound 4.2 -10.6 Italian lira 1.1 -1.9 Dutch guilder 0.1 -0.5 Austrian schilling 0.4 -0.1 Portuguese escudo 1.4 -2.7 Finnish markka -0.2 -3.0

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Luxembourg franc

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 0.2 0.2 0.2 0.3 0.1 0.1 0.2 0.1 Short-term interest rate differentials(b) -0.2 -0.2 -0.2 -0.1 0.0 0.2 0.2 0.0

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

180 Chart 4 Luxembourg franc: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) LUF/DKK LUF/DEM LUF/ESP LUF/FRF LUF/IEP

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

LUF/ITL LUF/NLG LUF/ATS LUF/PTE LUF/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Luxembourg: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 17.0 13.5 15.4 13.7 14.0 18.1 15.9 15.9 Net foreign assets (+) or liabilities (-)(c) ...... Exports (goods and services)(d) 97.9 98.4 98.7 93.3 93.4 94.0 93.3 95.3 Imports (goods and services)(e) 96.4 99.0 94.0 88.9 85.2 85.2 83.5 85.5

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in BLEU national exports of goods was 70.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in BLEU national imports of goods was 73.6%; Direction of Trade Statistics Yearbook 1997, IMF.

181 IV Long-term interest rate developments

Table 10 Luxembourg: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 6.3 5.6 5.6 5.4 5.2 5.6 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 5 (a) Luxembourg: Long-term interest rate (monthly averages; in percentages)

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Luxembourg: Long-term interest rate and CPI inflation differentialsagainst EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

2

1

0

-1

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

182 NETHERLANDS

Price developments pattern of generally low rates of inflation is also apparent when it is measured in Over the reference period from February terms of other relevant price indices (see 1997 to January 1998 the average rate of Table 2). HICP inflation in the Netherlands was 1.8%, i.e. well below the reference value of Looking at recent trends and forecasts, 2.7%. This was also the case in 1997 as a current outturns for consumer price whole. In 1996 average HICP inflation was inflation (measured as a percentage change 1.4% (see Table 1). Seen over the past two over the corresponding month a year years, HICP inflation in the Netherlands earlier) have been decreasing to below 2% has tended to increase while remaining at but there are some signs of immediate levels which are generally considered to be upward pressure on the basis of the consistent with price stability. measures shown in Table 3a. Forecasts of inflation suggest rates of around 2‰% for Looking back, consumer price inflation in 1998 and 1999 (see Table 3b). The risks the Netherlands, as measured on the basis for price stability over this period are of the CPI, peaked at 3.2% in 1992 before associated with tight labour market declining to 1.9% in 1995. Since then, conditions and a narrowing of the output inflation has tended to increase slightly gap. (see Chart 1). The environment of generally moderate rates of inflation reflects the Looking further ahead, maintaining an ongoing pursuit of stability-oriented policies. environment conducive to price stability In particular, monetary policy has continued relates in the Netherlands to, inter alia, the to be geared towards price stability, conduct of fiscal policies over the medium underpinned by the objective of maintaining to long term; it will be equally important to a stable exchange rate of the Dutch guilder maintain national policies aimed at vis--vis the Deutsche Mark within the enhancing competition in product markets framework of the ERM. This has been and improving the functioning of labour supported by, inter alia, policies seeking to markets. encourage wage moderation and fiscal consolidation. In addition, the macroeconomic environment has Fiscal developments contributed to containing upward pressure on prices, with a negative output gap In the reference year 1997 the general emerging in 1993 (see Table 2). More government deficit ratio was 1.4%, i.e. well recently, real GDP growth has accelerated below the 3% reference value, and the and the output gap has narrowed. However, debt ratio was 72.1%, i.e. above the 60% despite a tightening of labour market reference value. Compared with the conditions, wage growth has remained previous year, the deficit ratio has been moderate, notwithstanding a slight reduced by 0.9 percentage point and the acceleration in 1997, and increases in unit debt ratio has decreased by 5.1 percentage labour costs have been low. Import price points. In 1998 the deficit ratio is forecast rises have been subdued throughout most to increase to 1.6% of GDP, while the debt of the 1990s, thereby facilitating control ratio is projected to decline to 70.0%. In over inflation. In 1997 upward pressure on 1996 and 1997 the deficit ratio did not consumer prices increased, not least as a exceed the ratio of public investment result of a rise in import prices. This expenditure to GDP (see Table 4).

183 Looking back over the years 1990 to 1997, During the 1990s a broadly flat trend up to the Dutch debt-to-GDP ratio declined by 1995 and subsequently improving outturns 7.1 percentage points. Whereas the debt can be observed in the deficit-to-GDP ratio. ratio increased from 79.2% in 1990 to Starting from a ratio of 5.1% in 1990, the 81.2% in 1993, a downward movement deficit fluctuated between 2.9% and 4.0% was discernible thereafter, and in 1997 the during the period up to 1995; thereafter debt ratio stood at 72.1% (see Chart 2a), the deficit fell to 2.3% in 1996 and 1.4% in i.e. a decline of 9.1 percentage points over 1997 (see Chart 3a). The improvement in four years. As is shown in greater detail in the deficit ratio has been modest taking Chart 2b, the primary surplus was not into account the favourable macroeconomic sufficiently high for most of the period up environment. As is shown in greater detail to 1995 to outweigh the debt-increasing in Chart 3b, which focuses on changes in effects of a negative growth/interest rate deficits, cyclical factors did not play a large differential. Various financial operations, role (with the exception of 1993). However, summarised under the heading of stock- the non-cyclical improvements could reflect flow adjustments, occasionally affected the a lasting, structural move towards more debt dynamics. These exceptional factors balanced fiscal policies and/or a variety of were mostly rather small, but two measures with temporary effects. Evidence exceptional items exerted a major available suggests that measures with a downward influence. The first, in 1994, temporary effect played a deficit-reducing related to a financial reform in the social role in 1996, amounting to 0.6% of GDP, housing sector, and the second, in 1997, but did not play a role in 1997. occurred when the Treasury moved to a nearly balanced position at De Moving on to examine trends in other fiscal Nederlandsche Bank and used the earlier indicators, it can be seen from Chart 4 that surplus to pay off debt. In 1996 and 1997 the general government total expenditure the macroeconomic environment became ratio rose steadily between 1990 and 1993, more favourable: GDP growth mainly reflecting an increase in current strengthened, average interest rates transfers (see Table 6) in the context of the declined marginally, and primary surpluses slowdown in the economy and higher increased, thereby contributing to a falling unemployment. After 1993 the ratio declined. debt ratio. The patterns observed in the Against the background of the economic early 1990s may be seen as indicative of recovery and falling unemployment, current the upward pressure on the debt ratio transfers declined substantially as a percentage which can arise when the primary surplus is of GDP, as did all other categories of not sufficiently high to offset the effects of expenditure. On balance, the expenditure adverse economic conditions. In this ratio in 1997 was nearly 5 percentage points context, it may be noted that the share of lower than in 1990, reflecting a downward debt with a short-term residual maturity movement in all major items of government has been low (though increasing) during spending. The continuation of such a the 1990s, and the average maturity has downward trend would seem to require the remained broadly stable in the period main emphasis to be placed on current considered (see Table 5). Also taking into transfers and public consumption. Government account the current level of the debt ratio, revenue in relation to GDP also tended to fiscal balances are relatively insensitive to increase sharply until 1993, but thereafter changes in interest rates. In addition, the declined to levels below those observed at proportion of foreign currency debt is the beginning of the 1990s before negligible, rendering fiscal balances experiencing a small increase in 1997. It may insensitive to changes in exchange rates. be at a level which is detrimental to economic growth.

184 According to the Dutch medium-term fiscal real trend GDP growth in 1998. Stock-flow policy strategy, as presented in the adjustments are not taken into account. Convergence Programme for 1995-98 While such calculations are purely updated in December 1996, a declining or illustrative, and can by no means be stabilising trend in the deficit ratio and a regarded as forecasts, they provide an declining trend in the debt ratio are illustration of the need for further substantial projected for 1998. The outcome for the progress in consolidation in order to bring debt ratio in 1997 reflects a better the debt ratio in the Netherlands down to performance than was envisaged in the 60% of GDP or below within an appropriate original programme for 1998. Against the period of time. background of stronger economic growth than foreseen, the budget for 1998 shows Stressing the need for considerable a larger reduction in the deficit ratio than improvement in the deficit ratio and to planned in the programme. Currently, there sustain consolidation over time is indeed is no evidence of significant measures with appropriate in the case of the Netherlands. a temporary effect in the 1998 budget. As has been seen in the past, less favourable While the current programme does not economic conditions than those currently contain projections beyond 1998, the Dutch prevailing tend to imply an increase in the authorities have committed themselves to debt ratio. In addition, as is highlighted in complying with the medium-term objective Table 7, from around 2010 onwards a of the Stability and Growth Pact, effective marked ageing of the population is from 1999 onwards, of having a budgetary expected. While the Netherlands benefits position that is close to balance or in from a sizable funded occupational pension surplus, which entails a need for further system covering most private and public substantial fiscal consolidation compared sector employees, unfunded social security with projections for 1998. pensions remain substantial and public pension expenditure is projected to increase With regard to the future horizon for in terms of GDP if policies regarding reducing the debt ratio to the 60% benefits continue unchanged. In this respect, reference value for countries with a debt current efforts to build up a reserve fund ratio of clearly above 60% but below 80% over time should further strengthen the of GDP, the EMI presents calculations, as system. Alleviation of the overall burden of detailed in Chart 5. On the assumption population ageing will be facilitated if public that overall fiscal positions and debt ratios finances have created sufficient room for as projected by the European Commission manoeuvre before entering the period for 1998 are achieved, realising a balanced during which the demographic situation budget from 1999 onwards would reduce worsens. the debt ratio to below 60% of GDP in 2002. This would also be achieved by maintaining the 1998 primary surplus of Exchange rate developments 3.3% of GDP but debt reduction would be slower. Instead, maintaining the 1998 overall The Dutch guilder has been participating in deficit of 1.6% of GDP would prolong the the ERM since its inception on 13 March process to 2005. Such calculations are 1979, i.e. for much longer than two years based on the normative assumption of a prior to the examination (see Table 8a). As constant nominal rate of interest of 6% mentioned above, Dutch monetary policy (average real cost of public debt outstanding has been geared towards price stability, of 4% and 2% inflation) and the assumption underpinned by the objective of maintaining of a constant real GDP growth rate of a stable exchange rate of the guilder to the 3.1%, as estimated by the Commission for Deutsche Mark within the framework of

185 the ERM. The Netherlands and Germany Long-term interest rate developments have an agreement whereby the fluctuation margin between the guilder and the Over the reference period from February Deutsche Mark is set at – 2.25%. Focusing 1997 to January 1998 long-term interest on the reference period from March 1996 rates in the Netherlands were 5.5% on to February 1998, the currency has normally average, and thus stood well below the traded close to its central rates against reference value for the interest rate criterion other ERM currencies and very close to of 7.8% set on the basis of the three best- those vis--vis the Belgian franc, the performing Member States in terms of Deutsche Mark and the Austrian schilling price stability. This was also the case for (see Chart 6 and Table 8a). On occasion 1997 as a whole, as well as for 1996 (see the Dutch guilder traded outside a range Table 11). close to its central rates vis--vis several partner currencies. The maximum upward Long-term interest rates have been on a and downward deviations from central broadly declining trend since the early rates, on the basis of 10 business day 1990s (see Chart 7a). A close convergence moving averages, were 2.8% and -2.8% of Dutch long-term interest rates with respectively, abstracting from the those prevailing in the EU countries with autonomous upward trend of the Irish the lowest bond yields has been observed pound (see Table 8a). The episodes in for most of the period since the beginning which such deviations occurred were of the 1990s; in the more recent period temporary, the degree of exchange rate the (typically negative) differential has been volatility vis--vis the Deutsche Mark was close to zero (see Chart 7b). The main continuously very low (see Table 8b) and factors underlying this trend were the short-term interest rate differentials against comparatively low rate of inflation, the those EU countries with the lowest short- stability of the Dutch guilders exchange term interest rates were insignificant. During rate, the pursuit of a similar monetary the reference period the Netherlands has policy stance to that followed in the above- not devalued its currencys bilateral central mentioned countries and the improvement rate against any other Member States in the fiscal position. The more recent currency. moderate increase in inflationary pressures has apparently not had a significant influence In a longer-term context, measures of the on the financial markets general outlook real effective exchange rate of the Dutch on the Netherlands. guilder vis--vis the currencies of ERM participating Member States depicted in Table 9 suggest that current levels are Concluding summary close to historical values. As regards other external developments, the Netherlands Over the reference period the Netherlands has maintained large current account has achieved a rate of HICP inflation of surpluses and a sizable net external asset 1.8% which is well below the reference position (see Table 10). It may also be value stipulated by the Treaty. The increase recalled that the Netherlands is a small in unit labour costs was subdued and open economy with, according to the most generally low rates of inflation were also recent data available, a ratio of foreign apparent in terms of other relevant price trade to GDP of 63% for exports and 56% indices. Looking ahead, there are some for imports, and a share of intra-EU trade signs of immediate upward pressure on of 78% for exports and 60% for imports. inflation; forecasts project inflation will rise to around 2‰% in 1998 and 1999. The Dutch guilder has been participating in the

186 ERM for much longer than two years. Over debt ratio down to 60% of GDP within an the reference period it remained broadly appropriate period of time, thus pointing stable, generally close to its unchanged to the need for further substantial progress central parities, without the need for in consolidation. The Stability and Growth measures to support the exchange rate. Pact also requires as a medium-term The level of long-term interest rates was objective a budgetary position that is close 5.5%, i.e. well below the respective to balance or in surplus. Given the current reference value. debt ratio of above 70% of GDP, achieving the fiscal position forecast for 1998 and In 1997 the Netherlands achieved a fiscal realising a balanced budget thereafter would deficit ratio of 1.4% of GDP, i.e. well below reduce the debt ratio to below 60% in the reference value, and the outlook is for 2002. an increase to 1.6% in 1998. The debt-to- GDP ratio is above the 60% reference With regard to other factors, in 1996 and value. After having reached a peak in 1993, 1997 the deficit ratio did not exceed the the ratio declined by 9.1 percentage points ratio of public investment to GDP, and the to stand at 72.1% in 1997. Regarding the Netherlands maintained large current sustainability of fiscal developments,,, the account surpluses as well as a net external outlook is for a decrease in the debt ratio asset position. In the context of the ageing to 70.0% of GDP in 1998. Looking further of the population, the Netherlands benefits ahead, keeping the deficit ratio at current from a sizable funded occupational pension levels would not be sufficient to bring the system.

187 List of Tables and Charts*

NETHERLANDS

I Price developments Table 1 Netherlands: HICP inflation Chart 1 Netherlands: Price developments Table 2 Netherlands: Measures of inflation and related indicators Table 3 Netherlands: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Netherlands: General government financial position Chart 2 Netherlands: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Netherlands: General government gross debt - structural features Chart 3 Netherlands: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Netherlands: General government expenditure and receipts Table 6 Netherlands: General government budgetary position Chart 5 Netherlands: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 7 Netherlands: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Netherlands: Exchange rate stability (b) Key indicators of exchange rate pressure for the Dutch guilder Chart 6 Dutch guilder: Deviations from ERM bilateral central rates Table 9 Dutch guilder: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Netherlands: External developments

IV Long-term interest rate developments Table 11 Netherlands: Long-term interest rates Chart 7 (a) Netherlands: Long-term interest rate (b) Netherlands: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

188 1 Price developments

Table 1 Netherlands: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.4 1.9 2.5 2.2 1.6 1.8 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Netherlands: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

5

4

3

2

1

0

-1

-2

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

189 Table 2 Netherlands: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 2.4 3.1 3.2 2.6 2.8 1.9 2.0 2.2 CPI excluding changes in net indirect taxes(b) 2.1 2.6 2.6 2.4 2.4 1.8 1.5 2.2 Private consumption deflator 2.2 3.2 3.1 2.1 2.8 1.5 1.3 1.8 GDP deflator 2.4 2.7 2.2 2.0 2.2 1.7 1.3 1.7 Producer prices -0.6 1.5 0.4 -1.0 0.7 2.6 1.7 1.9 Related indicators Real GDP growth 4.1 2.3 2.0 0.8 3.2 2.3 3.3 3.3 Output gap (p.pts) 2.2 1.8 1.1 -0.8 -0.4 -1.0 -0.7 -0.4 Unemployment rate (%) 6.0 5.4 5.3 6.4 7.5 7.0 6.6 5.9 Unit labour costs, whole economy 1.7 3.9 3.1 2.2 -1.3 1.2 0.2 0.1 Compensation per employee, whole economy 2.8 3.8 4.0 3.0 1.5 1.6 1.3 2.5 Labour productivity, whole economy 1.0 -0.1 0.9 0.8 2.8 0.4 1.1 2.4 Import price deflator -1.3 0.4 -1.4 -2.3 0.1 0.9 0.7 3.2 Exchange rate appreciation(c) 4.0 -0.8 2.3 2.8 0.3 4.2 -1.9 -4.5 Broad monetary aggregate (M3H)(d) 9.9 6.0 6.4 6.7 4.4 0.7 6.1 7.0 Stock prices -10.0 2.3 8.4 14.3 22.3 6.7 26.8 49.4 House prices 2.0 2.6 8.3 8.3 8.7 3.6 10.3 6.8

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. Unit labour costs, compensation per employee and labour productivity: market economy. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Netherlands: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 2.4 2.3 2.5 2.3 1.8 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 2.3 2.3 3.2 3.3 2.0 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 2.1 2.2 2.2 2.5 2.5

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 2.3 2.5 OECD (December 1997), private consumption deflator 2.3 2.4 IMF (October 1997), CPI 2.3 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

190 II Fiscal developments

Table 4 Netherlands: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -2.3 -1.4 -1.6 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) 0.4 1.4 . General government gross debt 77.2 72.1 70.0 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Netherlands: General government gross debt (as a percentage of GDP)

(a) Levels

85

80

75

70 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors

Primary balance Growth / interest rate differential Stock-flow adjustment Total change

5

0

-5

-10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

191 Table 5 Netherlands: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 79.2 79.0 80.0 81.2 77.9 79.1 77.2 72.1 Composition by currency (% of total) In domestic currency 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 In foreign currencies 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Domestic ownership (% of total) 86.0 83.8 80.3 77.8 83.1 80.0 82.3 . Average maturity(a) (years) . 5.6 6.3 6.8 6.9 6.9 6.4 5.5 Composition by maturity(a) (% of total) Short-term(b) (< 1 year) . . 3.7 8.5 7.3 3.7 1.3 6.7 Medium-term (1-5 years) . . 32.1 23.6 27.9 31.7 30.6 30.3 Long-term (> 5 years) . . 64.1 67.9 64.9 64.6 68.1 63.0

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Central government debt only. (b) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Netherlands: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0 -1 -2 -3 -4 -5 -6 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

3

2

1

0

-1

-2 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

192 Chart 4 Netherlands: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

60

55

50

45 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Netherlands: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 50.2 52.8 52.5 53.3 50.6 49.0 48.7 49.2 Taxes 28.0 29.4 28.8 29.8 27.1 26.0 26.8 26.8 Social security contributions 17.1 18.0 18.6 18.6 19.2 19.1 18.1 18.9 Other current receipts 5.1 5.4 5.0 4.8 4.2 3.9 3.8 3.5 Total expenditure 55.3 55.7 56.4 56.5 54.4 53.0 51.0 50.5 Current transfers 31.2 31.8 32.3 32.4 31.2 29.7 28.9 28.7 Actual interest payments 6.0 6.2 6.3 6.3 5.9 6.0 5.6 5.3 Public consumption 14.6 14.5 14.7 14.9 14.5 14.4 14.1 14.1 Net capital expenditure 3.5 3.2 3.0 2.9 2.8 2.9 2.3 2.4 Surplus (+) or deficit (-) -5.1 -2.9 -3.9 -3.2 -3.8 -4.0 -2.3 -1.4 Primary balance 0.9 3.3 2.4 3.0 2.1 2.0 3.3 3.9 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -0.5 -1.1 -1.3 0.4 1.4

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

193 Chart 5 Netherlands: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

70

65

60

55 1998 1999 2000 2001 2002

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 70.0% of GDP for 1998 is as forecast and that the 1998 overall balance of -1.6% of GDP or the primary balance of 3.3% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 3.1% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 7 Netherlands: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 19.1 20.8 24.2 33.9 45.1 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

194 III Exchange rate developments

Table 8 (a) Netherlands: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 13 March 1979 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 0.5 -0.1 Danish krone 2.0 -0.3 Deutsche Mark 0.8 -0.0 Spanish peseta 0.5 -1.7 French franc 2.8 -0.3 Irish pound 4.6 -10.5 Italian lira 1.3 -1.7 Austrian schilling 0.8 -0.0 Portuguese escudo 1.8 -2.5 Finnish markka -0.2 -2.8

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Dutch guilder

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 0.5 0.5 0.3 0.3 0.4 0.3 0.2 0.1 Short-term interest rate differentials(b) -0.6 -0.5 -0.4 -0.2 -0.1 0.0 0.0 -0.1

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

195 Chart 6 Dutch guilder: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) NLG/BEF NLG/DKK NLG/DEM NLG/ESP NLG/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

NLG/IEP NLG/ITL NLG/ATS NLG/PTE NLG/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Dutch guilder: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -3.1 -0.3 -3.2 PPI/WPI-based 3.9 2.5 3.2 Memo item: Nominal effective exchange rate 11.9 1.8 4.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

196 Table 10 Netherlands: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 3.2 2.6 2.3 4.4 5.3 5.9 5.2 7.3 Net foreign assets (+) or liabilities (-)(c) 20.9 20.9 17.7 19.8 16.9 13.4 . . Exports (goods and services)(d) 54.2 55.4 55.9 56.3 58.2 60.9 61.7 63.2 Imports (goods and services)(e) 49.5 50.4 50.4 49.0 50.7 53.1 54.2 55.7

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 78.1%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 60.0%; Direction of Trade Statistics Yearbook 1997, IMF.

197 IV Long-term interest rate developments

Table 11 Netherlands: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 6.2 5.6 5.5 5.3 5.1 5.5 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Netherlands: Long-term interest rate (monthly averages; in percentage)

10

9

8

7

6

5

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Netherlands: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

2

1

0

-1

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

198 AUSTRIA

Price developments

Over the reference period from February Looking at recent trends and forecasts, 1997 to January 1998 the average rate of current outturns for consumer price HICP inflation in Austria was 1.1%, i.e. well inflation (measured as a percentage change below the reference value of 2.7%. This over the corresponding month a year was also the case in 1997 as a whole. In earlier) indicate that monthly rates of 1996 average HICP inflation was 1.8% (see inflation have been stable at around 1% Table 1). Seen over the past two years, but there are some signs of upward pressure HICP inflation in Austria has been at levels on the basis of the measures shown in which are generally considered to be Table 3a. Forecasts of inflation suggest consistent with price stability. rates of around 1‰% for 1998 and 1999 (see Table 3b). Looking back, consumer price inflation in Austria, as measured on the basis of the Looking further ahead, maintaining an CPI, has followed a downward trend after environment conducive to price stability 1992 (see Chart 1). Inflation peaked at relates in Austria to, inter alia, the conduct 4.1% in 1992 before declining in subsequent of fiscal policies over the medium to long years. This experience of declining rates of term; it will be equally important to inflation reflects the pursuit of policies strengthen policies aimed at enhancing geared towards price stability. Monetary competition in product markets and policy has continued to be determined by improving the functioning of labour markets. the objective of closely linking the Austrian schilling to the Deutsche Mark, since January 1995 within the framework of the ERM. Fiscal developments This general orientation has also been supported by policies seeking to encourage In the reference year 1997 the general wage moderation, increased foreign price government deficit ratio was 2.5%, i.e. competition following Austrias accession below the 3% reference value, and the to the EU in 1995 and consolidation efforts debt ratio was 66.1%, i.e. above the 60% of fiscal policy. In addition, the reference value. Compared with the macroeconomic environment has previous year, the deficit ratio has been contributed to containing upward pressure reduced by 1.5 percentage points and the on prices. In particular, in the context of debt ratio has decreased by 3.4 percentage the slowdown in economic activity in 1992- points. In 1998 the deficit ratio is forecast 93 and only modest GDP growth since to decline to 2.3% of GDP, while the debt then, a negative output gap has gradually ratio is projected to decrease to 64.7%. In emerged (see Table 2). Against this 1996 the deficit ratio exceeded the ratio of background, growth in compensation per public investment expenditure to GDP, employee has been restrained, and the while in 1997 the deficit ratio is expected increase in nominal unit labour costs has to be virtually identical to the investment been subdued since 1994. Broadly stable ratio (see Table 4). import price rises have helped to contain inflationary pressures. Low rates of inflation Looking back over the years 1990 to 1997, are also apparent when it is measured in the Austrian debt-to-GDP ratio increased by terms of other relevant price indices (see 8.2 percentage points. Until 1992 the debt Table 2). ratio had remained stable at around 58%,

199 while the ratio increased year by year past two years, with the ratio being reduced thereafter to reach 69.5% in 1996 before to 2.5% in 1997 (see Chart 3a). As is declining to 66.1% in 1997 (see Chart 2a), shown in greater detail in Chart 3b, which i.e. a decline of 3.4 percentage points in focuses on changes in deficits, cyclical factors one year. As shown in greater detail in contributed to the sharp increase in deficit Chart 2b, in 1991-92 primary surpluses in 1993, reflecting the fading of the boom were sufficiently high to compensate for of the preceding years, but played less of a the upward pressure exerted on the debt role thereafter. Instead, pronounced ratio by other factors. However, in changes in overall deficits were mainly subsequent years the primary surplus attributable to the remaining non-cyclical disappeared, and a negative growth/interest factors, both as deficits increased and, rate differential, as well as several stock- more recently, in the context of deficit flow adjustment items, caused the debt reduction. However, these non-cyclical ratio to increase. Only in 1997 could this improvements could reflect a lasting, trend be reversed, largely as a result of structural move towards more balanced privatisation receipts, sales of financial claims fiscal policies and/or a variety of measures and the reclassification of certain public with temporary effects. Evidence available companies to the private sector (see the suggests that measures with a temporary stock-flow adjustment items). The patterns effect reduced the deficit by 0.5% of GDP observed thus far during the 1990s may be in 1997, compared with 0.2% of GDP in seen as indicative of the risks to the debt 1996. As the measures in 1997 were partly ratio which can arise when there is an self-reversing, compensating measures unfavourable growth/interest rate already included in the 1998 budget will differential and the primary surplus is not need to yield their expected results in sufficiently high to compensate for the 1998 in order to keep fiscal balances on effects on debt resulting from the the planned path and, in addition, macroeconomic environment. In this compensating measures will be required context, it may be noted that the share of when the self-reversing effects unwind in debt with a short-term residual maturity is the future. noticeable and that the average maturity has tended to decrease (see Table 5). Moving on to examine trends in other With regard to 1997, taking into account fiscal indicators, it can be seen from Chart the current level of the debt ratio, fiscal 4 that the general government total balances are relatively insensitive to changes expenditure ratio rose sharply between in interest rates. On the other hand, the 1990 and 1995. The increase was mainly proportion of foreign currency debt is caused by a surge in current transfers and relatively high and fiscal balances are in public consumption as a percentage of principle relatively sensitive to changes in GDP (see Table 6). Thereafter, the exchange rates, although the bulk of this expenditure ratio declined as a result of debt may eventually be redenominated in reductions in all expenditure items relative euro. to GDP. On balance, the expenditure ratio in 1997 was 3.0 percentage points higher During the 1990s a pattern of first stable, than in 1990 on account of higher current then deteriorating and subsequently transfers and public consumption. Given improving outturns can be observed in the this pattern, a continuation of the recent deficit-to-GDP ratio. Starting from a ratio of downward movement in the expenditure 2.4% in 1990, the deficit first improved to ratio and the achievement of levels similar 2.0% in 1992; it deteriorated thereafter, to or below those of the early 1990s reaching a peak of 5.2% of GDP in 1995. would appear to require additional Finally, an improvement took place in the adjustments in terms of both public transfers

200 and consumption. After 1994 government and 1.7% of GDP constant in subsequent revenue in relation to GDP increased and years would imply a slower path of debt the revenue ratio in 1997 was 3.0 reduction and would generate a debt ratio percentage points higher than in 1990; it of below 60% in 2010 and 2004 may thus have approached a level which is respectively. Such calculations are based detrimental to economic growth. on the normative assumption of a constant nominal rate of interest of 6% (average real According to the Austrian medium-term cost of public debt outstanding of 4% and fiscal policy strategy, as presented in the 2% inflation) and the assumption of a Convergence Programme for 1997-2000 constant real GDP growth rate of 2.5%, as updated in October 1997, the general estimated by the Commission for real government financial deficit and debt ratios trend GDP growth in 1998. Stock-flow are expected to decline in 1998. The adjustments are not taken into account. budget for 1998 is in line with the While such calculations are purely illustrative programme and Commission forecasts are and can by no means be regarded as slightly more favourable. The budget forecasts, they provide an illustration of includes plans for fiscal measures promoting the need for further substantial progress in employment without increasing tax rates consolidation in order to bring the debt or non-wage labour costs. Currently, there ratio in Austria down to 60% of GDP or is no evidence of significant measures with below within an appropriate period of a temporary effect in the 1998 budget. time. According to current plans, in the year 2000 the overall deficit ratio is planned to Stressing the need for considerable stand at just below 2% and the debt ratio improvement in the deficit ratio and to to be just below 65% of GDP. This implies sustain consolidation over time is indeed a somewhat faster improvement in public warranted in the case of Austria, since sector finances than envisaged in the additional room for manoeuvre is necessary previous programme. Compared with fiscal in order to be able to address future balances projected in the Convergence budgetary challenges. As is highlighted in Programme for 1999-2000, further Table 7, from around 2010 onwards a substantial consolidation is needed in order marked ageing of the population is expected to comply with the medium-term objective and, in the context of an unfunded pension of the Stability and Growth Pact, effective system, public pension expenditure is from 1999 onwards, of having a budgetary forecast to increase in terms of GDP, position that is close to balance or in particularly if policies regarding benefits surplus. continue unchanged. The overall burden of population ageing will become more With regard to the future horizon for manageable the better the state of public reducing the debt ratio to the 60% finances when the demographic situation reference value for countries with a debt worsens. ratio of clearly above 60% but below 80% of GDP, the EMI presents calculations, as detailed in Chart 5. On the assumption Exchange rate developments that overall fiscal positions and debt ratios as projected by the European Commission The Austrian schilling has been participating for 1998 are achieved, realising a balanced in the ERM since 9 January 1995, i.e. for budget from 1999 onwards would reduce longer than two years prior to the the debt ratio to below 60% of GDP as examination (see Table 8a). As mentioned early as the year 2000. Instead, maintaining above, Austrian monetary policy has 1998 overall and primary balances of -2.3% continued to be determined by the

201 objective of closely linking the Austrian Long-term interest rate developments schilling to the Deutsche Mark, since January 1995 within the framework of the ERM. Over the reference period from February Focusing on the reference period from 1997 to January 1998 long-term interest March 1996 to February 1998, the currency rates in Austria were 5.6% on average, and has normally traded close to its central thus stood well below the reference value rates against other ERM currencies and for the interest rate criterion of 7.8% set very close to those vis--vis the Belgian on the basis of the three best-performing franc, the Deutsche Mark and the Dutch Member States in terms of price stability. guilder (see Chart 6 and Table 8a). On This was also the case for 1997 as a whole, occasion the Austrian schilling traded as well as for 1996 (see Table 11). outside a range close to its central rates vis--vis several partner currencies. The Long-term interest rates have been on a maximum upward and downward broadly declining trend since the early deviations from central rates, on the basis 1990s (see Chart 7a). At the same time, a of 10 business day moving averages, were close convergence of Austrias long-term 2.2% and -2.9% respectively, abstracting interest rates with those prevailing in the from the autonomous upward trend of the EU countries with the lowest bond yields Irish pound (see Table 8a). The episodes in has been observed since the early 1990s, which such deviations occurred were with the differential typically being around temporary, the degree of exchange rate zero (see Chart 7b). The main factors volatility vis--vis the Deutsche Mark was underlying this trend were the continuously very low (see Table 8b) and comparatively low rate of inflation, the short-term interest rate differentials against relative stability of the Austrian schillings those EU countries with the lowest short- exchange rate, the pursuit of a similar term interest rates were insignificant. During monetary policy stance to that followed in the reference period Austria has not the above-mentioned countries and, most devalued its currencys bilateral central recently, the gradual improvement in the rate against any other Member States state of the countrys public finances. currency.

In a longer-term context, measures of the Concluding summary real effective exchange rate of the Austrian schilling vis--vis the currencies of ERM Over the reference period Austria has participating Member States depicted in achieved a rate of HICP inflation of 1.1%, Table 9 suggest that current levels are which is well below the reference value close to historical values. With regard to stipulated by the Treaty and one of the other external developments, the current three lowest inflation rates in the Union. account turned negative during the 1990s, Unit labour costs were broadly stable over which has contributed to an increasing net the reference period (having decreased in external liability position (see Table 10). It 1996) and low rates of inflation were also may also be recalled that Austria is a small apparent in terms of other relevant price open economy with, according to the most indices. Looking ahead, there are some recent data available, a ratio of foreign signs of upward pressure on inflation. The trade to GDP of 49% for exports and 48% Austrian schilling has been participating in for imports, and a share of intra-EU trade the ERM for longer than two years. Over of 60% for exports and 75% for imports. the reference period it remained broadly stable, generally close to its unchanged central parities, without the need for measures to support the exchange rate.

202 The level of long-term interest rates was appropriate period of time, thus pointing 5.6%, i.e. well below the respective to the need for further substantial progress reference value. in consolidation. The Stability and Growth Pact also requires as a medium-term In 1997 Austria achieved a fiscal deficit objective a budgetary position that is close ratio of 2.5%, i.e. below the reference to balance or in surplus. Given the current value, and the outlook is for a decrease to debt ratio of above 65% of GDP, achieving 2.3% in 1998. The debt-to-GDP ratio is the fiscal position forecast for 1998 and above the 60% reference value. After realising a balanced budget thereafter would having reached a peak in 1996, it declined reduce the debt ratio to below 60% as by 3.4 percentage points to stand at 66.1% early as the year 2000. in 1997. Regarding the sustainability of fiscal developments, the outlook is for a With regard to other factors, in 1996 the decrease in the debt ratio to 64.7% of deficit ratio exceeded the ratio of public GDP in 1998. Looking further ahead, investment to GDP, while in 1997 the keeping the deficit ratio at current levels difference was close to zero. Austria has would not be sufficient to bring the debt maintained current account deficits as well ratio down to 60% of GDP within an as a net external liability position.

203 List of Tables and Charts*

AUSTRIA

I Price developments Table 1 Austria: HICP inflation Chart 1 Austria: Price developments Table 2 Austria: Measures of inflation and related indicators Table 3 Austria: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Austria: General government financial position Chart 2 Austria: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Austria: General government gross debt - structural features Chart 3 Austria: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Austria: General government expenditure and receipts Table 6 Austria: General government budgetary position Chart 5 Austria: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 7 Austria: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Austria: Exchange rate stability (b) Key indicators of exchange rate pressure for the Austrian schilling Chart 6 Austrian schilling: Deviations from ERM bilateral central rates Table 9 Austrian schilling: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Austria: External developments

IV Long-term interest rate developments Table 11 Austria: Long-term interest rates Chart 7 (a) Austria: Long-term interest rate (b) Austria: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

204 1 Price developments

Table 1 Austria: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.8 1.2 1.1 1.0 1.1 1.1 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Austria: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

5

4

3

2

1

0

-1 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

205 Table 2 Austria: Measures of inflation and related indicators (annual percentage changes unless otherwise stated) 1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 3.3 3.3 4.1 3.6 3.0 2.2 1.9 1.3 CPI excluding changes in net indirect taxes(b) 3.3 3.3 3.9 3.6 2.8 1.7 1.7 1.2 Private consumption deflator 3.5 3.0 3.9 3.3 3.3 1.5 2.5 1.8 GDP deflator 3.4 3.7 4.3 2.8 2.8 2.1 2.1 1.4 Producer prices(c) 2.9 0.8 -0.2 -0.4 1.3 0.4 0.0 0.4 Related indicators Real GDP growth 4.6 3.4 1.3 0.5 2.5 2.1 1.6 2.5 Output gap (p.pts) 2.0 2.9 1.8 -0.1 0.0 -0.3 -1.1 -1.0 Unemployment rate (%) - - - - 3.8 3.9 4.4 4.4 Unit labour costs, whole economy 2.8 4.5 4.8 3.5 0.8 1.1 -0.5 0.0 Compensation per employee, whole economy 5.5 6.3 5.8 4.6 3.3 3.0 1.6 1.5 Labour productivity, whole economy 2.6 1.8 0.9 1.0 2.5 1.9 2.1 1.6 Import price deflator 0.5 1.0 0.0 0.7 0.8 1.0 1.2 0.7 Exchange rate appreciation(d) 3.4 -0.7 2.0 2.1 0.0 3.5 -1.6 -2.7 Broad monetary aggregate (M3H)(e) 14.3 13.4 9.3 4.0 6.3 6.1 5.7 2.7 Stock prices 64.7 -16.7 -20.6 -2.4 14.7 -13.4 4.8 13.8 House prices ...... -1.4 -1.7

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Wholesale prices. (d) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (e) National harmonised data; annual average.

Table 3 Austria: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation

Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.0 1.1 1.0 1.0 1.2 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted -2.5 0.0 4.1 5.9 4.5 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 0.1 0.2 0.2 0.5 1.2

Source: National non-harmonised data.

(b) Inflation forecasts

1998 1999 European Commission (spring 1998), HICP 1.3 1.5 OECD (December 1997), private consumption deflator 1.5 1.6 IMF (October 1997), CPI 1.6 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

206 II Fiscal developments

Table 4 Austria: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -4.0 -2.5 -2.3 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -1.2 0.1 . General government gross debt 69.5 66.1 64.7 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Austria: General government gross debt (as a percentage of GDP)

(a) Levels

70

65

60

55 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

6 4 2 0 -2 -4 -6 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

207 Table 5 Austria: General government gross debt - structural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 57.9 58.1 58.0 62.7 65.4 69.2 69.5 66.1 Composition by currency(a) (% of total) In domestic currency 84.3 84.2 82.6 80.8 77.5 76.3 76.5 79.7 In foreign currencies 15.7 15.8 17.4 19.2 22.5 23.7 23.5 20.3 Domestic ownership(b) (% of total) 81.5 80.7 77.8 73.1 73.3 69.7 71.3 . Average maturity(c) (years) 7.7 7.1 6.7 6.2 6.2 6.2 6.1 5.9 Composition by maturity(d) (% of total) Short-term (< 1 year) ...... 8.6 10.7 Medium-term (1-5 years) ...... 36.4 40.2 Long-term (> 5 years) ...... 55.0 49.1

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) 1990-93 Federal government only. 1997 estimated. (b) 1990-93 Federal government debt; 1994-96 general government debt; all positions are partly estimated. (c) Residual maturity. Federal government debt only. (d) Residual maturity. Federal government debt only; debt linked to short-term interest rates according to maturity.

208 Chart 3 Austria: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0 -1 -2 -3 -4 -5 -6 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

2

1

0

-1

-2

-3 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 Austria: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

60

55

50

45 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

209 Table 6 Austria: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 47.8 48.3 50.0 50.7 49.4 50.0 50.7 50.8 Taxes 27.6 28.1 28.7 29.0 27.4 27.9 29.1 29.7 Social security contributions 15.7 15.8 16.4 17.1 17.5 17.6 17.5 17.1 Other current receipts 4.5 4.4 4.9 4.6 4.5 4.6 4.1 4.0 Total expenditure 50.2 51.3 52.0 54.9 54.3 55.2 54.6 53.2 Current transfers 22.9 23.4 23.6 25.4 25.0 26.0 26.1 25.6 Actual interest payments 4.0 4.2 4.3 4.3 4.1 4.4 4.4 4.1 Public consumption 18.6 18.9 19.4 20.2 20.3 20.1 19.8 19.4 Net capital expenditure 4.7 4.8 4.7 5.0 5.0 4.7 4.4 4.2 Surplus (+) or deficit (-) -2.4 -3.0 -2.0 -4.2 -5.0 -5.2 -4.0 -2.5 Primary balance 1.6 1.2 2.3 0.1 -0.9 -0.8 0.4 1.6 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -1.0 -1.7 -2.2 -1.2 0.1

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 5 Austria: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

65

60

55 1998 1999 2000

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 64.7% of GDP for 1998 is as forecast and that the 1998 overall balance of -2.3% of GDP or the primary balance of 1.7% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 2.5% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 7 Austria: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 22.4 23.3 27.7 32.6 44.0 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

210 III Exchange rate developments

Table 8 (a) Austria: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 9 January 1995 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 0.1 -0.4 Danish krone 1.4 -0.3 Deutsche Mark 0.1 -0.0 Spanish peseta 0.1 -2.3 French franc 2.2 -0.2 Irish pound 3.9 -10.6 Italian lira 1.1 -1.8 Dutch guilder 0.0 -0.8 Portuguese escudo 1.1 -2.8 Finnish markka -0.2 -2.9

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Austrian schilling

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 0.1 0.1 0.1 0.2 0.1 0.1 0.1 0.1 Short-term interest rate differentials(b) -0.2 -0.1 0.1 0.1 0.1 0.1 0.1 0.1

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

211 Chart 6 Austrian schilling: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) ATS/BEF ATS/DKK ATS/DEM ATS/ESP ATS/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

ATS/IEP ATS/ITL ATS/NLG ATS/PTE ATS/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Austrian schilling: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 5.8 1.1 1.9 PPI/WPI-based 1.6 0.1 -0.3 Memo item: Nominal effective exchange rate 13.5 2.5 5.9

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

212 Table 10 Austria: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) 0.8 0.0 -0.1 -0.4 -0.9 -2.0 -1.8 -1.8 Net foreign assets (+) or liabilities (-)(c) -4.0 -6.3 -5.8 -6.6 -8.6 -12.7 -12.4 . Exports (goods and services)(d) 40.2 41.1 41.3 40.5 41.7 43.5 46.8 49.3 Imports (goods and services)(e) 38.9 40.0 40.2 39.7 41.9 44.0 47.0 48.3

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 59.7%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 74.8%; Direction of Trade Statistics Yearbook 1997, IMF.

213 IV Long-term interest rate developments

Table 11 Austria: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 6.3 5.7 5.6 5.4 5.2 5.6 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Austria: Long-term interest rate (monthly averages; in percentages)

10

9

8

7

6

5 1990 1991 1992 1993 1994 1995 1996 1997

(b) Austria: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

2

1

0

-1 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

214 PORTUGAL

Price developments inflation is also apparent when it is measured in terms of other relevant price indices, Over the reference period from February while some measures exceeded HICP 1997 to January 1998 the average rate of inflation in 1997 (see Table 2). HICP inflation in Portugal was 1.8%, i.e. well below the reference value of 2.7%. Looking at recent trends and forecasts, This was also the case in 1997 as a whole. current outturns for consumer price In 1996 average HICP inflation was 2.9% inflation (measured as a percentage change (see Table 1). Seen over the past two over the corresponding month a year years, HICP inflation in Portugal has been earlier) have been around 2% and there reduced to a level which is generally are no signs of immediate upward pressure considered to be consistent with price on the basis of the measures shown in stability. Table 3a. Most forecasts of inflation suggest a rate of somewhat above 2% for 1998 and Looking back, consumer price inflation in 1999 (see Table 3b). Risks for price stability Portugal, as measured on the basis of the over this period are associated with a CPI, has followed a downward trend since narrowing of the output gap and the early 1990s, with the rate falling steadily accelerating unit labour costs. from above 13% at the start of the decade (see Chart 1). This experience of disinflation Looking further ahead, maintaining an reflects a number of important policy environment conducive to price stability choices. Monetary policy has been geared relates in Portugal to, inter alia, the conduct increasingly towards the reduction of of fiscal policies over the medium to long inflation rates, first through a unilateral link term; it will be equally important to to a basket of ERM currencies, and then, strengthen national policies aimed at from spring 1992 onwards, through enhancing competition in product markets membership of the ERM. This general and improving the functioning of labour orientation has been supported by markets. adjustments in fiscal policy, reforms designed to enhance product market competition and labour market reforms. In addition, the Fiscal developments macroeconomic environment has contributed to containing upward pressure In the reference year 1997 the general on prices. In particular, in the context of government deficit ratio was 2.5%, i.e. weak GDP growth in 1993-94, a negative below the 3% reference value, and the output gap emerged. In the subsequent debt ratio was 62.0%, i.e. just above the recovery, the output gap has been reduced 60% reference value. Compared with the gradually (see Table 2). Against this previous year, the deficit ratio has been background, upward pressures on reduced by 0.7 percentage point and the compensation per employee have been debt ratio has decreased by 3.0 percentage restrained although increases have still been points. In 1998 the deficit ratio is forecast considerable. Growth in unit labour costs to decrease to 2.2% of GDP, while the has decelerated markedly over the 1990s. debt ratio is projected to decrease to Import price developments have 60.0%, at the level of the reference value. underpinned the disinflationary process In 1996 and 1997 the deficit ratio did not during most of the period under review. exceed the ratio of public investment The general trend towards lower rates of expenditure to GDP (see Table 4).

215 Looking back over the years 1990 to 1997, deficit fluctuated around 6% until 1995, the Portuguese debt-to-GDP ratio declined with the exception of a lower deficit in by 3.3 percentage points. After falling 1992; since then, the deficit has fallen to sharply to 60.1% in 1992 from 67.3% in 3.2% in 1996 and 2.5% in 1997 (see Chart 1991, the ratio tended to increase 3a). As is shown in greater detail in Chart continuously until 1995, when it reached 3b, which focuses on changes in deficits, 65.9%. Thereafter, it was again on a declining cyclical factors contributed to an increase trend, decreasing to 62.0% in 1997 (see in the deficit ratio up to 1995 and to a Chart 2a), i.e. a decline of 3.9 percentage reduction in 1996-97, but the impact was points over two years. As is shown in small with the exception of 1993-94. greater detail in Chart 2b, the sharp drop However, the non-cyclical improvements in 1992 was the result of both a high could reflect a lasting, structural move primary surplus and a sizable stock-flow toward more balanced fiscal policies and/ adjustment, reflecting a net disposal of or a variety of measures with temporary government assets. In the years 1993-95 effects. Evidence available suggests that the primary surplus almost disappeared, measures with a temporary effect played a while a negative growth/interest rate role in improving the fiscal balance in 1996 differential increased the debt ratio. Finally, and 1997 but that the impact did not in the last two years, primary surpluses exceed 0.2% of GDP. As the measures in increased and, together with a less 1997 were mainly of a self-reversing unfavourable growth/interest rate nature, compensating measures already differential, reversed the upward trend in included in the 1998 budget will need to the debt ratio. The patterns observed thus yield their expected results and, in addition, far during the 1990s may be seen as compensating measures will need to be indicative of the risks to the debt ratio taken in later years when the self-reversing which can arise when macroeconomic effects unwind. conditions deteriorate and these effects are not counterbalanced by a sufficiently Moving on to examine trends in other high primary surplus. In this context, it may fiscal indicators, it can be seen from Chart be noted that the share of debt with a 4 that the general government total short-term residual maturity has been expenditure ratio rose in the early 1990s. decreasing from the high levels of the early Against the background of rising 1990s, while the average maturity has unemployment, current transfers to remained broadly stable (see Table 5). households increased, as did public With respect to 1997, the proportion of consumption relative to GDP (see Table debt with a short-term residual maturity is 6). After 1993 the ratio of total expenditure still high, and, taking into account the to GDP was broadly stable, reflecting a current level of the debt ratio, fiscal balances sharp reduction in interest payments and are sensitive to changes in interest rates. In upward trends in current transfers and addition, the proportion of foreign currency public consumption. On balance, the debt has increased to noticeable levels, expenditure ratio in 1997 was more than rendering fiscal balances in principle 3‰ percentage points higher than at the relatively sensitive to changes in exchange beginning of the 1990s, reflecting an rates, although the bulk of this debt may increase in current transfers and public eventually be redenominated in euro. consumption, while interest payments are now nearly 4 percentage points lower. During the 1990s a broadly flat trend until Given that interest payments have already 1995 and subsequently improving outturns come down substantially in recent years can be observed in the deficit-to-GDP ratio. and further declines at a similar pace are Starting from a ratio of 5.1% in 1990, the not expected, controlling public expenditure

216 would seem to require greater emphasis to 1997, and forecast to decline further in be placed on the control of other 1998, for reducing the debt ratio. Stressing expenditure items. Government revenue in the benefits of further improvement in the relation to GDP has tended to increase deficit ratio and of sustaining consolidation since 1994, and it is now more than 6 over time is indeed appropriate in the case percentage points higher than in 1990. The of Portugal. As has been seen in the past, national accounts treatment of the State less favourable economic conditions than transfers to the civil servants pension those currently prevailing tend to imply an system imply a double counting of these increase in the debt ratio. In addition, as is transfers. Over the period 1990-97, State highlighted in Table 7, from around 2010 transfers to the civil servants pension onwards a marked ageing of the population system accounted for increases of 1.3 is expected and in the context of an percentage points in the ratios of both unfunded pension system, public pension revenue and expenditure to GDP. expenditure is projected to increase relative to GDP, particularly if policies regarding According to the Portuguese medium-term benefits continue unchanged. The overall fiscal strategy, as presented in the new burden of population ageing will become Convergence Programme for 1998-2000 more manageable the better the state of dated March 1997, a declining trend in public finances when the demographic deficit and debt ratios is projected to situation worsens. continue in 1998. The budget plan for 1998 is in line with the programme and Commission forecasts are slightly more Exchange rate developments favourable. The budget foresees a reduction in the share of government expenditure in The Portuguese escudo has been GDP, whereas government revenues are participating in the ERM since 6 April 1992, planned to increase in line with GDP. i.e. for considerably longer than two years Currently, there is no evidence of significant prior to the examination (see Table 8a). As measures with a temporary effect in the mentioned above, Portuguese monetary 1998 budget. According to current plans, policy has been geared towards the the deficit ratio is expected to reach 1.5% achievement of price stability, from spring of GDP in the year 2000. The goals of the 1992 onwards within the context of the previous programmes for 1997 have been ERM. Focusing on the reference period from more than met. Compared with fiscal March 1996 to February 1998, the currency, balances projected in the Convergence benefiting from sizable short-term interest Programme for 1999-2000, further rate differentials vis--vis most partner substantial consolidation is required in order currencies, has normally traded close to its to comply with the medium-term objective central rates against other ERM currencies of the Stability and Growth Pact, effective (see Chart 5 and Table 8a). On occasion from 1999 onwards, of having a budgetary the Portuguese escudo traded outside a position that is close to balance or in range close to its central rates vis--vis surplus. various partner currencies. The maximum upward and downward deviations from With regard to the potential future course central rates, on the basis of 10 business of the debt ratio, the EMIs Report does not day moving averages, were 3.5% and -2.3% consider this issue in detail for those respectively, abstracting from the countries forecast to have a debt ratio of autonomous upward trend of the Irish 60% of GDP or below in 1998. Projected pound (see Table 8a). The episodes in developments underline the benefits of the which such deviations occurred were reduction in the deficit position achieved in temporary, the degree of exchange rate

217 volatility vis--vis the Deutsche Mark was prevailing in the EU countries with the low (see Table 8b) and short-term interest lowest bond yields has also been observed rate differentials against those EU countries for most of the period since the early with the lowest short-term interest rates 1990s. Since mid-1995 this process of were continuously narrowing. During the convergence has accelerated and the reference period Portugal has not devalued differential has now been virtually eliminated its currencys bilateral central rate against (see Chart 6b). The main factor underlying any other Member States currency. this trend was the significant narrowing of the inflation differential. In addition, the In a longer-term context, the available real relative stability of the Portuguese escudos effective exchange rate data for the exchange rate and the improvement in the Portuguese escudo against other ERM countrys fiscal position also played a role. participating currencies depicted in Table 9 These underlying developments were seen suggest that current levels are above 1987 by markets as improving the prospects for average values; since 1992 the real exchange participation in Stage Three of EMU - an rate has been broadly stable. As regards element which may in turn have played an other external developments, after having independent role in accelerating the maintained a virtually balanced position in narrowing of yield differentials, both directly the period 1990-93, the Portuguese current and by further improving the prospects for account shifted into deficit in 1994; the price and exchange rate stability. Portuguese economy maintained a net foreign asset position (see Table 10). It may also be recalled that Portugal is a small Concluding summary open economy with, according to the most recent data available, a ratio of foreign Over the reference period Portugal has trade to GDP of 46% for exports and 59% achieved a rate of HICP inflation of 1.8%, for imports, and a share of intra-EU trade which is well below the reference value of 80% for exports and 76% for imports. stipulated by the Treaty. The increase in unit labour costs has decelerated markedly over the 1990s and the general trend Long-term interest rate developments towards low rates of inflation was also apparent in terms of other relevant price Over the reference period from February indices. Looking ahead, there are no signs 1997 to January 1998 long-term interest of immediate upward pressure on inflation; rates in Portugal were 6.2% on average, forecasts project inflation to stand and thus stood below the reference value somewhat above 2% in 1998 and 1999. for the interest rate criterion of 7.8% set The Portuguese escudo has been on the basis of the three best-performing participating in the ERM for considerably Member States in terms of price stability. longer than two years. Over the reference This was also the case for 1997 as a whole, period it remained broadly stable, generally as well as for 1996 (see Table 11). Twelve- close to its unchanged central parities, month average long-term interest rates without the need for measures to support have been below the reference value since the exchange rate. The level of long-term November 1996. interest rates was 6.2%, i.e. below the respective reference value. Long-term interest rates have been on a broadly declining trend since the early In 1997 Portugal achieved a fiscal deficit 1990s (see Chart 6a). A broad trend ratio of 2.5%, i.e. below the reference towards the convergence of Portuguese value, and the outlook is for a decrease to long-term interest rates with those 2.2% in 1998. The debt-to-GDP ratio is

218 just above the 60% reference value. After of having a budgetary position that is close reaching a peak in 1995 the ratio declined to balance or in surplus, thus pointing to a by 3.9 percentage points to stand at 62.0% need for further substantial consolidation. in 1997. Regarding the sustainability of This would also imply a reduction in the fiscal developments, the outlook is for a debt ratio to below 60%. decrease in the debt ratio to 60.0% of GDP in 1998, i.e. a level equal to the With regard to other factors, in 1996 and reference value. Looking further ahead, 1997 the deficit ratio did not exceed the current fiscal deficit ratios exceed the ratio of public investment to GDP, and medium-term objective of the Stability and Portugal has recorded current account Growth Pact, effective from 1999 onwards, deficits and a net external asset position.

219 List of Tables and Charts*

PORTUGAL

I Price developments Table 1 Portugal: HICP inflation Chart 1 Portugal: Price developments Table 2 Portugal: Measures of inflation and related indicators Table 3 Portugal: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Portugal: General government financial position Chart 2 Portugal: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Portugal: General government gross debt - structural features Chart 3 Portugal: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Portugal: General government expenditure and receipts Table 6 Portugal: General government budgetary position Table 7 Portugal: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Portugal: Exchange rate stability (b) Key indicators of exchange rate pressure for the Portuguese escudo Chart 5 Portuguese escudo: Deviations from ERM bilateral central rates Table 9 Portuguese escudo: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Portugal: External developments

IV Long-term interest rate developments Table 11 Portugal: Long-term interest rates Chart 6 (a) Portugal: Long-term interest rate (b) Portugal: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

220 1 Price developments

Table 1 Portugal: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 2.9 1.9 1.9 2.1 1.6 1.8 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Portugal: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

20

15

10

5

0

-5

-10 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

221 Table 2 Portugal: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 13.4 11.4 8.9 6.5 5.2 4.1 3.1 2.2 CPI excluding changes in net indirect taxes(b) . . 6.5 5.3 5.0 3.5 3.3 2.4 Private consumption deflator 13.8 12.1 10.2 6.8 5.4 4.2 3.1 2.2 GDP deflator 13.0 14.8 13.2 6.8 5.0 5.0 2.8 2.9 Producer prices(c) . 2.2 0.2 2.0 3.2 5.1 4.2 1.9 Related indicators Real GDP growth 4.6 2.3 1.8 0.3 0.7 1.9 3.6 3.8 Output gap (p.pts) 4.1 3.5 2.5 0.1 -1.9 -2.7 -2.0 -1.3 Unemployment rate (%) 4.7 4.1 4.1 5.5 6.8 7.2 7.3 6.7 Unit labour costs, whole economy 15.7 15.1 13.3 6.5 4.2 2.0 2.9 2.8 Compensation per employee, whole economy 17.7 14.2 14.1 7.5 4.8 5.0 5.7 4.8 Labour productivity, whole economy 1.7 -0.8 0.7 0.9 0.6 2.9 2.7 1.9 Import price deflator 6.4 0.5 -6.1 3.2 3.4 1.7 0.3 -0.3 Exchange rate appreciation(d) -2.4 0.7 3.4 -6.0 -4.2 2.0 -0.4 -2.0 Broad monetary aggregate (M3H)(e) 9.4 18.0 21.8 11.2 7.3 10.5 7.5 8.1 Stock prices -0.5 -16.2 -11.5 14.5 34.1 -3.3 15.6 56.9 House prices 15.0 19.4 12.4 1.3 1.2 1.5 1.6 3.6

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Manufacturing sector. (d) Nominal effective exchange rate against 25 industrialised countries. Note: A positive (negative) sign indicates an appreciation (depreciation). (e) National harmonised data.

Table 3 Portugal: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98(b) National consumer price index (CPI) Annual percentage change 1.8 1.8 2.1 2.3 1.9 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted(a) 1.5 1.3 1.4 1.6 . Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted(a) 2.4 2.3 1.9 1.9 .

Source: National non-harmonised data. (a) CPI excluding seasonal items. (b) New index; no seasonally adjusted data available.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 2.2 2.3 OECD (December 1997), private consumption deflator 2.2 2.1 IMF (October 1997), CPI 2.3 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

222 II Fiscal developments

Table 4 Portugal: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -3.2 -2.5 -2.2 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) 0.8 1.9 . General government gross debt 65.0 62.0 60.0 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Portugal: General government gross debt (as a percentage of GDP)

(a) Levels

68 66 64 62 60 58 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

5

0

-5

-10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

223 Table 5 Portugal: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 65.3 67.3 60.1 63.1 63.8 65.9 65.0 62.0 Composition by currency (% of total) In domestic currency 90.0 92.9 93.0 88.3 84.7 81.7 81.2 . In foreign currencies 10.0 7.1 7.0 11.7 15.3 18.3 18.8 . Domestic ownership (% of total) 86.8 85.3 90.5 83.3 79.3 78.2 75.3 . Average maturity(a) (years) 3.5 3.6 3.6 3.5 3.0 3.0 3.2 3.4 Composition by maturity(b) (% of total) Short-term(c) (< 1 year) 47.7 38.9 35.6 33.5 36.0 38.5 42.1 33.1 Medium-term (1-5 years) 15.3 36.3 58.4 54.5 47.1 39.1 31.5 38.0 Long-term (> 5 years) 37.0 24.8 6.0 12.0 16.9 22.4 26.3 28.9

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. Domestic currency debt only. An average maturity of five years is assumed for savings certificates, which represent between 14.3% (1994) and 7.7% (1990) of total debt. (b) Residual maturity. State debt excluding coins and domestic bank loans, which represents between 87.1% (1991) and 96.3% (1994) of the general government gross debt. Savings certificates are classified as short-term debt. 1990-93 domestic currency debt only. (c) Including savings certificates.

224 Chart 3 Portugal: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0

-2

-4

-6

-8 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

4

2

0

-2

-4 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 Portugal: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

45

40

35

30 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

225 Table 6 Portugal: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 35.0 36.4 39.6 37.9 37.2 38.0 40.0 41.2 Taxes 21.6 22.4 24.4 22.6 22.8 23.2 24.4 24.8 Social security contributions 10.4 10.9 11.5 12.1 11.8 11.9 11.6 11.9 Other current receipts 3.0 3.2 3.7 3.2 2.7 2.9 4.1 4.5 Total expenditure 40.1 42.4 42.5 44.0 43.3 43.8 43.3 43.7 Current transfers 12.8 13.9 14.1 15.8 16.3 16.4 17.1 17.3 Actual interest payments 8.1 7.9 7.2 6.2 6.2 6.3 4.8 4.3 Public consumption 15.5 17.2 17.4 17.9 17.6 17.7 18.1 18.6 Net capital expenditure 3.6 3.4 3.8 4.0 3.2 3.4 3.2 3.4 Surplus (+) or deficit (-) -5.1 -6.0 -3.0 -6.1 -6.0 -5.7 -3.2 -2.5 Primary balance 3.0 1.8 4.3 0.1 0.2 0.6 1.6 1.9 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -2.1 -2.4 -2.0 0.8 1.9

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 Portugal: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 19.5 20.9 22.0 25.3 33.5 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

226 III Exchange rate developments

Table 8 (a) Portugal: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 6 April 1992 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 2.8 -1.4 Danish krone 2.8 0.0 Deutsche Mark 2.9 -1.1 Spanish peseta 1.7 -2.3 French franc 3.5 -0.0 Irish pound 3.0 -9.3 Italian lira 3.0 -0.7 Dutch guilder 2.5 -1.7 Austrian schilling 2.9 -1.1 Finnish markka 1.2 -1.4

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b)Key indicators of exchange rate pressure for the Portuguese escudo

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 2.0 1.3 1.5 1.8 2.0 1.7 1.1 0.4 Short-term interest rate differentials(b) 4.1 3.8 3.8 3.1 2.7 2.5 1.8 1.4

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

227 Chart 5 Portuguese escudo: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) PTE/BEF PTE/DKK PTE/DEM PTE/ESP PTE/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

PTE/IEP PTE/ITL PTE/NLG PTE/ATS PTE/FIM

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: Deviations against the Finnish markka refer to the period from 14 October 1996 onwards, while deviations against the Italian lira refer to the period from 25 November 1996 onwards.

Table 9 Portuguese escudo: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 11.8 7.7 26.8 PPI/WPI-based . . . Memo item: Nominal effective exchange rate -55.9 -6.2 -16.3

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

228 Table 10 Portugal: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -0.3 -0.9 -0.1 0.1 -2.5 -0.2 -1.4 -2.0 Net foreign assets (+) or liabilities (-)(c) 7.7 10.5 13.3 17.4 14.1 7.9 10.6 9.9 Exports (goods and services)(d) 34.3 33.8 34.6 34.5 38.2 42.0 43.9 45.7 Imports (goods and services)(e) 41.9 43.6 47.3 45.7 50.3 53.7 55.7 59.2

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current acco unt in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the close st possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 80.0%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 75.7%; Direction of Trade Statistics Yearbook 1997, IMF.

229 IV Long-term interest rate developments

Table 11 Portugal: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 8.6 6.4 6.0 5.7 5.4 6.2 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) Portugal: Long-term interest rate (monthly averages; in percentages)

16

14

12

10

8

6

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Portugal: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

12

9

6

3

0

-3 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

230 FINLAND

Price developments growth in labour productivity have contributed to the subdued rise in unit Over the reference period from February labour costs; import prices have remained 1997 to January 1998 the average rate of broadly stable in recent years, thereby also HICP inflation in Finland was 1.3%, i.e. well helping to keep inflationary pressures under below the reference value of 2.7%. This control. Low rates of inflation are also was also the case in 1997 as a whole. In apparent when it is measured in terms of 1996 average HICP inflation was 1.1% (see other relevant price indices (see Table 2). Table 1). Seen over the past two years, HICP inflation in Finland has been at levels Looking at recent trends and forecasts, which are generally considered to be current outturns for consumer price consistent with price stability. inflation (measured as a percentage change over the corresponding month a year Looking back, consumer price inflation in earlier) have been increasing slightly towards Finland, as measured on the basis of the 2% and there are some signs of immediate CPI, has followed a downward trend since upward pressure on the basis of the the early 1990s, with the rate having stood measures shown in Table 3a. Forecasts of close to, or well below, 2% since 1993 (see inflation suggest a rate of 2-2‰% for 1998 Chart 1). This experience of disinflation and 1999 (see Table 3b). Risks for price reflects a number of important policy stability over this period are associated choices, most notably the shift in monetary with capacity constraints and trends in policy towards the primary objective of asset prices. price stability. Since 1993 this objective has been enshrined in a target of around 2% Looking further ahead, maintaining an for the underlying rate of consumer price environment conducive to price stability inflation and it has most recently been relates in Finland to, inter alia, the conduct pursued within the framework of the ERM. of fiscal policies over the medium to long This general orientation has been supported term; it will be equally important to by, inter alia, adjustments in fiscal policy strengthen national policies aimed at and enhanced competition in formerly enhancing competition in product markets protected sectors of the economy, linked and improving the functioning of labour also to Finlands accession to the EU in markets against the background of the 1995. Measures have also been taken to current high rate of unemployment in increase the flexibility of the economy, Finland. including the labour markets. In addition, the macroeconomic environment has contributed significantly to containing Fiscal developments upward pressure on prices. In particular, in the context of the dramatic fall in output In the reference year 1997 the general between 1990 and 1993, a large negative government deficit ratio was 0.9%, i.e. well output gap emerged (see Table 2). Since below the 3% reference value, and the 1994 a robust recovery has been under debt ratio was 55.8%, i.e. below the 60% way and the output gap has narrowed. reference value. Compared with the Against this background, growth in previous year, the deficit ratio has been compensation per employee picked up in reduced by 2.4 percentage points and the 1994-95. Cuts in employers social security debt ratio has decreased by 1.8 percentage contributions in conjunction with strong points. In 1998 a surplus of 0.3% of GDP is

231 expected, while the debt ratio is projected sensitivity of the government fiscal balance to decrease to 53.6%. Whereas in 1996 to changes in interest rates is significantly the deficit ratio exceeded the ratio of reduced. On the other hand, the proportion public investment expenditure to GDP, in of foreign currency debt is high (although 1997 it was below it (see Table 4). decreasing more recently), rendering fiscal balances in principle sensitive to changes in Looking back over the years 1990 to 1997, exchange rates, although part of this debt the Finnish debt-to-GDP ratio increased by may eventually be redenominated in euro. 41.3 percentage points; initially the situation of Finlands government finances During the 1990s a pattern of first sharply deteriorated sharply, and the debt ratio deteriorating and subsequently improving rose from 14.5% of GDP in 1990 to 59.6% outturns can be observed in the deficit-to- in 1994. Thereafter, the debt ratio declined GDP ratio. Starting from a surplus of 5.4% to 55.8% (see Chart 2a). As is shown in of GDP in 1990, a deficit emerged in 1991 greater detail in Chart 2b, in the early and increased quickly to reach a peak of 1990s both an unfavourable growth and 8.0% in 1993; since then, the deficit has interest rate environment, reflecting a fall declined year by year to stand at 0.9% in in Finlands GDP of 13% over three years, 1997 (see Chart 3a). As is shown in and a deteriorating primary balance played greater detail in Chart 3b, which focuses a role in increasing government debt. on changes in deficits, cyclical factors However, as is reflected in the so-called dominated the increase in the deficit until stock-flow adjustment item of public debt, 1993 and its decrease thereafter. However, the financial support granted to the banking the non-cyclical improvements could reflect sector and the revaluation of foreign a lasting, structural move towards more currency denominated government debt balanced fiscal policies and/or a variety of after the sizable depreciation of the Finnish measures with temporary effects. Evidence markka between 1991 and 1993 had the available suggests that measures taken in strongest impact. Having reached a balanced the context of the 1993 tax reform led to a position in 1995, the primary surplus started one-off increase in revenues in 1997, to increase thereafter, thereby estimated to amount to 0.6% of GDP. compensating for the debt-increasing effects resulting from the macroeconomic Moving on to examine trends in other environment and further stock-flow fiscal indicators, it can be seen from Chart adjustments in 1997. The pattern observed 4 that the general government total thus far during the 1990s is an illustration expenditure ratio rose sharply between of the powerful effects which exceptional 1990 and 1993. Against the background of events combined with a strong deterioration high and rising unemployment current in the macroeconomic environment can transfers in the form of social security have on the debt ratio, particularly if the payments increased steeply, and, owing to primary balance does not improve promptly the rapid increase in the debt ratio, interest so as to counterbalance such effects. In this payments also surged as a percentage of context, it may be noted that the share of GDP, while public consumption increased debt with a short-term residual maturity mostly as a result of the decline in GDP has tended to increase during the 1990s, (see Table 6). After 1993 the total while the average maturity has remained expenditure ratio declined as a broadly stable (see Table 5). With regard consequence of a reduction in all to 1997, the proportion of gross debt with expenditure categories with the exception a short-term residual maturity is noticeable. of interest payments. The expenditure ratio However, since short-term debt in Finland in 1997 was nearly 8 percentage points is matched by liquid short-term assets, the higher than at the beginning of the 1990s,

232 reflecting higher ratios for all major items With regard to the potential future course except net capital expenditure and public of the debt ratio, the EMIs Report does not consumption. Given this pattern and taking consider this issue in detail for those into account both that interest payments countries with a debt ratio of below 60% have increased in line with the higher debt of GDP. In the case of Finland it would ratio and that current transfers are still well appear that a further reduction in the debt above the level observed in 1990, a ratio to levels of well below 60% can be continuation of the downward trend of achieved if current budgetary plans are total expenditure to GDP would seem to maintained. Such considerations are also require greater emphasis to be placed on important in the case of Finland since adjustments in current transfers. Government additional room for manoeuvre will be revenue increased in relation to GDP until necessary in order to be able to address 1992, since when it has tended to decline. future budgetary challenges. As is highlighted It may be at a level which is detrimental to in Table 7, from around 2010 onwards a economic growth. marked ageing of the population is expected. As a consequence, public pension According to the Finnish medium-term fiscal expenditure is forecast to increase in policy strategy, as presented in the relation to GDP, particularly if policies Convergence Programme for 1998-2001 regarding benefits continue unchanged. dated September 1997, the general Finland benefits, however, from a partly government financial position is expected funded pension system. One aspect of to be close to balance in 1998 and the particular relevance in Finland is that the debt ratio is expected to decline. The partly funded pension system currently budget for 1998 is in line with the invests a large part of its surpluses in programme. On the part of the central government paper, thereby reducing the government, the budget foresees both consolidated government gross debt. As a reduced expenditure (mostly as a result, any change in this investment policy consequence of cuts in transfers and the would pose a risk to the gross debt ratio postponement of investment to prevent (but not, however, to the interest burden). the economy overheating) as well as Moreover, the demographic trend over increased income tax revenues. Currently, the next few decades will have an adverse there is no evidence of significant measures effect on the current surpluses in the with a temporary effect in the 1998 budget. pension system, thereby making further Surpluses are projected from 1998 onwards improvements in the general government and the debt ratio is expected to continue fiscal balance essential. Alleviation of the to decline. With regard to the development overall burden of population ageing will be of fiscal deficits and debt ratios, current facilitated to a greater degree the better projections are more favourable than the the state of public finances when the 1997 update of the Convergence demographic situation worsens. Programme. If fiscal balances turn out as projected in the Convergence Programme for 1999-2000, Finland should comply with Exchange rate developments the medium-term objective of the Stability and Growth Pact, effective from 1999 The Finnish markka has been participating onwards, of having a budgetary position in the ERM since 14 October 1996, i.e. for that is close to balance or in surplus. around 16 months of the two-year reference However, the actual fiscal position benefits period (from March 1996 to February 1998) from a strong economy; risks may arise if prior to the examination by the EMI (see economic growth slows down. Table 8a). As mentioned above, in 1993 Finnish monetary policy adopted price

233 stability as its primary objective, which has currencies suggest that the currency is most recently been pursued within the somewhat below historical values based context of the ERM. on long-term averages and on the year 1987 (see Table 9). With regard to other At the beginning of the reference period, external developments, sizable current before it joined the ERM, the markka account surpluses have been recorded initially continued its weakening movement since 1994, which have reduced the large apparent over the previous few months, net external liability position which occurred which had interrupted the longer-term as a result of the accumulation of deficit upward movement since 1993. It reached positions over several decades (see Table a maximum downward deviation of 6.5% 10). It may also be recalled that Finland is a below its future central rate against one small open economy with, according to the ERM currency in April 1996. Thereafter, it most recent data, a ratio of foreign trade appreciated and generally traded within a to GDP of 37% for exports and 29% for narrow range around its later central imports, and a share of intra-EU trade of parities. 53% for exports and 59% for imports.

Since joining the ERM in October 1996 the markka has normally traded close to its Long-term interest rate developments central rates against other ERM currencies (see Chart 5 and Table 8a). On occasion Over the reference period from February the Finnish markka traded outside a range 1997 to January 1998 long-term interest close to its central rates vis--vis various rates in Finland were 5.9% on average, and partner currencies. The maximum upward thus stood below the reference value for and downward deviations from central the interest rate criterion of 7.8% set on rates, on the basis of 10 business day the basis of the three best-performing moving averages, were 3.6% and -1.1% Member States in terms of price stability. respectively, abstracting from the For 1997 as a whole, as well as for 1996, autonomous upward trend of the Irish they were well below the reference value pound (see Table 8a). The episodes in (see Table 11). which such deviations occurred were temporary, the relatively high degree of Long-term interest rates have been on a exchange rate volatility vis--vis the broadly declining trend since the early Deutsche Mark observed in specific periods 1990s (see Chart 6a). A trend towards the declined to low levels over the reference convergence of Finnish long-term interest period (see Table 8b) and short-term rates with those prevailing in the EU interest rate differentials against those EU countries with the lowest bond yields has countries with the lowest short-term also been observed for most of the period interest rates were insignificant. Since joining since the early 1990s. This process of the ERM Finland has not devalued its convergence has accelerated since late currencys bilateral central rate against any 1994, and the differential has now been other Member States currency. virtually eliminated (see Chart 6b). The main factors underlying this trend were the In a longer-term context, when measured comparatively low rate of inflation, the in terms of real effective exchange rates, relative stability of the Finnish markkas current exchange rates of the Finnish exchange rate and an improvement in the markka against other ERM participating countrys fiscal position.

234 Concluding summary In 1997 Finland achieved a fiscal deficit ratio of 0.9% of GDP, i.e. well below the Over the reference period Finland has reference value, and the outlook is for a achieved a rate of HICP inflation of 1.3%, surplus of 0.3% in 1998. In addition, the which is well below the reference value fiscal debt ratio declined to 55.8% of GDP stipulated by the Treaty. Unit labour costs in 1997, thus remaining below the 60% declined in 1997 and low rates of inflation reference value. Regarding the sustainability were also apparent in terms of other of fiscal developments, the outlook is for a relevant price indices. Looking ahead, there further decline to 53.6% in 1998. Against are some signs of immediate upward this background, Finland should comply pressure on inflation; forecasts suggest a with the medium-term objective of the rate of 2-2‰% in 1998 and 1999. The level Stability and Growth Pact, effective from of long-term interest rates was 5.9%, i.e. 1999 onwards, of having a budgetary below the respective reference value. position that is close to balance or in surplus, and the debt ratio would fall The Finnish markka has been participating further below 60%. in the ERM for around 16 months, i.e. for less than two years prior to the examination With regard to other factors, Finland has by the EMI. On the basis of the evidence recorded sizable current account surpluses reviewed in the Report, in an ex post while continuing to have a net foreign assessment, the Finnish markka has been liability position. In the context of the broadly stable over the reference period as ageing of the population, Finland benefits a whole. Within the ERM, it has remained from a partly funded pension system. generally close to its unchanged central parities without the need for measures to support the exchange rate.

235 List of Tables and Charts*

FINLAND

I Price developments Table 1 Finland: HICP inflation Chart 1 Finland: Price developments Table 2 Finland: Measures of inflation and related indicators Table 3 Finland: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Finland: General government financial position Chart 2 Finland: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Finland: General government gross debt - structural features Chart 3 Finland: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Finland: General government expenditure and receipts Table 6 Finland: General government budgetary position Table 7 Finland: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Finland: Exchange rate stability (b) Key indicators of exchange rate pressure for the Finnish markka Chart 5 Finnish markka: Deviations from ERM bilateral central rates Table 9 Finnish markka: Measures of the real effective exchange rate vis--vis ERM Member States Table 10 Finland: External developments

IV Long-term interest rate developments Table 11 Finland: Long-term interest rates Chart 6 (a) Finland: Long-term interest rate (b) Finland: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

236 1 Price developments

Table 1 Finland: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 1.1 1.2 1.8 1.6 1.8 1.3 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Finland: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

10

5

0

-5 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

237 Table 2 Finland: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 6.2 4.3 2.9 2.2 1.1 1.0 0.6 1.2 CPI excluding changes in net indirect taxes(b) 4.6 2.6 1.6 0.8 0.5 -0.1 -0.2 0.8 Private consumption deflator 6.0 5.7 4.1 4.2 1.4 0.3 1.6 1.4 GDP deflator 5.8 2.5 0.7 2.4 1.3 2.4 1.3 1.2 Producer prices 2.1 -0.1 2.5 3.6 1.6 3.4 0.1 0.5 Related indicators Real GDP growth 0.0 -7.1 -3.6 -1.2 4.5 5.1 3.6 5.9 Output gap (p.pts) 7.7 -1.1 -5.8 -8.3 -5.9 -3.3 -2.4 0.3 Unemployment rate (%) 3.3 7.4 12.7 17.3 17.8 16.7 15.8 14.5 Unit labour costs, whole economy 8.8 7.7 -1.8 -4.7 -2.2 0.7 0.6 -2.4 Compensation per employee, whole economy 9.4 5.7 1.9 1.0 3.5 4.0 3.2 -0.4 Labour productivity, whole economy 0.6 -2.0 3.7 5.7 5.7 3.3 2.6 2.0 Import price deflator 1.1 0.5 7.2 8.7 -0.3 0.4 1.8 1.6 Exchange rate appreciation(c) 1.8 -4.0 -12.9 -14.0 7.8 10.6 -2.8 -2.4 Broad monetary aggregate (M3H)(d) 5.3 9.9 2.4 4.0 0.0 3.1 -1.2 7.4 Stock prices -27.3 -27.5 -19.4 59.5 49.4 3.5 6.6 56.9 House prices -5.5 -13.9 -17.0 -8.8 6.0 -3.6 5.5 17.5

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Finland: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.6 1.7 1.9 1.9 2.0 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 2.3 2.6 2.5 2.6 2.5 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 2.1 2.2 2.3 2.5 2.6

Source: National non-harmonised data.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 2.0 2.0 OECD (December 1997), private consumption deflator 2.2 2.5 IMF (October 1997), CPI 2.3 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

238 II Fiscal developments

Table 4 Finland: General government financial position (as a percentage of GDP) 1996 1997 1998(a) General government surplus (+) / deficit (-) -3.3 -0.9 0.3 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -0.6 1.7 . General government gross debt 57.6 55.8 53.6 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Finland: General government gross debt (as a percentage of GDP)

(a) Levels

80

60

40

20

0 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

20 15 10 5 0 -5 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

239 Table 5 Finland: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 14.5 23.0 41.5 58.0 59.6 58.1 57.6 55.8 Composition by currency (% of total) In domestic currency 66.1 60.8 45.1 43.3 41.0 45.1 46.6 50.4 In foreign currencies 33.9 39.2 54.9 56.7 59.0 54.9 53.4 49.6 Domestic ownership (% of total) 60.2 48.4 38.2 36.2 36.3 40.3 39.3 36.8 Average maturity(a) (years) 4.6 4.9 5.2 4.9 4.7 4.3 4.4 4.7 Composition by maturity(a) (% of total) Short-term(b) (< 1 year) 11.3 10.0 12.2 13.8 13.7 20.3 24.1 19.1 Medium-term (1-5 years) 73.8 64.0 59.8 52.8 54.2 52.8 48.2 48.1 Long-term (> 5 years) 14.9 25.9 28.0 33.3 32.1 26.9 27.8 32.8

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Residual maturity. (b) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Finland: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

10

5

0

-5

-10 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

4 2 0 -2 -4 -6 -8 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

240 Chart 4 Finland: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

70

60

50

40 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Finland: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 52.1 54.0 54.9 53.8 54.4 53.5 54.6 53.5 Taxes 33.1 33.2 32.3 30.3 31.3 31.2 33.1 33.2 Social security contributions 13.0 13.9 14.9 15.4 16.2 15.2 14.5 13.7 Other current receipts 6.0 6.9 7.7 8.1 6.8 7.1 7.0 6.6 Total expenditure 46.8 55.5 60.7 61.8 60.8 58.3 57.9 54.5 Current transfers 20.4 25.2 29.5 31.0 30.2 28.4 27.4 25.7 Actual interest payments 1.5 1.9 2.6 4.6 5.0 5.2 5.6 5.4 Public consumption 21.1 24.2 24.8 23.3 22.3 21.8 21.9 20.9 Net capital expenditure 3.9 4.1 3.7 3.0 3.3 2.9 3.1 2.4 Surplus (+) or deficit (-) 5.4 -1.5 -5.9 -8.0 -6.4 -4.7 -3.3 -0.9 Primary balance 6.8 0.4 -3.2 -3.4 -1.4 0.4 2.3 4.5 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -5.2 -3.6 -2.1 -0.6 1.7

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 Finland: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 19.7 21.5 24.3 34.7 41.1 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

241 III Exchange rate developments

Table 8 (a) Finland: Exchange rate stability (14 October 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) Yes Membership since 14 October 1996 Devaluation of bilateral central rate on country’s own initiative No Maximum upward (+) and downward (-) deviations from central rates in the ERM grid (%) against(a)

Belgian franc 3.1 0.2 Danish krone 2.8 0.1 Deutsche Mark 3.0 0.2 Spanish peseta 2.1 -0.2 French franc 3.6 0.1 Irish pound -0.3 -9.1 Italian lira 3.0 -0.4 Dutch guilder 2.9 0.2 Austrian schilling 3.0 0.2 Portuguese escudo 1.4 -1.1

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. Deviations against the Italian lira refer to the period from 25 November 1996 onwards.

(b) Key indicators of exchange rate pressure for the Finnish markka

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 4.5 4.0 2.2 5.3 4.4 3.5 2.3 1.1 Short-term interest rate differentials(b) 0.4 0.1 -0.1 -0.1 -0.2 -0.2 -0.0 -0.1

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

242 Chart 5 Finnish markka: Deviations from ERM bilateral central rates (daily data; percentages; 1 March 1996 to 27 February 1998) FIM/BEF FIM/DKK FIM/DEM FIM/ESP FIM/FRF

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

FIM/IEP FIM/ITL FIM/NLG FIM/ATS FIM/PTE

15

10

5

0

-5

-10

-15 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission. Note: The vertical line indicates when Finland joined the ERM (14 October 1996). Deviations prior to 14 October 1996 refer to the Finnish markkas bilateral central rates as established upon ERM entry except in the case of the Italian lira. In this case, deviations prior to 25 November 1996 refer to the bilateral central rate established upon the liras re-entry to the ERM.

Table 9 Finnish markka: Measures of the real effective exchange rate vis--vis ERM Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -11.3 -11.1 -14.8 PPI/WPI-based -8.8 -5.5 -9.4 Memo item: Nominal effective exchange rate -15.2 -7.7 -14.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

243 Table 10 Finland: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -5.1 -5.5 -4.6 -1.3 1.3 4.1 3.8 5.3 Net foreign assets (+) or liabilities (-)(c) -27.4 -35.3 -47.8 -54.1 -51.7 -42.2 -42.6 -43.4 Exports (goods and services)(d) 23.1 23.2 26.4 31.2 33.8 34.8 34.9 37.4 Imports (goods and services)(e) 24.6 23.3 24.5 24.9 26.9 27.4 27.6 28.5

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current account in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the closest possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 53.4%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 58.5%; Direction of Trade Statistics Yearbook 1997, IMF.

244 IV Long-term interest rate developments

Table 11 Finland: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 7.1 6.0 5.8 5.6 5.3 5.9 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) Finland: Long-term interest rate (monthly averages; in percentages)

14

12

10

8

6

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Finland: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points)

Long-term interest rate differential CPI inflation differential

6

4

2

0

-2

-4 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

245 SWEDEN

Price developments unit labour costs rose to 4.6% in 1996, before declining to 1.2% in 1997. Control Over the reference period from February over inflationary pressures has been 1997 to January 1998 the average rate of facilitated by declines or only small increases HICP inflation in Sweden was 1.9%, i.e. in import prices in 1996-97 and weak well below the reference value of 2.7%. domestic demand against the background This was also the case in 1997 as a whole. of fiscal retrenchment. In addition, falling In 1996 average HICP inflation was 0.8% mortgage costs have contributed to lower (see Table 1). Seen over the past two rates of CPI inflation. Underlying inflation12 years, HICP inflation in Sweden has tended has been close to or below 2% since 1992. to increase somewhat while remaining at Low rates of inflation are also apparent levels which are generally considered to be when it is measured in terms of other consistent with price stability. relevant price indices (see Table 2).

Looking back, consumer price inflation in Looking at recent trends and forecasts, Sweden, as measured on the basis of the current outturns for consumer price CPI, has followed a downward trend since inflation (measured as a percentage change the early 1990s, with inflation falling sharply over the corresponding month a year from above 10% at the start of the decade earlier) have been decreasing to around and significantly lower rates being 1‰% and there is little sign of immediate discernible since 1994. In 1996-97 inflation upward pressure on the basis of the was below 1% and there were generally measures shown in Table 3a. Most forecasts low inflationary pressures (see Chart 1). of inflation suggest rates of 1‰-2% for This experience of disinflation reflects a 1998 and 2% for 1999 (see Table 3b). number of important policy choices, Risks for price stability over this period are including, in particular, the shift in the associated with wage developments in the orientation of monetary policy towards the light of the strengthening of economic primary objective of price stability. Since activity. 1995 this objective has been expressed as an explicit inflation target of 2% for the Looking further ahead, maintaining an consumer price index. This general environment conducive to price stability orientation has been supported by, inter relates in Sweden to, inter alia, the conduct alia, adjustments in fiscal policy and greater of fiscal policies over the medium to long product market competition, linked partly term; it will be equally important to to Swedens accession to the EU in 1995 strengthen national policies aimed at and fostered by the competition law enhancing competition in product markets framework. In addition, the macroeconomic and improving the functioning of labour environment has contributed to containing markets against the background of the upward pressure on prices. Notably, in the current high rate of unemployment in context of the severe recession in the early Sweden. 1990s a considerable negative output gap emerged (see Table 2). Since 1994 a recovery in economic activity has taken place and the output gap has narrowed appreciably. Against this background, there 12 Underlying inflation is defined here as the CPI excluding was an acceleration of growth in mortgage interest costs and the effects of indirect taxes and compensation per employee in 1996 and subsidies.

246 Fiscal developments absence of a primary surplus to compensate for these factors. In this context, it may be In the reference year 1997 the general noted that the share of debt with a short- government deficit ratio was 0.8%, i.e. well term maturity has been decreasing from below the 3% reference value, and the the high levels of the early 1990s, while the debt ratio was 76.6%, i.e. above the 60% average maturity has remained broadly reference value. Compared with the stable in recent years (see Table 5). With previous year, the deficit ratio has been regard to 1997, the proportion of debt reduced by 2.7 percentage points and the with a short-term residual maturity is still debt ratio has decreased marginally by 0.1 high, and, taking into account the current percentage point. In 1998 a surplus of 0.5% level of the debt ratio, fiscal balances are of GDP is expected, while the debt ratio is sensitive to changes in interest rates. In projected to decrease to 74.1%. In 1996 addition, the proportion of foreign currency the deficit ratio exceeded the ratio of debt increased to high levels, rendering public investment expenditure to GDP, fiscal balances in principle sensitive to whilst in 1997 the deficit ratio was below changes in exchange rates, although part of the investment ratio (see Table 4). this debt may eventually be redenominated in euro. Looking back over the years 1990 to 1997, the Swedish debt-to-GDP ratio increased by During the 1990s a pattern of first very 33.3 percentage points; initially the situation sharply deteriorating and subsequently of Swedens government finances improving outturns can be observed in the deteriorated sharply, and the debt ratio deficit-to-GDP ratio. Starting from a surplus rose from 43.3% of GDP in 1990 to 79.0% position of 4.2% in 1990, a deficit emerged in 1994. Thereafter, the ratio has decreased in 1991, and increased to reach a peak of to 76.6% in 1997 (see Chart 2a), i.e. a 12.2% of GDP in 1993; since then, the decline of 2.4 percentage points over three deficit has declined year by year to stand at years. As is shown in greater detail in Chart 0.8% in 1997 (see Chart 3a). As is shown 2b, in the early 1990s both a negative in greater detail in Chart 3b, which focuses growth/interest rate differential, reflecting on changes in deficits, cyclical factors a 5% fall in Swedens GDP over three contributed substantially to the increase in years, and a deteriorating primary balance the deficit until 1993, as well as to its played a role in increasing government decrease in the following two years. In debt. However, as is reflected in the so- 1996-97 cyclical factors played a minor called stock-flow adjustment item of public role. However, the non-cyclical debt, the financial support granted to the improvements could reflect a lasting, banking sector and the revaluation of foreign structural move towards more balanced currency denominated government debt fiscal policies and/or a variety of measures after the sizable depreciation of the Swedish with temporary effects. Evidence available krona between 1991 and 1992 had a suggests that measures with a temporary strong impact. Since 1996 the primary effect played a deficit-reducing role in balance has been in surplus and gradually 1996, amounting to 0.3% of GDP, but did increasing, more than compensating in 1997 not play a role in 1997. for the unfavourable growth/interest rate differential. The pattern observed thus far Moving on to examine trends in other during the 1990s is an illustration of the fiscal indicators, it can be seen from Chart powerful effects which a strong 4 that the general government total deterioration in the macroeconomic expenditure ratio rose sharply between environment and exceptional events can 1990 and 1993. In particular, current have on the debt ratio, particularly in the transfers increased steeply, reflecting a

247 marked increase in payments related to goal of a surplus over the cycle of 2% and unemployment and other social security the debt ratio is forecast to stand at 67%. items; in addition, all other major The current plans are broadly in line with expenditure items rose as a percentage of the previous update of the programme but GDP (see Table 6). After 1993 the total imply a faster improvement than envisaged expenditure ratio declined rapidly as a in the original 1995 programme. If fiscal consequence of a reduction in all balances turn out as projected in the expenditure categories with the exception Convergence Programme for 1999-2000, of interest payments. Nevertheless, the Sweden should comply with the medium- expenditure ratio in 1997 was 3 percentage term objective of the Stability and Growth points higher than at the beginning of the Pact, effective from 1999 onwards, of 1990s, reflecting higher ratios in current having a budgetary position that is close to transfers - notably to the unemployed - balance or in surplus. and interest payments. Given this pattern and taking into account both that interest With regard to the future horizon for payments have increased in line with the reducing the debt ratio to the 60% higher debt ratio and that capital spending reference value for countries with a debt has been reduced substantially since 1993, ratio of clearly above 60% but below 80% a continuation of the downward trend of of GDP, the EMI presents calculations as total expenditure to GDP would in detailed in Chart 5. On the assumption particular seem to require emphasis to be that overall fiscal positions and debt ratios placed on current transfers, which are still as projected by the European Commission well above the level observed in 1990. for 1998 are achieved, maintaining the Government revenue in relation to GDP projected 1998 primary surplus of 6.8% of tended to decrease until 1994, since when GDP constant in subsequent years would it has been gradually increasing. It may be be consistent with a reduction in the debt at a level which is detrimental to economic ratio to below 60% in 2001. Maintaining growth. the 1998 overall fiscal surplus of 0.5% of GDP constant in subsequent years would According to the Swedish medium-term generate a debt ratio of below 60% by fiscal policy strategy, as presented in the 2003. Finally, maintaining a balanced budget latest review of the Convergence would, in the case of Sweden, extend this Programme for 1995-2000 dated process to 2004. Such calculations are September 1997, the general government based on the normative assumption of a financial position is expected to be in constant nominal rate of interest of 6% surplus in 1998 and the debt ratio is (average real cost of public debt outstanding planned to decrease further. The budget of 4% and 2% inflation) and the assumption plan for 1998 is in line with the programme. of a constant real GDP growth rate of Even though the budget contains some 1.9%, as estimated by the Commission for increased expenditure, it does not breach real trend GDP growth in 1998. Stock-flow previously set spending ceilings, and both adjustments are not taken into account. expenditure and revenue ratios are While such calculations are purely expected to decline. Currently, there is illustrative, and can by no means be evidence of measures with a temporary regarded as forecasts, they provide an effect in the 1998 budget, amounting to illustration of the need to maintain 0.8% of GDP. According to current plans, considerable consolidation efforts in order in the year 2000 the overall balance is to bring the debt ratio in Sweden down to projected to show a surplus of 1.5% of 60% of GDP or below within an appropriate GDP as a step towards the medium-term period of time.

248 Stressing the need for considerable on the reference period, the currency has improvement in the deficit ratio and to normally traded above its March 1996 sustain consolidation over time is indeed average bilateral exchange rates against appropriate in the case of Sweden. As has most other EU currencies, which are used been seen in the past, unexpected shocks as a benchmark for illustrative purposes in can substantially increase the debt ratio. In the absence of central rates (see Chart 6 addition, as is highlighted in Table 7, from and Table 8a). The main exceptions were around 2010 onwards a marked ageing of the development against the Irish pound, the population is expected. Therefore, the pound sterling and, to a lesser extent, public pension expenditure would increase the Italian lira. In parallel with these in relation to GDP if policies regarding developments the degree of volatility of benefits were to continue unchanged. The the Swedish kronas exchange rate against Swedish pension system is partly funded the Deutsche Mark has tended to decrease but is basically of the pay-as-you-go type. It recently while remaining relatively high has been decided to gradually supplement (see Table 8b), while short-term interest the public pension system by a more rate differentials against those EU countries robust system linked to economic growth with the lowest short-term interest rates and demographic variations, which will have narrowed significantly. reduce the pressure on public finances and diminish the need for a large buffer fund. In a longer-term context, when measured The buffer fund currently invests a large in terms of real effective exchange rates, part of its surpluses in government paper, current exchange rate levels of the Swedish thereby reducing the consolidated general krona against other EU currencies are government gross debt. As a result, any somewhat below historical average values change in this investment policy would and 1987 average values (see Table 9). As introduce a measure of uncertainty for the regards other external developments, future course of the gross debt ratio. The Sweden has maintained an increasing demographic trend over the next few current account surplus since 1994 against decades will have an adverse effect on the the background of a relatively large net current surpluses in the pension system, external liability position (see Table 10). It thereby making improvements in the may also be recalled that Sweden is a small general government fiscal balance essential. open economy with, according to the most Alleviation of the overall burden of recent data available, a ratio of foreign population ageing will be facilitated if public trade to GDP of 47% for exports and 38% finances have created sufficient room for for imports, and a share of intra-EU trade manoeuvre before entering the period of 55% for exports and 66% for imports. during which the demographic situation worsens. Long-term interest rate developments

Exchange rate developments Over the reference period from February 1997 to January 1998 long-term interest During the reference period from March rates in Sweden were 6.5% on average, 1996 to February 1998 the Swedish krona and thus stood below the reference value has not participated in the ERM (see Table for the interest rate criterion of 7.8% set 8a). Swedish monetary policy has been on the basis of the three best-performing oriented towards the primary objective of Member States in terms of price stability. price stability by means of an explicit This was also the case for 1997 as a whole, inflation target of 2% for the CPI. Focusing as well as for 1996 (see Table 11).

249 Long-term interest rates have been on a EU currencies, which are used as a broadly declining trend since the early benchmark for illustrative purposes in the 1990s (see Chart 7a). At the same time, a absence of central rates. trend towards the convergence of Swedish long-term interest rates with those In 1997 Sweden achieved a fiscal deficit prevailing in the EU countries with the ratio of 0.8% of GDP, i.e. well below the lowest bond yields has been observed reference value, and the outlook is for a since the early 1990s. Since mid-1995 this surplus of 0.5% in 1998. The debt-to-GDP process of convergence has accelerated ratio is above the 60% reference value. and the differential has now been virtually After having reached a peak in 1994, the eliminated (see Chart 7b). The main factors ratio declined by 2.4 percentage points to underlying this trend were the stand at 76.6% in 1997. Regarding the comparatively low rate of inflation and the sustainability of fiscal developments, the improvement in the countrys public outlook is for a decline in the debt ratio to finances. 74.1% of GDP in 1998. Against the background of recent trends in the deficit ratio, Sweden should comply with the Concluding summary medium-term objective of the Stability and Growth Pact, effective from 1999 onwards, Over the reference period Sweden has of having a budgetary position that is close achieved a rate of HICP inflation of 1.9%, to balance or in surplus. Given the current which is well below the reference value debt ratio of above 75% of GDP, achieving stipulated by the Treaty. The increase in the overall surplus forecast for 1998 and unit labour costs was subdued in 1997 and maintaining it in subsequent years would low rates of inflation were also apparent in reduce the debt ratio to below 60% of terms of other relevant price indices. GDP in 2003. Looking ahead, there is little sign of immediate upward pressure on inflation; With regard to other factors, the deficit forecasts project inflation will stand at 1‰- ratio exceeded the ratio of public 2% in 1998 and 2% in 1999. The level of investment to GDP in 1996, while falling long-term interest rates was 6.5%, i.e. below that level in 1997. In addition, below the respective reference value. Sweden recorded current account surpluses, while maintaining a net external Sweden does not participate in the ERM. liability position. In the context of the Over the reference period, the Swedish ageing of the population, Sweden benefits krona traded above its March 1996 average from a partly funded pension system. bilateral exchange rates against most other

250 List of Tables and Charts*

SWEDEN

I Price developments Table 1 Sweden: HICP inflation Chart 1 Sweden: Price developments Table 2 Sweden: Measures of inflation and related indicators Table 3 Sweden: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 Sweden: General government financial position Chart 2 Sweden: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 Sweden: General government gross debt - structural features Chart 3 Sweden: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 Sweden: General government expenditure and receipts Table 6 Sweden: General government budgetary position Chart 5 Sweden: Potential future debt ratios under alternative assumptions for fiscal balance ratios Table 7 Sweden: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) Sweden: Exchange rate stability (b) Key indicators of exchange rate pressure for the Swedish krona Chart 6 Swedish krona: Bilateral exchange rates Table 9 Swedish krona: Measures of the real effective exchange rate vis--vis EU Member States Table 10 Sweden: External developments

IV Long-term interest rate developments Table 11 Sweden: Long-term interest rates Chart 7 (a) Sweden: Long-term interest rate (b) Sweden: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

251 1 Price developments

Table 1 Sweden: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 0.8 1.8 2.7 2.7 2.1 1.9 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 Sweden: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

15

10

5

0

-5

-10 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

252 Table 2 Sweden: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI) 10.4 9.7 2.6 4.7 2.4 2.8 0.8 0.9 CPI excluding changes in net indirect taxes(b) 7.5 5.7 3.4 4.0 2.4 1.9 0.5 0.3 Private consumption deflator 9.9 10.3 2.2 5.7 3.0 2.7 1.2 2.3 GDP deflator 8.9 7.6 1.0 2.6 2.4 3.7 1.1 1.6 Producer prices 4.2 2.4 -0.3 1.1 4.4 8.2 -0.2 1.1 Related indicators Real GDP growth 1.4 -1.1 -1.4 -2.2 3.3 3.9 1.3 1.8 Output gap (p.pts) 3.6 1.2 -1.4 -4.7 -2.8 -0.5 -0.9 -0.9 Unemployment rate (%) 1.7 3.0 5.3 8.2 8.0 7.7 8.0 8.3 Unit labour costs, whole economy 10.6 6.4 0.4 1.9 0.5 0.0 4.6 1.2 Compensation per employee, whole economy 11.3 6.8 4.0 4.4 4.8 2.7 6.6 3.9 Labour productivity, whole economy 0.6 0.4 3.5 2.5 4.2 2.7 1.9 2.7 Import price deflator 3.0 0.0 -2.2 14.4 3.5 4.8 -4.9 1.4 Exchange rate appreciation(c) -1.3 -0.5 1.4 -19.2 -1.3 -0.2 9.8 -3.7 Broad monetary aggregate (M3H)(d) ------Stock prices -7.5 -4.8 -15.2 31.0 25.7 11.8 23.0 43.9 House prices 11.8 6.9 -9.4 -10.1 3.5 0.5 -0.2 6.2

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) National estimates. (c) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (d) National harmonised data.

Table 3 Sweden: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI) Annual percentage change 1.7 1.8 1.8 1.9 1.3 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 3.1 3.2 2.6 2.0 0.8 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 1.8 2.1 2.4 2.5 2.5

Source: National non-harmonised data.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 1.5 1.8 OECD (December 1997), private consumption deflator 2.2 2.2 IMF (October 1997), CPI 2.0 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

253 II Fiscal developments

Table 4 Sweden: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -3.5 -0.8 0.5 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -1.4 1.6 . General government gross debt 76.7 76.6 74.1 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 Sweden: General government gross debt (as a percentage of GDP)

(a) Levels

80

70

60

50

40 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

15 10 5 0 -5 -10 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

254 Table 5 Sweden: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) 43.3 52.8 66.8 75.8 79.0 77.6 76.7 76.6 Composition by currency(a) (% of total) In domestic currency 86.1 91.5 73.2 65.4 67.1 66.3 66.6 68.3 In foreign currencies 13.9 8.5 26.8 34.6 32.9 33.7 33.4 31.7 Domestic ownership (% of total) 80.5 78.2 58.3 53.1 57.9 58.7 57.5 54.2 Average maturity(b) (years) . . . . 2.4 2.8 2.7 2.6 Composition by maturity(c) (% of total) Short-term(d) (< 1 year) 54.7 62.5 63.3 43.4 40.6 35.3 35.8 34.0 Medium and long-term (≥ 1 year) 45.3 37.5 36.7 56.6 59.4 64.7 64.2 66.0

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data. Differences in the totals are due to rounding. (a) Consolidated debt. (b) Modified duration. (c) Residual maturity. The decomposition is an approximation based on the composition of the debt instruments of general government. (d) Including short-term debt and debt linked to short-term interest rates.

Chart 3 Sweden: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

5

0

-5

-10

-15 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Cyclical factors Non-cyclical factors Total change

4 2 0 -2 -4 -6 -8 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

255 Chart 4 Sweden: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

80

70

60

50 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

Table 6 Sweden: General government budgetary position (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 64.6 61.4 60.6 60.1 59.2 59.8 62.5 62.6 Taxes 40.4 37.5 36.6 36.3 36.0 36.3 37.7 38.9 Social security contributions 15.5 15.4 14.7 14.3 14.4 14.0 15.1 15.2 Other current receipts 8.7 8.5 9.3 9.5 8.9 9.6 9.7 8.6 Total expenditure 60.4 62.5 68.4 72.3 69.5 66.7 66.0 63.4 Current transfers 25.9 27.6 30.8 33.0 32.2 31.5 30.6 29.0 Actual interest payments 5.0 5.1 5.4 6.2 6.8 6.4 7.2 6.2 Public consumption 27.2 27.1 27.8 28.0 27.1 25.7 26.1 25.8 Net capital expenditure 2.3 2.6 4.4 5.2 3.4 3.2 2.1 2.4 Surplus (+) or deficit (-) 4.2 -1.1 -7.7 -12.2 -10.3 -6.9 -3.5 -0.8 Primary balance 9.1 4.0 -2.4 -6.1 -3.5 -0.5 3.7 5.4 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -11.2 -7.2 -4.0 -1.4 1.6

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

256 Chart 5 Sweden: Potential future debt ratios under alternative assumptions for fiscal balance ratios (as a percentage of GDP)

Constant overall balance Constant primary balance Balanced budget

75

70

65

60

55 1998 1999 2000 2001

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: The three scenarios assume that the debt ratio of 74.1% of GDP for 1998 is as forecast and that the 1998 overall balance of 0.5% of GDP or the primary balance of 6.8% of GDP will be kept constant over the period considered (as a percentage of GDP), or, alternatively, that a balanced budget is maintained from 1999 onwards. The underlying assumptions are a real trend GDP growth rate in 1998 of 1.9% as estimated by the Commission; an inflation rate of 2%; and, in the constant primary balance scenario, a nominal interest rate of 6%. Stock-flow adjustments are disregarded.

Table 7 Sweden: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 27.6 26.9 29.1 35.6 39.4 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

257 III Exchange rate developments

Table 8 (a) Sweden: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) No Membership since - Devaluation of bilateral central rate on country’s own initiative - Maximum upward (+) and downward (-) deviations from March 1996 average bilateral rates (%) against(a)

ERM currencies: Belgian franc 7.0 -1.1 Danish krone 5.1 -1.1 Deutsche Mark 6.6 -1.1 Spanish peseta 6.9 -1.0 French franc 4.6 -1.2 Irish pound 1.3 -11.9 Italian lira 1.6 -5.9 Dutch guilder 7.3 -1.1 Austrian schilling 6.7 -1.1 Portuguese escudo 4.9 -2.5 Finnish markka 4.2 -3.7 Non-ERM currencies: Greek drachma 3.1 -3.3 Pound sterling 1.4 -22.5

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average. (b) Key indicators of exchange rate pressure for the Swedish krona

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 6.9 6.4 4.3 6.2 7.7 6.6 6.9 4.2 Short-term interest rate differentials(b) 3.0 2.0 1.3 0.6 0.8 0.8 0.7 0.8

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

258 Chart 6 Swedish krona: Bilateral exchange rates (daily data; average of March 1996=100; 1 March 1996 to 27 February 1998) SEK/BEF SEK/DKK SEK/DEM SEK/GRD SEK/ESP SEK/FRF

120

110

100

90

80

70 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

SEK/IEP SEK/ITL SEK/NLG SEK/ATS SEK/PTE SEK/FIM SEK/GBP

120

110

100

90

80

70 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission.

Table 9 Swedish krona: Measures of the real effective exchange rate vis--vis EU Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based -13.1 -8.5 -7.5 PPI/WPI-based -5.2 -2.7 -2.8 Memo item: Nominal effective exchange rate -22.8 -8.4 -15.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

259 Table 10 Sweden: External developments (as a percentage of GDP)

1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -2.9 -2.0 -3.4 -2.0 0.3 2.2 2.3 2.7 Net foreign assets (+) or liabilities (-)(c) -37.0 -25.8 -37.4 -46.3 -46.0 -37.2 -43.1 -47.1 Exports (goods and services)(d) 29.9 29.6 30.7 33.8 37.2 40.5 42.4 47.0 Imports (goods and services)(e) 29.5 28.4 29.1 29.1 31.8 33.8 34.6 37.9

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current acco unt in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the close st possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 55.0%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 66.4%; Direction of Trade Statistics Yearbook 1997, IMF.

260 IV Long-term interest rate developments

Table 11 Sweden: Long-term interest rates (percentages) 1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 8.0 6.6 6.3 6.0 5.7 6.5 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 7 (a) Sweden: Long-term interest rate (monthly averages; in percentages)

14

12

10

8

6

4 1990 1991 1992 1993 1994 1995 1996 1997

(b) Sweden: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points) Long-term interest rate differential CPI inflation differential

12

8

4

0

-4 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

261 UNITED KINGDOM13

Price developments Meanwhile, import price rises have varied considerably in recent years, partly as a Over the reference period from February result of sizable fluctuations in effective 1997 to January 1998 the average rate of exchange rates. In the recent past falling HICP inflation in the United Kingdom was import prices linked to exchange rate 1.8%, i.e. well below the reference value of appreciation have put downward pressure 2.7%. This was also the case in 1997 as a on prices in an environment of strong whole. In 1996 average HICP inflation was domestic demand. A general tendency 2.5% (see Table 1). Seen over the past two towards low rates of inflation is also years, HICP inflation in the United Kingdom apparent when it is measured in terms of has been reduced to a level which is other price indices, although in 1997 generally considered to be consistent with consumer prices measured on the basis of price stability. the RPIX remained above the target value and well above other measures of inflation Looking back, consumer price inflation in before declining to the target value in the United Kingdom, as measured on the January 199814 (see Table 2). basis of the retail price index excluding mortgage interest payments (RPIX), Looking at recent trends and forecasts, followed a broad downward trend during current outturns for consumer price the early 1990s (see Chart 1). Inflation inflation (measured as a percentage change stood at 8.1% in 1990 and fell to 2.3% in over the corresponding month a year 1994, before edging up to stand at or just earlier) have been decreasing slightly to under 3% in 1995-97. This experience of 2‰% but there are some signs of immediate disinflation reflects a number of important upward pressure on the basis of the policy choices, including the shift in measures shown in Table 3a15. Forecasts of monetary policy after the autumn of 1992 inflation suggest a rate of around 2-2‰% towards the pursuit of an explicit inflation for 1998 and 1999 (see Table 3b). Risks for target, which is currently specified by the price stability over this period are associated Government to be an objective of 2.5% for with strong money and credit growth as the RPIX and, more recently, the granting well as pressures in the labour market. of operational independence to the Bank of England. The reduction in inflation has Looking further ahead, although the United been facilitated by, inter alia, the orientation Kingdom does not intend to participate in of fiscal policy, enhanced competition in the single monetary policy as from 1999, formerly protected sectors of the economy, there will be a need to pursue economic and labour market reforms. In addition, in policies which do not overburden monetary the early 1990s the macroeconomic policy and which are conducive to exchange environment contributed to containing rate stability. The environment of low upward pressure on prices. Notably, in the context of the recession in 1991-92 a considerable negative output gap emerged 13 The Convergence Report does not take into account the UK (see Table 2). Since then, a robust recovery Budget measures which were introduced shortly before the has been under way and the output gap release date. 14 Inflation as measured on the basis of the RPIX is higher than has gradually been closed. As the labour when measured on the basis of the HICP. A large part of the market has tightened, earnings growth has difference is purely algebraic; RPIX is constructed as an risen modestly, with unit labour cost growth arithmetic mean and HICP as a geometric mean. 15 These measures may be vulnerable to distortions owing to remaining at around 2% in 1996-97. residual seasonality in the data.

262 domestic inflation in the United Kingdom maturity has been decreasing since the also needs to continue to be supported by early 1990s, while the average maturity has the conduct of appropriate fiscal policies remained stable and is the highest in the and the maintenance of national policies Union (see Table 5). With regard to 1997, aimed at enhancing competition in product the proportion of debt with a short-term markets and improving the functioning of residual maturity is still indicated to be labour markets. relatively high but current statistical applications do distort the qualitative picture (see footnote to Table 5). Taking these Fiscal developments into account as well as the current level of the debt ratio, fiscal balances may be seen In the reference year 1997 the deficit ratio as relatively insensitive to changes in interest was 1.9%, i.e. well below the 3% reference rates. In addition, the proportion of foreign value, and the debt ratio was 53.4%, i.e. currency denominated debt is low, below the 60% reference value. Compared rendering fiscal balances relatively insensitive with the previous year, the deficit ratio has to changes in exchange rates. been reduced by 2.9 percentage points and the debt ratio has decreased by 1.3 During the 1990s a pattern of rapid percentage points. In 1998 the deficit ratio deterioration and subsequently improving is forecast to decrease to 0.6% of GDP, outturns can be observed in the deficit-to- while the debt ratio is projected to decline GDP ratio. Starting from a ratio of 0.9% in to 52.3%. In 1996 and 1997 the deficit 1990, fiscal imbalances reached 7.9% in ratio exceeded the ratio of public 1993; since then, the deficit has declined investment expenditure to GDP (see year by year to stand at 1.9% of GDP in Table 4). 1997 (see Chart 3a). As is shown in greater detail in Chart 3b, which focuses Looking back over the years 1991 to 1997, on changes in deficits, cyclical factors the United Kingdoms debt-to-GDP ratio contributed substantially to an increase in increased by 17.8 percentage points. the deficit until 1993, as well as to its Starting from 35.6% in 1991, the ratio rose reduction thereafter. However, the non- continuously to reach 54.7% in 1996, before cyclical improvements could reflect a lasting, declining to 53.4% in 1997 (see Chart 2a). structural move towards more balanced As is shown in greater detail in Chart 2b, fiscal policies and/or a variety of measures during the period considered debt growth with temporary effects. Evidence available was mainly driven by at times sizable suggests that measures with a temporary primary deficits, while some upward effect reduced the deficit ratio by 0.5% of pressure resulted from the combination of GDP in 1997. These were mainly of a self- GDP growth and interest rates. Only in reversing nature. This implies that 1997 did a restored primary surplus have a compensating measures already included debt-decreasing effect. Stock-flow in budget plans for 1998 will need to offset adjustments played a role in checking the the unwinding of these effects in order to rise in the debt ratio in 1994 and 1996. maintain the budget on its planned path. The patterns observed thus far during the 1990s may be seen as indicative of the Moving on to examine trends in other close link between primary deficits and fiscal indicators, it can be seen from Chart adverse debt dynamics, irrespective of the 4 that the general government total starting level of debt - which in the case of expenditure ratio rose between 1990 and the United Kingdom was comparatively 1993. Against the background of rising low. In this context, it may be noted that unemployment both current transfers to the share of debt with a short-term residual households and public consumption

263 increased (see Table 6). After 1993 the consider this issue in detail for those ratio of total expenditure to GDP declined, countries with a debt ratio of below 60% reflecting a reduction in current transfers, of GDP. Nevertheless, current trends public consumption and net capital suggest that the debt level can be expenditure relative to GDP; interest maintained at below 60%. From around payments started to decline only in 1997. 2010 onwards a marked ageing of the The overall expenditure ratio in 1997 has population is expected (see Table 7) but, returned broadly to the level observed in in contrast to most other EU Member 1990, although current transfers are now States, the United Kingdom benefits from a higher as a percentage of GDP and net pension system which is heavily reliant on capital expenditures are lower. Given the funded private pensions, and in which successive reduction in net capital unfunded social security pensions play a expenditure during the 1990s, a lesser role than in other EU countries. continuation of the downward trend of Public pension expenditure in terms of total expenditure to GDP would require GDP is forecast not to increase significantly greater adjustments in items such as current on present plans. While some comfort transfers and public consumption. may be drawn from such estimates, there Meanwhile, government revenue in relation are significant uncertainties surrounding to GDP tended to decline until 1993, and them, and developments during the 1990s thereafter started to increase, to reach a have indicated the risks to the debt ratio level in 1997 which was close to that associated with allowing deficit positions to observed in 1990. grow rapidly.

According to the United Kingdoms medium-term fiscal policy strategy, as Exchange rate developments presented in the September 1997 Convergence Programme covering the During the reference period from March period up to the financial year 2001/02, a 1996 to February 1998 the pound sterling declining trend in deficit and debt ratios is has not participated in the ERM (see Table projected to continue in 1998, with a 8a). The United Kingdoms monetary policy position close to balance being reached in has pursued price stability via an explicit the financial year 1998/99. The budget for inflation target, which is currently specified 1998 is in line with the programme. It by the Government to be an objective of foresees a reduction in the expenditure 2.5% for the RPIX. Focusing on the ratio and an increase in the revenue ratio. reference period, the currency appreciated Currently, there is no evidence of significant against other EU currencies, partly reflecting measures with a temporary effect in the the differing position in the business cycle 1998 budget. For the financial year 2000/ and the associated monetary policy stance, 01 a surplus of 0.5-1.5% is foreseen, and a as reflected in sizable actual and expected further decline in the debt ratio is envisaged. short-term interest rate differentials vis-- If fiscal balances turn out as projected in vis ERM countries. Hence, sterling has for the Convergence Programme, the United the most part traded well above its March Kingdom should comply with the medium- 1996 average bilateral exchange rates term objective of the Stability and Growth against other EU currencies, which are Pact, effective from 1999 onwards, of used as a benchmark for illustrative having a budgetary position that is close to purposes in the absence of central rates balance or in surplus. (see Chart 5 and Table 8a). In parallel with these developments the degree of volatility With regard to the potential future course of the pounds exchange rate against the of the debt ratio, the EMIs Report does not Deutsche Mark tended to increase from

264 the early 1996 level (see Table 8b) and cycle vis--vis continental European short-term interest rate differentials against countries (partly in turn reflecting the those EU countries with the lowest short- different pattern of monetary policy and term interest rates widened over the exchange rate developments). More reference period. recently, the long-term interest rate differential has shown a tendency to narrow. In a longer-term context, when measured in terms of real effective exchange rates, current exchange rate levels of the pound Concluding summary sterling against other EU currencies appear to stand well above historical values (see The United Kingdom, in accordance with Table 9). As regards other external the terms of Protocol No. 11 of the developments, the current account has Treaty, has notified the EU Council that it been broadly balanced in recent years does not intend to move to the third stage (with a small surplus in 1997), while net in 1999. As a consequence, it will not external assets have fallen to between 1% participate in the single currency at the and 2% of GDP (see Table 10). It may also start of Stage Three. Nevertheless, its be recalled that, according to the most progress towards convergence is examined recent data available, the United Kingdom in detail. has a ratio of foreign trade to GDP of 32% for exports and 33% for imports, and a Over the reference period the United share of intra-EU trade of 53% for exports Kingdom has achieved a rate of HICP and 50% for imports. inflation of 1.8%, which is well below the reference value stipulated by the Treaty. The increase in unit labour costs was Long-term interest rate developments subdued and a general tendency towards low rates of inflation was also apparent in Over the reference period from February terms of other relevant price indices. 1997 to January 1998 long-term interest Looking ahead, forecasts project inflation rates in the United Kingdom were 7.0% on at 2-2‰% in 1998 and 1999. The level of average, and thus stood below the long-term interest rates was 7.0%, i.e. reference value for the interest rate criterion below the respective reference value. of 7.8% set on the basis of the three best- performing Member States in terms of The United Kingdom does not participate price stability. This was also the case for in the ERM. Over the reference period, the 1997 as a whole, as well as for 1996 (see currency appreciated against other EU Table 11). currencies, partly reflecting the differing position in the cycle and the associated Long-term interest rates declined steeply monetary policy stance. in the early 1990s. Following an interruption in this trend in early 1994 the rate of In 1997 the United Kingdom achieved a decline was more gradual (see Chart 6a). fiscal deficit ratio of 1.9% of GDP, i.e. a Against this background, a broad trend has level well below the reference value, and been observed since the early 1990s of, the outlook is for a further decline to 0.6% first, convergence with and, later, divergence in 1998. In addition, the fiscal debt ratio from the rates prevailing in the EU countries decreased to 53.4% of GDP in 1997, thus with the lowest bond yields (see Chart 6b). remaining below the 60% reference value The main factor underlying the widening of and the outlook is for a further decline to the differential since 1993 was the different 52.3% in 1998. Regarding the sustainability position of the United Kingdom in the of fiscal developments, looking ahead, with

265 fiscal balances as projected, the United With regard to other factors, the United Kingdom should comply with the medium- Kingdom has recorded a small current term objective of the Stability and Growth account surplus in 1997, and has a net Pact, effective from 1999 onwards, of foreign asset position. In the context of the having a budgetary position that is close to ageing of the population, the United balance or in surplus, and the debt ratio Kingdom benefits from a pension system would fall further below 60%. which is heavily reliant on funded private pensions.

266 List of Tables and Charts*

UNITED KINGDOM

I Price developments Table 1 United Kingdom: HICP inflation Chart 1 United Kingdom: Price developments Table 2 United Kingdom: Measures of inflation and related indicators Table 3 United Kingdom: Recent inflation trends and forecasts (a) Recent trends in consumer price inflation (b) Inflation forecasts

II Fiscal developments Table 4 United Kingdom: General government financial position Chart 2 United Kingdom: General government gross debt (a) Levels (b) Annual changes and underlying factors Table 5 United Kingdom: General government gross debt - structural features Chart 3 United Kingdom: General government surplus (+) / deficit (-) (a) Levels (b) Annual changes and underlying factors Chart 4 United Kingdom: General government expenditure and receipts Table 6 United Kingdom: General government budgetary position Table 7 United Kingdom: Projections of elderly dependency ratio

III Exchange rate developments Table 8 (a) United Kingdom: Exchange rate stability (b) Key indicators of exchange rate pressure for the pound sterling Chart 5 Pound sterling: Bilateral exchange rates Table 9 Pound sterling: Measures of the real effective exchange rate vis--vis EU Member States Table 10 United Kingdom: External developments

IV Long-term interest rate developments Table 11 United Kingdom: Long-term interest rates Chart 6 (a) United Kingdom: Long-term interest rate (b) United Kingdom: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates

* Chart scales may differ across countries.

267 1 Price developments

Table 1 United Kingdom: HICP inflation (annual percentage changes)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

HICP inflation 2.5 1.8 1.9 1.8 1.5 1.8 Reference value 2.5 2.7 - - - 2.7

Source: European Commission.

Chart 1 United Kingdom: Price developments (annual percentage changes)

CPI Unit labour costs Import price deflator

12

10

8

6

4

2

0

-2

-4

-6 1990 1991 1992 1993 1994 1995 1996 1997

Source: National data.

268 Table 2 United Kingdom: Measures of inflation and related indicators (annual percentage changes unless otherwise stated)

1990 1991 1992 1993 1994 1995 1996 1997(a) Measures of inflation Consumer price index (CPI)(b) 8.1 6.7 4.7 3.0 2.3 2.9 3.0 2.8 CPI excluding changes in net indirect taxes(c) 7.3 6.7 4.3 2.9 1.7 2.3 2.6 2.2 Private consumption deflator 5.5 7.5 5.0 3.5 2.2 2.7 2.4 2.3 GDP deflator 6.4 6.5 4.6 3.2 1.7 2.5 2.9 1.8 Producer prices 6.3 5.4 3.1 3.9 2.6 4.1 2.7 1.1 Related indicators Real GDP growth 0.4 -2.0 -0.5 2.1 4.3 2.8 2.3 3.5 Output gap (p.pts) 3.2 -0.8 -3.2 -3.2 -1.1 -0.5 -0.5 0.6 Unemployment rate (%) 5.8 8.0 9.7 10.3 9.3 8.2 7.5 5.8 Unit labour costs, whole economy 10.1 7.1 3.2 0.4 -0.4 1.4 2.1 1.9 Compensation per employee, whole economy 9.6 8.0 6.1 3.4 4.0 3.3 3.9 4.3 Labour productivity, whole economy 0.0 0.8 2.1 3.3 3.7 1.9 1.4 2.2 Import price deflator 3.4 0.3 0.0 8.5 2.9 7.1 0.6 -5.6 Exchange rate appreciation(d) -1.4 0.6 -3.7 -8.9 0.2 -4.6 2.0 16.3 Broad monetary aggregate (M3H)(e) 17.3 8.6 5.8 4.0 6.1 8.3 13.0 13.4 Stock prices -1.6 8.7 3.1 19.0 8.0 4.6 15.0 18.0 House prices 0.0 -1.2 -5.6 -2.9 0.5 -1.7 4.5 6.3

Source: National data except real GDP growth and the output gap (European Commission, spring 1998 forecasts) and exchange rate (BIS). (a) Partly estimated. (b) RPIX. (c) RPIY. No CPI excluding net indirect taxes is published. (d) Nominal effective exchange rate against 25 industrialised countries. Note: a positive (negative) sign indicates an appreciation (depreciation). (e) National harmonised data.

Table 3 United Kingdom: Recent inflation trends and forecasts (annual percentage change unless otherwise stated)

(a) Recent trends in consumer price inflation Sep 97 Oct 97 Nov 97 Dec 97 Jan 98 National consumer price index (CPI)(a) Annual percentage change 2.7 2.8 2.8 2.7 2.5 Change in the average of latest 3 months from previous 3 months, annualised rate, seasonally adjusted 3.6 3.0 2.6 2.7 3.0 Change in the average of latest 6 months from previous 6 months, annualised rate, seasonally adjusted 2.5 2.5 2.6 2.9 2.9

Source: National non-harmonised data. (a) RPIX.

(b) Inflation forecasts 1998 1999 European Commission (spring 1998), HICP 2.4 1.8 OECD (December 1997), private consumption deflator 2.3 2.6 IMF (October 1997), CPI 2.7 .

Source: European Commission (spring 1998 forecasts), OECD and IMF.

269 II Fiscal developments

Table 4 United Kingdom: General government financial position (as a percentage of GDP)

1996 1997 1998(a) General government surplus (+) / deficit (-) -4.8 -1.9 -0.6 Reference value -3 -3 -3 Surplus (+) / deficit (-), net of public investment expenditure(b) -3.5 -0.9 . General government gross debt 54.7 53.4 52.3 Reference value 60 60 60

Source: European Commission (spring 1998 forecasts) and EMI calculations. (a) European Commission projections. (b) A negative sign indicates that the government deficit is higher than investment expenditure.

Chart 2 United Kingdom: General government gross debt (as a percentage of GDP)

(a) Levels

60 55 50 45 40 35 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors Primary balance Growth / interest rate differential Stock-flow adjustment Total change

8 6 4 2 0 -2 -4 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts) and EMI calculations. Note: In Chart 2b negative values indicate a contribution of the respective factor to a decrease in the debt ratio, while positive values indicate a contribution to its increase.

270 Table 5 United Kingdom: General government gross debt str uctural features

1990 1991 1992 1993 1994 1995 1996 1997 Total debt (as a percentage of GDP) . 35.6 41.8 48.5 50.5 53.9 54.7 53.4 Composition by currency (% of total) In domestic currency 95.9 96.3 91.7 93.8 94.8 95.2 96.3 96.5 In foreign currencies 4.1 3.7 8.3 6.2 5.2 4.8 3.7 3.5 Domestic ownership (% of total) 88.5 83.2 81.0 78.7 81.2 82.3 82.8 82.4 Average maturity(a) (years) 10.2 9.9 10.0 10.8 10.6 10.4 10.1 10.1 Composition by maturity(b) (% of total) Short-term(c) (< 1 year) 41.1 40.8 37.1 30.4 29.2 30.6 26.7 26.8 Medium and long-term (≥ 1 year) 58.9 59.2 62.9 69.6 70.8 69.4 73.3 73.2

Source: National data except for total debt (European Commission (spring 1998 forecasts)). End-year data except for 1997: end-March data. Differences in the totals are due to rounding. (a) Residual maturity. Of dated stocks in market hands as at 31 March. (b) Residual maturity. (c) Including short-term debt and debt linked to short-term interest rates. The proportion of short-term debt sensitive to interest rate changes is distorted by the current statistical treatment which includes notes and coins and medium-term National Savings Instruments (i.e. with a maturity exceeding a year) as having a residual maturity of less than one year. In 1997, these items amounted to around 17% of general government gross debt; the implication is that only 9.8% of debt is actually sensitive to interest rate changes. The current statistical treatment is due to change later this year when the United Kingdom adopts ESA95.

271 Chart 3 United Kingdom: General government surplus (+) / deficit (-) (as a percentage of GDP)

(a) Levels

0 -2 -4 -6 -8 -10 1990 1991 1992 1993 1994 1995 1996 1997

(b) Annual changes and underlying factors

Cyclical factors Non-cyclical factors Total change

4

2

0

-2

-4

-6 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts). Note: In Chart 3b negative values indicate a contribution to an increase in deficits, while positive values indicate a contribution to their reduction.

Chart 4 United Kingdom: General government expenditure and receipts (as a percentage of GDP)

Total expenditure Total current receipts

45

40

35 1990 1991 1992 1993 1994 1995 1996 1997

Source: European Commission (spring 1998 forecasts).

272 Table 6 United Kingdom: General government budgetary position (as a percentage of GDP) 1990 1991 1992 1993 1994 1995 1996 1997 Total current receipts 39.0 38.2 36.9 35.8 36.4 37.6 37.2 38.4 Taxes 29.9 29.4 28.3 27.3 27.8 29.0 28.7 30.1 Social security contributions 6.3 6.3 6.2 6.2 6.3 6.3 6.3 6.3 Other current receipts 2.7 2.5 2.4 2.3 2.3 2.2 2.2 2.0 Total expenditure 39.9 40.6 43.1 43.7 43.3 43.1 42.0 40.4 Current transfers 12.7 13.3 15.3 16.0 15.8 15.9 15.3 15.0 Actual interest payments 3.2 2.8 2.7 2.9 3.2 3.5 3.7 3.5 Public consumption 20.6 21.6 22.1 22.0 21.6 21.3 21.0 20.5 Net capital expenditure 3.4 2.9 2.9 2.9 2.6 2.4 2.0 1.4 Surplus (+) or deficit (-) -0.9 -2.3 -6.2 -7.9 -6.8 -5.5 -4.8 -1.9 Primary balance 2.2 0.4 -3.5 -5.0 -3.6 -2.0 -1.1 1.6 Surplus (+) or deficit (-), net of public investment expenditure(a) . . . -6.0 -5.0 -3.7 -3.5 -0.9

Source: European Commission (spring 1998 forecasts) and EMI calculations. Differences in the totals are due to rounding. (a) A negative sign indicates that the government deficit is higher than investment expenditure.

Table 7 United Kingdom: Projections of elderly dependency ratio

1990 2000 2010 2020 2030 Elderly dependency ratio (population aged 65 and over as a proportion 24.0 24.4 25.8 31.2 38.7 of the population aged 15-64)

Source: Bos, E. et al. (1994), World population projections 1994-95, World Bank, Washington DC.

273 III Exchange rate developments

Table 8 (a) United Kingdom: Exchange rate stability (1 March 1996 - 27 February 1998)

Membership of the Exchange Rate Mechanism (ERM) No Membership since - Devaluation of bilateral central rate on country’s own initiative - Maximum upward (+) and downward (-) deviations from March 1996 average bilateral rates (%) against(a)

ERM currencies: Belgian franc 35.2 -0.1 Danish krone 32.7 -0.1 Deutsche Mark 34.6 -0.1 Spanish peseta 34.9 -0.3 French franc 32.6 -0.4 Irish pound 23.5 -1.0 Italian lira 24.1 -1.7 Dutch guilder 35.5 -0.1 Austrian schilling 34.7 -0.1 Portuguese escudo 31.4 -0.3 Finnish markka 28.6 -1.8 Non-ERM currencies: Greek drachma 28.8 -0.8 Swedish krona 29.0 -1.4

Source: European Commission and EMI calculations. (a) Daily data at business frequency; 10-day moving average.

(b) Key indicators of exchange rate pressure for the pound sterling

Average of 3 months ending: May 96 Aug 96 Nov 96 Feb 97 May 97 Aug 97 Nov 97 Feb 98 Exchange rate volatility(a) 4.2 5.7 6.5 10.1 9.8 10.6 10.5 7.6 Short-term interest rate differentials(b) 2.5 2.3 2.7 3.1 3.1 3.6 3.8 3.9

Source: European Commission, national data and EMI calculations. (a) Annualised monthly standard deviation of daily percentage changes of the exchange rate against the DEM, in percentages. (b) Differential of three-month interbank interest rates against a weighted average of interest rates in Belgium, Germany, France, the Netherlands and Austria, in percentage points.

274 Chart 5 Pound sterling: Bilateral exchange rates (daily data; average of March 1996=100; 1 March 1996 to 27 February 1998) GBP/BEF GBP/DKK GBP/DEM GBP/GRD GBP/ESP GBP/FRF

140

130

120

110

100

90 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

GBP/IEP GBP/ITL GBP/NLG GBP/ATS GBP/PTE GBP/FIM GBP/SEK

140

130

120

110

100

90 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: European Commission.

Table 9 Pound sterling: Measures of the real effective exchange rate vis--vis EU Member States (monthly data; percentage deviations; February 1998 compared with different benchmark periods)

Average Average Average Apr 73-Feb 98 Jan 87-Feb 98 1987 Real effective exchange rates: CPI-based 18.3 17.7 24.4 PPI/WPI-based 27.7 21.7 29.9 Memo item: Nominal effective exchange rate 1.3 12.4 8.8

Source: BIS and EMI calculations. Note: A positive (negative) sign indicates an appreciation (depreciation).

275 Table 10 United Kingdom: External developments (as a percentage of GDP) 1990 1991 1992 1993 1994 1995 1996 1997(a) Current account plus new capital account(b) -3.4 -1.4 -1.7 -1.6 -0.2 -0.5 -0.3 0.4 Net foreign assets (+) or liabilities (-)(c) 1.3 1.9 3.7 5.9 4.2 3.7 3.2 1.5 Exports (goods and services)(d) 24.4 24.7 25.9 26.3 27.5 28.9 30.2 31.5 Imports (goods and services)(e) 27.1 26.2 28.2 28.5 28.8 29.2 31.0 32.6

Source: National data except exports and imports (European Commission, spring 1998 forecasts). (a) Partly estimated. (b) According to the 5th edition of the IMF Balance of Payments Manual, which is conceptually the equivalent of the current acco unt in previous editions of the Manual. (c) International investment position (IIP) as defined by the IMF (see Balance of Payments Yearbook, Part 1, 1994), or the close st possible substitute. (d) In 1996 the share of intra-EU exports of goods in total national exports of goods was 52.7%; Direction of Trade Statistics Yearbook 1997, IMF. (e) In 1996 the share of intra-EU imports of goods in total national imports of goods was 49.7%; Direction of Trade Statistics Yearbook 1997, IMF.

276 IV Long-term interest rate developments

Table 11 United Kingdom: Long-term interest rates (percentages)

1996 1997 Nov 97 Dec 97 Jan 98 Feb 97- Jan 98

Long-term interest rate 7.9 7.1 6.7 6.4 6.2 7.0 Reference value 9.1 8.0 - - - 7.8

Source: European Commission.

Chart 6 (a) United Kingdom: Long-term interest rate (monthly averages; in percentages)

14

12

10

8

6 1990 1991 1992 1993 1994 1995 1996 1997

(b) United Kingdom: Long-term interest rate and CPI inflation differentials against EU countries with lowest long-term interest rates* (monthly averages; in percentage points) Long-term interest rate differential CPI inflation differential

8

6

4

2

0

-2 1990 1991 1992 1993 1994 1995 1996 1997

Source: Interest rates: European Commission (where these are not available the most comparable data have been used); the CPI data used are non-harmonised national data. * Weighted average of data for Belgium, Germany, France, the Netherlands and Austria.

277 Annex I

Developments in the private ECU markets Developments in the private ECU markets

The overall size of the ECU financial markets rebuttable taking into account the intention declined further in 1997, standing at ECU of the parties, thereby preserving the 146.4 billion at end-September 1997, principle of contractual freedom. Legal compared with ECU 154.0 billion at end- counsels and market practitioners generally September 1996 (see Table). Total welcomed the legislation as having struck outstanding amounts of ECU-denominated an appropriate balance between continuity international bank assets and liabilities fell and contractual freedom. The legislation by 17% and 13% respectively between has also prompted other authorities, issuers end-September 1996 and end-September and private market associations to declare 1997. Estimated ECU bank lending that terms as specified in the Regulation decreased by 8% during the same period. would apply. Meanwhile, the outstanding total of international bonds, Euro-CP and Euro- The spread between market and basket notes at end-September 1997 amounted ECU exchange rates, which had been to ECU 58.0 billion, compared with ECU gradually narrowing since early 1996 from 60.7 billion at end-September 1996, which a peak of 330 basis points, narrowed represented a decrease of 4.4%. The market further between end-December 1996 and share of the ECU in international bond end-December 1997 from around 90 basis markets continued to decline from 2.8% at points to par, and the market ECU was end-September 1996 to 1.9% at end- even at a premium for a short period September 1997. Domestic ECU bonds towards the end of the year (see Chart). outstanding were flat at ECU 57.8 billion. The spreads between market and basket EU sovereign issuers continued to figure ECU interest rates, particularly short-term prominently in ECU issuing activity, rates, remained within a narrow range accounting for over 50% of total announced during most of 1997. Several factors may issues in 1997. The relatively small market be identified to explain the behaviour of for ECU-denominated Euro-CP and short- exchange rate and interest rate spreads. term Euro-notes remained broadly First, their behaviour reflects the financial unchanged, standing at ECU 2.4 billion at market perceptions of improved prospects end-September 1997, compared with ECU for EMU combined with the reduction in 2.1 billion at end-September 1996. legal uncertainty. A second factor appears to have been calm overall conditions within On 17 June 1997 the Council of Ministers the ERM; in the past wide spread of the European Union approved the divergences were often associated with Council Regulation (EC) No. 1103/97 on crises in EU currency markets. Third, certain provisions relating to the technical factors also appear to have played introduction of the euro. This legislation a role, contributing to short-term volatility. states that contracts making reference to Liquidity in the ECU foreign exchange the Community definition of the ECU (i.e. market has diminished, reflecting the basket ECU) will be converted into euro reduced number of market-makers, so that at the 1:1 rate and establishes a presumption large commercial and financial orders may that the same will happen in the case of have accentuated temporary fluctuations contracts without such a definition of the of the spread. ECU, although this presumption will be

279 Table for Annex 1 ECU financial markets (outstanding stocks at end-period: in billions of ECUs)

1993 1994 1995 1996 1997 Q3 Q3 Q3 Q3 Q1 Q2 Q3 Q4 Bonds, of which 124.5 125.4 119.1 110.2 112.1 110.8 113.4 118.1 - international (a) 78.2 69.1 62.5 51.8 55.5 55.0 55.6 58.0 - domestic 46.3 56.3 56.6 58.4 56.6 55.8 57.8 60.1 (National) Treasury bills 8.3 4.7 3.5 3.5 3.5 3.5 3.5 3.5 Euro-CP and Euro-notes (a) 6.5 6.4 8.2 8.9 2.7 2.3 2.4 2.8 (b) Estimated bank lending 66.6 59.9 57.3 51.4 46.7 45.0 47.1 . Estimated total market size (c) 185.9 176.4 168.1 154.0 145.0 141.6 146.4 . Bank assets, of which: 196.0 178.4 164.5 142.0 128.1 117.2 118.1 . - vis-à-vis non-banks (d) 61.0 55.6 52.6 46.9 42.2 40.7 42.7 . Bank liabilities, of which: 191.9 174.7 157.7 136.7 129.9 120.6 118.9 . - vis-à-vis non-banks (d) 30.9 27.1 23.1 20.9 21.9 21.7 21.4 . Memorandum items: Central banks holdings of private ECUs 19.1 24.0 23.3 21.8 22.9 21.4 19.1 19.9 Turnover of ECU securities (e) 333.6 402.0 479.6 392.5 412.1 390.3 337.4 313.6 % of total turnover in all currencies 6.1 6.9 7.4 4.1 3.9 3.6 2.7 2.5

Source: BIS, Euroclear, Cedel and EMI. (a) From 1997 medium-term notes have been included under international bonds; for earlier years, they are included under Euro-CP and Euro-notes. (b) Final lending and lending to banks outside the reporting area. (c) ECU 20 billion are deducted for estimated double counting: there is an overlap between the securities and banking markets owing to the role of banks as issuers and holders of ECU securities. In the absence of comprehensive data, this overlap may only be estimated. (d) Identified non-banks only. (e) Primary and secondary market, Euro-bonds and domestic straight bonds, convertibles, floating rate notes, CDs, short and medium- term notes.

280 Chart for Annex 1 Difference between market and theoretical exchange rates of the ECU (percentages)

1.0

0.0

-1.0

-2.0

-3.0

-4.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1996 1997

Source: National data.

281 Annex 2

Statistical methodology on convergence indicators Statistical methodology on convergence indicators

This Annex provides information on the harmonised classification for HICP sub- statistical methodology of the convergence indices has been agreed, which allows for a indicators and details of the harmonisation consistent comparison of price achieved in these statistics. developments in detailed sub-groups of consumer expenditures across the Member States. Finally, a recently adopted Consumer prices Commission Regulation lays down rules for the frequency with which the Protocol No. 6 on the convergence criteria commodity weights in HICPs are to be referred to in Article 109j (1) of the Treaty revised. The methodological improvements establishing the European Community which were introduced for HICPs in 1997 requires price convergence to be measured were substantial steps towards the by means of the consumer price index on a achievement of fully comparable HICPs. comparable basis, taking into account differences in national definitions. Although HICPs are used for measuring consumer current consumer price statistics in the price convergence in this Report. Member States are largely based on similar Furthermore, the HICP covering the euro principles, there are considerable differences area as a whole is expected to be the main of detail and these affect the comparability measure of consumer prices for the single of the national results. currency area from January 1999 onwards. There is therefore a strong continuing The conceptual work on the harmonisation interest in harmonisation in this area. of consumer price indices is carried out by the European Commission (EUROSTAT) in close liaison with the National Statistical Public finances Institutes (NSIs). As a key user, the EMI is closely involved in this work. In October Protocol No. 5 on the excessive deficit 1995 the EU Council adopted a Regulation procedure annexed to the Treaty together concerning Harmonised Indices of with a Council Regulation of November Consumer Prices (HICPs), which serves as 1993 define government, deficit, interest the framework for further detailed expenditure, investment, debt and gross harmonisation measures. It sets out a step- domestic product (GDP) by reference to by-step approach for harmonising consumer the European System of Integrated price indices to provide the necessary data Economic Accounts (ESA), second edition. for the analysis of convergence. The ESA is a coherent and detailed set of national accounts tables developed in order The first HICPs were released by to facilitate comparative analyses between EUROSTAT for January 1997. Back data Member States. According to a Council are available to 1995. The harmonisation Regulation of June 1996, the second edition measures introduced for HICPs have so far of the ESA will be applied for the excessive been based on three comprehensive deficit procedure up to and including 1999 Regulations of the European Commission. and will be replaced by the ESA 95 They concern - inter alia - the initial thereafter. coverage of HICPs, initial standards for the procedures of quality adjustment and Government comprises central common rules for the treatment of new government, regional or local government goods and services. Moreover, a detailed and social security funds. It does not

283 include public enterprises and is therefore for providing the statistical data to be used to be distinguished from a more broadly for the excessive deficit procedure to the defined public sector. European Commission. Against this background, the Statistical Office of the Government deficit is mainly the difference Commission (EUROSTAT) monitors the between government gross saving and the consistency of the statistical data reported sum of government investment (defined as in accordance with the ESA, second edition, gross fixed capital formation) and net and their comparability between Member capital transfers payable by government. States. Where the second edition of the Government debt is the sum of the ESA does not give clear guidance, outstanding gross liabilities at nominal value EUROSTAT seeks the opinion of the of government as classified in the second Committee on Monetary, Financial and edition of the ESA, in the categories Balance of Payments Statistics (CMFB), currency and deposits, bills and bonds, and which includes representatives of Member other loans. Government debt does not States national central banks and NSIs. cover trade credits and other liabilities Taking account of the CMFBs opinion, which are not represented by a financial EUROSTAT makes an independent decision document such as overpaid tax advances, on the statistical treatment to be applied nor does it include contingent liabilities by the Member States. such as government guarantees and pension commitments. The definitions of government deficit and government debt Exchange rates imply that the change in government debt outstanding at the end of two consecutive Exchange rates vis--vis the ECU of the years may differ substantially from the size currencies of the Member States are quoted of the government deficit for the year daily (the so-called 2.15 p.m. concertation) under consideration. For example, and are published in the Official Journal of government debt may be reduced by using the European Communities; European cross the receipts from privatising public rates used throughout this Report are enterprises or by selling other financial derived from these ECU exchange rates. assets without any immediate impact on For information purposes, reference is also the government deficit. Conversely, the made in this Report to nominal and real government deficit may be reduced by effective exchange rates on the basis of substituting loans provided by government series calculated by the BIS. for transfers without any immediate impact on government debt. Long-term interest rates The gross domestic product (GDP) used for the compilation of the Communitys Protocol No. 6 on the convergence criteria own resources is also used in connection referred to in Article 109j (1) of the Treaty with the excessive deficit procedure. The establishing the European Community GDP compilation procedures are requires interest rate convergence to be monitored by a Committee established by assessed on the basis of long-term a Council Directive of February 1989. government bonds, or comparable securities, observed over a period of one As from the beginning of 1994 Member year before the assessment, taking into States have been reporting data related to account differences in national definitions. the government deficit and government debt to the European Commission at least While Article 5 of Protocol No. 6 assigns twice a year. The Treaty gives responsibility responsibility for providing the statistical

284 data for the application of the Protocol to values. Finally, a uniform formula was chosen the European Commission, assistance has from existing international standards, namely been provided by the EMI in defining formula 6.3 from the formulae for yield representative long-term interest rate and other calculations of the International statistics, given its expertise in the area, Securities Market Association. Where there and in collecting the data from the central is more than one bond in the sample, the banks for transmission to the European liquidity of the selected bonds warrants the Commission. use of a simple average of the yields to produce the representative rate. The aim Although the methodology for calculating of these changes was to focus on the the yields of bonds is similar across Member statistical measurement of the perceived States, considerable differences existed in durability of convergence. As mentioned long-term interest rate statistics regarding above, the production of the harmonised the choice of securities, the yield formulae representative long-term interest rates has used, the maturities chosen, the treatment been implemented by the central banks, of taxation and adjustments for coupon and fully harmonised data are used in this effects. The purpose of the harmonisation Report. exercise was to make recommendations, in particular with regard to these choices, which would be general enough to allow Other factors for differences in national markets, and yet flexible enough to allow those markets to The last paragraph of Article 109j (1) of evolve, without the comparability of data the Treaty states that the reports of the being impaired. European Commission and the EMI shall, besides the four main criteria, also take The harmonisation principles were that the account of the development of the ECU, issuer of bonds should be the central the results of the integration of markets, government, with fixed coupon securities the situation and development of the of close to ten years to maturity, and that balances of payments on current account yields should be measured gross of tax. To and an examination of the development of ensure that the depth of the market is unit labour costs and other price indices. taken into account, and that no liquidity premium is carried into the yield, the Whereas for the four main criteria Protocol representative securities should be chosen No. 6 describes the data to be used in on the basis of their high liquidity. more detail and stipulates that the European Responsibility for this choice is a matter for Commission will provide the data to be the Member States. At end-December used for the assessment of compliance 1997 eleven countries were using a with these criteria, there is no reference to benchmark bond and four a sample of these other factors in the Protocol. While bonds, using the liquidity of the market at the development of the ECU and the the ten-year point as the determining integration of markets relate to progress factor. Special feature bonds (e.g. towards Economic and Monetary Union in embedded option, zero coupon) are more general terms, the analysis of the excluded from the assessment. The other factors is based on definitions which selection of highly liquid bonds is also seen currently provide the most comparable as an effective indirect means by which to results between Member States. minimise the effects of different coupon

285 286 Chapter II

Compatibility of national legislation with the Treaty 1 General observations

1.1 Introduction intended to achieve the legal convergence as required by the EMI for full compliance Article 109j (1) and (4) of the Treaty16 with the Treaty and the Statute of the requires the EMI (as well as the ESCB. Throughout the European Union Commission) to report, inter alia, on the legislators, with the above exceptions, have compatibility between each Member States undertaken a legislative process intended national legislation, including the statutes to prepare NCBs for Stage Three of EMU. of its national central bank, and Articles 107 and 108 of this Treaty and the Statute of the ESCB (in this Report also referred 1.2 Scope of adaptation to as legal convergence). Article 108 of the Treaty, as reproduced in Article 14.1 1.2.1 Areas of adaptation of the Statute,16 states in this connection that Member States shall ensure, at the For the purpose of identifying those areas latest at the date of the establishment of where adaptation of national legislation is the ESCB, that their national legislation, necessary, a distinction is drawn between: including the statutes of their national central banks (NCBs), is compatible with - the independence of NCBs (see in the Treaty and the Statute. particular Articles 107 of the Treaty and Articles 7 and 14.2 of the Statute); The EMI has examined the legal situation in the Member States and the legislative - the legal integration of NCBs in the measures which have been taken and/or ESCB (see in particular Articles 12.1 need to be taken by the Member States and 14.3 of the Statute); and with a view to achieving compatibility of their national legislation with the Treaty - legislation other than statutes of NCBs. and the Statute. The results of this examination are presented below. The present Report draws on the EMIs previous Independence of NCBs reports on legal convergence: the 1995 and 1996 Reports on Progress towards The Statute contemplates an important Convergence and the legal update thereof role for governors of NCBs (via their dated October 1997. membership of the Governing Council of the ECB) with regard to the formulation of All Member States except Denmark, whose monetary policy and for the NCBs with legislation does not require adaptation, regard to the execution of the operations either have introduced in 1997 or in 1998, of the ESCB (see Article 12.1 of the Statute, or are in an advanced process of last paragraph). Thus, it will be essential for introducing, changes in the statutes of their the NCBs to be independent in the NCBs, following the criteria laid down in performance of their ESCB-related tasks the EMIs Reports and in the EMIs opinions. vis--vis external bodies. The United Kingdom, which is exempt from the obligations under Article 108 of the Treaty, is in the process of introducing 16 a new statute of its NCB which, while References to the Treaty and the Statute are references to the Treaty establishing the European providing a greater level of operational Community and the Statute of the ESCB/ECB, central bank independence, is not expressly unless otherwise indicated.

288 Legal integration of NCBs in the ESCB extent that these do not interfere with the objectives and tasks of the ESCB. Provisions Article 14.3 of the Statute states that the enabling such additional functions would NCBs shall be an integral part of the ESCB, be a clear example of circumstances where that they shall act in accordance with the differences in NCB statutes may continue. guidelines and instructions of the ECB and Rather, the term compatible implies that that the Governing Council shall take the national legislation and the statutes of the necessary steps to ensure compliance with NCBs need to be adjusted in order to such guidelines and instructions. Provisions eliminate inconsistencies with the Treaty in national legislation (particularly in NCB and the Statute and to ensure the necessary statutes) which would prevent the degree of integration of the NCBs in the execution of ESCB-related tasks or ESCB. In particular, while national traditions compliance with decisions of the ECB may continue to exist, all provisions which would be incompatible with the effective infringe on an NCBs independence as operation of the System. Therefore, defined in the Treaty and its role as an adaptations to national legislation and NCB integral part of the ESCB have to be statutes are necessary to ensure adjusted. The Treaty and the Statute require compatibility with the Treaty and the the removal of incompatibilities with the Statute. Treaty and the Statute in national legislation. Neither the supremacy of the Treaty and the Statute over national legislation nor the Legislation other than statutes of NCBs nature of the incompatibility affects this obligation. The obligation of legal convergence under Article 108 of the Treaty, which is The obligation in Article 108 of the Treaty incorporated in a chapter entitled Monetary only extends to incompatibilities with Treaty Policy, applies to those areas of legislation and Statute provisions and not to which are affected by the transition from incompatibilities with secondary Community Stage Two to Stage Three and which legislation to be adopted after the selection would be incompatible with the Treaty and of participating Member States and to Statute if they were to remain unchanged. enter into force at the beginning of Stage The EMIs assessment in this field focuses Three. After the start of Stage Three in particular on laws with an impact on an national legislation which is incompatible NCBs performance of ESCB-related tasks with secondary EC or ECB legislation will, and laws in the monetary area. of course, also have to be brought into line with such secondary legislation. This general requirement derives from the case law of 1.2.2 “Compatibility” versus the European Court of Justice. “harmonisation” Finally, the Treaty and the Statute do not Article 108 of the Treaty requires national prescribe the manner in which national legislation to be compatible with the legislation needs to be adapted. This may Treaty and the Statute. The term be achieved by references to the Treaty compatible indicates that the Treaty does and the Statute, by the incorporation of not require harmonisation of NCBs provisions thereof, by the simple deletion statutes, either inter se or with that of the of incompatibilities or by a mixture of ECB. National particularities may continue these methods. to exist. Indeed, Article 14.4 of the Statute permits NCBs to perform functions other than those specified in the Statute, to the

289 1.2.3 Timetable for adaptation Finally, Article 108 targets one specific point in time, i.e. the date of the Article 108 of the Treaty requires national establishment of the ESCB. Possible legal legislation to be compatible with the Treaty changes after that date, for example as a and the Statute at the latest at the date of result of secondary Community legislation, the establishment of the ESCB (which, do not fall within its scope. Therefore, the under Article 109l (1) of the Treaty, will be present Report does not, for instance, earlier than the start of Stage Three). In address future adaptations of national order to comply with Article 108, national legislation relating to the introduction of legislative procedures must be accomplished the euro flowing from the EU Council in such a way that the compatibility of Regulations on this topic, such as the national legislation is ensured at the latest replacement of national banknotes and at the date of the establishment of the coins by and coins and the ESCB. legal aspects thereof.17

Compatibility requires that the legislative process be completed, i.e. that the 1.3 Member States with a respective act has been adopted by the derogation, Denmark and the national legislator and that all further steps, United Kingdom for example promulgation, have been accomplished. This applies to all legislation 1.3.1 Member States with a derogation under Article 108. However, the distinction between different areas of legislation is In relation to the application of Articles important when it comes to determining 107 and 108, the Treaty and the Statute do the date on which legislation must enter not make a distinction between Member into force. States with and Member States without a derogation. Also, Article 109k of the Treaty Many decisions which the Governing and Article 43 of the Statute do not provide Council of the ECB and the NCBs will take for an exemption to the obligation to between the date of the ESCBs ensure central bank independence for establishment and the end of 1998 will Member States with a derogation. A predetermine the single monetary policy derogation only implies, in accordance with and its implementation within the euro these Articles, that the respective NCB area. Therefore, incompatibilities which retains its powers in the field of monetary relate to the independence of an NCB policy and participates in the ESCB on a need to be effectively removed at the date restricted basis until the date on which the of the ESCBs establishment, which implies Member State adopts the single currency. that the respective amendments must not only be adopted, but must also be in force at this date. Other statutory requirements 1.3.2 Denmark relating to the legal integration of NCBs in the ESCB need only enter into force at the Protocol No. 12 of the Treaty on certain moment that the integration of an NCB in provisions relating to Denmark states that the ESCB becomes effective, i.e. the starting the Danish Government shall notify the date of Stage Three or, in the case of a Council of its position concerning Member State with a derogation or a special status, the date on which it adopts 17 the single currency. See EU Council Regulation 1103/97 on certain provisions relating to the introduction of the euro and draft EU Council Regulation .../98 on the introduction of the euro.

290 participation in Stage Three before the 1.3.3 United Kingdom Council makes its assessment under Article 109j (2) of the Treaty. Denmark has already According to Protocol No. 11 of the given notification that it will not participate Treaty on certain provisions relating to the in Stage Three. In accordance with Article United Kingdom of Great Britain and 2 of Protocol No. 12, this means that Northern Ireland, the United Kingdom Denmark will be treated as a Member shall be under no obligation to move to State with a derogation. Implications thereof Stage Three unless it notifies the Council for Denmark were elaborated in a Decision that it intends to do so. Pursuant to the taken by the Heads of State or Government notification given by the United Kingdom at their Edinburgh Summit meeting on 11 to the Council on 30 October 1997 that it and 12 December 1992. This Decision does not intend to adopt the single currency states that Denmark will retain its existing on 1 January 1999, certain provisions of powers in the field of monetary policy the Treaty (including Articles 107 and 108) according to its national laws and and of the Statute do not apply to the regulations, including the powers of United Kingdom. Accordingly, there is no Danmarks Nationalbank in the field of current legal requirement to ensure that monetary policy. As Article 107 of the national legislation (including the statute of Treaty, in accordance with Article 109k (3) the Bank of England) is compatible with of the Treaty, applies to Denmark, the Treaty and the Statute. Danmarks Nationalbank has to fulfil the requirements of central bank independence.

2 Independence of NCBs

2.1 General remarks Central bank independence finds its limits in statutes defining the objective of a The ESCB will have the exclusive right and central bank and the scope of its powers, duty to define and implement monetary as well as in the review by the judiciary of policy. Independence from political its acts. authorities will allow the System to define a monetary policy aimed at the statutory The EMI has established a list of features of objective of price stability. Independence central bank independence, distinguishing also requires the System to possess the between features of an institutional, powers necessary to implement monetary personal and financial nature.18 In doing so, policy decisions. the EMI made three basic assumptions:

Central bank independence is essential for - Central bank independence is required the credibility of the move to Monetary when exercising the powers and carrying Union and, thus, a prerequisite of Monetary out the tasks and duties conferred upon Union. The institutional aspects of Monetary the ECB and the NCBs by the Treaty Union require monetary powers, currently and the Statute. Features of central held by Member States, to be exercised in a new system, the ESCB. This would not be 18 acceptable if Member States could influence There is also a criterion of functional independence, but as NCBs will in Stage Three be integrated in the the decisions taken by the governing bodies ESCB, this is being dealt with in the framework of of the ESCB. the legal integration of NCBs in the ESCB (see paragraph 3 below).

291 bank independence should therefore - to hold and manage the official foreign be considered from that perspective. reserves of the Member States;

- Such features should not be seen as a - to promote the smooth operation of kind of secondary Community legislation, payment systems. going beyond the scope of the Treaty and the Statute, but as tools to facilitate The reference in Article 107 to the tasks an assessment of the independence of and duties of the ESCB implies that the the NCBs. independence requirement refers to all ESCB-related tasks. In other fields of activity, - Central bank independence is not a instructions are not forbidden. This applies, matter which can be expressed in for example, to NCBs in fulfilling other arithmetical formulae or applied in a tasks permitted within the limitations of mechanical manner and the way in Article 14.4 of the Statute, which states which it is achieved for individual NCBs that NCBs may perform functions other is therefore assessed on a case-by-case than those in the Statute, unless the basis. Governing Council finds, by a two-thirds majority, that these interfere with the objectives and tasks of the ESCB. 2.2 Institutional independence The prohibition on instructions and Institutional independence is a feature of attempts to influence covers all sources of central bank independence which is external influence on the NCBs in relation expressly referred to in Article 107 of the to ESCB matters which prevent them from Treaty as reproduced in Article 7 of the complying with the Treaty and the Statute. Statute. These Articles prohibit the ECB, the NCBs and members of their decision- The following rights of third parties (e.g. making bodies from seeking or taking government or parliament) are incompatible instructions from Community institutions with the Treaty and/or the Statute and or bodies, from any government of a therefore require adaptation. Member State or from any other body. They also prohibit Community institutions and bodies and the governments of the 2.2.1 A right to give instructions Member States from seeking to influence the members of the decision-making bodies Rights of third parties to give instructions of the ECB or of those decision-making to NCBs or their decision-making bodies bodies of the NCBs whose decisions may are incompatible with the Treaty and the have an impact on the fulfilment by the Statute as far as ESCB-related tasks are NCBs of their ESCB-related tasks. concerned.

The main tasks of the ESCB are defined in Article 3 of the Statute: 2.2.2 A right to approve, suspend, annul or defer decisions - to define and implement the monetary policy of the Community; Rights of third parties to approve, suspend, annul or defer decisions of NCBs are - to conduct foreign exchange operations incompatible with the Treaty and the consistent with the provisions of Statute as far as ESCB-related tasks are Article 109 of this Treaty; concerned.

292 2.2.3 A right to censor decisions on legal level (see, in particular, Article 109b of the grounds Treaty and Article 15.3 of the Statute). However, dialogue between NCBs and A right to censor, on legal grounds, decisions their respective political authorities, even relating to the performance of ESCB-related when based on statutory obligations to tasks is incompatible with the Treaty and provide information and exchange views, is the Statute as the performance of these not incompatible with the Treaty and the tasks may not be obstructed at a national Statute, provided that: level. This is not only an expression of central bank independence but also of the - this does not result in interference with more general requirement of the integration the independence of the members of of NCBs in the ESCB (see Section 3 the decision-making bodies of NCBs; below). A right of the governor to censor decisions on legal grounds and subsequently - the ECBs competences and submit them to the political authorities for accountability at the Community level final decision would, although a governor is as well as the special status of a governor not a third party, be equivalent to seeking in his/her capacity as a member of its instructions from political bodies, which is decision-making bodies are respected; incompatible with Article 107 of the Treaty. and

- confidentiality requirements resulting 2.2.4 A right to participate in the decision- from Statute provisions are observed. making bodies of an NCB with a right to vote 2.3 Personal independence The participation of representatives of other bodies (e.g. government or parliament) in Central bank independence is further the decision-making bodies of an NCB substantiated by the provision of the Statute with a right to vote on matters concerning which provides for security of tenure for the performance by the NCB of ESCB- members of the ESCBs decision-making related tasks, even if this vote is not bodies. Article 14.2 of the Statute states decisive, is incompatible with the Treaty that the statutes of NCBs shall, in particular, and the Statute. provide for a minimum term of office for a governor of five years. It also gives protection against the arbitrary dismissal of 2.2.5 A right to be consulted (ex ante) on governors, by stating that a governor may an NCB’s decisions be relieved from office only if he/she no longer fulfils the conditions required for An explicit statutory obligation for an NCB the performance of his/her duties or if he/ to consult the political authorities provides she has been guilty of serious misconduct, a formal mechanism to ensure that their with the possibility of appeal to the views may influence the final decision and European Court of Justice. The statutes of is therefore incompatible with the Treaty NCBs will need to be in conformity with and the Statute. this.

It is noted that in Stage Three primary Against this background, the statutes of responsibility for the fulfilment of the ESCBs NCBs have to respect the following features tasks is vested in the Governing Council of of personal independence: the ECB. Dialogue with political bodies will then take place mainly at the Community

293 2.3.1 Minimum term of office for confer comparable security of tenure follows governors from various Treaty and Statute articles. Article 14.2 of the Statute does not restrict The statutes of NCBs must, in accordance the security of tenure of office to governors, with Article 14.2 of the Statute, contain a while Article 107 of the Treaty and Article 7 minimum term of office for a governor of five of the Statute refer to any members of years. This, of course, does not preclude decision-making bodies of NCBs rather than longer terms of office, while an indefinite to governors. This applies in particular term of office does not require the adaptation where a governor is primus inter pares of statutes if the grounds for the dismissal of between colleagues with equivalent voting a governor are in line with those of Article rights or where, in the case referred to in 14.2 of the Statute (see point 2.3.2 below). A Article 10.2 of the Statute, such other compulsory retirement age is in itself not members may have to deputise for the incompatible with the Statute requirement of governor within the Governing Council. This a minimum term of five years. general principle would not exclude a differentiation in terms of office and/or in grounds for dismissal in those cases where 2.3.2 Grounds for the dismissal of governors members of decision-making bodies and/or such bodies themselves are not involved in The statutes of NCBs must ensure that a the performance of ESCB-related tasks. governor may not be dismissed for reasons other than those mentioned in Article 14.2 With regard to the system of appointment of the Statute (i.e. no longer fulfilling the of members of the decision-making bodies conditions required for the performance of one particular issue merits specific attention: his/her duties or being guilty of serious some statutes of NCBs provide that, when misconduct). The purpose of this a vacancy arises, the new member is requirement is to prevent the dismissal of a appointed for the remainder of the original governor from being at the discretion of term of the leaving (or deceased) member. the authorities involved in his/her This is aimed at ensuring a pre-established appointment, particularly government or rhythm of replacements in those decision- parliament. As from the date of the making bodies, irrespective of unexpected establishment of the ESCB, the statutes of early vacancies, and, in that sense, NCBs should contain grounds for dismissal strengthens the collective independence of which are compatible with those laid down the decision-making bodies from political in Article 14.2 of the Statute or should not authorities. While these systems may not mention any grounds for dismissal since always ensure that each individual member Article 14.2 is directly applicable. of the decision-making bodies serves the minimum five years to which Article 14.2 of the Statute of the ESCB refers, the 2.3.3 Security of tenure of members of the general aim pursued by such systems is not decision-making bodies of NCBs incompatible with the Treaty if the normal involved in the performance of ESCB- term of office is generally established at related tasks other than governors five years or more.19 However, for the avoidance of doubt with respect to Article Personal independence could be jeopardised if the same rules for the security of tenure of 19 office of governors were not also applied to Such systems are foreseen in the Treaty for other independent Community institutions: the European the other members of the decision-making Commission (Article 159), the European Court of bodies of NCBs involved in the performance Justice (Article 167) and the European Court of of ESCB-related tasks. A requirement to Auditors (Article 188b(6)).

294 14.2 of the Statute of the ESCB, the EMI performance of ESCB-related tasks is recommends that all statutes of NCBs incompatible with the exercise of other ensure that each individual member of a functions which might create a conflict of decision-making body involved in the interest. performance of ESCB-related tasks has a minimum term of office of five years. 2.4 Financial independence Such a recommendation is not warranted for transitional arrangements whereby new If an NCB is fully independent from an decision-making bodies are put in place institutional and functional point of view, and different expiry dates for appointees but at the same time unable to avail itself terms of office are foreseen. These are autonomously of the appropriate economic once and for all schemes, aimed at means to fulfil its mandate, its overall ensuring different dates for the expiry of independence would nevertheless be terms of office of members of decision- undermined. In the EMIs opinion, NCBs making bodies and, thus, achieving continuity should be in a position to avail themselves in the management of the NCB.20 of the appropriate means to ensure that their ESCB-related tasks can be properly fulfilled. An ex post review of an NCBs 2.3.4 Safeguards against conflicts of financial accounts may be regarded as a interest reflection of an NCBs accountability towards its owners provided that the NCBs Personal independence also entails ensuring statute contains adequate safeguards that that no conflicts of interest arise between such a review will not infringe its the duties of members of decision-making independence. However, in those countries bodies of NCBs vis--vis their respective where third parties and, particularly, the NCB (and of governors, additionally, vis-- government and/or parliament are in a vis the ECB) and any other functions which position, directly or indirectly, to exercise such members of decision-making bodies influence on the determination of an NCBs involved in the performance of ESCB- budget or the distribution of profit, the related tasks may have and which may relevant statutory provisions should contain jeopardise their personal independence. a safeguard clause to ensure that this does As a matter of principle, membership of a not impede the proper performance of the decision-making body involved in the NCBs ESCB-related tasks.

20 Article 50 of the Statute of the ESCB provides for such a system of staggered initial appointments of the members of the Executive Board of the ECB, exclusive of the President.

295 3 Legal integration of NCBs in the ESCB

Another area of legal convergence concerns This applies to any provisions which in the legislative measures required for the Stage Three form an impediment to the legal integration of NCBs in the ESCB.21 In execution of ESCB-related tasks and, in particular, measures may be necessary to particular, to provisions which do not enable NCBs to execute tasks as members respect the ECBs competences under of the ESCB and in accordance with Chapter IV of its Statute. decisions by the ECB. The main areas of attention are those where statutory provisions may form an obstacle to an 3.3 Instruments NCB complying with the requirements of the ESCB or to a governor fulfilling his/her The statutes of many, if not all, NCBs duties as a member of the Governing contain provisions on monetary policy Council of the ECB, or where statutory instruments. Again, national provisions on provisions do not respect the prerogatives such instruments are to be compared with of the ECB. A distinction is drawn between those contained in the Treaty and Statute those areas of which statutes of NCBs are and incompatibilities need to be removed usually composed: statutory objectives, in order to comply with Article 108 of the tasks, instruments, organisation and financial Treaty. provisions.

3.4 Organisation 3.1 Statutory objectives In addition to the prohibition on giving, The integration of NCBs in the ESCB accepting or soliciting instructions, there requires that their (primary and secondary) must be no mechanisms in the statutes of statutory objectives are compatible with NCBs which could either bind a governor the ESCBs objectives as laid down in in his/her voting behaviour in the Governing Article 2 of the Statute. This means, inter Council of the ECB in which he/she acts in alia, that statutory objectives with a national the separate capacity as a member of that flavour, for example referring to an Council or prevent an NCBs decision- obligation to conduct monetary policy making bodies from complying with rules within the framework of the general adopted at the level of the ECB. economic policy of the Member State concerned, need to be adapted. 3.5 Financial provisions

3.2 Tasks Financial provisions in the Statute, which may be of particular relevance as far as the In Stage Three an NCBs tasks are identification of incompatibilities in the predominantly determined by its status as an integral part of the ESCB and, thus, by the Treaty and the Statute. In order to 21 Article 14.3 in conjunction with Article 43.1 of the comply with Article 108 of the Treaty, Statute implies that fully participating NCBs will provisions on tasks in the statutes of NCBs become an integral part of the ESCB and that they will have to comply with guidelines and instructions therefore need to be compared with the from the ECB. 22 relevant Treaty and Statute provisions 22 In particular Articles 105 and 105a of the Treaty and incompatibilities need to be removed. and Articles 3 to 6 of the Statute.

296 statutes of NCBs is concerned, may be 3.6 Miscellaneous divided into rules on accounting23, auditing24, capital subscriptions25, transfer of foreign In addition to the above-mentioned issues, reserve assets26 and monetary income27. there may be other areas where the These rules imply that NCBs need to be adaptation of the statutes of NCBs is able to comply with their obligations under required. For example, the obligation of the relevant Treaty and Statute articles. professional secrecy for staff of the ECB and NCBs as laid down in Article 38 of the Statute may have an impact on similar provisions in the statutes of NCBs as well.

4 Legislation other than the statutes of NCBs

The obligation of legal convergence under 4.2 Coins Article 108 of the Treaty, which is incorporated in a chapter entitled Monetary A number of Member States have laws on Policy, applies to those areas of legislation the issuance, production and distribution which are affected by the transition from of coins. Usually, governments or, more Stage Two to Stage Three and which specifically, Ministers of Finance have the would be incompatible with the Treaty and exclusive right to mint coins, while NCBs the Statute if they were to remain are often involved in the distribution unchanged. The EMIs assessment focuses thereof. In some cases, the right to print on laws with an impact on an NCBs banknotes and mint coins is combined performance of ESCB-related tasks and within an NCB. Irrespective of the division laws in the monetary field. Relevant of responsibilities in this field between legislation requiring adaptation may in governments and NCBs, the relevant particular be found in the following areas: provisions have to recognise the ECBs power of approval of the volume of issuance of coins. 4.1 Banknotes

The currency acts of a number of Member 4.3 Foreign reserve management States assign the exclusive right to issue banknotes to their NCBs. These acts have One of the main tasks of the ESCB is to to recognise the Governing Councils hold and manage the official foreign reserves exclusive right to authorise the issuance of of the Member States (Article 105 (2) of banknotes as laid down in Article 105a (1) the Treaty). Member States which do not of the Treaty and repeated in Article 16 of transfer their official foreign reserves to the Statute. In addition, provisions enabling their NCB do not comply with this governments to exert an influence on issues such as the denominations, production, volume and withdrawal of 23 banknotes have to recognise the ECBs Article 26 of the Statute. 24 Article 27 of the Statute. powers with regard to the euro banknotes 25 Article 28 of the Statute. as laid down in the above Treaty and 26 Article 30 of the Statute. Statute articles. 27 Article 32 of the Statute.

297 requirement of the Treaty (with the responsibility for the euro areas exchange exception of foreign exchange working rate policy will be transferred to the balances, which the governments of the Community level in accordance with Article Member States may keep under Article 109 of the Treaty, which assigns the 105 (3) of the Treaty). In addition, a right responsibility for such policy to the EU of a third party, for example government Council in close co-operation with the or parliament, to influence decisions of an ECB. NCB with regard to the management of the official foreign reserves would (under Article 105 (2) of the Treaty) not be in 4.5 Miscellaneous conformity with the Treaty. Furthermore, NCBs will have to provide the ECB with There are many other areas where foreign reserve assets in proportion to legislation may have an impact on an their shares in the subscribed capital of the NCBs performance of ESCB-related tasks. ECB. This means that there must be no For example, Member States are free to statutory obstacles to NCBs transferring organise their respective NCBs under public foreign reserve assets to the ECB. or private law, but provisions governing the legal status of an NCB - in the latter case, for instance, company law - may not 4.4 Exchange rate policy infringe Treaty and Statute requirements for Stage Three. Furthermore, the In most Member States, national legislation confidentiality regime of the ESCB is provides that the government is responsible governed by Article 38 of the Statute. The for the exchange rate policy with a supremacy of Community law and rules consultative and/or executive role for the adopted thereunder implies that national respective NCB. Full responsibility for a laws on access of third parties to public Member States exchange rate policy is documents may not lead to infringements only assigned to an NCB in a few cases. of the ESCBs confidentiality regime. Provisions have to reflect the fact that

5 Country assessments

The above specification of areas of particular 5.1 Belgium importance to the adaptation of statutes of NCBs and other legislation with a view to The statute of the National Bank of Belgium Treaty and Statute requirements for Stage was amended to meet Treaty and Statute Three may serve as a basis for a country- requirements for Stage Three with Law by-country assessment of the state of No. 1061/12-96/97 (the new law), which affairs in this respect. Such an assessment will progressively enter into force as from of the situation as at 24 March 1998 has February 1998. The EMI has been consulted been elaborated in an Annex to this Report on a draft version of the new law, which and is summarised below. has been amended, inter alia, in the light of the EMIs opinion.

298 With the adoption and entry into force of Bundesbank is compatible with Treaty and the new law, and assuming that specific Statute requirements for Stage Three. provisions thereof (for which progressive adaptation through Royal Decrees is As far as the adaptation of other legislation envisaged in Article 38) will enter into is concerned, the EMI takes note that force on time, the statute of the National adaptation of the Act on Coins is envisaged. Bank of Belgium will be compatible with The EMI is not aware of any other statutory Treaty and Statute requirements for Stage provisions which would require adaptation Three. under Article 108 of the Treaty.

As far as other legislation is concerned, the EMI takes note that adaptations are 5.4 Greece envisaged of the Law of 12 June 1930 creating a Monetary Fund, the Law of 28 The statute of the Bank of Greece was December 1973, the Law of 23 December amended to meet Treaty and Statute 1988 and Decree-Law No. 5 of 1 May requirements for Stage Three with Law 1944. The EMI is not aware of any other 2548 dated 12 December 1997, which was statutory provisions which would require published in the Government Gazette on adaptation under Article 108 of the Treaty. 19 December 1997 (the new law). The EMI has been consulted on a draft of the new law, which has been amended, inter 5.2 Denmark alia, in the light of the EMIs opinion.

The statute of Danmarks Nationalbank With the adoption and entry into force of does not contain incompatibilities in the the new law, there are no remaining area of central bank independence. The incompatibilities with Treaty and Statute legal integration of the Bank in the ESCB requirements for Stage Three in the statute does not need to be provided for and of the Bank of Greece. The new law other legislation does not need to be addresses both the period during which adapted as long as Denmark does not the Bank of Greece is not an integral part adopt the single currency. of the ESCB as well as a situation in which Greece has adopted the single currency. There are, however, two imperfections in 5.3 Germany the new law which still require adaptation before Greece adopts the single currency. The statute of the Deutsche Bundesbank Some of the provisions of the new law will was amended to meet Treaty and Statute become obsolete upon the adoption by requirements for Stage Three with the Greece of the single currency. This applies Sixth Act amending the Deutsche to the following provisions: Bundesbank Act dated 22 December 1997, which was published in the Federal Law - Article 7.4 (new) on the imposition of Gazette on 30 December 1997 (the new minimum reserves and penalties in the law). The EMI has been consulted on a case on non-compliance does not draft of the new law, which has been recognise the ECBs powers in this field. amended, inter alia, in the light of the EMIs opinion. - Article 2.4 (new) on the Banks participation in international monetary With the adoption and entry into force of and economic organisations does not the new law, the statute of the Deutsche refer to the ECBs power of approval.

299 As far as other legislation is concerned, the begin on 7 April 1998 and should be EMI is not aware of any other statutory concluded on 30 April 1998. The EMI has provisions which would require adaptation been consulted on the draft law, which has under Article 108 of the Treaty. been amended, inter alia, in the light of the EMIs opinion.

5.5 Spain Assuming that the draft law is adopted as it stood on 24 March 1998 and that it will The statute of the Banco de Espaæa was enter into force on time, the statute of the amended to meet Treaty and Statute Banque de France will be compatible with requirements for Stage Three in the area Treaty and Statute requirements for Stage of central bank independence with Law Three. 66/1997 of 30 December 1997 (the new law). The Banks statute is in the process Article 6 (draft) states that the General of being amended to meet Treaty and Council shall decide on issues related to Statute requirements in the area of the the conduct of the Banque de Frances Banks integration in the ESCB with a draft activities other than those deriving from law (the draft law) which is currently the tasks of the European System of Central pending before Parliament. The EMI has Banks. In this context, it is pointed out that been consulted on a draft of the law, which certain operations mentioned in Article 11 has been amended, inter alia, in the light of and in Chapter III of the statute of the the EMIs opinion. The Spanish Government Banque de France are to be considered as expects the draft law to be adopted before ESCB operations in the sense of Chapter the date of the establishment of the ESCB. IV of the Statute. This would merit clarification. Assuming that the draft law is adopted as it stood on 24 March 1998 and that it will As far as the adaptation of other legislation enter into force on time, the statute of the is concerned, the EMI takes note that Banco de Espaæa will be compatible with adaptations are envisaged of Decree No. Treaty and Statute requirements for Stage 93-1278 of 3 December 1993 on the Three. Banque de France, Law No. 84-46 of 24 January 1984, Decree No. 84-708 of 24 As far as other legislation is concerned, the July 1984 and the Regulation on Coinage. EMI takes note that further adaptation of The EMI is not aware of any other statutory Law No. 10/1975 of 12 March 1975 on provisions which would require adaptation Coinage is envisaged. The EMI is not aware under Article 108 of the Treaty. of any other statutory provisions which would require adaptation under Article 108 of the Treaty. 5.7 Ireland

The statute of the Central Bank of Ireland 5.6 France was amended to meet Treaty and Statute requirements for Stage Three by the Central The statute of the Banque de France is Bank Act 1998 (the new law) which, in currently being adapted to meet Treaty accordance with Article 1.3 thereof, will and Statute requirements for Stage Three. progressively enter into force through The Ministry of the Economy, Finance and ministerial orders. The EMI has been Industry has prepared a draft law (the consulted on the new law, which has been draft law) and has confirmed that the amended, inter alia, in the light of the EMIs parliamentary debate on that draft will opinion.

300 With the adoption and entry into force of Italian legislation into line with Article 108 the new law, and assuming that specific of the Treaty through a legislative decree. provisions thereof will enter into force on Subsequently, the EMI was consulted on a time, there will be no remaining draft legislative decree submitted to it by incompatibilities with Treaty and Statute the Italian Government. This legislative requirements for Stage Three in the statute decree (No. 43 dated 10 March 1998; the of the Central Bank of Ireland. There are, legislative decree) was published in the however, two imperfections, which will Official Gazette of 14 March 1998. It not jeopardise the overall functioning of amends various laws and also provides for the ESCB at the start of Stage Three and amendments to the Statute of the Banca which will be addressed in the context of dItalia (the By-Laws). The amendments forthcoming legislative changes. of the Banks By-Laws, on which the EMI was consulted, were adopted by the Banks - The Minister for Finances ability under General Meeting of Shareholders on 19 Article 134 (new law) to suspend in the March 1998 and will enter into force upon national interest certain business approval by a Presidential Decree. The transactions seems to refer to operations Government expects this to take place in of entities other than the Bank and not the first half of April 1998. to include the Banks (ESCB-related) operations. However, this needs to be Assuming that the amendments to the clarified in order to avoid any possibility Banks By-Laws adopted by the General of government interference in the Banks Meeting of Shareholders are approved by a ESCB-related operations. Presidential Decree and that they will enter into force on time, and assuming that - The consent of the Minister for Finance, the provisions referred to in Article 11.1 of which is required under Articles 10.1 Legislative Decree No. 43 dated 10 March and 13.1(b) of the Central Bank Act 1998 will enter into force on the date of 1997 before the Bank may refuse to the establishment of the ESCB at the latest, approve the rules of a payment system the statute of the Banca dItalia will be or subsequently revoke such approval, compatible with Treaty and Statute is unrestricted and may therefore also requirements for Stage Three. extend to the Banks ESCB-related involvement in payment systems. As far as other legislation is concerned, the EMI is not aware of any other statutory As far as other legislation is concerned, the provisions which would require adaptation Decimal Currency Act has also been under Article 108 of the Treaty. adapted through the new law. The EMI is not aware of any other statutory provisions which would require adaptation under 5.9 Luxembourg Article 108 of the Treaty. The Law of 20 May 1983 establishing the Institut MonØtaire Luxembourgeois (IML) 5.8 Italy as amended and the Law of 15 March 1979 on the monetary status of Luxembourg are The statutory provisions governing the currently being amended to meet Treaty Banca dItalia, which are contained in various and Statute requirements for Stage Three laws and decrees, have been amended to with Law No. 3862 (the draft law). The meet Treaty and Statute requirements for Government expects the draft law to be Stage Three. Law No. 433 of 17 December adopted by Parliament before April 1998 1997 empowered the Government to bring so that it may enter into force on 1 May 1998.

301 In February 1994 the EMI was consulted As far as other legislation is concerned, the on an initial draft. EMI is not aware of any other statutory provisions which would require adaptation Assuming that the draft law is adopted as it under Article 108 of the Statute. stood on 24 March 1998 and that it will enter into force on time, there will be no remaining incompatibilities with Treaty 5.10 Netherlands and Statute requirements for Stage Three in the statute of the IML, although there The statute of De Nederlandsche Bank is are various imperfections which will, currently being amended to meet Treaty however, not jeopardise the overall and Statute requirements for Stage Three. functioning of the ESCB at the start of The EMI has been consulted on a draft law Stage Three: (the draft law), which has been amended, inter alia, in the light of the EMIs opinion. - Article 2.2, first indent, and Article 6 lit. The draft law was endorsed by the Second a (draft) state that the IMLs Council Chamber of Parliament on 17 February shall define and implement monetary 1998 and is currently pending before the policy at a national level; this is First Chamber of Parliament, which can inconsistent with Article 2A)(3) and (4) only reject or endorse the draft law in its (draft), which states that the IML entirety. The Government expects the becomes a part of the ESCB and fulfils draft law to be endorsed by the First its missions within the framework of Chamber of Parliament on 24 March 1998 international monetary treaties to which and published in the Government Gazette Luxembourg is a party. In addition, the on 25 March 1998. Banks Council is largely composed of members who will not fulfil their duties Assuming that the draft law is adopted as it vis--vis the IML on the basis of stood on 24 March 1998 and that it will professional exclusivity while, at the enter into force on time, there will be no same time, no explicit rules ensure that remaining incompatibilities with Treaty and conflicts of interest might not arise from Statute requirements for Stage Three in other functions of the IMLs Council the statute of De Nederlandsche Bank, members. These inconsistencies should although there is one imperfection, which be corrected urgently. will, however, not jeopardise the overall functioning of the ESCB at the start of - The IMLs statutory objective as laid Stage Three: Article 3 (draft) states that down in Article 2.1 (draft) does not the Bank shall co-define the ESCBs unambiguously reflect the primacy of the monetary policy, whereas it is the Banks ESCBs secondary statutory objective. Governor who will do so in his/her capacity as a member of the Governing Council of - Article 2.2, fifth indent, and Article 17 the ECB. (draft) state that the IML shall issue monetary tokens, which without As far as other legislation is concerned, the recognising the competences of the EMI takes note that adaptations are ECB in this field. envisaged of the Coinage Act, the Act on the exchange rate of the guilder, the Act - Article 25 (draft) states that the IML on external financial relations 1994, the may provide credit facilities to ensure Act on the supervision of securities trade the stability of payment systems without 1995, the Archives Act 1995, and Royal recognising the competences of the Decrees adopted under the Act on public ECB in this domain. access to Government documents as well

302 as under the Ombudsman Act. The EMI is State. This reference to international not aware of any other statutory provisions norms intends to cover in particular which would require adaptation under the Treaty and the Statute. Article 108 of the Treaty. - The Organic Law of the Banco de Portugal of 30 October 1990 as 5.11 Austria amended was changed with Law No. 5/ 98 of 31 January 1998 (the new law). The statute of the Oesterreichische Nationalbank is currently being adapted to With the adoption and the entry into force meet Treaty and Statute requirements for of the Constitutional Law No. 1/97 and the Stage Three. A draft law (the draft law) new law, the statute of the Banco de has been submitted to Parliament and the Portugal is compatible with Treaty and Government expects the draft law to be Statute requirements for Stage Three. adopted in the course of April 1998. The EMI has been consulted on the draft law, As far as other legislation is concerned, the which has been amended, inter alia, in the EMI takes notes that adaptations are light of the EMIs opinion. envisaged of Decree-Law No. 333/81 of 7 December 1981, Decree-Law No. 293/86 Assuming that the draft law is adopted as it of 12 September 1986, Decree-Law No. stood on 24 March 1998 and that it will 178/88 of 19 May 1988 and Decree-Law enter into force on time, the statute of the No. 13/90 of 8 January 1990. The EMI is Oesterreichische Nationalbank will be not aware of any other statutory provisions compatible with Treaty and Statute which would require adaptation under requirements for Stage Three. Article 108 of the Treaty.

As far as other legislation is concerned, the EMI takes note that adaptation of the 5.13 Finland Foreign Exchange Act is envisaged. The EMI is not aware of any other statutory The statute of Suomen Pankki was amended provisions which would require adaptation to meet Treaty and Statute requirements under Article 108 of the Treaty. for Stage Three by means of a revised Act on the Bank of Finland (the revised law), which entered into force on 1 January 1998. 5.12 Portugal The revised law has, again, been adapted through a new law (the new law) in order The statute of the Banco de Portugal was to bring the Banks statute fully into line amended to meet Treaty and Statute with the Treaty and the Statute. The new requirements for Stage Three, following a law was adopted by Parliament on 20 consultation with the EMI, as follows. March 1998 and is expected to be promulgated on 27 March 1998. The new - Article 105 of the Constitution was law will enter into force, in respect of the adapted by means of the Constitutional provisions on independence, immediately Law No. 1/97 of 20 September 1997. after its promulgation and, in respect of the The new article (renumbered Article provisions on the Banks legal integration 102) now states that the Bank is the in the ESCB, on 1 January 1999. The EMI national central bank of Portugal and has been consulted on both the revised performs its functions in accordance law and the new law in their draft versions, with the law and with the international and both have been amended, inter alia, in norms binding upon the Portuguese the light of the EMIs opinion.

303 With the adoption of the new law, the Statute requirements for Stage Three in statute of Suomen Pankki will be compatible the statute of Sveriges Riksbank: with Treaty and Statute requirements for Stage Three. - The timetable for adaptation (see above) is incompatible with Article 108 of the As far as other legislation is concerned, the Treaty, which requires adaptations in EMI takes note that adaptations of the the area of central bank independence Currency Act and the Act on Coins have to become effective at the date of the been completed. The EMI is not aware of establishment of the ESCB at the latest. any other statutory provisions which would require adaptation under Article 108 of - The draft law does not anticipate the the Treaty. Banks legal integration in the ESCB, although Sweden is not a Member State with a special status and must therefore 5.14 Sweden comply with all adaptation requirements under Article 108 of the Treaty. This The Constitution Act, the Riksdag Act and affects a number of provisions in the the Sveriges Riksbank Act are currently Banks statute. being adapted to meet Treaty and Statute requirements for the independence of As far as other legislation is concerned, the Sveriges Riksbank. A draft law (the draft EMI notes that legislation on access to law) is currently pending before Parliament. public documents and the law on secrecy An adaptation of the Constitution Act need to be reviewed in the light of the requires the approval of two consecutive confidentiality regime under Article 38 of Parliaments, the next Parliament coming the Statute. The EMI is not aware of any into being after the general election in other statutory provisions which would September 1998. A first approval of require adaptation under Article 108 of amendments to the Constitution Act and the Treaty. the Riksdag Act by Parliament was given on 4 March 1998 and a second approval is expected to be given in October 1998, 5.15 United Kingdom when the Sveriges Riksbank Act is also expected to be adopted in accordance Since the United Kingdom has notified the with the Constitution Act as amended. All Council that it does not intend to adopt adaptations are envisaged to enter into the single currency on 1 January 1999, force as from 1 January 1999. The EMI has there is no current legal requirement to been consulted on the envisaged changes ensure that national legislation (including to the above-mentioned Acts, which have the statute of the Bank of England) is been amended, inter alia, in the light of the compatible with the Treaty and the Statute. EMIs opinion. The EMI notes, however, that the United Kingdom is in the process of adopting Assuming that the draft law is adopted as it several reforms covering its monetary policy stood on 24 March 1998, there are two framework. Further legislation would be remaining incompatibilities with Treaty and required if the United Kingdom were to notify the Council that it intended to adopt the single currency.

304 Annex

Compatibility of national legislation, including the statutes of national central banks (“NCBs”) , with the Treaty/Statute, with particular emphasis on adaptations under Article 108 of the Treaty in view of Stage Three

This Annex contains an assessment of the compatibility of national legislation, including the statutes of the individual NCBs, in the Member States of the European Union with the Treaty and the Statute. It pays particular attention to completed and/or planned adaptations of such legislation under Article 108 of the Treaty. Issues listed in this Annex follow the sequence of topics addressed in Chapter II of the present Report.

For the sake of brevity, the content of this Annex is deliberately condensed and should be read in conjunction with the relevant parts of the present Report and the EMIs previous reports on legal convergence in the EU Member States for further clarification. Likewise, no reference is made to opinions on the adaptation of national legislation which the EMI has delivered in accordance with the consultation procedures under Article 109f (6) of the Treaty and Article 5.3 of its Statute, unless there is a specific reason to do so.

References to articles relate to those of the statute of the NCB concerned, unless otherwise indicated. References to articles in the Treaty and the Statute relate to those in the Treaty establishing the European Community and the Statute of the ESCB/ECB respectively.

305 BELGIUM

1 Legislation within 2.1.1 Institutional independence the scope of Article 108 of the Treaty Article 29 (old) gave the Minister for Finance and Foreign Trade the right to The following legislation required adaptation oppose the execution of any measure under Article 108 of the Treaty: adopted by the Bank which would be contrary to the law, statutes or interests of - the Organic Law on the National Bank the State. In addition, Article 30 (old) gave of Belgium of 24 August 1939 as the Government Commissioner the right amended (the old law); to suspend any decision by the Bank that would be contrary to the law, statutes or - the Law of 12 June 1930 creating a interests of the State. These articles were Monetary Fund; already amended by the Law of 22 March 1993, but the possibility for the Minister - the Law of 28 December 1973; for Finance and Foreign Trade or the Government Commissioner to challenge - the Law of 23 December 1988; decisions of the Bank on legal grounds, which could potentially also extend to - Decree-Law No. 5 of 1 May 1944. decisions on ESCB-related tasks, was maintained. This possibility has now been restricted by Article 22 (new) to the 2 Adaptation of the statute Banks non-ESCB related tasks. of the National Bank of Belgium In addition, whereas under the old law the Council of Regency was competent to take The statute of the National Bank of Belgium certain monetary policy decisions, Article was amended to meet Treaty and Statute 20 (new) restricts the Council of Regencys requirements for Stage Three with Law involvement to an advisory role without an No. 1061/12-96/97 (the new law), which ex ante right of consultation. However, the will progressively enter into force as from provisions of the old law concerning the February 1998. The EMI has been consulted competences of the Council of Regency on a draft version of the new law, which will be abrogated on a date to be decided has been amended, inter alia, in the light of by the King, at the latest on the day of the EMIs opinion. introduction of the euro (Article 38(1) and (3) of the new law). As the Council of Regency does not fulfil the requirements of 2.1 Independence the Treaty and the Statute on independence and provisions on independence need to With regard to the Banks independence, be effective at the date of the establishment the following adaptations of the old law of the ESCB at the latest, the Government have been made in the new law with effect envisages an adaptation in this respect to from the date of the establishment of the take effect at the date of establishment of ESCB at the latest. the ESCB at the latest.

306 2.1.2 Personal independence with the Treaty and the Statute as far as ESCB-related tasks are concerned. Under Article 44 of the present Articles of Association of the Bank, the Governor could be suspended or dismissed by the 2.2.3 Instruments King without indication of a reason. This incompatibility with Article 14.2 of the Articles 11 to 19 (old), which established Statute has been resolved in Article 25 inter alia the instruments which the Bank (new), in which the grounds for dismissal was empowered to apply in carrying out its are reproduced as laid down in Article tasks, have been adapted in Chapter II, 14.2. Articles 5 to 9 (new) so as to be in line with the Treaty and the Statute in this respect. 2.2 Legal integration in the ESCB

With regard to the Banks legal integration, 2.2.4 Organisation the following adaptations have been made with effect from the date on which Belgium Whereas under the old law the Council of adopts the single currency. Regency had the competence to take certain monetary policy decisions, in Article 20 (new) its role has been restricted to 2.2.1 Statutory objective advisory tasks.

The old law neither reflected the primacy of the ESCBs statutory objective nor 3 Adaptation of other anticipated the Banks integration in the legislation ESCB. This has been resolved in the new law through the fact that the Banks 3.1 Law of 12 June 1930 creating a statutory objective in Stage Three will be Monetary Fund determined by directly applicable Community law and in particular Article 105 Article 1 of this law, which sets a limit on (1) of the Treaty and Article 2 of the the volume of divisionary monies which Statute and through Article 2 (new), which may be issued by the Treasury (which may explicitly acknowledges the Banks be extended by Royal Decree), does not integration in the ESCB. recognise the ECBs power of approval of the volume of issuance as laid down in Article 105a (2) of the Treaty. The so- 2.2.2 Tasks called euro legislation which is in the process of being adopted will remove this Articles 6 to 9 (old) on the issuance, incompatibility. design, text, replacement and withdrawal of banknotes did not recognise the ECBs powers in this field. This has been resolved 3.2 Law of 28 December 1973 in Article 2 (new) through the general reference to the Banks status as an integral Articles 1 to 3 of this law relating to budget part of the ESCB. In addition, Articles 11 to proposals for 1973 and 1974, which are 19 (old), which listed inter alia the Banks the legal basis for the imposition of tasks, have been adapted in Chapter II, minimum reserves on credit institutions by Articles 5 to 9 (new), which bring the the Bank, do not respect the ECBs description of the Banks tasks into line competences in this field. According to

307 Article 38(4), third paragraph, of the new 3.4 Decree-Law No. 5 of 1 May 1944 law, the above provisions will be repealed with effect from the date on which Belgium This Decree-Law is incompatible with the adopts the single currency. Treaty and the Statute to the extent that it relates to the execution of international payment, exchange and compensation 3.3 Law of 23 December 1988 agreements entered into by the Bank for the account of the State and to the extent Article 2 of this law, which authorises the that it relates to credit activities exercised Government to determine the exchange by the Bank outside the scope of monetary rate of the Belgian franc without prejudice policy such as bilateral payment agreements to international obligations applicable to with foreign states. According to Article the Belgian State, neither envisages the 38(4), second paragraph, of the new law, introduction of the euro nor recognises this Decree-Law will be repealed with the Communitys powers in the field of effect from the date on which Belgium exchange rates. According to Article 38(4), adopts the single currency. fourth paragraph, of the new law, the above article will be repealed with effect from the date on which Belgium adopts 4 Assessment of compatibility the single currency. The same applies to Article 3 of this law, which entrusts a With the adoption and entry into force of special regulatory power to the Minister the new law, and assuming that specific for Finance and Foreign Trade with regard provisions thereof (for which progressive to the application of Royal Decrees relating adaptation through Royal Decrees is to the Governments power to determine envisaged in Article 38) will enter into the exchange rate for the Belgian franc. force on time, the statute of the National According to Article 38(4), fourth Bank of Belgium will be compatible with paragraph, of the new law, Article 3 of the Treaty and Statute requirements for Stage Law of 23 December 1988 is repealed Three. with effect from the date on which Belgium adopts the single currency. As far as other legislation is concerned, the EMI takes note that adaptations are envisaged of the Law of 12 June 1930 creating a Monetary Fund, the Law of 28 December 1973, the Law of 23 December 1988 and Decree-Law No. 5 of 1 May 1944. The EMI is not aware of any other statutory provisions which would require adaptation under Article 108 of the Treaty.

308 DENMARK

1 Legislation within the Denmark will retain its existing powers in the scope of Article 108 of the field of monetary policy according to its Treaty national laws and regulations, including the powers of Danmarks Nationalbank in the field National Bank of Denmark Act (Act of monetary policy. In the light of this situation, No. 116) of 7 April 1936 as amended. no adaptation of the Banks statute in the area of its legal integration in the ESCB nor any other legislation is envisaged in view of Stage 2, 3 Adaptation of the statute Three. Finally, there are no incompatibilities in of Danmarks Nationalbank the area of central bank independence in the and other legislation Banks statute which would require adaptation under Article 108 of the Treaty in conjunction Protocol No. 12 of the Treaty on certain with Articles 109k (3) and 107 thereof. provisions relating to Denmark states that the Danish Government shall notify the Council of its position concerning participation in Stage 4 Assessment of compatibility Three before the Council makes its assessment under Article 109j (2) of the Treaty. Denmark The statute of Danmarks Nationalbank has already given notification that it will not does not contain incompatibilities in the participate in Stage Three and, in accordance area of central bank independence which with Article 2 of Protocol No. 12, this means would require adaptation under Article that Denmark will be treated as a Member 108 of the Treaty. The legal integration of State with a derogation. Implications of this the Bank in the ESCB does not need to be were elaborated in a Decision taken by the provided for and other legislation does not Heads of State or Government at their need to be adapted as long as Denmark Edinburgh summit meeting on 11 and 12 does not adopt the single currency. December 1992. The Decision states that

309 GERMANY

1 Legislation within the 2.1.2 Personal independence scope of Article 108 of the Treaty The fact that there used to be no guaranteed minimum five-year term of The following legislation required adaptation office for members of the Banks decision- under Article 108 of the Treaty: making bodies was incompatible with Article 14.2 of the Statute. Articles 7 and 8 (new) - the Bundesbank Act of 26 July 1957, as have increased the minimum term of office amended by the Fifth Act amending the of the Banks President, the other members Deutsche Bundesbank Act dated 8 July of the Board and the Presidents of the 1994 (the old law); Land Central Banks from two to five years.

- the Act on Coins. 2.2 Legal integration in the ESCB

2 Adaptation of the statute With regard to the Banks legal integration in of the Deutsche the ESCB, the following adaptations have Bundesbank been made with effect from the date on which Germany adopts the single currency. The statute of the Deutsche Bundesbank was amended to meet Treaty and Statute requirements for Stage Three with the Sixth 2.2.1 Statutory objective Act amending the Deutsche Bundesbank Act dated 22 December 1997, which was Article 3 (old), which contained the Banks published in the Federal Law Gazette on statutory objective, neither reflected the 30 December 1997 (the new law). The EMI primacy of the ESCBs statutory objective has been consulted on the draft of the new nor anticipated the Banks integration in law, which has been amended, inter alia, in the ESCB in Stage Three. Article 3 (new) the light of the EMIs opinion. introduces an explicit reference to the Banks integration in the ESCB. In addition, following a suggestion made by the EMI 2.1 Independence when it was consulted by the Federal Government on its draft legislation, Article With regard to the Banks independence, 12 (old) has been altered to state explicitly the following adaptations were made with that the Bank may only support national effect from 31 December 1997. economic policy if this is compatible with the objectives and tasks of the ESCB.

2.1.1 Institutional independence 2.2.2 Tasks Article 13.2 (old), which gave the German Government the right to defer a decision of the Article 14.1 (old), which established the Central Bank Council for up to two weeks, was Banks exclusive right to issue banknotes, incompatible with Treaty and Statute require- did not recognise the ECBs competence ments on central bank independence. This in this field. Article 14.1 (new), first sentence, provision has been repealed in the new law. introduces an explicit reference to the ECBs right of approval with regard to the

310 issuance of banknotes as laid down in 3 Adaptation of other Article 105a (1) of the Treaty and repeated legislation in Article 16 of the Statute. It is envisaged that the Act on Coins will be amended in order to give explicit 2.2.3 Instruments recognition to the competence of the ECB under Article 105a (2), first sentence, of Articles 15 and 16 (old), which listed the the Treaty. This amendment will be part of Banks monetary policy instruments the Act on the introduction of the euro (discount, lending and open market policies and will enter into force on the date on and minimum reserve policy), did not which Germany adopts the single currency. recognise the ECBs competences in this field. These provisions have been repealed in the new law. 4 Assessment of compatibility

With the adoption and entry into force of 2.2.4 Organisation the new law, the statute of the Deutsche Bundesbank is compatible with Treaty and Article 6.1 (old), first sentence, which Statute requirements for Stage Three. provided for the Central Bank Councils competence to determine the monetary As far as the adaptation of other legislation policy of the Bank, did not reflect the is concerned, the EMI takes note that ECBs competences in this field. Article 6.1 adaptation of the Act on Coins is envisaged. (new), first sentence, explicitly states that The EMI is not aware of any other statutory (a) the responsibility for the definition of provisions which would require adaptation monetary policy in Stage Three will pass to under Article 108 of the Treaty. the Governing Council of ECB; (b) the Bank will need to comply with guidelines and instructions from the ECB in the performance of ESCB-related tasks; and (c) the Banks President, in his/her capacity as a member of the Governing Council, is independent of instructions from the Central Bank Council.

2.2.5 Participation in international monetary institutions

Following a suggestion made by the EMI when it was consulted by the Federal Government on its draft legislation, Article 4 has been amended. An insertion into this provision makes it clear that the Banks power to participate in international monetary institutions will be subject to the ECBs approval.

311 GREECE

1 Legislation within the was incompatible with Treaty and Statute scope of Article 108 of the requirements on central bank Treaty independence. Article 1 (new) on the Banks statutory objective remedies this The statute of the Bank of Greece of 1927 situation (see also paragraph 2.2.1 below). as amended (the old law) required adaptation under Article 108 of the Treaty. 2.1.2 Personal independence

2 Adaptation of the statute Article 29 (old) did not contain a minimum of the Bank of Greece five-year term of office for the Banks Governor (or for the other members of The statute of the Bank of Greece was the General Council) and was therefore amended to meet Treaty and Statute incompatible with Article 14.2 of the requirements for Stage Three with Law Statute. Articles 5(3) and 6(3) (new) fix 2548 dated 12 December 1997, which was the term of office of the Governor, the published in the Government Gazette on Deputy Governors and the other members 19 December 1997 (the new law). The of the Monetary Policy Council at six years. EMI has been consulted on a draft of the All the members of the Monetary Policy new law, which has been amended, inter Council are required to devote their alia, in the light of the EMIs opinion. professional activities exclusively to the Bank, with only a few minor exceptions (such as academic positions) which cannot 2.1 Independence give rise to potential conflicts of interest.

With regard to the Banks independence, the following adaptations were made with 2.2 Legal integration in the ESCB effect from 19 December 1997. With regard to the Banks legal integration in the ESCB, a number of adaptations have 2.1.1 Institutional independence been made with effect from the date on which Greece adopts the single currency. Article 47 (old), which established the In general, the new law acknowledges in Government Commissioners power to Articles 1.2 and 2.3 that the Bank will veto decisions of the General Council on become an integral part of the ESCB and the grounds of legality, was incompatible will need to comply with the ECBs with Treaty and Statute requirements on guidelines and instructions. In addition, central bank independence. This Article 12.17 (new) states that any provision incompatibility has been resolved by means of the new law which is incompatible with of Article 6 of the new law, which makes a primary or secondary Community law newly established Monetary Policy Council governing the Banks ESCB-related tasks is responsible for the Banks ESCB-related to be deemed to be abolished as from the tasks, the decisions of which may not be date on which Greece adopts the single vetoed by the Government Commissioner. currency. Thus, the new law addresses In addition, the subordination of the Banks both a situation in which Greece is a monetary policy decisions to the Member State with a derogation as well as Governments macroeconomic objectives a situation in which Greece has adopted

312 the single currency. However, some of the 2.2.3 Instruments provisions of the new law will nevertheless become obsolete upon the adoption by Article 7.4 (new) on the imposition of Greece of the single currency and the minimum reserves and penalties in the statute of the Bank must then, for reasons case of non-compliance does not recognise of legal clarity and certainty, be further the ECBs powers in this field under Article adapted in the area of the Banks integration 19 of the Statute. This is an imperfection in in the ESCB. This applies to Articles 2.4 the new law which still requires adaptation and 7.4 (see paragraphs 2.2.4 and 2.2.3 with effect from the date on which Greece below). adopts the single currency.

2.2.1 Statutory objective 2.2.4 Participation in international monetary and economic organisations The Banks statutory objective neither reflected the primacy of the ESCBs Article 2.4 (new) states that the Bank may statutory objective nor anticipated the participate in international monetary and Banks legal integration in the ESCB. Article economic organisations. This Article does 1 (new) remedied this situation through a not reflect the ECBs right to approve such reference to the primacy of maintaining participation as laid down in Article 6.2 of price stability (in Article 1.1), through an the Statute. This is an imperfection in the explicit recognition of the Banks legal new law which still requires adaptation integration in the ESCB and through a with effect from the date on which Greece reference to the ESCBs statutory objective adopts the single currency. in the event of Greece adopting the single currency (in Article 1.2). 3 Adaptation of other legislation 2.2.2 Tasks The EMI is not aware of any other statutory Article 2.1 (new) states that the main tasks provisions which would require adaptation of the Bank shall be to define and implement under Article 108 of the Treaty. monetary policy and to conduct the policy with regard to the exchange rate of the Greek drachma against other currencies 4 Assessment of compatibility within the framework of the exchange rate policy chosen by the Government following With the adoption and entry into force of consultation from the Bank. In addition, the new law, there are no remaining Article 2.3 (new) recognises the Banks incompatibilities with Treaty and Statute legal integration in the ESCB once Greece requirements for Stage Three in the statute adopts the single currency and the fact that of the Bank of Greece. The new law the Bank from that moment onwards will addresses both the period during which have to perform the above tasks within the the Bank of Greece is not an integral part framework of the ESCB. Furthermore, of the ESCB as well as a situation in which Article 12.2 (new) states that the Bank Greece has adopted the single currency. shall conduct exchange rate policy in There are, however, two imperfections in accordance with the instructions and the new law which still require adaptation guidelines of the ECB as from the date on before Greece adopts the single currency. which Greece adopts the single currency. Some of the provisions of the new law will become obsolete upon the adoption by

313 Greece of the single currency. This applies - Article 2.4 (new) on the Banks to the following provisions: participation in international monetary and economic organisations does not - Article 7.4 (new) on the imposition of refer to the ECBs power of approval. minimum reserves and penalties in the case of non-compliance does not As far as other legislation is concerned, the recognise the ECBs powers in this field. EMI is not aware of any other statutory provisions which would require adaptation under Article 108 of the Treaty.

314 SPAIN

1 Legislation within the 2.1.1 Institutional independence scope of Article 108 of the Treaty Article 20.3 (old), which excluded voting rights for the Director-General of the Treasury and The following legislation required adaptation Financial Policy and the Vice-President of the under Article 108 of the Treaty: National Stock Market Commission, applied to monetary policy issues but not to all ESCB- - Law 13/1994 dated 1 June 1994 on the related tasks and was therefore incompatible Autonomy of the Banco de Espaæa as with Treaty and Statute requirements on amended (the old law); central bank independence. This Article has been adapted by the new law, which extends - Law 10/1975 of 12 March 1975 on the exclusion of voting rights described above Coinage. to cover all ESCB-related tasks.

2 Adaptation of the statute 2.1.2 Personal independence of the Banco de Espaæa Article 25.2 (old), which contained a term The statute of the Banco de Espaæa was of office for members of the Governing amended to meet Treaty and Statute Council other than the Governor and the requirements for Stage Three in the area Deputy Governor of four years rather than of central bank independence with Law a minimum of five years, was incompatible 66/1997 of 30 December 1997 (the new with Article 14.2 of the Statute. This Article law). The statute of the Bank is in the has been adapted by the new law, which process of being amended to meet Treaty extends the term of office of such members and Statute requirements in the area of the to six years. Banks integration in the ESCB with a draft law (the draft law) which is currently pending before Parliament. The EMI has 2.2 Legal integration in the ESCB been consulted on a draft of the law, which has been amended, inter alia, in the light of With regard to the Banks legal integration the EMIs opinion. The Spanish Government in the ESCB, the following adaptations are expects the draft law to be adopted before envisaged in the draft law with effect from the date of the establishment of the ESCB. the date on which Spain adopts the single currency.

2.1 Independence 2.2.1 Statutory objective With regard to the Banks independence, the new law contains the following adaptations Article 7 (old): which will enter into force on the date of the establishment of the ESCB/ECB. - The Banks powers to define and implement monetary policy do not recognise the ECBs powers in this field.

- The Banks secondary objective to support the general economic policy of the Spanish

315 Government is not in conformity with the - Article 12, which establishes the Banks ESCBs statutory objective. competence to implement the Governments exchange rate system, Article 7.2 (draft) provides for an does not recognise the ECBs amendment of Article 7 which would be competence in this field. compatible with Treaty and Statute requirements for Stage Three. The draft law provides for amendments to the above articles which would make them compatible with Treaty and Statute 2.2.2 Tasks requirements for Stage Three.

- Issuance of banknotes Article 7.3 (c) and (d) and Article 15, 3 Adaptation of other which establish the Banks exclusive right legislation to issue banknotes and to determine the volume of coins issued, do not recognise 3.1 Law 10/1975 of 12 March 1975 the ECBs competences in this field. on Coinage

- Monetary policy This law establishes a regime for minting Articles 8 and 9, which lay down the coins in a manner that does not recognise Banks powers with regard to the the competences of the ECB under Article formulation and implementation of 105a (2) of the Treaty. The draft law monetary policy, do not acknowledge provides for an amendment of Article 4 of the ECBs powers in this field. Law 10/1975 of 12 March 1975 on Coinage which would make it compatible with - Foreign exchange policy Treaty and Statute requirements for Stage Article 11, which specifies the power of Three. the Spanish Government to adapt the exchange rate system and the parity of the Spanish peseta against other 4 Assessment of compatibility currencies, does not recognise the Communitys competence in exchange Assuming that the draft law is adopted as it rate arrangements and does not envisage stood on 24 March 1998 and that it will the introduction of the euro. enter into force on time, the statute of the Banco de Espaæa will be compatible with The draft law provides for amendments to Treaty and Statute requirements for Stage the above articles which would make them Three. compatible with Treaty and Statute requirements for Stage Three. As far as other legislation is concerned, the EMI takes note that further adaptation of Law No. 10/1975 of 12 March 1975 on 2.2.3 Instruments Coinage is envisaged. The EMI is not aware of any other statutory provisions which - Article 9, which contains rules on would require adaptation under Article minimum reserves, does not 108 of the Treaty. acknowledge the fact that their content will be determined by the ECB.

316 FRANCE

1 Legislation within the Governor, Deputy Governors and the scope of Article 108 of the members of the Monetary Policy Council, Treaty which is responsible only for monetary policy issues. Consequently, it does not The following legislation required adaptation extend to all ESCB-related tasks. Article 1 under Article 108 of the Treaty: (draft), third paragraph, extends the prohibition on external influence to all - Law No. 93-980 of 4 August 1993 on ESCB-related issues, while Article 5 (draft) the status of the Banque de France and recognises the independence of the Banks the activities and supervision of credit President in his/her capacity as a member institutions as amended; of the Governing Council of the ESCB/ ECB. - Decree No. 93-1278 of 3 December 1993 on the Banque de France; - Article 2, third paragraph, states that the Bank shall hold and manage the States - Law No. 84-46 of 24 January 1984; and foreign exchange reserves, which shall be recorded as assets in its balance - Decree No. 84-708 of 24 July 1984. sheet. The same Article also states that these provisions shall be applied in accordance with a formal agreement 2 Adaptation of the statute between the State and the Bank, which of the Banque de France shall be subject to approval by Parliament. Article 2.II (draft) amends Article 2, third The statute of the Banque de France is paragraph, in such a manner that the Bank currently being adapted to meet Treaty and shall hold and manage the above reserves Statute requirements for Stage Three. The under the conditions laid down in the Ministry of the Economy, Finance and Industry Statute and, as in the past, the reserves has prepared a draft law and has confirmed shall be recorded as assets in the Banks that the parliamentary debate on that draft will balance sheet according to modalities laid begin on 7 April 1998 and should be concluded down in a formal agreement between the on 30 April 1998. The EMI has been consulted State and the Bank. The EMI takes note on the draft law, which has been amended, that the French Government has inter alia, in the light of the EMIs opinion. committed itself to submitting the above agreement to the ECB for its approval.

2.1 Independence - Article 19 provides for an obligation for the Banks Governor to report at least With regard to the Banks institutional once a year to the President of the independence, the following adaptations Republic and Parliament on the Banks are envisaged in the draft law with effect activities, monetary policy and its from the date on which France participates prospects and states in a second in the appointment of members of the paragraph that the Governor may be Executive Board of the ECB. asked, and may him/herself ask, to appear before the Finance Committees of the - Article 1 of the current statute, which two Chambers of Parliament. Article 7 contains a prohibition on external influence, (draft) envisages amendment of Article is restricted in its application to the 19, second paragraph, adding that this is

317 without prejudice to Article 107 of the the constraints derived from that status, Treaty and the ECBs secrecy rules. which is expected to lead to a revision of the statutes of the IEDOM.

2.2 Legal integration in the ESCB - Monetary policy (Article 7) The power of the Monetary Policy Council With regard to the Banks legal integration to define (the terms and conditions of) in the ESCB, the following adaptations are monetary policy operations does not envisaged in the draft law with effect as from recognise the ECBs powers in this field. 1 January 1999 or, alternatively, as from Article 4 (draft) envisages the amendment the date on which France adopts the single of Article 7 in such a manner that it will currency if that were to be a later date. explicitly be recognised that the ECBs Governing Council, and not the Banks Monetary Policy Council, will define 2.2.1 Statutory objective monetary policy.

Article 1, which contains the Banks statutory - Foreign exchange policy (Article 2) objective, reflects neither the ESCBs statutory The Governments powers to determine objective nor the Banks legal integration in the the exchange rate regime and the parity of ESCB in Stage Three. Article 1 (draft) envisages the French franc, as laid down in Article 2, accommodating this point through an explicit first paragraph, and the task of the Bank to recognition of the Banks status as an integral regulate the exchange rates between the part of the ESCB in Stage Three and a franc and other currencies both on behalf reference to the ESCBs statutory objective. of the Government and within the framework of the general exchange rate policy guidelines formulated by the Minister 2.2.2 Tasks of the Economy, Finance and Industry, as laid down in Article 2, second paragraph, - Issuance of banknotes (Article 5) do not envisage the introduction of the The Banks exclusive right to issue euro and do not recognise the Communitys banknotes does not recognise the ECBs competence in exchange rate matters. It is competence in this field. While Article 3.I envisaged in Article 2.I (draft) that the (draft) on the issuance of banknotes above paragraphs will be repealed. refers explicitly to Article 105a of the Treaty, it also states that the Bank shall The Banks right to participate in have the sole right to issue banknotes international monetary agreements with with status within metropolitan the permission of the Minister of the France in the dØpartements doutre-mer Economy, Finance and Industry does not and in the territorial collectivities of Saint recognise the Communitys competences Pierre et Miquelon and Mayotte. Banknotes in this field. Article 2.III (draft) amends issued in the dØpartements doutre-mer Article 2 in such a manner that the ECBs and the above territorial collectivities are and Communitys competences will be put into circulation by the Institut recognised through explicit references to dØmission des dØpartements doutre- Article 6.2 of the Statue and Article 109 of mer (IEDOM) on behalf of the Bank. The the Treaty. EMI takes note that the French Government is currently examining the consistency of the arrangements between the Bank and the IEDOM with the Banks status as an integral part of the ESCB and

318 2.2.3 Instruments 2.2.4 Organisation

- Article 2, third paragraph, and Article 7, The Banks General Council is, in accordance second and third paragraphs, on the Banks with Article 11, second paragraph, in charge instruments to conduct foreign exchange of the Banks activities other than those rate policy and monetary policy, directly related to monetary policy. As the respectively, do not recognise the ECBs General Council cannot, in view of its competences in this field. Article 2.II (draft) composition, which includes government envisages amendment of Article 2, third representatives with a right to vote, be paragraph (see paragraph 2.1, second considered to fulfil Treaty and Statute indent, above), while Articles 4.I and 4.II requirements for Stage Three on (draft) amend Article 7, second and third independence, adaptation is required as far as paragraphs, in such a manner that the ESCB-related tasks are concerned. Therefore, second paragraph on open market and Article 6 (draft) states that the General credit operations will explicitly recognise Council shall decide on issues related to the that such operations will be conducted conduct of the Banks activities other than within the framework of the ESCB and in those deriving from the tasks of the ESCB. In accordance with the guidelines and this context, it is pointed out that certain instructions of the ECB, while references operations mentioned in Article 11, fourth to the Banks power to impose minimum paragraph, and in Chapter III, Articles 15.2, 17 reserves (third paragraph) will be repealed. and 18 of the Banks statute are to be considered as ESCB operations in the sense - Article 18 establishes the Banks right to of Chapter IV of the Statute. This would enter into financial operations. This right merit clarification. must be without prejudice to the Banks ESCB-related obligations and particularly ECB approval and collateral requirements. 3 Adaptation of other It is envisaged to accommodate this concern legislation through Article 1 (draft), which states that the Bank participates in carrying out the 3.1 Decree No. 93-1278 of tasks and achieving the objectives of the 3 December 1993 on the Banque ESCB conferred upon it by the Treaty. In de France addition, where the tasks of the Monetary Policy Council are concerned, the draft law This decree stipulates the application respects the exclusive competences of the procedures for Law No. 93-980 of 4 Governing Council of the ECB (for example, August 1993 on the status of the Banque Article 4.I (draft) states that the Monetary de France and the activities and supervision Policy Council examines monetary policy of credit institutions as amended. developments, analyses the implications of the ESCBs monetary policy and It lays down the procedures for: specifies within the framework of the ECBs guidelines and instructions the nature - appointing and remunerating the and scope of collateral accepted by the members of the Monetary Policy Council Banque de France). and of the General Council;

- the functioning of the Monetary Policy Council and of the General Council;

- electing the representative of the Banks staff on the General Council;

319 - drawing up the Banks annual budget, 3.3 Decree No. 84-708 of 24 July which is submitted to the General 1984 Council; Article 13 of this decree entitles the Bank to - the presentation and approval of the delegate its competences in the field of accounts, including the distribution of minimum reserves to the IEDOM and the profits. Institut dØmission doutre-mer (IEOM), which act under its authority and for its account. It also establishes the rules governing the Article 4 (draft) abrogates the Banks drawing-up of the Banks accounts and the competences with respect to minimum auditing of these accounts by external reserves, and therefore the entitlement to auditors. delegate these functions also disappears.

Responsibility for the budget, the accounts, the profit allocation proposal and the audit 4 Assessment of compatibility belongs to the competence of the General Council. As a consequence of Article 6 Assuming that the draft law is adopted as it (draft), adaptation would be required for stood on 24 March 1998 and that it will enter the legal integration of the Bank in the into force on time, the statute of the Banque ESCB. de France will be compatible with Treaty and Statute requirements for Stage Three.

3.2 Law No. 84-46 of 24 January Article 6 (draft) states that the General 1984 Council shall decide on issues related to the conduct of the Banque de Frances activities Article 33(8) of Law No. 84-46 of 24 other than those deriving from the tasks of January 1984 empowers the Committee the European System of Central Banks. In on banking and financial regulations to this context, it is pointed out that certain adopt, without prejudice to the operations mentioned in Article 11 and in competences of the Monetary Policy Chapter III of the statute of the Banque de Council, instruments and rules on credit. France are to be considered as ESCB This Article does not recognise the ECBs operations in the sense of Chapter IV of the power in this field. Article 8 (draft) states Statute. This would merit clarification. that the Monetary Policy Council shall adopt subject to the tasks conferred upon As far as the adaptation of other legislation the ESCB by Article 105(2) of the Treaty is concerned, the EMI notes that adaptations establishing the European Community, the are envisaged of Decree No. 93-1278 of 3 instruments and rules of credit policy. December 1993 on the Banque de France, Law No. 84-46 of 24 January 1984, Decree No. 84-708 of 24 July 1984 and the Regulation on Coinage. The EMI is not aware of any other statutory provisions which would require adaptation under Article 108 of the Treaty.

320 IRELAND

1 Legislation within the the Treaty or the Statute shall be vested in scope of Article 108 of the the Governor or, in his/her absence, the Treaty Director General of the Bank.

The Central Bank Acts 1942-1997 and Article 6.2 of the Central Bank Act 1942, legislation relating to coinage required which imposed the obligation on the Governor adaptation under Article 108 of the or the Board of Directors to consult the Treaty. Minister for Finance if requested, was an explicit statutory mechanism which could be used to influence the decision-making process within 2 Adaptation of the statute the Bank and was, therefore, incompatible of the Central Bank of with Treaty and Statute requirements on central Ireland bank independence. The new law overcomes this by means of Article 5, which requires the The statute of the Central Bank of Ireland Governor and the Board of Directors to was amended to meet Treaty and Statute consult the Minister for Finance only with requirements for Stage Three by the Central regard to functions and duties other than Bank Act 1998 (the new law) which, in those imposed by the Treaty and the Statute. accordance with Article 1.3 thereof, will In addition, while the Minister may request progressively enter into force through that the Governor or the Board of Directors ministerial orders. The EMI has been consulted informs him/her with regard to the pursuit of on the new law, which has been amended, the Banks primary objective to maintain price inter alia, in the light of the EMIs opinion. stability, this power is subject to Treaty and Statute requirements (Article 5 of the new law).

2.1 Independence According to Article 24 of the Central Bank Act 1997, the Governor was required to With regard to the Banks independence, attend the meeting of a Select Committee of the following adaptations were made and DÆil ireann. This obligation would only have are expected to be brought into operation been compatible with the Treaty and the from the date of the establishment of the Statute if it (a) respected the independence of ESCB/ECB. the Governor in his/her capacity as a member of the Governing Council/General Council of the ECB; (b) only applied to ex post information; 2.1.1 Institutional independence and (c) was without prejudice to the confidentiality regime of Article 38 of the Article 5.3 of the Central Bank Act 1942, Statute. The new law addresses this issue in which contained the right of Service Article 17 by means of a provision which states Directors to participate in meetings of that the Governors attendance is to be the Board of Directors with a right to subject to Treaty and Statute requirements. vote, was incompatible with Treaty and Statute requirements on central bank The Minister for Finances power under independence. The new law overcomes Article 134 (new law) to suspend in the this by means of the provision in Article 4 national interest certain business transactions that sole authority and responsibility for after consulting the Bank seems to refer to the performance and exercise of any of the operations of entities other than the Bank Banks functions, duties or powers under and not to include the Banks (ESCB-related)

321 operations. However, this lack of legal clarity be vested in the Governor or, in his/her is an imperfection in the new law which absence, the Director General of the Bank. merits further consideration in order to rule out any possibility of government interference in the Banks ESCB-related operations. The 2.1.3 Financial independence EMI takes note that the Irish Government intends to do this in the context of forthcoming The power of the Minister for Finance under legislative changes. Article 23 of the Central Bank Act 1989 to regulate the periodical determination and Articles 10.1 and 13.1(b) of the Central Bank distribution of surplus income needed to be Act 1997 require the consent of the Minister adapted by means of the addition of a for Finance before the Bank may refuse to safeguard clause to prevent it from impeding approve the rules of a payment system or the proper performance of ESCB-related subsequently revoke such approval. This tasks. Article 12 (new law) adapts this power requirement is unrestricted and may therefore of the Minister by requiring him/her to have also extend to the Banks ESCB-related regard to the Banks powers, functions and involvement in payment systems which would duties under the Treaty and the Statute. not be in line with Treaty and Statute requirements for Stage Three. This lack of legal clarity is an imperfection in the new law which 2.2 Legal integration in the ESCB the Irish Government intends to address in the context of forthcoming legislative changes. With regard to the Banks legal integration, the following adaptations have been made.

2.1.2 Personal independence 2.2.1 Statutory objective Article 21 of the Central Bank Act 1942 was not fully in line with the grounds specified in The Banks statutory objective neither Article 14.2 of the Statute with regard to the reflected the primacy of the ESCBs statutory grounds for dismissal of the Governor, who objective nor anticipated the Banks integration may be dismissed for cause stated. Article 7 in the ESCB. Article 5 (new law) addresses (new law) addresses this issue by making this point by expressly providing that the express reference to serious misconduct as primary objective of the Bank, in discharging a ground for dismissal and by including a its functions as part of the ESCB, shall be to provision which states that any decision to maintain price stability. remove the Governor is subject to referral to the European Court of Justice in such a manner and for such reasons as are consistent 2.2.2 Tasks with Article 14.2 of the Statute. It was necessary to confer specific new In relation to the Banks non-executive powers on the Bank in order to enable it Directors, there were no arrangements in to participate in the ESCB and fulfil the place to ensure that no conflicts of interest obligations laid down in the Treaty. Articles could arise in their performance of ESCB- 4 and 5 (new law) contain provisions to related tasks. Article 4 (new law) overcomes enable this to be achieved. this by providing that sole authority and responsibility for the performance and exercise of any of the Banks functions, duties or powers under the Treaty or the Statute shall

322 2.2.3 Issuance of banknotes 4 Assessment of compatibility

The Banks exclusive right to issue banknotes With the adoption and entry into force of the did not recognise the ECBs competences in new law, and assuming that specific provisions this field. Article 16 (new law) addresses this thereof (for which progressive adaptation point by providing that it shall be lawful for through ministerial orders is envisaged in the Bank, with the authorisation of the ECB, Article 1.3) will enter into force on time, to issue legal tender banknotes denominated there will be no remaining incompatibilities in Irish pounds and any other denomination with Treaty and Statute requirements for for which the ECB has authorised the issuance. Stage Three in the statute of the Central In addition, Article 16 expressly provides that Bank of Ireland. There are, however, two such banknotes and banknotes issued by the imperfections, which will not jeopardise the ECB in accordance with Article 105a of the overall functioning of the ESCB at the start of Treaty shall be legal tender in Ireland for Stage Three and which will be addressed in payments of any amount. the context of forthcoming legislative changes.

- The Minister for Finances ability under 2.2.4 Foreign exchange policy Article 134 (new law) to suspend in the national interest certain business transactions Provisions in the Central Bank Acts 1942 seems to refer to operations of entities and 1989 gave powers to the Minister for other than the Bank and not to include the Finance to set exchange rates which do Banks (ESCB-related) operations. However, not recognise Community competences in this needs to be clarified in order to avoid this field in Stage Three. Article 13 (new any possibility of government interference law) repealed these provisions. in the Banks ESCB-related operations.

- The consent of the Minister for Finance, 3 Adaptation of other which is required under Articles 10.1 and legislation 13.1(b) of the Central Bank Act 1997 before the Bank may refuse to approve 3.1 Decimal Currency Act the rules of a payment system or subsequently revoke such approval, is The rights of the Ministry of Finance with unrestricted and may therefore also extend respect to coinage did not recognise the ECBs to the Banks ESCB-related involvement competences in this field. Article 14 (new in payment systems. law) addresses this issue by amending the Decimal Currency Act 1969, so as to provide As far as other legislation is concerned, the that the issuance of coins by the Minister for Decimal Currency Act has also been adapted Finance through the Bank is subject to the through the new law. The EMI is not aware of ECBs approval of the volume of coins issued. any other statutory provisions which would require adaptation under Article 108 of the Treaty.

323 ITALY

1 Legislation within the Subsequently, the EMI was consulted on a scope of Article 108 of the draft legislative decree submitted to it by Treaty the Italian Government. This legislative decree (No. 43 dated 10 March 1998; the The following legislation required adaptation legislative decree) was published in the under Article 108 of the Treaty: Official Gazette of 14 March 1998. It amends various laws and also provides for - statute of the Banca dItalia (Royal amendments to the statute of the Banca Decree No. 1067 of 11 June 1936 as dItalia (the By-Laws). The amendments amended); of the Banks By-Laws, on which the EMI was consulted, were adopted by the Banks - the 1910 codified law on the Banks of Issue General Meeting of Shareholders on (Royal Decree No. 204 of 28 April 1910 19 March 1998 and will enter into force as amended); upon approval by a Presidential Decree. The Government expects this to take - Title III of the 1936 Banking Law (Royal place in the first half of April 1998. Decree Law No. 375 of 12 March 1936 as amended); 2.1 Independence - Royal Decree Law No. 1284 of 23 November 1914; With regard to the Banks independence, the following adaptations were made with - Royal Decree No. 1377 of 17 June 1928; effect from 14 March 1998.

- Presidential Decree No. 811 of 9 October 1981; 2.1.1 Institutional independence

- Presidential Decree No. 148 of - Article 2 of Royal Decree Law No. 31 March 1988; 1284 of 23 November 1914 and Article 5 of Royal Decree No. 1377 of 17 June - Law No. 82 of 7 February 1992; 1928, which established the power of the Minister of the Treasury, Budget - Law No. 483 of 26 November 1993. and Economic Planning to set interest rates on certain interest-bearing current account deposits with the Bank (with 2 Adaptation of statutory the exception of those on compulsory provisions governing reserves), were incompatible with Treaty the Banca dItalia and Statute requirements on central bank independence. Article 3, first The statutory provisions governing the paragraph, of the legislative decree Banca dItalia, which are contained in various provides for the repeal of these laws and decrees, have been amended to provisions. Furthermore, pursuant to meet Treaty and Statute requirements for Article 3 of the legislative decree, the Stage Three. Law No. 433 of 17 December power of the Minister is transferred to 1997 empowered the Government to bring the Governor until the adoption by Italy Italian legislation into line with Article 108 of the single currency. Subsequently, of the Treaty through a legislative decree.

324 decisions shall be taken in accordance of the legislative decree, the Bank will with the Treaty and the Statute. independently manage the official foreign exchange reserves in conformity with - The Board of Directors decides on the Article 31 of the Statute as from the issuance of banknotes and the rules and date of the establishment of the ESCB. conditions for the Banks operations. The term of office of its members was three years, which did not comply with Article 2.1.2 Personal independence 14.2 of the Statute. Article 3, second paragraph, of the legislative decree, which The Board of Directors has some limited is intended to replace Article 22, second competence in certain ESCB-related paragraph, of the 1936 Banking Law, matters other than monetary policy. All of raises the term of office of the members its component members, with the exception of the Board to five years. A corresponding of the Governor, are non-executive amendment of Article 17 of the Banks members. In order to achieve full statute is provided for by the amendment compliance with the requirements on of the Banks By-Laws. personal independence concerning the need to avoid conflicts of interest arising from - The 1910 codified law on the Banks of other functions, the amendment of the Issue provided for the power of the Banks By-Laws provides for an amendment Treasury to suspend or annul resolutions of Article 60, according to which existing adopted by the Board of Directors of cases of incompatibilities are broadened the Bank on grounds of legitimacy. This and a general clause is inserted which was incompatible with Treaty and excludes from membership of the Board all Statute requirements on institutional persons having a conflict of interest with independence. Article 3.3 of the the Bank. legislative decree foresees that the power of the Minister of the Treasury, Budget and Economic Planning to 2.2 Legal integration in the ESCB suspend or annul deliberations of the Board of Directors for legal reasons With regard to the Banks legal integration shall not apply to resolutions adopted in the ESCB, the following adaptations are by the Board that relate to matters envisaged with effect from the date on within the scope of the authority of the which Italy adopts the single currency. ESCB and, in particular, to those involving banknotes denominated in lira, the rules and conditions for the Banks operations 2.2.1 Tasks and the appointment of the Banks correspondents in Italy and abroad. - Issuance of banknotes This removes the incompatibility. Various articles (Article 1 and Article 20, second paragraph, points 1 and 2, of - The Italian foreign reserves are currently the statute of the Bank; Articles 4 and managed by the Ufficio italiano dei 142 of the 1910 codified law on the cambi (UIC) and the Bank, which is Banks of Issue; Presidential Decree No. incompatible with Article 105 (2), third 811 of 9 October 1981) did not indent, of the Treaty, which states that recognise the ECBs competences in one of the tasks of the ESCB is to hold this field. Article 4 of the legislative and manage the official foreign reserves decree states that the Bank shall issue of the Member States. It is assumed banknotes in accordance with the Treaty that, according to Articles 7.2 and 11.1 and the Statute.

325 - Control of the amount of banknotes and - Formulation and implementation of coins held by the Bank monetary policy Article 110, Article 111, first paragraph, Law No. 82 of 7 February 1992, which point 1, and Article 111, last paragraph, established the power of the Governor of the 1910 codified law on the Banks of the Bank to change the official of Issue, which stated the consultative discount rate and the rate on fixed term duties assigned to a parliamentary advances for the purpose of controlling committee chaired by the Minister of market liquidity, did not recognise the the Treasury, Budget and Economic ECBs powers in this field. Planning in matters concerning the control of the currency issued by the Article 10 of Law No. 483 of 26 November Treasury and the Bank, did not recognise 1993, which laid down the power of the the ECBs powers in this field. Article 4 Bank to establish reserve requirements of the legislative decree provides for for banks and related rules, did not the repeal of Article 111 and an recognise the ECBs powers in this field. amendment of Article 110 so that the control of the currency is no longer According to Article 6.1 of the legislative extended to banknotes in circulation. decree, the above powers are no longer exercised at the national level as they Articles 120, 122 and 124(b) of the 1910 fall within the scope of Chapter IV of codified law on the Banks of Issue on the the Statute of the ESCB. The power of the Minister of the Treasury, amendment of the Banks By-Laws Budget and Economic Planning to control, amends Article 25.4 thereof accordingly. inter alia by means of inspections, compliance with the rules governing the - Dealing in foreign exchange and the movement of banknotes, the amount of management of official foreign exchange banknotes and coins held by the Bank, the reserves actual quantity of banknotes in circulation, Article 4, first and second paragraphs, held by the Banks cashiers department of the Presidential Decree No. 148 of and in stock and the quantity of those 31 March 1988, which established the which are withdrawn because they are power of the Bank and the UIC to worn but have yet to be destroyed did manage the official foreign exchange not recognise the ECBs competence in reserves and to conduct foreign this field. Article 4 of the legislative decree exchange operations in pursuit of their provides for the repeal of the above institutional aims on the basis of the provisions. powers assigned to them, did not envisage the transfer of such reserves Article 130 of the 1910 codified law on to the ESCB and did not recognise the the Banks of Issue, which contained an ECBs powers in this field. Article 7 of obligation for the Minister of the the legislative decree provides that the Treasury, Budget and Economic Planning Bank is required to transfer foreign to submit a report to Parliament on the exchange reserves to the ECB in issuance of banknotes in the previous compliance with Article 30 of the year, did not recognise the ECBs powers Statute. In addition, the Bank is in this field. Article 4 of the legislative empowered to manage the official decree provides for the repeal of Article foreign exchange reserves in conformity 130 of the 1910 codified law on the with Article 31 of the Statute. Banks of Issue.

326 2.2.2 Instruments which established the power of the Minister of the Treasury, Budget and - Articles 26, 27, 29, 60 and 62 of the Economic Planning to control 1910 codified law on the Banks of Issue compliance with the binding restrictions and Articles 41, 42 and 45(2) to 53 of on the operations conducted by the the Banks By-Laws, as well as various Bank and the application of the official other laws on securities which specified rate for such operations, did not and regulated the operations, classified recognise the ECBs powers in this field. by type, in which the Bank could engage Article 6.2 of the legislative decree and the securities which it could accept provides for the repeal of these on an exhaustive basis, did not recognise provisions. the ECBs powers in this field. Articles 6.2 and 6.3 of the legislative decree provide for the repeal of the above 2.2.3 Financial provisions provisions of the 1910 codified law on the Banks of Issue and the other laws Article 11 of Law No. 483 of 26 November which established the eligibility of certain 1993, which contained an obligation for types of instruments to be used as the Bank to pay a contribution to the security for advances. Articles 6.2 and Ministry of the Treasury, Budget and 6.3 of the legislative decree foresee that Economic Planning related to the income the Banks operations are subject to the accruing from the management of Statute and to the provisions adopted compulsory reserves, did not recognise the by the ECB in the implementation of its ECBs powers in this field. Article 8.4 of Statute. The amendment of the Banks the legislative decree provides for the By-Laws provides for the repeal of repeal of this provision. Moreover, for the Articles 45 to 52 and an amendment of purpose of the integration of the Bank in Articles 41 and 42 in accordance with the ESCB, Article 8.1 of the legislative Articles 6.2 and 6.5 of the legislative decree provides that, in drawing up its decree. annual accounts, the Bank may harmonise its accounting and financial reporting - Article 20, second paragraph, points 3 methods with the corresponding rules and and 5, of the Banks By-Laws, which recommendations issued by the ECB. describes the power of the Board of Directors to establish rules and terms for the Banks operations and to appoint 3 Adaptation of other the Banks domestic and foreign legislation correspondents, did not recognise the ECBs powers in this field. Article 6.4 of See Section 2. the legislative decree states that the above powers of the Board of Directors are subject to the Statute and to the 4 Assessment of compatibility provisions adopted by the ECB in the implementation of its Statute. In Assuming that the amendments to the compliance with these provisions, the Banks By-Laws adopted by the General amendment of the Banks By-Laws Meeting of Shareholders are approved by a provides for a corresponding Presidential Decree and that they will amendment of its Article 20. enter into force on time, and assuming that the provisions referred to in Article 11.1 of - Articles 124(e), 128 and 131 of the the Legislative Decree No. 43 dated 10 1910 codified law on the Banks of Issue, March 1998 will enter into force on the

327 date of the establishment of the ESCB at As far as other legislation is concerned, the the latest, the statute of the Banca dItalia EMI is not aware of any other statutory will be compatible with Treaty and Statute provisions which would require adaptation requirements for Stage Three. under Article 108 of the Treaty.

328 LUXEMBOURG

1 Legislation within the 2.1.1 Institutional independence scope of Article 108 of the Treaty Under the present law, the last word in monetary policy decisions belongs to the The following legislation required adaptation Government, a situation which is incompatible under Article 108 of the Treaty: with Treaty and Statute requirements on central bank independence. Articles 5 and 6 - the Law of 20 May 1983 establishing (draft), which reproduce the first part of the the Institut MonØtaire Luxembourgeois prohibition on seeking or taking instructions as amended; as laid down in Article 107 of the Treaty, vests responsibility for decisions in the - the Law of 15 March 1979 on the monetary domain at the national level in the monetary status of Luxembourg. Council of the IML.

2 Adaptation of the statute 2.1.2 Personal independence of the Institut MonØtaire Luxembourgeois - Article 12.3 states that, if there is a fundamental disagreement between the The Law of 20 May 1983 establishing the Government and the Management on the Institut MonØtaire Luxembourgeois as IMLs policy and the execution of its tasks, amended and the Law of 15 March 1979 on the Government, with the consent of the the monetary status of Luxembourg are Council of the IML, may propose to the currently being amended to meet Treaty and Grand-Duke the collective, and only the Statute requirements for Stage Three with collective, dismissal of the Management. Law No. 3862 (the draft law). The Fundamental disagreement is a ground Government expects the draft law to be for dismissal which is incompatible with adopted by Parliament before April 1998 so Article 14.2 of the Statute and this is now that it may enter into force on 1 May 1998. In intended to be remedied in Article 12.3 February 1994 the EMI was consulted on an of the draft law, which reproduces the initial draft. The draft law provides that the literal grounds for dismissal as laid down in name of the IML will be changed to the the Statute. Central Bank of Luxembourg at the date of the establishment of the ESCB. - According to Article 6 (draft), the Council shall be the highest decision-making body within the IML. The Council is largely 2.1 Independence composed of members who will not fulfil their duties for the IML on the basis of With regard to the independence of the professional exclusivity, while, at the same IML, the following adaptations are envisaged time, no explicit rules ensure that conflicts in the draft law. of interest might not arise from other functions of the IMLs Council members. This is an inconsistency in the draft law which should be corrected urgently.

329 2.2 Legal integration in the ESCB of the draft law, the Council of the IML shall have the task to define and implement With regard to the IMLs legal integration monetary policy at a national level. It is in the ESCB, the following adaptations are recognised that Articles 2.3 and 2.4 (draft) envisaged in the draft law. explicitly state that the IML will become an integral part of the ESCB as the Central Bank of Luxembourg and that it will have 2.2.1 Statutory objective to perform its tasks within the framework of international agreements in the monetary Article 2.2, which states that the IML is field entered into by Luxembourg, such as responsible for promoting the stability of the Treaty. However, as monetary policy in the currency, neither reflects the primacy Stage Three will be defined by the of the ESCBs statutory objective nor Governing Council of the ECB and anticipates the integration of the IML in the implemented by the Executive Board of ESCB. Article 2.1(1) (draft) states explicitly the ECB, any allocation of competences that the IMLs primary objective shall be to beyond the scope of the execution of maintain price stability and Articles 2.3 and monetary policy to the IMLs Council is an 2.4 (draft) provide that the IML shall inconsistency in the draft law which should become an integral part of the ESCB as the be corrected urgently. Central Bank of Luxembourg and that it will have to perform its tasks within the Pursuant to Article 2.2, fifth indent, and framework of international agreements in Article 17 (draft), the IML shall issue the monetary field entered into by monetary tokens. These provisions Luxembourg, such as the Treaty. There is, recognise neither the competences of the however, a lack of legal clarity in the ECB under Article 105a (1) of the Treaty secondary objectives of the IML as set out with regard to banknotes nor its in the draft law: Article 2.1 (draft) states competences under Article 105a (2), first that without prejudice to the objective of sentence, of the Treaty with respect to price stability, the IML supports the general coins. Again (see also above), although economic policy. This implies that the IML Articles 2.3 and 2.4 (draft) explicitly state may have to support the economic policy that the IML will become an integral part of of the Luxembourg Government rather the ESCB as the Central Bank of than the general economic policies in the Luxembourg and that it will have to perform Community as laid down in Article 105(1) its tasks within the framework of a of the Treaty, although a national international agreements in the monetary economic policy can only be supported by field entered into by Luxembourg, such as an NCB insofar as this is compatible with the Treaty, there is still a lack of clarity its obligations as an integral part of the which merits further consideration. ESCB. This lack of legal clarity is an imperfection in the draft law which merits further consideration. 2.2.3 Instruments

Articles 21 to 29 on the IMLs instruments 2.2.2 Tasks in the monetary field are incompatible with the Treaty and Statute as they do not Article 2, which lists the IMLs activities, respect the ECBs competences in this does not respect the ECBs competences field. Articles 21 to 27 (draft) provide for with regard to a number of the IMLs amendments of the former articles so as to activities in Stage Three. According to reproduce, where appropriate, the relevant Article 2.2, first indent, and Article 6 lit. a Articles of the Statute.

330 Article 25 (draft) states that the IML may the Institut MonØtaire Luxembourgeois, provide credit facilities to ensure the stability although there are various imperfections of payment systems without recognising which will, however, not jeopardise the the ECBs competences in this field. This is overall functioning of the ESCB at the start an imperfection in the draft law which of Stage Three. merits further consideration. - Article 2.2, first indent, and Article 6 lit. a (draft) state that the IMLs Council 3 Adaptation of other shall define and implement monetary legislation policy at a national level; this is inconsistent with Article 2A)(3) and (4) 3.1 The Law of 15 March 1979 on (draft), which states that the IML the monetary status of becomes a part of the ESCB and fulfils Luxembourg its missions within the framework of international monetary treaties to which This law lays down provisions on the Luxembourg is a party. In addition, the issuance and distribution of banknotes and Banks Council is largely composed of coins (Article 3) which do not recognise members who will not fulfil their duties the ECBs and the EU Councils powers in vis--vis the IML on the basis of this field as laid down in Article 105a (2) of professional exclusivity, while, at the the Treaty. Furthermore, the law attributes same time, no explicit rules ensure that exclusive competence for the exchange conflicts of interest might not arise from rate policy with regard to the Luxembourg other functions of the IMLs Council franc to the Government (Article 2), which members. These inconsistencies should neither envisages the introduction of the be corrected urgently. euro nor recognises the Communitys powers in the field of exchange rates. - The IMLs statutory objective as laid down in Article 2.1 (draft) does not The draft law on the monetary status of unambiguously reflect the primacy of Luxembourg addresses these issues. the ESCBs secondary statutory However, Article 2.1 (draft) states that the objective. Government may formulate general orientations for the exchange rate policy of - Article 2.2, fifth indent, and Article 17 the Luxembourg franc in relation to other (draft) state that the IML shall issue currencies. Although this prima facie may monetary tokens, without recognising not seem to be in line with the Treaty and the competences of the ECB in this the Statute, it is understood that once the field. Luxembourg franc has disappeared as a currency in its own right, i.e. from the date - Article 25 (draft) states that the IML on which Luxembourg adopts the single may provide credit facilities to ensure currency onwards, the above provisions the stability of payment systems without lose their applicability. recognising the competences of the ECB in this domain.

4 Assessment of compatibility As far as other legislation is concerned, the EMI is not aware of any other statutory Assuming that the draft law is adopted as it provisions which would require adaptation stood on 24 March 1998 and that it will under Article 108 of the Statute. enter into force on time, there will be no remaining incompatibilities in the statute of

331 NETHERLANDS

1 Legislation within the 2.1 Independence scope of Article 108 of the Treaty With regard to the Banks independence, the following adaptations are envisaged in The following legislation required adaptation the draft law with effect from May 1998. under Article 108 of the Treaty:

- the Bank Act 1948 as amended; 2.1.1 Institutional independence

- the Coinage Act; Article 26, which contains a right of the Minister for Finance to give instructions to - the Act on the exchange rate of the the Bank, is incompatible with Treaty and guilder; Statute requirements on central bank independence. The supervisory role of the - the Act on external financial relations Royal Commissioner, as currently 1994; elaborated in the Banks statute, is also incompatible with Treaty and Statute - the Act on the supervision of securities requirements on central bank trade 1995; independence. According to the draft law, the right of instruction of the Minister for - the Archives Act 1995; Finance will be abolished. In addition, Article 3.3 of the draft law states that the - statutory instruments pursuant to the Banks Governing Board can only be bound Act on public access to Government by the ECBs guidelines, decisions or documents and the Ombudsman Act. instructions. Furthermore, according to the draft law, the office of the Royal Commissioner will be abolished. Instead, it 2 Adaptation of the statute is envisaged in the draft law that the of De Nederlandsche Bank Government will have the right to appoint one special member to the Banks The statute of De Nederlandsche Bank is Supervisory Board (see also paragraph 2.2.4 currently being amended to meet Treaty below). and Statute requirements for Stage Three. The EMI has been consulted on a draft law (the draft law), which has been amended, 2.1.2 Personal independence inter alia, in the light of the EMIs opinion. The draft law was endorsed by the Second Article 23.5, which makes non-compliance Chamber of Parliament on 17 February with instructions from the Minister for 1998 and is currently pending before the Finance a ground for dismissal, is First Chamber of Parliament, which can incompatible with the grounds for dismissal only reject or endorse the draft law in its listed in Article 14.2 of the Statute. entirety. The Government expects the Article 11.3 of the draft law states that the draft law to be endorsed by the First members of the Governing Board can only Chamber of Parliament on 24 March 1998 be relieved from office on the grounds and published in the Official Bulletin on 25 mentioned in Article 14.2 of the Statute. March 1998.

332 2.2 Legal integration in the ESCB power to request information about non-ESCB-related and ESCB-related With regard to the Banks legal integration activities of the Bank, a request which, in the ESCB, the following adaptations are in accordance with Article 13 (draft), envisaged in the draft law with effect from may be rejected if the information the date on which the Netherlands adopts requested is confidential, either on the the single currency. basis of the Statute or on the basis of national legislation. It is also envisaged in the draft law that the Government 2.2.1 Statutory objective representative will be subject to the prohibition on receiving or soliciting Article 9.1, which contains the statutory instructions as laid down in Article 107 objective of the Bank, reflects neither the of the Treaty. primacy of the ESCBs statutory objective nor the Banks legal integration in the ESCB. - Article 3 (draft) states that the Bank Article 2 (draft) copies the statutory objective shall co-define (and execute) the of the ESCB into the statute of the Bank and ESCBs monetary policy in the states explicitly that the Bank will become an implementation of the Treaty and within integral part of the ESCB upon adoption of the framework of the ESCB. As it is the the single currency by the Netherlands. Banks Governor, and not the Bank itself, who will participate in the definition of the ESCBs monetary policy in his/ 2.2.2 Tasks her capacity as a member of the Governing Council of the ECB, the Chapter II of the present statute of the word co-define in combination with Bank on its activities does not envisage the the words the Bank in Article 3 (draft) Banks ESCB-related tasks in Stage Three. would not seem to be in line with the Article 3 (draft) enumerates the ESCB- Treaty and the Statute. However, on related tasks of the Bank, including the the following grounds it could be argued issuance of banknotes, and also clarifies the that this is not a major problem. First, fact that the Bank will exercise these tasks the umbrella provision of Article 2 within the framework of the ESCB and the (draft) on the Banks status as an integral implementation of the Treaty. part of the ESCB already defines the Banks position in Stage Three as well as the legal perspective from which the 2.2.3 Instruments law, once in force, will have to be applied. Second, Article 3 (draft) only Chapter II of the present statute of the enumerates the Banks ESCB-related Bank does not envisage the introduction of tasks and does not address the question the ECBs monetary policy instruments. as to which organ of the Bank will be Articles 2 and 3 (draft) provide for the given specific responsibility for executing integration of the Bank in the ESCB and these tasks. This question is addressed enumerate the Banks ESCB-related tasks. in Article 7 of the (draft) Articles of Association of the Bank, which, with reference to the Statute, explicitly 2.2.4 Organisation recognises that the Governor - but only the Governor - has a dual capacity: as - It is envisaged in the draft law that the President of the Bank and, as such, as a Government representative on the member of the ESCBs decision-making Supervisory Board will only have the body on, inter alia, monetary policy

333 matters, the Governing Council of the and jointly with the Member States of the ECB. Moreover, co-define might be future euro area, arrangements on the understood as meaning a co-decision, exchange rate of the euro in relation to the which does not correspond to the rules currencies of those Member States which for decision-making in the ESCB. On do not adopt the single currency from the the above grounds, the combination of outset. A draft law to this effect is pending the words the Bank and co-define is before the First Chamber of Parliament. considered as an imperfection which The Government expects this law to enter will, however, not jeopardise the overall into force as from the date on which the functioning of the ESCB at the start of Netherlands adopts the single currency. Stage Three.

3.3 Act on external financial 3 Adaptation of other relations 1994 legislation This Act does not envisage the introduction of the euro or the Banks integration in the 3.1 Coinage Act ESCB. It is envisaged that this Act will be amended in order to ensure that the The Coinage Act contains the Minister for obligations on De Nederlandsche Bank to Finances competence to issue guilder coins comply with general guidelines from the and lower-denomination coins. This power Minister for Finance and to exchange does not recognise the ECBs power to information with the Minister do not approve the volume of issuance of coins contravene the Banks Treaty obligations, and the EU Councils competences with and in order to ensure that the Bank is able regard to the denomination and technical to exchange information with the ECB. A specifications of coins as laid down in draft law to this effect is pending before Article 105a (2) of the Treaty. However, the First Chamber of Parliament. The Article 23 of the draft law adapting the Government expects this law to enter into statute of the Bank introduces a provision force on the date of the establishment of to the effect that these national the ESCB. competences will have to be exercised with due regard to the ECBs and the EU Councils powers in this field. The 3.4 Act on the supervision of Government envisages that this provision securities trade 1995 will be adopted in March 1998 and enter into force as from the date on which the This Act does not envisage the monetary Netherlands adopts the single currency. policy functions of the ECB in Stage Three. It is envisaged that this Act will be amended so as to ensure that the ECB, as De 3.2 Act on the exchange rate of the Nederlandsche Bank, will not be subject to guilder the supervisory regime applicable to securities institutions. A draft law to this This Act does not envisage the introduction effect is pending before the First Chamber of the euro or the transfer of competences of Parliament. The Government expects in exchange rate matters to the Community the draft law to enter into force as from level. It is envisaged that this Act will be the date on which the Netherlands adopts replaced by a legislative provision the single currency. authorising the Minister for Finance to conclude, on behalf of the Netherlands

334 3.5 Archives Act 1995 4 Assessment of compatibility

This Act grants citizens the right of access, Assuming that the draft law is adopted as it subject to certain restrictions and stood on 24 March 1998 and that it will conditions, to information contained in the enter into force on time, there will be no archives of public bodies and entities. The remaining incompatibilities with Treaty and Act is also applicable to the Bank in view of Statute requirements for Stage Three in its public function and is therefore currently the statute of De Nederlandsche Bank, being reviewed in the light of the although there is one imperfection which confidentiality regime within the ESCB will, however, not jeopardise the overall under Article 38 of the Statute. functioning of the ESCB at the start of Stage Three: Article 3 (draft) states that the Bank shall co-define the ESCBs 3.6 Act on public access to monetary policy, whereas it is the Banks Government documents and the Governor in his/her capacity as a member Ombudsman Act of the Governing Council of the ECB who will do so. The Act on public access to Government documents and the Ombudsman Act are As far as other legislation is concerned, the applicable to the Bank with the exception EMI takes note that adaptations are of its activities in the fields of monetary envisaged of the Coinage Act, the Act on policy and prudential supervision. These the exchange rate of the guilder, the Act Acts contain provisions enabling third on external financial relations 1994, the parties to gain access (subject to certain Act on the supervision of securities trade well-defined restrictions) to Bank 1995, the Archives Act 1995, and Royal documents. This does not respect the Decrees adopted under the Act on public ESCBs confidentiality regime. The access to Government documents as well Government therefore envisages that as under the Ombudsman Act. The EMI is secondary legislation will ensure that not aware of any other statutory provisions documents containing confidential which would require adaptation under information relating to the Banks ESCB- Article 108 of the Treaty. related tasks will be exempt from these Acts. Furthermore, the draft law adapting the statute of the Bank also explicitly provides for adherence to the ESCBs confidentiality regime (Articles 18, 19 and 20 of the draft law).

335 AUSTRIA

1 Legislation within the 2.1.1 Institutional independence scope of Article 108 of the Treaty Article 22.3 states that the General Council, which is a decision-making body in monetary The following legislation required adaptation policy matters, is largely composed of under Article 108 of the Treaty: representatives of various branches of industry who fulfil their duties towards the - the National Bank Act 1984 of Bank on a non-exclusive basis. This 20 January 1984 as amended; combination of responsibility for monetary policy, on the one hand, and the - the Foreign Exchange Act. representation of the interests of third parties, on the other, creates a potential for conflicts of interest and is, therefore, 2 Adaptation of the statute incompatible with the Treaty and the of the Oesterreichische Statute. According to the draft law, the Nationalbank General Council of the Bank will remain its decision-making body in the field of The statute of the Oesterreichische monetary policy until Austria adopts the Nationalbank is currently being adapted to single currency. As NCBs will have to take meet Treaty and Statute requirements for important decisions between the date of Stage Three. A draft law (the draft law) the establishment of the ESCB and the has been submitted to Parliament and the start of Stage Three, decision-making bodies Government expects the draft law to be of NCBs have to fulfil the independence adopted in the course of April 1998. The requirements of the Treaty and the Statute EMI has been consulted on the draft law, on the date of the establishment of the which has been amended, inter alia, in the ESCB at the latest. This is accomplished light of the EMIs opinion. through: Article 34.1 (draft), which states that the Governor shall be independent in his/her capacity as a member of the 2.1 Independence Governing Council of the ECB; Article 21.5 (draft), which states that the General With regard to the Banks independence, Council may not take any decisions which the following adaptations are envisaged in could impede the performance of the the draft law with effect from the date of Banks ESCB-related tasks; and Article 88.2 the decision by the EU Council - in the (5) (draft), which adds that the Board of composition of Heads of State or Executive Directors is responsible for the Government in accordance with Article implementation of preparatory measures 109j (4) of the Treaty - as to which for Stage Three rather than the General Member States qualify for adoption of the Council, which may not give instructions in single currency. this field or otherwise take measures which could obstruct such implementation.

Article 45.4, which gives the State Commissioner the right to raise - with suspensive effect - objections to a decision of the General Council, is incompatible with Treaty and Statute requirements on

336 central bank independence. The draft law 2.2.2 Tasks envisages that, as a government representative, the State Commissioner Article 3, which contains a provision relating will in future be entitled to attend the to the Banks participation in international meetings of the General Council of the monetary institutions, does not recognise Bank, albeit in an advisory capacity. the ECBs competence in this field. Article 3 (draft) explicitly acknowledges the ECBs right to approve such participation as laid 2.1.2 Personal independence down in Article 6 of the Statute.

Article 21.14, which implies that the members of the Board of Executive 2.2.3 Instruments Directors do not have a minimum term of office of five years, is incompatible with - Article 61, which establishes the Banks Treaty and Statute requirements on central exclusive right to issue banknotes and bank independence. Chapter I, Article 33, requires the Federal Minister for Finance of the draft law envisages the appointment to approve the face value of the of the members of the Board of Executive banknotes, does not recognise the ECBs Directors for a five-year period. competence in this field.

- Article 41, which contains a provision 2.2 Legal integration in the ESCB that public authorities are prohibited from drawing on the funds of the Bank With regard to the Banks legal integration without providing the countervalue, an in the ESCB, the following adaptations are exception being made with regard to envisaged in the draft law with effect from the discount of short-term Federal the date on which Austria adopts the Treasury certificates, is in contradiction single currency. with Article 104 of the Treaty.

- Article 43 on minimum reserve 2.2.1 Statutory objective requirements does not acknowledge the ECBs powers in this field. The Banks statutory objective reflects neither the primacy of the ESCBs statutory - Articles 47 to 60 on the operations in objective nor the Banks legal integration in which the Bank may be involved do not the ESCB. According to the draft law, this recognise the ECBs powers in this field. provision will be abolished. Chapter I, Article 2.2, of the draft law states that, The draft law provides for amendments to according to Article 105 of the Treaty and the above Articles which would be Article 2 of the Statute, the Bank has to compatible with the Treaty and the Statute. ensure the fulfilment of the objective of price stability and that, only insofar as this is possible without interfering with the 2.2.4 ERP financial operations objective of maintaining price stability, the Bank has to take into account the According to Article 83 of the draft law, macroeconomic requirements with regard ERP financial operations may be entered to economic growth and employment into by the Bank outside the framework of trends. the General Documentation on ESCB monetary policy instruments and procedures (General Documentation),

337 whereas such operations will not be subject 4 Assessment of compatibility to the collateral requirements of the General Documentation. The continuation Assuming that the draft law is adopted as it of such operations and the terms under stood on 24 March 1998 and that it will which such operations are entered into will enter into force on time, the statute of the have to be examined in the light of the Oesterreichische Nationalbank will be Banks integration in the ESCB and the compatible with Treaty and Statute possible constraints which may be derived requirements for Stage Three. from the Statute in this respect. As far as other legislation is concerned, the EMI takes note that further adaptation of 3 Adaptation of other the Foreign Exchange Act is envisaged. The legislation EMI is not aware of any other statutory provisions which would require adaptation 3.1 Foreign Exchange Act under Article 108 of the Treaty.

Articles 2.5 and 2.6 of this Act contain provisions on exchange rates which do not reflect the Communitys powers in this field. The EMI takes note that the abolition of these two provisions is envisaged in the framework of the draft law and is expected to enter into force from the date on which Austria adopts the single currency.

338 PORTUGAL

1 Legislation within the reference to international norms scope of Article 108 of the intends to cover in particular the Treaty Treaty and the Statute.

The following legislation required adaptation - The old law was amended with Law under Article 108 of the Treaty: No. 5/98 of 31 January 1998 (the new law). - Article 105 of the Constitution referring to the Banco de Portugal; 2.1 Independence - the Organic Law of the Banco de Portugal approved by Decree-Law With regard to the Banks institutional No. 337/90 of 30 October 1990 and independence, the following adaptations amended by Decree-Law No. 231/95 have been made with effect from 2 February of 12 September 1995 and by Law No. 1998: 3/96 of 5 February 1996 (the old law); - Notwithstanding the fact that the old - Decree-Law No. 333/81 of 7 December law empowered the Bank to conduct 1981; monetary policy, the Minister of Finance used to sign the Banks Avisos relating - Decree-Law No. 293/86 of to some features of the reserve 12 September 1986; requirements framework and the discount rate. This was incompatible - Decree-Law No. 178/88 of 19 May with Treaty and Statute requirements 1988; on central bank independence and the Minister of Finances involvement has - Decree-Law No. 13/90 of 8 January been abolished by means of the new 1990. law.

- The need to submit to the Government 2 Adaptation of the statute the vetoes of the Governor suspending of the Banco de Portugal decisions of the Board of Directors could have been regarded as a form of The statute of the Banco de Portugal was seeking instructions which would have amended to meet Treaty and Statute been incompatible with the Treaty and requirements for Stage Three, following the Statute and has been abolished in consultation of the EMI, as follows. the new law.

- Article 105 of the Constitution was adapted by means of the Constitutional 2.2 Legal integration in the ESCB Law 1/97 of 20 September 1997. The new article (renumbered Article 102) With regard to the Banks legal integration now states that the Bank is the national in the ESCB, the following adaptations central bank of Portugal and performs have been made with effect from the date its functions in accordance with the law on which Portugal adopts the single and the international norms binding currency. upon the Portuguese State. This

339 2.2.1 Statutory objectives - Under Article 22.1(a) and (c) of the old law, the Banks competence to direct Under Article 3 (old), the Banks statutory the money and foreign exchange markets objective did not anticipate the Banks and to define and impose minimum legal integration in the ESCB. Article 3 reserves did not recognise the ECBs (new) makes an explicit reference to the powers in these fields, while the Bank as an integral part of the ESCB, reference to the national economic pursuing the ESCBs objectives, participating policy objectives did not correspond to in the performance of its tasks and, subject the statutory objective of the ESCB. In to the provisions of the Statute, acting in the new law, Article 16 (corresponding accordance with its guidelines and to the old Article 22) explicitly states instructions. that the Bank will act pursuant to the rules adopted by the ECB, co-operating in the implementation of minimum 2.2.2 Tasks reserve requirements and other operational monetary control methods - Under the old law, Articles 6 (exclusive to which the ECB decides to resort, right to issue banknotes), 7, 8 (definition while the reference to the national and specifications of banknotes and economic policy objectives has been coins), 12 (imitation and reproduction deleted. of banknotes), 15, 16 and 17 (currency issues) did not recognise the ECBs - According to Article 32 (old), the Bank powers in respect of banknotes and was responsible for licensing external coins. In the new law, Article 6 contains payments whenever required. Under an explicit reference to the ECBs right Article 21 of the new law (corresponding of approval with regard to the issuance to the old Article 32), such responsibility of banknotes. Articles 7 and 8 have may only be assumed whenever required been removed, remaining in force only in accordance with the Treaty. in relation to banknotes and coins denominated in escudos and until the date on which they will lose their legal 2.2.3 Instruments tender status. Article 9 of the new law (corresponding to the old Article 12) Article 35 (old) on the Banks monetary refers only to banknotes denominated policy operations did not recognise the in escudos, while Articles 15, 16 and 17 ECBs powers in this field. Article 24 of the have been removed. new law (corresponding to the old Article 35) explicitly states that such operations - Articles 18.1 (conduct of monetary policy) will be carried out in order to meet the and 21 (implementation of monetary and ESCBs objectives and to perform ESCB- foreign exchange policies) of the old law related tasks. did not recognise the ECBs powers in these fields. In the new law, Article 12 (corresponding to the old Article 18) no 2.2.4 Organisation longer makes any reference to the conduct of monetary policy, and Article 15 Article 46 has been inserted into the new (corresponding to the old Article 21) law. It states that, without prejudice to the states that the duties of the Bank regarding powers of the Board of Auditors, the money and foreign exchange markets accounts of the Bank will also be audited must be performed within the scope of its by external auditors. participation in the ESCB.

340 2.2.5 Participation in international monetary envisages that this Decree-Law will be institutions amended in order to state that, as from the date on which Portugal adopts the single An insertion into Article 23 (new) makes it currency, the volume of issuance will be clear that the Banks power to participate subject to the ECBs approval and minting in international monetary institutions will will be done in accordance with any be subject to the ECBs approval. measures adopted by the EU Council under Article 105a (2) of the Treaty. A draft law amending this Decree-Law has 3 Adaptation of other been approved by the Government. legislation

Portugal is currently amending various laws 3.3 Decree-Law No. 178/88 of 19 with a view to Stage Three. The EMI has May 1988 been consulted on draft amendments to all the legislation listed below. This Decree-Law contains one provision (Article 4) which reproduces Article 9 of Decree-Law No. 293/86 and, as stated 3.1 Decree-Law No. 333/81 of 7 above, does not recognise the ECBs December 1981 powers in respect of coins. The same solution as for Decree-Law No. 293/86 is This Decree-Law gives Imprensa Nacional foreseen by the Government. - Casa de Moeda (the national mint) the exclusive right to produce coins and does not recognise the ECBs powers in this 3.4 Decree-Law No. 13/90 of 8 field. The Government envisages that this January 1990 Decree-Law will be amended so that such a right will be exercised without prejudice This Decree-Law deals with rules on foreign to Article 105a (2) of the Treaty. A draft exchange operations which will have to be law amending this Decree-Law has been reviewed in the light of the introduction of approved by the Government. The the euro. For example, the definition of Government envisages that the draft law foreign currency in Article 5.3, which will enter into force on the date on which includes banknotes and coins which are Portugal adopts the single currency. legal tender in foreign countries, does not anticipate the fact that euro banknotes and coins, notwithstanding their status as legal 3.2 Decree-Law No. 293/86 of 12 tender in all participating Member States, September 1986 will not be a foreign currency. The Government envisages that this Decree- This Decree-Law establishes the legal Law will be amended in such a way that it system with regard to the legal tender will be made clear that, on the one hand, status of coins and some of its provisions, any references to foreign currency or to in particular Article 9, which deals with banknotes and coins which are legal tender legal acts authorising the minting of in foreign countries do not relate to the commemorative coins (which are legal euro and, on the other, all references to tender according to Article 12 of the same the ECU as a basket currency (as distinct Decree-Law) and defines their technical from the national currency) will disappear, characteristics, designs, volume of issuance with the result that the euro will be treated and liberatory power, do not recognise the as the national currency in its own right. A ECBs powers in this field. The Government draft law amending the Decree-Law, which

341 is to enter into force as from the date on As far as other legislation is concerned, the which Portugal adopts the single currency, EMI takes note that adaptations are has been approved by the Government. envisaged of Decree-Law No. 333/81 of 7 December 1981, Decree-Law No. 293/86 of 12 September 1986, Decree-Law No. 4 Assessment of compatibility 178/88 of 19 May 1988 and Decree-Law No. 13/90 of 8 January 1990. The EMI is With the adoption and the entry into force not aware of any other statutory provisions of the Constitutional Law No. 1/97 and the which would require adaptation under new law, the statute of the Banco de Article 108 of the Treaty. Portugal is compatible with Treaty and Statute requirements for Stage Three.

342 FINLAND

1 Legislation within the 2.1 Independence scope of Article 108 of the Treaty With regard to the Banks independence, the following adaptations were made with The following legislation required adaptation effect from 1 January 1998 (for the revised under Article 108 of the Treaty: law) and with effect from the date of the new laws promulgation (for the new law). - the Act on the Bank of Finland of 21 December 1925 as amended (the old law); 2.1.1 Institutional independence

- the Currency Act; - The Banks institutional independence has been enhanced in the revised and - the Act on Coins. the new law. Article 1 (revised) stated that the Bank is an independent institution. Furthermore, Article 5 2 Adaptation of the statute (revised) introduced a prohibition on of Suomen Pankki seeking or taking instructions in the monetary field, while Article 4 (new) The statute of Suomen Pankki was amended provides for an extension to all ESCB- to meet Treaty and Statute requirements related tasks. The latter Article also for Stage Three by means of a revised Act states that such a prohibition is to apply on the Bank of Finland (the revised law), to the Bank as well as to the members which entered into force on 1 January 1998. of its decision-making bodies, but that it The revised law has, again, been adapted does not, at the same time, apply to through a new law (the new law) in order instructions issued by the ECB. Finally, to bring the Banks statute fully into line Article 13 (revised) attributed with the Treaty and the Statute. The new responsibility for supervising the law was adopted by Parliament on 20 administration of the Bank to the March 1998 and is expected to be Parliamentary Supervisory Council, while promulgated on 27 March 1998. The new Article 16 (revised) made the Board law will enter into force, in respect of the responsible for the fulfilment of the provisions on independence (see Banks mandate and for the paragraphs 2.1.1 and 2.1.2 below), administration of the Bank. immediately after its promulgation and, in respect of the provisions on the Banks - The new law contains various articles legal integration in the ESCB (see paragraph with extensive possibilities for obtaining 2.2 below), on 1 January 1999. The EMI and obligations to provide information has been consulted on both the revised about the Banks activities. See, for law and the new law in their draft versions, example, Article 11, paragraph 1, and both have been amended, inter alia, in section 5 (Parliamentary Supervisory the light of the EMIs opinion. Council vis--vis Parliament); Article 11, paragraph 3, last sentence; Article 14 (Board vis--vis Parliamentary Supervisory Council); and Article 27 (Bank vis--vis Parliament). Such provisions are only compatible with

343 Treaty and Statute requirements on this provision must be accompanied by a institutional independence if they do safeguard clause to ensure that it will not not lead de facto to ex ante impede the proper performance of the consultations of third parties on the Banks ESCB-related tasks. Such a safeguard Banks ESCB-related tasks. clause is contained in the Explanatory Memorandum to the new law, which in Scandinavian legal systems tends to have 2.1.2 Personal independence almost the same status as the law itself.

While under the old law the Governor and the other members of the Board could be 2.2 Legal integration in the ESCB dismissed by the President of the Republic at his/her considered discretion, Articles With regard to the Banks legal integration 18 and 19 (revised) stated that the President in the ESCB, the following adaptations of the Republic could remove the Governor were made with effect from 1 January or other members of the Board from office 1998 (for the revised law) and with effect if the Governor or such a member was from 1 January 1999 (for the new law). guilty of misconduct in office, if his/her performance had otherwise shown that he/she was not suited to continue in office 2.2.1 Statutory objective or if he/she no longer fulfilled the conditions required for the performance of his/her Article 2 (revised), which contained the duties. These grounds for dismissal did not Banks statutory objective, neither reflected correspond to the grounds for dismissal as the primacy of the ESCBs statutory laid down in Article 14.2 of the Statute. objective nor anticipated the Banks legal The new law addresses this incompatibility integration in the ESCB. Article 1 of the for members of the Board in Article 16 by new law overcomes this through explicit reproducing the grounds for dismissal as recognition of the Banks integration in the laid down in Article 14.2 of the Statute and ESCB and the obligation to perform its by recognising the fact that the possibility ESCB-related tasks in accordance with the for the Governor to appeal is governed by ECBs guidelines and instructions, as well the Statute. As the Parliamentary as through Article 2 of the new law, which Supervisory Council will not be involved in brings the Banks statutory objective into the performance of ESCB-related tasks, line with that of the ESCB. such adaptations are not required for its members. 2.2.2 Tasks

2.1.3 Financial independence - Issuance of banknotes Article 4 (revised), which established Article 21, paragraph 2, of the new law the Banks exclusive right to issue provides for objective criteria with regard banknotes, did not recognise the ECBs to the distribution of profit to the State competence in this field. from which the Parliamentary Supervisory Council may only deviate if this can be - Monetary policy justified on the basis of either the Banks Articles 3 and 6 (revised), which financial position or the size of its reserve established the Banks powers to define fund. As such a deviation may have an and implement monetary policy, did not impact on the means available to the Bank acknowledge the ECBs competence in for it to perform its ESCB-related tasks, this field.

344 - Foreign exchange policy with exceptionally good reason the Bank Article 3 (revised), which established could temporarily rescind this collateral the Banks competence to manage and requirement. This exception was not in invest Finlands foreign exchange line with Article 18 of the Statute and reserves and to take other measures has therefore been deleted from the necessary to support the countrys Banks statute in Article 7 of the new external liquidity, did not recognise the law. ECBs powers in this field.

The new law overcomes all the above 2.2.4 Organisation points by recognising in the wording of Article 3 (new) that the execution of the Article 17 (old) defined the Parliamentary Banks tasks will take place within the Supervisory Councils responsibilities in such framework of the ESCB (i.e. the Bank will a way that they also extended to monetary contribute to the execution of monetary policy issues which, in the light of the policy as defined by the Governing Council Councils composition, was incompatible of the ECB, to the issuance of banknotes with the Treaty. Article 13 (revised) and to the holding and management of remedied this situation through the foreign exchange reserves). attribution to the Council of supervisory responsibilities with regard to the administration of the Bank, while Article 16 2.2.3 Instruments (revised) made the Board responsible for the fulfilment of the Banks mandate and - Article 6 (revised), which listed the for the administration of the Bank. This Banks instruments, did not recognise division of responsibilities is maintained in the ECBs competence in this field. Articles 11 and 14 (new), whereby the Article 5 of the new law overcomes this Boards responsibilities extend to ESCB- point through adaptation of Article 6 related tasks. (revised) which has to be read in conjunction with Article 3 of the new law; the latter Article recognises that 2.2.5 Confidentiality the Banks tasks will be executed, and its instruments thus applied, within the Article 36 (revised), which contained an framework of the ESCB. obligation to maintain secrecy, did not reflect the fact that the confidentiality - Article 7 (revised) on minimum reserves regime with regard to ESCB-related did not recognise the ECBs competence information will be governed by Article 38 in this field. It is resolved in the new law of the Statute. Article 26 (new) explicitly by deleting all references to minimum recognises the above regime. reserves; the power to impose such reserves will be derived directly from the Statute (Article 19) in conjunction 3 Adaptation of other with references in the new law to the legislation framework of the ESCB, of which the Bank will form part, and to Articles 1 and 3 (revised) in particular. 3.1 Currency Act

- Article 9 (revised) stated that the Bank The Governments competence with regard was required to obtain adequate to the exchange rate of the Finnish markka collateral when granting credit, but that and the Banks involvement in this matter,

345 as stipulated in the Currency Act, did not 4 Assessment of compatibility recognise the Communitys competence in exchange rate matters and did not envisage With the adoption of the new law, and the introduction of the euro. The Currency assuming that it will enter into force on Act has been repealed by the Currency time, the statute of Suomen Pankki will be Repeal Act, all necessary provisions relating compatible with Treaty and Statute to the use of the Finnish markka and penni requirements for Stage Three. as legal tender during the transitional period have been incorporated in transitional As far as other legislation is concerned, the provisions, and the provision on decision- EMI notes that adaptations of the Currency making concerning the external value of Act and the Act on Coins have been the Finnish markka has been repealed. completed. The EMI is not aware of any other statutory provisions which would require adaptation under Article 108 of 3.2 Act on Coins the Treaty.

In connection with the Currency Repeal Act, a new Coins Act has been enacted to supplement the European Community legislation on coins.

346 SWEDEN

1 Legislation within the 2.1 Independence scope of Article 108 of the Treaty With regard to the Banks independence, the following adaptations are envisaged in The following legislation required adaptation the draft law. under Article 108 of the Treaty:

- the Constitution Act; 2.1.1 Institutional independence

- the Riksdag Act; Article 42 of the Sveriges Riksbank Act, which contains the provision that the - the Sveriges Riksbank Act (1988:1385) Minister of Finance has to be consulted as amended. prior to the Riksbank making a monetary policy decision of major importance, is incompatible with Treaty and Statute 2 Adaptation of the statute requirements on central bank independence. of Sveriges Riksbank The draft law proposes that Article 42 of the Act be reformulated to make provision The Constitution Act, the Riksdag Act and for the Riksbank, prior to every monetary the Sveriges Riksbank Act are currently policy decision of importance, to inform being adapted to meet Treaty and Statute the Minister of Finance. This is not requirements for the independence of incompatible with Treaty and Statute Sveriges Riksbank. A draft law (the draft requirements on institutional independence, law) is currently pending before Parliament. provided that it does not interfere with the An adaptation of the Constitution Act independence of the members of the requires the approval of two consecutive Banks Executive Board, respects the Parliaments, the next Parliament coming competence and accountability of the ECB into being after the general election in and the members of its decision-making September 1998. A first approval of bodies, and observes the confidentiality amendments to the Constitution Act and requirements of the Statute. the Riksdag Act by Parliament was given on 4 March 1998 and a second approval is expected to be given in October 1998, 2.1.2 Personal independence when the Sveriges Riksbank Act is also expected to be adopted in accordance - Chapter 9, Article 12, of the Constitution with the Constitution Act as amended. All Act, which implies that a refusal to adaptations are envisaged to enter into discharge a Board member from his/her force as from 1 January 1999. The EMI has responsibility may be used as a ground been consulted on the envisaged changes for dismissal and that Board members to the above-mentioned Acts, which have may remove the Governor from his/her been amended, inter alia, in the light of the position without specifying the reasons EMIs opinion. for his/her dismissal, is not in conformity with Article 14.2 of the Statute. The draft law remedies this by reproducing the literal grounds for dismissal as laid down in Article 14.2 of the Statute and

347 in Chapter 9, Article 12, of the 2.2 Legal integration in the ESCB Constitution Act. Sweden is not a Member State with a - Chapter 8, Article 6, of the Riksdag Act special status. Thus, Article 108 of the provides that the term of office of Treaty is applicable to Sweden as well and members of the Banks Governing Board requires adaptations of Swedish legislation other than the Governor will be four necessary for the Banks legal integration in years, while Chapter 9, Article 12, of the ESCB to be prepared and adopted by the Constitution Act allows members the date of the establishment of the ESCB of Parliament to be members of the in order to become effective as from the Banks Governing Board. This is date on which Sweden adopts the single incompatible both with the term of currency. The following provisions are office stipulated in Article 14.2 of the incompatible with the Treaty and the Statute and with the prohibition on Statute. external influence as laid down in Article 107 of the Treaty, since the Banks Governing Board is a decision- 2.2.1 Statutory objective making body involved in monetary policy matters (for as long as Sweden does Article 4 of the Sveriges Riksbank Act, not adopt the single currency) or in the which contains the Banks statutory performance of ESCB-related tasks. objective, does not unambiguously reflect Article 41 of the draft law envisages the primacy of maintaining price stability. vesting responsibility for monetary policy Article 4 (draft) would remove this matters and, eventually, the performance incompatibility with the Treaty and Statute of ESCB-related tasks in the Banks requirements on the Banks legal integration Executive Board. Thus, there would be in the ESCB. no need for any further adaptation.

2.2.2 Tasks 2.1.3 Financial independence - Monetary policy Article 49 (draft) states that Parliament will Chapter 9, Article 12, of the Constitution determine the distribution of profit. In this Act and Article 4 of the Sveriges respect, if Parliament were to deviate from Riksbank Act, which establish the Banks the objective criteria to which it has adhered powers in this field, do not recognise in the past, this could affect the Banks the ECBs powers in this field. financial independence. A statutory safeguard clause should therefore be - Exchange rate policy considered in order to ensure that Chapter 9, Article 12, of the Constitution Parliaments power may not impede the Act and Article 4 of the Sveriges proper performance of the Banks ESCB- Riksbank Act, which establish the Banks related tasks. It is envisaged that this will be powers in this field, do not acknowledge accomplished through a reference in the the Communitys and the ECBs Explanatory Memorandum to the above- competence in this field. mentioned laws, which in Scandinavian legal systems has almost the same status as - Issuance of banknotes the law itself. This reference entails that Chapter 9, Article 13, of the Constitution the distribution of profit will continue to Act and Article 5 of the Sveriges be determined according to the established Riksbank Act, which establish the Banks objective criteria. exclusive right to issue banknotes and

348 coins, do not recognise the ECBs 4 Assessment of compatibility competence in this field. Assuming that the draft law is adopted as it stood on 24 March 1998, there are two 2.2.3 Instruments remaining incompatibilities with Treaty and Statute requirements for Stage Three in Article 20 of the Sveriges Riksbank Act, the statute of Sveriges Riksbank. which deals with the imposition of minimum reserves on credit institutions, does not - The timetable for adaptation (see above, respect the ECBs competence in this field. section 2, first paragraph) is incompatible with Article 108 of the Treaty, which requires adaptations in the area of 2.2.4 Exchange rate policy central bank independence to become effective at the date of the establishment Chapter 9, Article 12, of the Constitution of the ESCB at the latest. Act, and Article 4 of the Sveriges Riksbank Act do not recognise the powers of the EU - The draft law does not anticipate the Council and the ECB in the field of exchange Banks legal integration in the ESCB, rate matters. although Sweden is not a Member State with a special status and must therefore comply with all adaptation requirements 3 Adaptation of other under Article 108 of the Treaty. This legislation affects a number of provisions in the Banks statute. Sweden is not a Member State with a special status. Thus, Article 108 of the As far as other legislation is concerned, the Treaty is applicable to Sweden as well and EMI notes that legislation on access to requires adaptations of Swedish legislation public documents and the law on secrecy necessary in the area of other legislation to need to be reviewed in the light of the be prepared and adopted by the date of confidentiality regime under Article 38 of the establishment of the ESCB. This applies the Statute. The EMI is not aware of any in particular to legislation on access to other statutory provisions which would public documents and the law on secrecy, require adaptation under Article 108 of which need to be reviewed in the light of the Treaty. the confidentiality regime under Article 38 of the Statute.

349 UNITED KINGDOM

According to Protocol No. 11 of the intend to move to Stage Three of EMU on Treaty on certain provisions relating to the 1 January 1999, certain provisions of the United Kingdom of Great Britain and Treaty (including Articles 107 and 108) Northern Ireland, the United Kingdom will and of the Statute do not apply to the be under no obligation to move to Stage United Kingdom. Accordingly, there is no Three unless it notifies the Council that it current legal requirement to ensure that intends to do so. Pursuant to the notification national legislation (including the statute of given by the United Kingdom to the Council the Bank of England) is compatible with on 30 October 1997 that it does not the Treaty and the Statute.

350 Vakat 352 Glossary

353 Glossary

Bilateral central rate: the official exchange rate between any pair of ERM member currencies, around which the ERM fluctuation margins are defined.

Convergence criteria: criteria established in Article 109j (1) of the Treaty (and developed further in Protocol No. 6). They relate to the performance with respect to price stability, government financial positions, exchange rates and long-term interest rates. The reports produced under Article 109j (1) by the European Commission and the EMI shall examine the achievement of a high degree of sustainable convergence by reference to the fulfilment by each Member State of these criteria.

Convergence programmes: medium-term government plans and assumptions regarding the development of key economic variables towards the achievement of reference values indicated in the Treaty. Regarding budgetary positions, measures to consolidate fiscal balances as well as underlying economic scenarios are highlighted. Convergence programmes normally cover the next three to four years, but are regularly updated during that time. They are examined by the European Commission and the Monetary Committee. Their reports serve as the basis for an assessment by the ECOFIN Council. After the start of Stage Three of Economic and Monetary Union, Member States with a derogation will continue to submit convergence programmes, while countries which are members of the euro area will have annual stability programmes, in accordance with the Stability and Growth Pact.

Council (of the European Union): is made up of representatives of the Governments of the Member States, normally the Ministers responsible for the matters under consideration (therefore often referred to as the EU Council or Council of Ministers). The Council meeting in the composition of the Ministers of Finance and Economy is often referred to as the ECOFIN Council. In addition, the Council may meet in the composition of the Heads of State or of Government. See also European Council.

Current transfers: government transfers to enterprises, households and the rest of the world, net of transfers received from the rest of the world, that are not related to capital expenditure; they comprise, among other operations, production and import subsidies, social benefits and transfers to EC institutions.

Cyclical component of the budget balance: shows the effect on the budget balance of the output gap, as estimated by the European Commission.

Debt ratio: the subject of one of the fiscal convergence criteria laid down in Treaty Article 104c (2). It is defined as the ratio of government debt to gross domestic product at current market prices, where government debt is defined in Protocol No. 5 (on the excessive deficit procedure) as total gross debt at nominal value outstanding at the end of the year and consolidated between and within the sectors of general government”. General government is as defined in the European System of Integrated Economic Accounts.

Deficit ratio: the subject of one of the fiscal convergence criteria named in Treaty Article 104c (2). Defined as the ratio of the planned or actual government deficit to gross domestic product” at current market prices, where the government deficit is defined in Protocol No. 5 (on the excessive deficit procedure) as net borrowing of the general government. General government is as defined in the European System of Integrated Economic Accounts.

354 ECB (): the ECB will have legal personality. It will ensure that the tasks conferred upon the ESCB are implemented either by its own activities pursuant to its Statute or through the national central banks.

ECOFIN: see Council (of the European Union).

Economic and Financial Committee: a consultative Community body to be set up at the start of Stage Three, when the Monetary Committee will be dissolved. The Member States, the European Commission and the ECB shall each appoint no more than two members of the Committee. Article 109c (2) of the Treaty contains a list of the tasks of the Economic and Financial Committee, including the review of the economic and financial situation of the Member States and of the Community.

Economic and Monetary Union (EMU): the Treaty describes the process of achieving economic and monetary union in the EU in three stages. Stage One of EMU started in July 1990 and ended on 31 December 1993: it was mainly characterised by the dismantling of all internal barriers to the free movement of capital within the EU. Stage Two of EMU began on 1 January 1994. It provided for, inter alia, the establishment of the European Monetary Institute, the prohibition of monetary financing of and privileged access to financial institutions for the public sector and the avoidance of excessive deficits. Stage Three will start on 1 January 1999 in accordance with the decision pursuant to Article 109j (4), with the transfer of monetary competence to the ESCB and the introduction of the euro.

ECU (): in its present definition (Council Regulation No. 3320/94 of 20 December 1994), the ECU is a basket made up of the sum of fixed amounts of twelve out of the fifteen currencies of the Member States. Article 109g of the Treaty states that this composition shall not be changed until the start of Stage Three. The value of the ECU is calculated as a weighted average of the value of its component currencies. As official ECU, it serves, inter alia, as the numeraire of the ERM and as a reserve asset for central banks. Official ECUs are created by the EMI through three-month swap operations against one-fifth of the US dollar and gold assets held by the fifteen EU central banks. Private ECUs are ECU-denominated financial instruments (e.g. bank deposits or securities) which are based on contracts which, as a rule, make reference to the official ECU. The theoretical value of the private ECU is defined on the basis of the value of the individual components of the ECU basket. However, the use of the private ECU is different from that of the official ECU and in practice the market value of the private ECU may diverge from its theoretical basket value. The replacement of the private ECU by the euro at the rate of one to one is laid down in Article 2 of the Council Regulation on certain provisions relating to the introduction of the euro, see (EC) No. 1103/97 of June 1997.

Effective (nominal/real) exchange rates: in their nominal version, effective exchange rates consist of a weighted average of various bilateral exchange rates. Real effective exchange rates are nominal effective exchange rates deflated by a weighted average of foreign prices or costs relative to domestic ones. They are thus measures of a countrys price and cost competitiveness. The choice of currencies and weights reflects the economic issue being analysed. The most commonly used measures of effective exchange rates employ trade weights.

Elderly dependency ratio: shows the proportion of the population of a country aged 65 and over in comparison with the population aged 15-64; it thereby indicates approximately how many elderly persons unfunded social benefits have to be financed on average by each member of the generation that is still below retirement age.

355 EMS (European Monetary System): established in 1979 in accordance with the Resolution of the European Council on the establishment of the EMS and related matters of 5 December 1978. The Agreement of 13 March 1979 between the central banks of the Member States of the European Economic Community lays down the operating procedures for the EMS. The objective is to create closer monetary policy co-operation between Community countries leading to a zone of monetary stability in . The main components of the EMS are: the ECU; the exchange rate and intervention mechanism (ERM); and various credit mechanisms.

EMU: see Economic and Monetary Union.

ERM (Exchange Rate Mechanism): the exchange rate and intervention mechanism of the EMS defines the exchange rate of participating currencies in terms of a central rate vis--vis the ECU. These central rates are used to establish a grid of bilateral exchange rates between participating currencies. Exchange rates are allowed to fluctuate around bilateral central rates within the ERM fluctuation margins. In August 1993 the decision was taken to widen the fluctuation margins to –15%. Pursuant to a bilateral agreement between Germany and the Netherlands, fluctuation margins between the Deutsche Mark and the Dutch guilder are maintained at –2.25%. Adjustments of central rates are subject to mutual agreement between all countries participating in the ERM (see also realignment).

ERM fluctuation margins: floor and ceiling of bilateral exchange rates, within which ERM currencies are allowed to fluctuate.

ESCB (European System of Central Banks): the ESCB will be composed of the ECB and the national central banks of the Member States. Its primary objective will be to maintain price stability. Its basic tasks will be to define and implement the monetary policy of the euro area, to hold and manage the official reserves of the participating Member States and conduct foreign exchange operations and to promote the smooth operation of payment systems in the euro area. The ESCB will also contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system.

euro: the name of the European currency adopted by the European Council at its meeting in Madrid on 15 and 16 December 1995 and used instead of the generic term ECU used by the Treaty to refer to the European Currency Unit.

euro area: area encompassing those Member States where the euro will be adopted as the single currency in accordance with the Treaty and in which a single monetary policy will be conducted under the responsibility of the relevant decision-making bodies of the ECB.

European Commission: institution of the European Community which ensures the application of the provisions of the Treaty, takes initiatives for Community policies, proposes Community legislation and exercises powers in specific areas. In the economic policy area, the Commission recommends broad guidelines for the economic policies in the Community and reports to the Council on economic developments and policies. It monitors public finances and initiates the procedure on excessive deficits. It consists of twenty members and includes two nationals from Germany, Spain, France, Italy and the United Kingdom, and one from each of the other Member States. EUROSTAT is the Directorate General of the Commission responsible for the production of Community statistics through the collection and systematic processing of data, produced mainly by the national authorities, within the framework of comprehensive five-yearly Community statistical programmes.

356 European Council: provides the European Union with the necessary impetus for its development and defines the general political guidelines thereof. It brings together the Heads of State or of Government of the Member States and the President of the European Commission. See also Council.

European Parliament: consists of 626 representatives of the citizens of the Member States. It is a part of the legislative process, though with different prerogatives according to the procedures through which EU law is to be enacted. In the framework of EMU, the Parliament will have mainly consultative powers. However, the Treaty establishes certain procedures for democratic accountability of the ECB to the Parliament (presentation of the annual report, general debate on the monetary policy, hearings to the competent parliamentary committees).

European System of Integrated Economic Accounts (ESA): represents a system of uniform statistical definitions and classifications aiming at a coherent quantitative description of the economies of EU Member States. The ESA is the Communitys version of the United Nations revised System of National Accounts. The respective definitions are, inter alia, the basis for calculating the fiscal convergence criteria laid down in the Treaty.

EUROSTAT: see European Commission.

Excessive deficit procedure: the Treaty provision (defined in Article 104c and specified in Protocol No. 5) that requires EU Member States to maintain budgetary discipline, defines the conditions for a budgetary position to be judged as satisfactory and regulates the steps to be taken following the observation that these conditions are not fulfilled. In particular, the fiscal convergence criteria (government deficit ratio and debt ratio) are specified, the procedure that may result from the Councils decision that an excessive deficit exists in a certain Member State is described and further steps to be taken in the event that an excessive deficit situation persists are identified.

Exchange rate volatility: a measure of the variability of exchange rates, it is usually calculated using the standard deviation of daily percentage changes.

Funded and unfunded pensions: a funded pension scheme is one where pension commitments are covered by real or financial assets, as opposed to an unfunded, or pay-as-you- go, form of pension scheme in which current contributions of employers and employees are relied upon to pay current pensions directly.

General government: aggregation of central government, regional or local government and social security funds, with the exclusion of commercial operations, as defined in the European System of Integrated Economic Accounts (Protocol No. 5 on the excessive deficit procedure).

Growth-interest differential: the difference between the annual change in nominal GDP and the nominal average interest rate paid on outstanding government debt (the effective interest rate). It is one of the determinants of changes in the government debt ratio.

357 Harmonised Index of Consumer Prices (HICP): Protocol No. 6 on the convergence criteria referred to in Article 109j (1) of the Treaty establishing the European Community requires price convergence to be measured by means of the consumer price index on a comparable basis, taking into account differences in national definitions. Although current consumer price statistics in the Member States are largely based on similar principles, there are considerable differences of detail and these affect the comparability of the national results. In order to fulfil the Treaty requirement the European Commission (EUROSTAT), in close liaison with the National Statistical Institutes and the EMI, has carried out conceptual work on the harmonisation of consumer price statistics. The Harmonised Index of Consumer Prices is the outcome of these efforts.

Harmonised long-term interest rates: Protocol No. 6 on the convergence criteria referred to in Article 109j (1) of the Treaty establishing the European Community requires interest rate convergence to be measured by means of interest rates on long-term government bonds or comparable government securities, taking into account differences in national definitions. In order to fulfil the Treaty requirement the EMI has carried out conceptual work on the harmonisation of long-term interest rate statistics and regularly collects the data from national central banks, on behalf of the European Commission (EUROSTAT). Fully harmonised data are used in this report.

Intervention at the limits: compulsory intervention carried out by central banks, the currencies of which are respectively at the floor and ceiling of their ERM fluctuation margins.

Intra-marginal intervention: intervention carried out by a central bank to influence the exchange rate of its currency within its ERM fluctuation margins.

Investment: gross fixed capital formation as defined in the European System of Integrated Economic Accounts.

Measures with a temporary effect: comprise all non-cyclical effects on fiscal variables which (i) reduce (or increase) the general government deficit or gross debt (debt ratio, deficit ratio) in a specified period only (one-off effects) or (ii) improve (or worsen) the budgetary situation in a specified period at the expense (or to the benefit) of future budgetary situations (self-reversing effects).

Monetary Committee: a consultative Community body, composed of two representatives from each Member State in a personal capacity (normally, one from the government and one from the central bank) and two representatives of the European Commission. It was created in 1958 on the basis of Article 105 of the EEC Treaty. In order to promote co-ordination of the policies of Member States to the full extent needed for the functioning of the internal market, Article 109c of the Treaty lists a set of areas where the Monetary Committee contributes to the preparation of the work of the Council. At the start of Stage Three of Economic and Monetary Union, the Monetary Committee will be dissolved and an Economic and Financial Committee will be created instead.

Net capital expenditure: comprises a governments final capital expenditure (i.e. gross fixed capital formation, plus net purchases of land and intangible assets, plus changes in stocks) and net capital transfers paid (i.e. investment grants, plus unrequited transfers paid by the general government to finance specific items of gross fixed capital formation by other sectors, minus capital taxes and other capital transfers received by the general government).

358 Net external asset or liability position: or the International Investment Position (IIP) - the statistical statement of the value and composition of the stock of an economys financial assets or financial claims on the rest of the world, less an economys financial liabilities to the rest of the world.

Nominal effective exchange rates: see effective (nominal/real) exchange rates.

Non-cyclical factors: indicate influences on the governments budget balances that are not due to cyclical fluctuations (the cyclical component of the budget balance). They can therefore result from either structural, that is permanent, changes in budgetary policies or from measures with a temporary effect (see also measures with a temporary effect).

Output gap: is defined as the difference between the actual and potential output level of an economy as a percentage of the potential output. Potential output is calculated on the basis of the trend rate of growth of the economy, as estimated by the European Commission. A positive (negative) output gap means that actual output is above (below) the trend or potential level of output, and suggests the possible emergence (absence) of inflationary pressures.

Primary balance: government net borrowing or net lending excluding interest payments on government liabilities.

Real effective exchange rates: see effective (nominal/real) exchange rates.

Realignment: change in the ECU central rate and bilateral central rates of one or more currencies participating in the ERM.

Reference period: time intervals specified in Article 104c (2a) of the Treaty and in Protocol No. 6 on the convergence criteria for examining progress towards convergence.

Reference value: Protocol No. 5 of the Treaty on the excessive deficit procedure sets explicit reference values for the deficit ratio (3% of GDP) and the debt ratio (60% of GDP), whereas Protocol No. 6 on the convergence criteria specifies the methodology for the computation of the reference values relevant for the examination of price and long-term interest rate convergence.

Stability and Growth Pact: consists of two European Council Regulations on the strengthening of the surveillance of budgetary positions and the surveillance and co-ordination of economic policies and on speeding up and clarifying the implementation of the excessive deficit procedure and of a European Council Resolution on the Stability and Growth Pact adopted at the Amsterdam summit on 17 June 1997. It is intended to serve as a means of safeguarding sound government finances in Stage Three of EMU in order to strengthen the conditions for price stability and for strong sustainable growth conducive to employment creation. More specifically, budgetary positions close to balance or in surplus are mentioned as a condition for Member States to deal with normal cyclical fluctuations, while keeping the government deficit below the reference value of 3% of GDP. In accordance with the Stability and Growth Pact, countries participating in Monetary Union will report stability programmes, while countries with a derogation will continue to have convergence programmes.

359 Stock-flow adjustments: a statistical concept that ensures consistency between the government deficit (defined as net borrowing or net lending) and the annual variation of the stock of government gross debt. It comprises the governments accumulation of financial assets, the change in the value of the debt denominated in foreign currency, the governments privatisation receipts used for the repayment of debt, the change in the consolidated amount of general government debt and remaining statistical adjustments.

Treaty: refers to the Treaty establishing the European Community. The Treaty was signed in Rome on 25 March 1957 and entered into force on 1 January 1958. It established the European Economic Community (EEC) and was often referred to as the Treaty of Rome. The Treaty on European Union was signed in Maastricht (therefore often referred to as the Maastricht Treaty) on 7 February 1992 and entered into force on 1 November 1993. It amended the EEC Treaty, which is now referred to as the Treaty establishing the European Community. The Treaty on European Union will be amended by the Amsterdam Treaty, which was signed in Amsterdam on 2 October 1997 and is in the process of being ratified.

360