The euro is no panacea, but joining is even more desirable due to the crisis

The Magyar Nemzeti Bank has today published its Report on the Convergence Process. The Report states that the earlier path of financing growth from foreign borrowing can no longer be sustained. Reducing Hungary’s public and external debts is the key to sustainable growth and successful euro adoption. In other words, the economy will need to rely on a greater proportion of domestic savings to finance economic growth. The benefits of adopting the single European currency can only be exploited if backed by sustainable, stable and disciplined economic policy.

In the past, the pick-up in economic growth was often associated with a sharp deterioration in external balance. However, the financial crisis revealed the unsustainability of this growth model. Consequently, Hungary’s convergence will only be successful if economic growth is financed by a greater proportion of domestic savings in the future.

The Hungarian economy may react very sensitively to the crisis through two different channels. First, due to the cautious attitude of investors and the high level of domestic debt, the country may find it more expensive and harder to access credit than in the past. Second, the slow expansion in Hungary’s export markets makes it more difficult to reduce debts accumulated in previous years. For this reason, the economy may remain vulnerable to financial shocks for quite a long time, even if it pursues a disciplined economic policy.

Reducing the country’s vulnerability requires a fiscal policy which does not act as a drain on domestic savings and, consequently, savings can be made available to finance the private sector. However, a tight fiscal policy is a necessary but not sufficient condition for this. It will also be indispensable to restructure the government budget, in order to improve the country’s competitiveness, i.e. to create the conditions for sustainable economic growth.

Recent developments in European economies have confirmed that the benefits of the euro can only be exploited over the long term if economic policy is stable and disciplined and the real economy maintains its competitiveness. Adopting the single currency requires giving up independent monetary policy. Therefore, painful price and wage adjustments, coupled with a lasting economic downturn, can only be avoided through sustainable economic policy, should the economy become overheated.

Hungary currently does not meet any of the Maastricht criteria. However, fiscal adjustment made necessary by the economic crisis may help fulfil the criteria relating to government deficit and inflation. Meeting the Maastricht criteria over the medium term is insufficient for successful euro adoption. A fiscal policy is required which gives sufficient scope to manage economic shocks and contributes to the gradual reduction in the country’s high public and external debts. Anchoring inflation expectations is key to meeting the inflation criterion on a sustained basis. The Magyar Nemzeti Bank may contribute to this effort by maintaining adequate monetary conditions.

The Report is available on the Bank’s website at (under Publications / Report on Convergence).