Eurozone Watch

Today, Hungary abandoned its quest to adopt the euro by 2010. As Bloomberg reported, economy Minister Janos Koka said that there was “no target date” for accession now, but only the target to push the budget deficit below 3 percent “as soon as we can”.

Hungary’s admission that it will fail to fulfil the convergence criteria anytime soon is another hint that EMU enlargement after 2007 will be rather rocky. EMU membership for Latvia, Estonia and Lithuania has already been postponed after these countries failed to meet the inflation criterion. Given their still booming economy, it is not clear at all whether they will be able to meet the criterion next year. In Poland and the Czech republic, political forces seem to push EMU membership further into the future even though both countries have made surprising progress in their budget consolidation.

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In the past weeks, indications have firmed that there will be a massive fiscal tightening ahead for the eurozone. While for quite a while the German government had announced that it would tighten fiscal policy massively in 2007 by raising the VAT from 16 to 19 percent, by increasing contributions to the pension system and by cutting loopholes in the income tax system, now France and Italy voiced the intention to join the trend.

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Unnoticed by the public, the European Commission issued its first “Annual Statement on the Euro Area” and its companion piece, the first “Annual Report on the Euro Area” on Tuesday, July 12. Both are supposed to “raise awareness and stimulate a broad debate on euro-area economic policies and developments”. That both went down unnoticed by the public is ironic given this objective. But not surprising: under the current set-up of the eurozone, a broad political debate will not emerge.

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Italy's government has set itself the ambitious target of coming to grips with the country's economic problems. Prime Minister Romano Prodi wants to cut payroll taxes to increase the country's competitiveness. Last Friday, Finance Minister Tommaso Padoa-Schioppa announced a plan to push the budget deficit in 2007 back below 3 percent. For the euro area, the Italian attempts to tackle the dwindling competitiveness is a highly positive development. Over the last year, the country most frequently mentioned as a candidate for leaving the European Monetary Union was Italy.

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Not much noticed outside of Germany, a reform proposal was put to death last week which would have seriously engraved economic divergences in the euro-zone. In the discussion of how to reform the health care system, the social democrats had floated the idea to increase VAT and personal income taxes to finance the public health care system by up to 45 bn. € and to lower social security contributions paid by employers and employees by the same amount.

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