The EU Helsinki Summit held in December 1999 approved of twelve countries with whom the accession negotiations would be continued (Check Republic, Cyprus, Estonia, Hungary, Poland and Slovenia) or commenced (Bulgaria, Latvia, Lithuania, Malta, Romania, Slovakia). Turkey was nominated a new candidate state.

Since March 1998 when Estonia was invited to accession negotiations pre-accession processes have become significantly more intensive and monetary policy issues are getting into focus as well.


Key Principles in the EU Enlargement Policy

Clear principles have been outlined in developing the EU enlargement policy. An important objective is to achieve the consensus in significant political issues: on one hand, there is a wish to develop a dialogue with the central banks of applicant countries whereas, on the other hand, it is necessary to smooth enlargement risks which could also endanger the credibility of the European Economic and Monetary Union (EMU). Priority compared to the EMU enlargement is given to achieving the ultimate monetary policy goal.

General conditions (the Copenhagen criteria) have been set up for candidate countries, the meeting of the criteria being a significant prerequisite for successful accession. As economic and political starting points vary from state to state, no similar approach or timetable for joining the EMU is expected. It is also recognised that states apply different economic policy strategies (including exchange rate policy); they can also find the best-fitting solution in developing the financial infrastructure. The solutions proposed by the applicant country in elaborating strategies should not be in conflict with the accession process and they should consider perspective participation in the euro system. Thus, considering different starting points and economic level of different countries, the diversity of approaches has been approved of, provided that it would not threaten the principle of equal treatment.

Nominal and Real Convergence

Taking into account the specificity of transition economies, the real convergence (approximation of purchase power, price level, economic structure, etc with the EU level) is considered slightly more important than progress in the nominal convergence (achieving the Maastricht criteria). Applicant countries have already aligned their macroeconomic development schemes with the requirements of the euro area. This reflects also the increased market pressure and stresses the country's positive approach towards the EU membership and participation in the EMU.

Nominal convergence criteria focus on price stability. It is worth mentioning that applicants' inflation indicators have been relatively good: most of the countries with long-term high inflation rates have reached through disinflationary processes single-digit annual indicators[1].

Real convergence expects structural reforms and changes from the applicant country implemented by the country itself in order to ensure a sustainable economic development and smooth integration into the European Union.

Monetary and Exchange Rate Policy

The applicants' main monetary policy objective is price stability, the specific anticipated result of which in long term would be the achievement of the EU inflation level. Besides monetary policy choices it assumes a well-considered fiscal policy and successful structural reforms.

As accession to the European Union, accompanied by the liberalisation of capital movement and economic integration leads to integration into the monetary policy of the euro area, it is presumed that the applicant will consider it adjusting its monetary policy strategy in pre-accession period. A significant strategic decision has to be taken choosing the exchange rate policy whereas convergence criteria securing exchange rate stability (ie participation in the EU exchange rate system ERM2) should be considered.

Accession to the European Union, participation in ERM2 and adoptions of the euro are three different stages, therefore each of them requires a different approach. Nevertheless, Article 124 of the Treaty on European Union provides that upon accession to the European Union each aspirant shall treat its exchange rate policy as a matter of common interest. The context assumes that applicant countries will, as Member States with derogation, be expected to join ERM2 prior to adopting the euro.

Although the applicants' common objective after the accession to the European Union will be to participate in ERM2 and later to introduce the euro, the exchange rate mechanisms used currently in these countries differ very much, ranging from stringent currency board arrangements to more flexible systems. The current choices of the exchange rate mechanism have been based on historical factors of the macroeconomic environment as well as on requirements emerging in transition from planned economy to market economy. Countries using any other currency but the euro as the nominal anchor of the exchange rate or using crawling peg arrangements[2] , have considered necessary to change conditions of the exchange mechanism early enough to have an adequate adjustment period.

Summa summarum it can be concluded that the enlargement of the euro-zone is preferred to be done in a pretty similar way with the countries already acceded, meaning that ERM2 conditions should be met during at least two years prior to the introduction of the euro. It is not possible to participate in ERM2 before the accession to the European Union, just like meeting ERM2 requirements is not the most important measure in introducing the euro. More significant is the preparedness of the state to participate in the euro-zone. The European Commission has concluded that the applicants' readiness to join the euro area can be evaluated only after the following conditions will be met:
  1. the states have acceded to the European Union;
  2. they are competitive in the European common market;
  3. they participate in the EMU economic policy coordination procedures, provided by the EMU acquis, including participation in the General Council of the European Central Bank;
  4. the states' economic indicators have nominally significantly converged with those of the European Union.


Since the monetary reform in 1992 Estonia's monetary policy objective has been to achieve through exchange rate stability the price stability facilitating long-term economic development. Such a monetary policy objective is in compliance with the EMU monetary and exchange rate policy and has created a stable environment for the development of the real sector, also for nominal and real convergence. Considering these developments, it is possible to say that the chosen target - to participate in the Economic and Monetary Union - supports the best possible strategy for Estonia achieving both monetary and economic policy objectives.

The ultimate monetary policy objective in the euro-zone as well as in Estonia is to achieve and maintain price stability. The specificity of the transition economy, the small size and openness of the economy has proposed different strategic options. The fixed exchange rate of the kroon and the currency board arrangement have created favourable preconditions to bring down Estonia's inflation rate and converge it with that of the European Union.

Price convergence, which has been successful in the open sector, is not yet completed and continues throughout next years as well, bringing the price structure and price level closer to the respective indicators of European industrial countries. The assumption that productivity in Estonia grows faster than in the euro-zone, makes the moderate inflation rate, although slightly above the euro-zone, still acceptable in mid-term.

The continuous integration of Estonia's real and financial sector with European monetary and capital markets will thereby significantly help to soothe the implications of factors slowing down the convergence which could be caused by the smallness of the domestic market and maybe also by inadequate credibility[3].

Monetary Policy Framework and Exchange Rate Policy

Striving towards the European Economic and Monetary Union, it is necessary to have the monetary policy framework support the economy in transition to adjust itself to conditions in which monetary policy is considered as a matter of common interest and it is not possible to solve economic problems by influencing the exchange rate and money supply.

Considering, on one hand, the relative inflexibility which ensured the credibility of Estonia's monetary system (reflected in adequate responses to external shocks hitting the economy) and the convergence under way, on the other hand, it is possible to argue that Estonia's monetary policy framework manifested in the currency board system is in compliance with the requirement to have a stable exchange rate prior to the accession to the euro-zone. Estonia sees support in the statement by the European Central Bank that the diversity of exchange rate systems is acceptable in the pre-accession phase, on condition it will not damage the overall enlargement process.

Nevertheless, the need to improve the monetary policy operational framework cannot be excluded and several legal acts may need amending. It should firmly be considered that further decisions on the exchange rate system and monetary policy cannot be unilateral but must consider, first and foremost, the common interest principle.

Estonia's Negotiation Position on the EMU

Estonia is able to transpose the chapter on the EMU of the acquis communitaire in its obligatory scope and implement it from the date of accession to the European Union. Thereby we do not apply for transition periods or derogations. The EMU-related Estonian legislation is not yet fully harmonised with the EU acquis but the necessary harmonisation and implementation will be completed by 2003 which is the target Estonia has set itself for accession. Thus, Estonia could participate in the European Union as a non-euro country.

[1] Such a development is based mostly on the conditions of the external environment; monetary policy has played a secondary role.
[2] Such a strategy is applied in Hungary and Poland.
[3] This is indicated, first and foremost, in interest rate developments. Short-term money market interest rates do not differ much from base currency rates, whereas long-term interest rates have due to significant credit risk margins remained above the euro-zone level. Nevertheless, interest rate margins between the kroon and foreign currency instruments have not been too large (100-220 base points). The only exception being periods when the kroon was exposed to temporary speculative pressures (the autumns of 1997 and 1998).