The perceived downside of the Eurozone

When Slovakia adopted the euro in January 2009, Alexander Joszay loved driving across the border to Hungary, where financial crisis had weakened the forint to deliver lower prices for euro-earners.

But the factory where the 58-year-old maintenance man worked liked the idea too. It sacked Joszay and other Slovaks a few months later and moved across the border.

 “There was not just the single positive thing of people taking advantage of the exchange rate,” said Joszay, who worked for car parts firm MBE in this eastern Slovak town.

“People also lost work after the employers told them it was no longer profitable to continue with production.”

Slovakia’s case underscores the euro’s double-edged nature for the European Union’s ex-communist countries and serves as a warning for Poland, Estonia, Bulgaria and other states who see the stability of the single currency as a panacea for crisis.

Slovakia attracted billions of euros in foreign investment to become the world’s largest producer of cars per capita, but the country of 5.4 million people depends on autos and electronics for more than half its exports.

“Policy-makers in general envy Slovakia for entering the euro zone because they are scared of currency volatility. The euro provides stability in this sense,” said Lars Christensen, head of emerging markets research at Danske Bank.

“But it takes away the flexibility, and it is clear that Slovakia is suffering in terms of loss of competitiveness,” he added.

The euro has helped Slovakia be perceived as a better credit than others in the region: its 10-year benchmark bond yield is now 97 basis points over the euro zone’s benchmark German bund, much tighter than Poland’s 285 and Hungary’s 403 points.

The economic problems faced by many ex-communist EU newcomers are still too significant for them to consider joining the euro zone any time soon.

The euro entry criteria require all applicants to cut fiscal deficits to below three percent of GDP, but most euro candidates face ballooning fiscal gaps as the crisis bites deeply into budget revenue. Even euro members are giving themselves until 2011 to start bringing down deficits.

A Reuters poll shows economists expect Estonia to be the next eastern EU member to join the euro, perhaps in 2012. All other states were seen joining in 2014 at the earliest.

“Euro zone enlargement by another central European economy is … not going to happen quickly,” said Michal Dybula, central European economist at BNP Paribas in Warsaw.

Heavy shield
Slovakia became only the second ex-communist country to adopt the euro after Slovenia, capping a decade of transition from a central European laggard to a leader in economic growth, which culminated with 10.4 percent expansion in 2007.

Emboldened by investments by Volkswagen, Kia Motors and PSA Peugeot Citroen, the alpine country saw euro entry as the next prestigious move.

Two revaluations of its crown currency in the runup to the switch pushed it 30 percent higher against the euro, so low eurozone interest rates were not a spur to inflation as in euro-joiners Slovenia and Ireland.

From behind the euro shield against market turbulence, Slovaks went on bargain-hunting trips to neighbours like Poland, where the crisis had wiped a third off the value of the zloty versus the euro in a matter of months.

But with the euro appreciating by more than 20 percent against the dollar from 2007 to mid-2008 and regional currencies sliding by up to 30 percent in the early months of 2009, Slovak factories became more pricey than their regional peers.

That amplified problems as the crisis slashed demand for cars and electronics, drove unemployment to multi-year highs, stopped wage growth, and pushed down consumer spending.

In the service sector, once-popular Slovak ski resorts and spas suddenly found themselves too expensive for their usual guests, and Czech, Polish and Hungarian visitors fell by almost a third at the start of the year.

In 2005 before Slovakia joined the euro, its average unit labour cost was the equivalent of just EUR4.60 per hour, below the average of its neighbours Poland, Hungary and the Czech Republic. Once inside the euro that jumped 54 percent to EUR7.10 per hour in January 2009, undermining competitiveness.

MBE, which made cable boxes for Ford and employed around 700 people in 2008, said it had to cut production at the end of the year due to consumers’ evaporating demand for new cars.

“The euro was the last straw,” said former MBE executive Ladislav Mento. “Production became more expensive and it was moved to Hungary.”

Output pain
Not all producers share the view the currency has complicated doing business.

“The euro’s key advantage is that it lowers transaction costs in the economy – costs related with (foreign exchange) conversion, for securing against currency swings,” said Maria Valachyova, senior analyst at Slovenska Sporitelna.

And the benefits of euro-zone membership have continued to resonate for big subsidiaries of foreign firms. Because they sell most of their production in the euro zone anyway, they see the euro as a price stabiliser.

The largest Slovak company by sales, Volkswagen said the country’s adoption of the euro was one reason for siting production of its new small model UP! in the plant near the Slovak capital Bratislava.

“Euro adoption was very important from this point of view, because it enables long-term planning and eliminates foreign exchange risks related to currency volatility,” said Andreas Tostmann, chairman of the board of Volkswagen Slovakia.