Mr Joaquín Almunia
European Commissioner for Economic and Monetary Affairs

Czech Republic: on a smooth path towards the euro

Visit to Czech Republic - lecture at the University of Economics
Prague, 9 December 2005

Ladies and gentlemen,

I am pleased to be in the beautiful city of Prague today and to have the opportunity to take part in the ongoing discussions on the preparations for the introduction of the euro in the Czech Republic.

The adoption of the euro will constitute the next major leap forward of your country's integration into the European Union. This process started some 16 years ago with the "velvet revolution", or the "November events" as some prefer to call them. It culminated in your country's accession to the European Union on 1 May 2004. I consider that the European Union has greatly benefited from the accession of the Czech Republic as all Europeans can now share your country's rich cultural heritage and history more easily.

In my intervention today, I would like to focus on three main issues.

Firstly, I believe that the considerable benefits of the euro are sometimes not fully recognised. Recently, the euro has been incorrectly blamed for some of the difficulties which certain euro-area countries are currently facing. I would therefore like to highlight the important advantages of the adoption of the euro for the Czech Republic.

Secondly, joining the euro area requires the fulfilment of certain criteria. I will therefore discuss the Czech macroeconomic situation and the challenges ahead in terms of achieving the necessary degree of sustainable convergence.

Thirdly and finally, I would like to focus on the practical preparations which are necessary for a smooth introduction of the euro.

Benefits stemming from euro adoption

Let me start with the benefits stemming from the adoption of the euro.

I. The first benefit relates to macro-economic stability. Price stability constitutes an essential element of this framework. The European Central Bank has undeniably achieved a convincing track record in this respect. By adopting the euro, the Czech Republic will benefit from the euro area's low and stable inflationary environment. This will be further underpinned by a sound and balanced budgetary policy, which constitutes the second key element of the framework. These elements will contribute to maintaining stable and low long-term interest rates. As a consequence, public and private investment will be fostered and the cost of financing of public deficits will also be reduced.

II. The second main benefit stems from the euro's shielding effect against currency turmoil. Sharp fluctuations in the exchange rate present a significant threat to small open economies in an environment of liberalised capital flows. The Czech economy has recently experienced large currency movements which without doubt have affected the overall business environment.

The adoption of the euro will eliminate these risks as far as your most important trade partners in the euro area are concerned. This is particularly relevant for a traditionally open economy as the Czech one which has a share of imports and exports both around 70 percent of GDP.

In this respect, it is interesting to note that recent studies have demonstrated that the euro clearly fosters trade among participating countries. The accession to the European Union already significantly increased trade flows with the Czech Republic. Your country's future adoption of the euro will provide an additional boost in this respect.

Similar considerations apply in the area of foreign direct investment. The Czech Republic heads the list of top foreign direct investment inflows per capita of the ten recently acceded Member States and four-fifths of all this investment is coming from the European Union. The stability of the exchange rate and the overall size of the integrated markets play an essential role in long-term investment decisions. The adoption of the euro will constitute a further element of attraction for investors.

III. The third major benefit stemming from the single currency is linked to the possibility to reap the full potential of Europe's single market notably by eliminating transaction costs and associated currency risks.

Travellers and businessmen will no longer have to change currencies each time they cross your country's national border. Not only will their travelling be simplified but it will also become cheaper since there will no longer be any transaction costs to be born, which has crucial importance for a country like yours which is attracting so many visitors every year.

IV. Finally, the euro will generate a more efficient allocation of resources through improved price transparency and easier comparability of prices which will stir up competition and result in lower prices. Economies of scale associated with greater integration will also be conducive to higher growth and employment in particular for a country which needs to implement further structural reforms.

Before the Czech Republic acceded to the European Union some critics claimed that prices would rise without a corresponding growth in income. The contrary has happened: inflation has remained low while economic growth and household income have increased quicker than ever before. The euro will allow you to consolidate these gains and create a strong basis for future economic expansion.

As I already explained, some criteria must be met before a country is allowed to adopt the euro. Therefore, let me now turn to the assessment of the Czech macroeconomic situation and of the challenges ahead in terms of nominal convergence.

The Czech macroeconomic situation and the challenges ahead in terms of nominal convergence

Our recently published macroeconomic forecasts show that the Czech Republic has recently been doing very well and is expected to continue to do so in the next two years. Annual GDP growth in 2005-2007 is expected to be in excess of 4 percent, well above the EU-25 average.

In 2004, economic activity was driven mainly by vigorous exports which were boosted by EU accession. In 2005, the trade balance is expected to improve substantially and to reach a surplus for the first time since 1991.

Although net exports should continue to be an important driving force of GDP growth, their contribution to growth is expected to decline and to be replaced by domestic demand. Private demand will be stimulated by an enhanced labour market situation. Investment should benefit from a higher utilisation of EU structural funds and favourable financing conditions. Public consumption is also forecast to accelerate, though only slightly.

European Union entry has been associated with an improved growth performance and the Czech Republic continues to be an attraction pole for foreign investments. Your recent experience confirms my long-standing conviction that a stable macroeconomic framework is the best precondition for achieving sustainable and healthy economic growth.

The currently favourable economic situation should be no reason for complacency as challenges remains. Tackling them will help to further increase the growth potential of the Czech economy.

We have in particular been regularly pointing at an insufficiently flexible and efficient labour market. This is a relatively common problem in EU Member States. While the recent pick-up in economic activity in the Czech Republic contributed to an increase in employment, the rate of unemployment still remains too high, in particular in certain regions and among some groups of population, like the young and the Roma.

Public finance consolidation is another crucial challenge. So far, the Czech Republic has been successful in fulfilling the targets for the general government deficit set in 2004 by the Council to correct the excessive deficit. Better-than-expected economic growth and fiscal consolidation helped to decrease the budget deficit from 12.5 percent of GDP in 2003 (a figure inflated by one-off expenditures of about 6 percent of GDP) to 3 percent of GDP in 2004. The 2004 result has been flattered by the postponement to 2005 of expenditures. The budgetary outcome this year is nevertheless expected to be better than targeted in the convergence programme and the targets for 2006 and 2007 (3.8 and 3.3 percent of GDP respectively) are likely to be achieved. The Czech Republic thus appears to be on track to bring the deficit below 3 percent of GDP by 2008 as foreseen in the 2005 update of the convergence programme.

In spite of these positive developments, there remain several watch points for fiscal policy in the Czech Republic.

First, the Czech Republic is experiencing "good times" in terms of economic growth. This opportunity should definitely be seized to accelerate the budgetary consolidation. This would create a safety margin against an unexpected downturn which could possibly threaten the country's euro adoption calendar.

It would also further increase the room for manoeuvre once the Czech Republic is part of the euro area.

Second, as mentioned earlier, the large expenditure carryovers in 2004 contributed to a much better-than-expected deficit outcome.

A similar development is expected for 2005. However, uncertainty about the timing of further accumulation or spending of the expenditure carryovers complicates budgetary planning.

Third, the Czech Republic faces serious risks with regard to the long-term sustainability of its public finances, because the projected budgetary costs of its ageing population is considerable. It is thus vital that the ongoing work on the pension and health care reforms approaches the implementation phase.

The next challenge linked to euro adoption will be to fulfil the other nominal convergence criteria in a sustainable manner. This in particular involves maintaining low inflation, entering ERM II and demonstrating sufficient exchange rate stability against the euro. Meeting these challenges is not an easy task. We have consistently emphasized that it should be the result of a sound development of economic fundamentals and external balances. I am confident that in this respect the Czech Republic is going in the right direction.

Practical preparations for the introduction of the euro and co-operation between the Commission and the Czech authorities

Let me now move to the third and final part of my intervention. As nominal convergence advances, your country should also step up the practical preparations for the future introduction of the euro.

The Czech Government has recently made the first steps by appointing the national coordinator for the introduction of the euro and launching the elaboration of the National Changeover Plan.

In this connection, I would like to highlight some crucial factors that should be taken into account when designing your changeover scenario.

The experience of the first-wave countries clearly shows that countries which invested heavily in careful, pro-active and extensive preparations were rewarded for their efforts.

National governments and the public sector in general have a particular role and responsibility in this area. Their primary task is to draw up a comprehensive changeover scenario at an early stage. This general framework will allow the private sector to initiate its own preparations. Public administrations moreover have a general role of co-ordination, information and dialogue with all relevant economic sectors and the general public.

The Commission takes a close interest in these preparations and has recently adopted its Second Report on practical preparations in the different Member States concerned. This Report provides an assessment of the state of the practical preparations in the different countries. In addition, the Commission remains in close and regular contact with all countries concerned notably through the Public Administration Network (PAN II) in which all the 13 current pre-in countries are represented. The PAN continues to be an essential forum for discussion and exchange of views among the national representatives in charge of the changeover in their respective countries.

The changeover to the euro is a large-scale operation. It requires action and cooperation by many players, but above all it involves, in varying degrees, the entire population.

Apart from requiring meticulous preparation, it can only succeed with the support of extensive information and communication campaigns, aimed at both the business community and the general public. Adequate information and proper communication represent essential conditions for enabling the public to switch to the euro with complete confidence.

The last Eurobarometer has shown that the level of interest and general attitude of the Czech public opinion towards the euro is not very positive. A majority of respondents are unhappy that the euro could replace the national currency. It is therefore time to inform citizens about the benefits of the euro through a variety of channels.

The Commission intends to develop its communication activities on the basis of the principles of decentralisation and subsidiarity, coordination and partnership. The role of national governments is indeed essential in the communication process since they are closest to their citizens. They are best placed to know their information needs, sensitivities and the right channels to approach them.

In order to support the communication activities of those Member States which are close to the euro introduction date, the European Commission enters into Partnership Agreements with them. We concluded recently such Partnerships with Estonia, Lithuania and Slovenia. I hope that in a few years, when the euro introduction comes closer in the Czech Republic, we will also be able to sign a Partnership agreement with you.

Via those partnerships, the Commission can support several activities developed by the national authorities, such as publications, audiovisual campaigns, conferences and seminars, promotional materials, surveys and opinion polls.

Ladies and gentlemen,

Let me conclude. The euro is a vital element for Europe's prosperity now and in the future. Every day, it is proving its value and importance. It is one of Europe's greatest achievements and we should be proud of it.

As an open and dynamic economy, the Czech Republic has everything to gain from adopting the euro. The single currency will foster a more stable environment for enterprises and a more efficient allocation of resources which subsequently will speed up the Czech economy's real convergence towards the most prosperous euro-area countries.

Regarding the practical preparations, I encourage you to prepare yourselves in good time so as to ensure a smooth, short and efficient changeover to the euro. The Commission will be your active partner in this process. It will contribute as much as it can to a successful changeover in all future euro-area entrants.

Thank you very much for your attention.