Crunch decisions loom on the single currency

"For the moment, it seems protaganists are content to let slumbering dogs lie. But it is far from clear that events on the other side of the Channel will remain conveniently frozen in aspic until we have gone to the polls."
European monetary union has imperceptibly slipped from centre stage in the UK political debate in recent months. Last week, for example, nobody noticed that Tony Blair's comprehensive speech on Labour's economic strategy failed to devote a single one of its 9,000 words to the subject. Furthermore, a detailed and sceptical report on the subject by the Treasury's Independent Forecasting Panel passed into oblivion.

For the moment, it seems that the protaganists are content to let slumbering dogs lie. One reason for this unusual British reticence is that the issue seemed to have slipped down the agenda in Brussels. Late last year, almost everyone in the European Union, including the Commission, began tacitly to accept that the first possible date for the launch of EMU (1 January 1997) was a dead duck. This suited the British Government, which wants to shuffle the crunch decision until well into the next parliament. But in fact it is far from clear that events on the other side of the Channel will remain conveniently frozen in aspic until we have gone to the polls.

On Wednesday, the Commission will publish its long-awaited Green Paper on the transition to stage three of EMU. Although the paper will presumably accept that 1997 is no longer possible as a start date, it will not abandon the possibility of 1 January 1998. And the run-up to a 1998 launch - or even a launch in 1999 - means that Britain could face some critical decisions much earlier than it would like. If we do nothing, we could be choosing by default to stay out of EMU. Remember that the Maastricht Treaty says that EMU can only be launched in 1997 if a majority of the member states meet the convergence criteria by then. Everyone accepts that this will not now happen. However, if the 1997 date is missed, then the heads of government must, by 1 January 1999, set another date for the start of EMU. The date could in theory be after 1999, though that was not the intention of the treaty.

This all still seems a comfortable distance into the future. But as David Blake, of Goldman Sachs, has pointed out, another provision in the treaty could bring the effective decision point a great deal closer. In order to qualify for membership, each country must be participating within the "normal" bands of the ERM for at least two years before the start date. Furthermore, there must be no unilateral currency devaluations within the ERM over that period. Let us assume that the launch date is 1 January 1999, and work back from there.

In order to make this a practicable starting point, the participating countries will obviously need to be selected well in advance, probably by 1 January 1998. Counting two years back from that, countries will have to be inside the "normal" bands of the ERM by the beginning of next year if they are to qualify for EMU. This may be why the Italian government has been talking about the possibility of taking the lira back into the ERM by the end of 1995.

The Germans have quite definitely noticed this provision in the treaty, and appear determined to enforce it to the letter. In fact, their recent pronouncements on the subject suggest they will go beyond the letter of the treaty, and enforce its spirit as well.

When the treaty was drafted, the ERM was operating successfully with 2.25 per cent fluctuation bands for each currency. The clear intention of the drafters was that exchange rate movements would essentially wither away before EMU was launched, so that the first day under the new system would not be a particularly crucial turning point. So confident were they of this process that they left open the possibility that the "normal" fluctuation bands of the ERM would be reduced from 2.25 to 1 per cent or less before the eventual launch date for EMU. They therefore deliberately did not specify in the treaty a numerical definition of "normal" bands.

Ironically, this left the treaty intact after the ERM blow-up in 1992/93, when the fluctuation bands for the few remaining ERM members, including the French franc, were widened to 15 per cent. (The mark/guilder exchange rate remained within tiny margins, but only by a special bilateral agreement between the two central banks concerned.)

Following this event, enthusiasts for EMU refused to accept that anything untoward had happened, claiming instead that the 15 per cent bands could henceforward be treated as "normal".

It was in many ways bizarre that the entire mechanism envisaged in the treaty had been blown out of the water, yet the concept sailed serenely on. The Germans, however, have now put an end to this absurdity by insisting that they will interpret the convergence criteria in the treaty very strictly, not just on public debt and deficits, but on the operation of the ERM as well. This is important, since the German parliament will vote on whether the convergence criteria are met before it will allow Chancellor Kohl to abandon the mark for a European currency - a vote that, in effect, gives the Bundestag a veto on EMU. They will not hesitate to use the veto if the convergence criteria are fudged.

The result of all this is that some awkward choices are looming in the near future, not just for Britain, but for France as well. If the Germans really are going to insist on the maintenance of 2.25 per cent bands for two years before the participating countries are chosen on 1 January 1998, then these bands must be in place by the start of next year. It will not be good enough for France to leave the 15 per cent bands in situ, and hope that a subsequent decision by the European Council will deem this sufficient to meet the convergence criteria. There seem to be only three ways forward.

The first is to leave things as they are, and hope that the convergence criteria can be circumvented in 1997 or 1998. This may well be the preference of both the British and the French, for different reasons, but the distant threat of a veto by the German parliament in three years makes this option highly uncertain. In any case, recent statements by both the Bundesbank and the German government indicate that they will not accept it.

The second possibility is to recognise now that 1999 is not a feasible starting date, and to amend the treaty accordingly. But nobody seems ready to contemplate this option yet.

The third is to do something now to ensure that the convergence criteria will be met by the beginning of 1998, when the participating countries are selected.

For France, this would mean getting inside a renewed narrow band against the mark before the end of this year. But it seems rather hard to believe that this new narrow band would be consistent with the franc's old central parity of 3.35 against the mark, since it is currently trading at around 3.50. A revaluation in the mark's central rate, followed by a renewed narrowing of the bands, would presumably be required. There is no indication that the new administration in France is ready to contemplate any change in the central parity. And, of course, there is even less that the UK government is ready to go back into the ERM by the end of this year. But in the absence of these steps, neither country may be deemed by Germany to meet the convergence criteria in time for a start date in 1999.