Euro lures central Europe

CENTRAL EUROPEAN countries like the Czech Republic and Hungary could adopt the euro before they join the EU - and before the UK signs up for the single currency.

The policy of "euro-isation" would parallel the dollarisation under consideration by countries such as Argentina, and is a real possibility for half a dozen countries on the European Union's eastern fringe, according to a recent report from ING Barings.

Such economies could join the single currency as early as 2002, when euro notes and coins come into circulation.

The policy would involve fixing an exchange rate against the euro, then exchanging via the central bank's reserves all of the national currency in circulation for euro notes and coins.

Many emerging European economies do have high enough reserves to do this, according to Charles Robertson, the author of the report.

A handful are also close to satisfying the Maastricht criteria for convergence with the Euro-11, with the Czech Republic, Croatia and Lithuania at their head.

The benefits for these small economies on the borders of the 6-trillion- euro economy of Euroland would be many, Mr Robertson argues. Their interest rates would fall sharply to euro levels, where short term interest rates are currently 2.5 per cent.

Most of these potential single currency members already carry out much of their trade with the EU, so their exporters would face a reduced exchange rate risk.

This would be particularly attractive for the Czech Republic, whose freely convertible currency has been extremely volatile due to its use by hedge funds.

The move would also make the countries even more attractive as a base for direct investment from the EU. The surrender of monetary policy to the European Central Bank would allow investors to take advantage of the lower cost base in countries beyond the EU's borders without any risk of devaluation.

The catch is that greater job market flexibility might be required once the option of devaluation is lost.

Nevertheless, some countries have already indicated their interest in adopting the euro, notably Croatia.

Comments from the ECB and EU have hinted that they would not approve. But Mr Robertson says for countries like Lithuania, which are years away from being allowed to join the EU, disapproval might not be a deterrent.