Greek crisis casts shadow over euro expansion (Feature)

By Andrew McCathie May 4, 2010, 4:08 GMT

Berlin - Estonia's ambitions to become the 17th member of the euro is shaping up to be a key test of Europe's commitment to roll out the common currency across Central Europe, especially as Greece's financial crisis threatens to undercut the expansion drive.

With its deficit and debt levels comfortably within the strict fiscal targets for euro-candidates, Estonia had hoped that it would become the third member from the new European Union (EU) countries to sign up to the euro, adapting the common currency in January 2011.

But the mood surrounding eurozone enlargement in Europe's key capitals has darkened after the EU was forced to mount a major rescue operation for Greece amid claims that Athens cooked its books to gain entry into the eurozone in 2001, two years after the euro was launched in 1999.

'Having burnt their fingers with Greece's entry, the Europeans will be ensuring they double check the numbers this time,' said Rainer Guntermann, senior European economist with Germany's Commerzbank AG.

Even during the best of economic times, Western Europe's political and economic establishment are very cautious about opening up the exclusive euro club to new members.

But financial markets might see a delay in Estonia's membership as a sign of tensions in the eurozone. As a result, giving the small Baltic state the green light for adopting the euro could also signal Europe's confidence in the currency bloc.

Long considered in the vanguard of economic performers among the new EU members, Estonia's hopes of replacing the kroon with the euro come as most European nations gear up for a round of big budget cuts after their deficit and debt levels ballooned in the wake of what has been the world's deepest recession in a generation.

The budget deficit of the 16-member eurozone is expected to average 6 per cent of gross domestic product this year, well above the 3-per-cent target, thanks to falling tax revenue and growing government spending on economic stimulus measures.

In the meantime, the Greek fiasco is also fuelling speculation that European leaders might now move to toughen even further the criteria for euro membership.

But the new EU states, their economies having taken a hammering during the recession, are in no mood to slash public spending further to bring their budgets into line with current or stricter euro fiscal targets.

Initially seen as a safe haven as the global economic crisis tightened its grip, the euro now seems to have fallen out of favour with the new emerging economies in Central Europe. Many have pushed back their deadlines for membership applications further into the decade.

Earlier last month, Bulgaria announced that it was abandoning plans for joining the euro in the next three years after unaccounted procurement deals signed by the previous government left the country with a bigger-than-expected deficit last year.

Having managed to escape recession last year, Poland also seems reluctant to put at risk its current modest economic growth by moving to wind back its deficit from its present level of 7 per cent of GDP.

Since it was originally launched in 1999, euro membership has only been expanded to include relatively small EU member states. Thus, Poland's eurozone entry would prove a major challenge to the currency bloc's ability to absorb an economy that is based around a population of nearly 40 million people.

Under their EU membership agreements, Central European states are required to join the eurozone when they fulfil the strict conditions for membership.

Brussels is to set out next month which EU states currently outside the eurozone meet the strict fiscal criteria for adapting the common currency.

This includes a particularly tough inflation rule calling for consumer prices that are no more than 1.5 percentage points above the average of the three EU countries with the slowest price growth.

With Estonia having a sparkling set of fiscal numbers such as a projected 2010 deficit of 2.5 per cent and an inflation rate of 1.1 per cent, the country would seem to be a shoo-in for eurozone membership.

But the European establishment has in the past also insisted that euro candidates have to demonstrate that their budget, debt and inflation numbers are sustainable, which has also raised concerns that expansion could come down to a political decision.

Thus, questioning the sustainability of Estonia's key economic indicators might give Europe the chance to play for time and to delay the nation's euro entry ... and raise questions about further euro expansion.