MacroScope

Lack of debt Estonia’s undoing?

February 23, 2010

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Low public debt would usually be a good thing, but it might throw a spanner in the works of Estonia‘s quest to join the euro zone.

The small Baltic country has a stable currency, its deficits and inflation meet European Union rules, and its top policymakers exude confidence the country will adopt the euro next year.

But with government debt below 10 percent of gross domestic product (GDP), Estonia has not needed to issue a benchmark bond — a government bond issued in Estonian kroons for at least 10 years — which it could use to show it has low and stable interest rates, one criteria for euro candidates.

The European Commission has previously said Estonia should not expect any problems from this, and the Estonians hang on to that. “There is no reason to expect the European Commission to change its current interpretation of the interest rate criterion,” the ministry of finance said last month.

But with Greek problems — it had hidden the total extent of its deficits when joining the euro — Estonia is bound to face comprehensive scrutiny.

Deutsche Bank’s Gunter Deuber and Nicolaus Heinen, who see Estonia as a borderline case for qualifying for the euro from the beginning of next year, expect other data to make up for the missing interest rate.

“Uncertainties in the interest rate criterion could be met with an analysis of convergence and long-term sustainability,” they said in a note. While they expect that analysis to be positive for Estonia, they also said there could be a close look at measures taken to keep deficits at bay, including record dividends to the state from companies it has an ownership stake in.

Were Estonia successful, this would be no small feat considering no country already using the common currency would qualify to join the bloc this year — public sector deficits are on track to exceed the 3 percent limit in every single euro zone country, European Commission estimates show.

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