The adoption of the euro is likely to be a material medium-term driver of sovereign rating actions in Eastern Europe. Fitch believes it would render balance of payment and currency crises negligible, and could lead to one- or two-notch upgrades of Foreign Currency Issuer Default ratings (FCIDR). Cyprus and Malta will become the 14th and 15th countries to join the euro area in January 2008, following Slovenia in January 2007. Accordingly, Fitch upgraded the FCIDR of Cyprus to 'AA-' (AA minus) from 'A+', and of Malta to 'A+' from 'A' in July, after the formal decision of the Ecofin Council.
"Fitch believes there is a good prospect that Slovakia will join the euro in January 2009 and it revised the Outlook on its FCIDR of 'A' to Positive in July," says Mr Parker. However, there are risks to meeting the inflation criterion, particularly if the EU authorities adopt a harsh interpretation of a "sustainable" price performance or Exchange Rate Mechanism (ERM) membership without "severe tensions". "Its treatment by the EU authorities could be a key test case with systemic implications for the region," says Mr Parker. After Slovakia, however, Fitch anticipates a three year hiatus until the next country joins the euro area. Indeed, none of the other six 2004 EU entrants presently have clear official target dates, and no new country has joined the ERM II for nearly two years.
For the Baltic States, the agency expects rising inflation and macroeconomic imbalances to delay euro adoption until 2012 for Estonia, and 2013 for Lithuania and Latvia (the latter of which Fitch downgraded to 'BBB+'/Outlook Stable from 'A-' (A minus)/Outlook Negative in August). Excise tax rises, supply shocks and real income and price level convergence, in combination with fixed nominal exchange rates, will make it difficult to fulfil the inflation criterion, so even longer delays are possible.
Fitch does not expect Poland and the Czech Republic to join the euro until 2012 and 2013, respectively. A lack of political will appears to be the main constraint - the failure to enter the ERM II has already closed off entry before 2011 - so the next round of elections will be significant. They will also need greater fiscal discipline and to maintain low inflation. Fitch still believes 2014 is the most likely date for Hungary. Despite the government's good progress to date, sustaining fiscal consolidation will be challenging, particularly with elections due in 2010.
Fitch's forecasts for euro adoption for Bulgaria and Romania are 2013 and 2015, respectively. But these are uncertain as both have a long way to go on real convergence, are showing signs of overheating and will find it hard to meet the inflation criterion for many years. Bulgaria's failure to join the ERM II may point to reservations over its membership by the EU authorities.
