The fallout of the Greek financial crisis

It is difficult to imagine any direct economic fallout from the economic problems in Greece to Estonia. The two countries trade very little with each other and there are essentially no Estonian immigrants in Greece. Moreover, the risk of any financial spillovers is also small as the two countries’ financial systems are largely disassociated. The limited borrowing of the Estonian government takes place from intergovernmental lenders such as the European Investment Bank, and the debt crisis in Greece would likely not affect the lending from such institutions. In conclusion, the Greek debt crisis is unlikely to affect the Estonian economy in any way that may jeopardise the fulfilment of the Maastricht criteria.

The question then becomes whether there may be political fallouts from the crisis in Greece. It has been argued that the crisis might dampen the appetite for admitting new members to the euro area. The argument is that the administrative and economic resources of the euro area and EU would be directed towards solving the problems in Greece and other current euro area countries; the addition of new members of the euro area may therefore be seen as a distraction. According to this scenario some kind of technicality or political excuse would be found to refuse Estonia membership of the euro area (FT, 2010).

This scenario is not very likely. First of all, the European Commission, the European Central Bank and numerous euro area governments have emphasised that the euro area is open to any EU country satisfying the Maastricht criteria. The Commissioner for Economic Affairs, Olli Rehn, stated in his confirmation hearing that Estonia most likely would be the next euro area country but also that the admission process would follow the rules in the Maastricht Treaty (European Parliament, 2010). The president of the Eurogroup, the Prime Minister of Luxemburg, Jean-Claude Juncker, has recently called for a clear and consistent application of the Maastricht criteria (Junker, 2010). The Eurogroup, i.e. the group of euro area finance ministers, has the right to recommend an EU country for admission to the euro area.

Second, it would be surprising if the euro area would be closed in the current situation, in which the common currency has been hailed as a factor stabilising European financial markets. The four countries that have joined the euro area recently, i.e. Slovenia, Malta, Cyprus and Slovakia, have generally benefitted from the membership and they have not caused any major problems within the euro area.

Third, it would be ironic if fiscal problems in one or more countries in the euro area would lead to the barring of membership of the country with possibly the most tightly managed public finances in the EU. The Greek crisis has put the spotlight on the importance of prudent government housekeeping, and Estonia is an example of a country that has managed to balance its books over long periods of time and take measures when deemed needed for political or economic reasons (see Figure 1). It would be hard to see why the ministers of the euro area and the EU would exclude such a country as long as it satisfies the Maastricht criteria.

The Estonian authorities are aware of the possible complications emerging from the debt financing difficulties experienced by Greece and other euro area countries. The Estonian Prime Minister, Andrus Ansip, stressed in the middle of February that Estonia does not ask for exemptions to the Maastricht criteria and then added with reference to the situation in Greece: "I hope nobody will start to create new criteria for Estonia" (FT, 2010).

The lessons from fiscal management in Estonia
The Achilles heal of the common currency in Europe has turned out to the lack of coordination of fiscal policy and the free-riding in the form of excessive debt accumulation by individual governments. The lack of fiscal prudence can be explained by "fiscal blindness" amid economic upturns and low interest rates, but political constraints may also have played a role.

The fiscal problems in Greece and some of the other PIIGS countries go back a long time. Overall, very few of the euro area countries have managed to tighten budgets and bring down government debt levels since the introduction of the euro in 1999. The Stability and Growth Pact was originally meant to address the fiscal incentive problems by capping the deficit and the accumulated debt (Beetsma & Uhlig 1999). It is unfortunate that the revision of the Stability and Growth Pact in 2005 rendered it "toothless" so that it ceased to counterbalance pressures for deficit spending.

Estonia has fared well during the last 20 years while having exhibited an unusual degree of fiscal prudence. One lesson from Estonia is that a budget balanced over the economic cycle is entirely feasible even in a relatively poor country. Measures that are painful in the short term can be implemented without the electorate punishing the government. Another lesson is that governments need to manage their liquidity very carefully to avoid being caught out by disruptions in financial markets. The accumulation of reserves gives the government additional degrees of freedom and independence amid sudden changes in market confidence.

Estonia is ready to join the euro area and adopt the euro from January 2011. Estonia satisfies all of the Maastricht convergence criteria, including the deficit criterion in spite of very adverse economic circumstances. Estonia will undoubted be a strong voice for fiscal prudence in the euro area. As I see it, this is exactly what the euro area needs.

This policy brief series is a product of the European Policies Initiative (EuPI) within the project "Euro Monitor – Monitoring the process of accession of the EU member from Central and Eastern Europe to the euro zone".

The views expressed herein are those of the author(s) and do not necessarily reflect the position of the Open Society Institute –Sofia. Karsten Staehr is professor of international and public finance at Tallinn University of Technology, Estonia. All viewpoints expressed herein are personal.

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