Europe’s Moment

07/03/2014 at 4:45 pm

An enormous amount has been written about the current situation in Ukraine and one intention of this post is not to duplicate overmuch. The politics has mostly been well covered elsewhere for instance. The economic discussion, however, has tended to focus on its direct effects, such as trade sanctions, commodity prices, and Russian asset and currency weakness. But there is an indirect effect at work that could have important economic and market consequences over the medium and long term; consequences which would have seemed very surprising only a short time ago.

The maps displayed on news websites over the last couple of weeks have tended to focus on Ukraine itself – colour-coded from time to time by language or broad ethnicity – and more latterly on the Crimea. Events further north have received less attention, yet there has been some real anxiety and sabre-rattling in the Baltic too.

On Monday, Russian forces conducted exercises in the Kaliningrad exclave on the Polish and Lithuanian borders:

Defense Minister Sergei Shoigu earlier said the snap inspections of more than 150,000 troops of western and northern military units were not connected with events in Ukraine.

Perish the thought. On the same day, a website in Poland published photographs of troop movements observed by members of the public, connecting them speculatively with events over the border with Ukraine:

Poland’s defence minister … told the TVN24 news station that “there are no movements of Polish troops which deviate from their usual routine” and that any movement[s] of soldiers and equipment are due to “routine exercises”.

Naturally. Then yesterday, it was announced that American fighters and service personnel are to be dispatched to Poland, and also that fighters and tanker planes had arrived in Lithuania to reinforce air patrols over the Baltic states. This time the connection with Ukraine was explicit. Both Poland and Lithuania are members of NATO.

This brings us on to the economic point: neither Poland nor Lithuania are yet members of the euro. Estonia joined in 2011, Latvia has just joined this year and Lithuania is set to join in 2015. Poland, however – observing the sovereign debt crisis and benefiting from currency depreciation on occasion – has been lukewarm on the matter and is not yet even in the ERM. But this week, governor of the National Bank of Poland Marek Belka said that security concerns should change the country’s thinking:

Belka said the standoff in Ukraine is increasing the political benefits of becoming part of the euro area and its $12 trillion economy, which would give Poland a seat among the “core group” of EU countries …

“There’s more influence” inside the euro area on issues ranging from defense to energy policies, Belka told reporters this week. “Even if the economic benefits today look modest, we need to make the political calculation as well.”

The euro area “is an island of stability” that “certainly looks attractive” to countries that feel threatened by the situation in Ukraine, Mario Draghi, the president of the European Central Bank, told reporters in Frankfurt yesterday, when asked about Belka’s comments.

This kind of thinking, coming from the biggest economy in the eastern part of the EU bloc, could carry over to other EU members who remain wedded to the euro only in theory. Bulgaria and Romania, for instance, have put back firm plans for joining in the past. Might these be brought forward again? The Czech Republic made weaker commitments after joining the EU in 2004 but these fizzled out; again, it may be possible for the tide there to turn. Various weaknesses have emerged as stumbling blocks to Croatia and Hungary, though European recovery should help overcome them.

On the other hand, Sweden has no plans to join and is unlikely to be subject to the same pitch of political concerns over current events in the east; and Britain and Denmark remain opted out of the project.

The policial point raised about membership by Mr Belka is of course a valid one. During a chequered visit to the UK recently, EU Commission Vice-President Viviane Reding stated her belief that “the eurozone should become the United States of Europe.” And in connection with Ukraine, Commission President Barroso – in addition to his commitment to supporting the country with €11bn of aid – said only yesterday:

Not only we have reiterated the European Union’s commitment to signing the Association Agreement … we have also decided, as a matter of priority, that we will sign very shortly the political chapters. This means notably the general principles, the part on political cooperation and the Common Foreign and Security Policy (CFSP) of the Association Agreement. This will seal the political association of the European Union and Ukraine.

This might not mean too much in practice. After all, how many divisions has the EU Commission? And there are several countries – including Finland, who has a peaceful shared border with Russia – which are signed up to the EU and the euro and are not members of NATO. Still, one can see why some in Poland and elsewhere might be encouraged by this kind of thing, and Vladimir Putin and others rather less enthralled.

To summarise: negative sentiment on euro membership arising from the sovereign debt crisis has abated with the crisis itself. Further, it is clear that an unwitting consequence of the new crisis in Ukraine has been to make membership seem more attractive, at least to some.

Over the medium term this could entail market convergence as seen in the late 1990s: the extra yield on ten year local currency debt issued by Poland compared to euro-denominated debt is 1.5%, for example, and this gap would be expected to close.

Over the longer term, as the eurozone in particular gains momentum in its quest for “ever closer union”, the position of the dwindling number of EU states outside it would look increasingly anomalous. The economic consequences of political change taking place as a result of this, especially here in Britain, are unpredictable.

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