The currencies of Cyprus, Latvia and Malta were today included in the Exchange Rate Mechanism II (ERM II). They follow Estonia, Lithuania and Slovenia, which became members of ERM II on 28 June 2004, as well as Denmark, a long-standing member. The following questions and answers aim to explain how the system works.



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What is the ERM II?

The ERM II mechanism is based on stable but adjustable central rates to the euro for the participating currencies, with standard fluctuation bands being +/-15% around the central rate. Exchange rate policy co-operation may be further strengthened, as is presently the case with Denmark, which has an agreed fluctuation band of +/- 2.25%.

ERM II is based on the 16 June 1997 Amsterdam Resolution of the European Council on the establishment of an exchange-rate mechanism (ERM) in the third stage of Economic and Monetary Union. The new ERM replaced the European Monetary System as from 1 January 1999.

Which countries are currently part of ERM II?

Estonia, Lithuania and Slovenia joined ERM II on 28 June 2004. Together with Denmark and the three countries which joined today, there are seven participants in ERM II.

How is the decision on joining ERM II taken?

Decisions on ERM II are taken by mutual agreement between euro area members, ERM II participants and the ECB following a common procedure involving the European Commission and after consultation of the Economic and Financial Committee.

How is participation announced?
ERM II participation of Cyprus, Latvia and Malta has been announced in a communiqué, which reveals that the decision to participate in the mechanism was accompanied by a commitment by the countries concerned to pursue very sound policies – sound fiscal policies, effective financial supervision, appropriate wage policies and structural reforms. By implementing these policies, the countries will make further progress in their convergence process and also help to ensure stability in the mechanism.

What is the role of ERM II in the euro adoption process?

ERM II plays a role in the formal euro adoption process as spelled out in the Treaty. Besides the formal requirement of a two-year participation in ERM II before the examination, the mechanism is intended to help Member States to achieve exchange rate stability.

The 1997 Council Resolution in particular recalls that the exchange-rate mechanism will help ensure that Member States participating in the mechanism orient their policies towards stability, foster convergence and thereby help them in their efforts to adopt the euro. At the same time, the mechanism also helps protect them and the other Member States from unwarranted pressures in the foreign-exchange markets. In such cases, the mechanism may assist participating Member States, when their currencies come under pressure, to combine appropriate policy responses, including interest-rate measures, with co-ordinated intervention.

What is the situation with regard to euro area enlargement?

Reports by the Commission and the European Central Bank in October 2004 (the Convergence reports) concluded that the “Member States with a derogation” – the 10 new + Sweden – had made progress towards meeting the criteria. But none of them met all the criteria, if only because none of the countries assessed had been in ERM II for a sufficiently long period of time. See Commission report on:

http://www.europa.eu.int/comm/economy_finance/publications/european_economy/convergencereports2004_en.htm

Another Commission report of 10 November 2004 titled “First report on the practical preparations for the future enlargement of the euro area” can be found at:

http://www.europa.eu.int/comm/economy_finance/publications/euro_related/eurorelated_communication2004_748_en.htm

What are the criteria for euro membership?

Article 121 of the EU Treaty established the following euro membership criteria:

the achievement of a high degree of price stability;
the sustainability of public finances;
the observance of the normal fluctuation margins provided for by the ERM for at least two years,
the durability of convergence achieved by the Member State and of its participation in the ERM being reflected in the long-term interest-rate levels.
The four criteria mentioned are developed further in a Protocol annexed to the Treaty which states that:

-- The criterion on price stability means that a Member State shall have a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing Member States in terms of price stability.

-- The criterion on the government budgetary means that at the time of the examination the Member State is not the subject of a Council decision under Article 104c(6) of this Treaty that an excessive deficit exists.

-- The criterion on participation in the ERM means that a Member State will have respected the normal fluctuation margins provided for by the ERM without severe tensions for at least the last two years before the examination. In particular, the Member State shall not have devalued its currency's bilateral central rate against the euro on its own initiative for the same period.

-- The criterion on the convergence of interest rates means that, observed over a period of one year before the examination, a Member State will have had an average nominal long-term interest rate that does not exceed by more than 2 percentage points that of, at most, the three best performing Member States in terms of price stability. Interest rates shall be measured on the basis of long term government bonds or comparable securities, taking into account differences in national definitions.


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