Cyprus files formal application to join the eurozone

CYP peg likely at 0.585274, devaluation fears unjustified

The Republic of Cyprus applied Tuesday formally to join the eurozone on January 1, 2008, Finance Minister Michalis Sarris announced, after a fromal letter to that effect was sent to the European Central Bank President Jean-Claude Trichet and European Monetary Affairs Commissioner Joaquin Almunia.Cyprus joined the European Union in May 2004. The Cyprus pound has been part of the ERM2 since May 2005. The pound is expected to be locked into the euro in June or July this year.

The assessment of Cyprus‘ application to join the eurozone will be carried out on the basis of the economic criteria provided by the Maastricht Treaty, EU Commissioner for Economic and Monetary Affairs Joaquin Almunia’s spokeswoman, Amelia Torres, said.
Torres noted that the accession of a member state to the Economic and Monetary Union (EMU) is determined by the provisions of the Maastricht Treaty, and the member states decide on the basis of the reports issued by the European Commission and the European Central Bank, that have only a financial content.

The final decision is expected to be taken in Brussels on June 21-22 at an EU Summit to be ratified by all EU heads of state. After that and sometime in the first weeks of July 2007, the rate the Cyprus pound will be fixed and locked with the euro will be determined.

 

No question of devaluation

The Cyprus pound has been in the ERM2 mechanism, a proving ground for euro adoption, since May 2005. It now trades at a central reference rate of one euro equalling 0.585274 Cyprus pounds or 1.7086 and in a fluctuation band of 2.25%. The reference rate is the same at which Cyprus unilaterally pegged the CYP to the ECU (the predecessor of euro) in 1992.

The Cypriot currency has never fallen below the central reference value. Cyprus was forced in the early stages of ERM2 admission to cut interest rates because of the risk of the pound busting its 2.25% upper limit against the euro.

The CYP was last quoted at 0.5774-0.5804 against the euro for a middle rate of 0.5790 (1.7274) and the currency is most likely to slide towards the central parity rate just before the rate is locked, which in most likelihood will be 0.585274.

Centra Bank Governor Christodoulos Christodoulou said there was no chance of devaluation of the Cyprus pound prior to eurozone entry.
In an interview with the Cyprus News Agency (CNA), Christodoulou said fears of devaluation were unjustified and unfounded.
“The Cyprus pound remains strong and sound, and there is no question of devaluation prior to the changeover,” he said.
“I would like to remind people that similar unfounded claims were particularly intense on the eve of Cyprus’ accession to the EU.”
Not only was the pound underestimated back then, but it went on barely a year later to join ERM2 with the same equivalence against the euro at which it had stood in 1992, Christodoulou said.
After joining ERM2, the precursor to full eurozone entry, the pound strengthened further and remains on the high side of its 2.5% of the devaluation band.
Christodoulou referred to the “minor headache” involved in restraining the pound within the 2.5% limit, but said today it stood at 1.1% over the central rate. Last October, the pound was 1.5% stronger than the parity rate.

The Economist Intelligence Unit (EIU) has also predicted there will be no devaluation. In its latest report on Cyprus, the EIU says the reason why many Britons feel the Cyprus pound is overvalued is because of their own currency’s swings against the euro.
“We expect Cyprus to adopt the euro on schedule on January 1st 2008 at its central parity rate within the EU’s revised exchange-rate mechanism (ERM2) of CYP0.585:EUR1,” it said.

EUR will not affect social benefits
Cypriot Government Spokesman Christodoulos Pashiardis assured on Tuesday that social benefits would not be put on hold after the official request of the Republic of Cyprus to join the Economic and Monetary Union.
”The Cypriot government reiterates its definite assurance that in no way and to no extent will the government’s social policy be affected or social benefits suspended,” he said.
Pashiardis noted that social benefits have been paid and more are to follow.

On Monday, Finance Minister Michalis Sarris promised a package of measures by the end of 2007 aimed at helping the lesser well off people.

 

EUR benefits
Economists said joining the eurozone would encourage more foreign direct investment to the island and spur closer alignment of Cypriot interest rates with those of the European Central Bank.
At 4.5%, Cyprus‘ main refinancing rate is now 100 basis points higher than that of the ECB. The Cypriot Central Bank’s next regular rate review session is on February 23.
Fiscal slippage from 2000 to 2003 saw Cyprus‘ hopes of earlier euro zone admission dashed and the island was forced to wait in a queue until it got its public finances in order.
Nicosia has been following an austerity programme since 2004, designed to slash its budget deficit from above 6% of gross domestic product to a projected 1.6% in 2007.
It is also turning in lower public debt, expected to drop to 60.5% of GDP this year from 64.5% in 2006. Both indicators are key factors underpinning the EU’s Stability Pact.
“[Our goal] confirms our strong hypothesis that a strong economy is important both for the welfare of the people and politically for the country,” said Sarris.

On Monday, Christodoulou called on the government to maintain the austerity drive and not to go on a spending spree just because state finances had improved. “We have to show that our ratios are sustainable.”

Price hike fears

Christodoulou said he believed the economy was meeting the terms for euro adoption as scheduled, and expected prospects within the eurozone to be healthy. He said he was concerned over public fears that they would fall prey to profiteering on changeover.
The Central Bank governor said this was a “subjective, negative prejudice due to erroneous experiences”.
He said the reality in some other countries was that prices appeared to increase between 0.1% and 0.3%.
“Available statistics from the EU and the European Central Bank indicate that the adoption of the euro does not lead to a substantive or significant increase in prices,” he said.
Central Bank officials point out that the fact the pound is worth more than the euro will make it harder for businesses to profiteer.
Christodoulou also said a bill was before the House of Representatives providing for compulsory dual pricing for four months before the euro is introduced and for six months afterwards.
Christodoulou said Cypriot banks were set to have the first euro coins and banknotes in the autumn.
“The distribution of coins in euro will probably begin in October and banknotes will be allocated a month later. Banks will subsequently supply businesses with the euro, coins and notes,” he said.