DIFFERENT VIEWS ON THE EURO: DEFINITIONS, ECONOMIC POLICY ISSUES AND UPCOMING TASKS

The concept "euroisation" or "the early introduction of the euro" has been used in Estonia's economic policy discussions meaning three independent processes. First, the euroisation means the introduction of the euro as a new currency to replace the Estonian kroon. Second, the euroisation means the accession to the Economic and Monetary Union (EMU) and the Eurosystem. Third, the euroisation means also an ever widening use of the euro in daily life - in payments and settlements, to express prices of goods and services, etc. Below we are going to describe briefly all of the approaches, their nature and relations with Estonia's current economic policy circumstances.

I DEFINITIONS

1. Economic and Monetary Union. EMU as a Monetary Reform

The Economic and Monetary Union is an integral part of the European Union, all EU Member States participate with or without a derogation in the monetary union. EMU is the key instrument for achieving the main economic policy objectives of the European Union - stable growth and low inflation. Economic and Monetary Union is based on two pillars - coordination of economic policies and single monetary policy. The single monetary policy and EMU cannot succeed without collaboration in the economic and fiscal policy and without the free movement of goods, services and capital in the single market.

The first pillar applying to all Member States of EMU is the mutual coordination of economic and fiscal policies between the Member States and the European Commission. This is being implemented through regular economic programmes drawn up by the Member States with the main aim (i) to meet Maastricht criteria by the Member States with a derogation and (ii) to maintain balanced budget provided for in the Stability and Growth Pact by the Member States without a derogation. EMU's second pillar is the single monetary policy implemented by the European System of Central Banks (ESCB) and the European Central Bank (ECB) with the primary objective of price stability. It should be stressed that the single monetary policy is applicable only in the Member States who have fulfilled the Maastricht criteria and joined the European single currency area (Eurosystem).

The fundamental difference between two EMU pillars is the discretionary supremacy. The economic and fiscal policy is within the competence of the Member States and national policies are coordinated on the EU level. Decisions in economic and fiscal policy issues are taken by the Economic and Financial Affairs Council (ECOFIN). The single monetary policy is fully within the competence of the European Union (ESCB/ECB). The EU monetary policy decisions are made by the Governing Council of the ECB comprising of the Governors of the National Central Banks of the Member States and all six members of the Executive Board of the ECB.

The scope of participation in EMU divides all EU Member States into two groups: "ins" and "pre-ins". The reason for such distinction is evident - in long term the monetary union performance will not depend on national governments' political will but on the stability and economic convergence of the Member States. The single monetary policy cannot be successful if a Member State has a chronic budget deficit as it would have an immediate impact on interest rates of the euro area. The single monetary policy could not succeed without all the National Central Banks of the Member States being independent either. What's more important, the single monetary policy could not succeed unless all national governments and central banks had common economic policy core principles. Therefore for the participation in EMU the Member States have to satisfy the convergence criteria reflecting their preparedness to participate in designing and implementing the single monetary policy.

The criteria of participation in EMU fall into three groups. First, for full participation in EMU it is necessary to prepare a national economic and fiscal policy programme and have the implementation capacity. Such an economic policy preparedness becomes manifest in their ability to develop and implement economic convergence programmes in cooperation with EU Member States and the EU Commission and to implement the excessive deficit procedure. The convergence programme aims at fulfilling the Maastricht criteria (see below) and ensuring stable economic development, inter alia, the observance of the provisions of the Stability and Growth Pact.

The second full participation criterion is legal: national economic, fiscal and monetary policy legislation should comply with the Amsterdam Treaty and other EMU acquis.

Thirdly, it is necessary to satisfy the Maastricht criteria in order to ensure the nominal convergence of the economies of the acceding country and the euro area countries. The Maastricht criteria fall into two categories - one characterises price convergence and the other - balance in the fiscal policy. The price convergence is reflected in low inflation and low interest rates. A small budget deficit and stable foreign debt should guarantee balanced fiscal policy, so important for EMU. The low inflation and balanced budget (the internal balance) exclude sharp changes in the balance of payments (in the flow of goods, services and capital) leading to the exchange rate stability (the fifth Maastricht criterion). Briefly, the Maastricht criteria characterise such an economic policy balance in EU Member States that the Member State would be "ready" to join the euro area.

A vital precondition preparing for the participation in EMU and holding successful negotiations would be a clear understanding of the economic policy core of the above convergence criteria. The first two sets of criteria - economic administrative capacity and harmonisation of the legislation - speak for themselves. It has often been stressed that EMU is not only a common currency but also, first and foremost, (i) coordination of economic policy, and (ii) a single monetary policy (presuming economic policy cooperation in other fields).

The economic policy substance of the Maastricht criteria lies in the following. Upon joining the euro area the EU Member State gives up its monetary policy as a policy instrument. The national central bank cannot, in case of economic difficulties, directly or indirectly finance the budget deficit. The national central bank cannot, in case of economic difficulties, increase the amount of cash in circulation either, leading, thus, to lower interest rates and depreciating exchange rate. The government can apply fiscal policy but this would also create problems. Constant budget deficit fuels inflation, which in its turn would increase interest rates and slow down the output growth. Due to the convergence of interest rates in the euro area, the monetary policy environment of the euro area would depend on the fiscal policy of each of the Member States. Thus, the criteria of the balanced budget and stable exchange rate ensure the balanced economic policy of the Member State, proving that the state does not rely on budget deficits and currency devaluation.

Low inflation, as a precondition for long-term investments and economic growth is well known. This leads to the main objective of the price stability criterion (and interest rate stability criterion as a measure of the anticipated inflation) -- conviction that the euro area economies are used to operate in the environment of low inflation and confidence that the monetary policy of the Member States has secured price stability.

Summa summarum - participating in EMU, the Member States agree to reduce independent macroeconomic policy decision-making and increase coordinated decision-making. The Member States that joined the euro area set up the Monetary Union with the monetary policy implemented by the European Central Bank, established and owned by the Member States. For each country joining the euro area this step is a monetary reform - the current national currency is given up for a more efficient internal market and a coordinated economic policy. The monetary reform will set a framework for macroeconomic decisions on the national level. In order to minimise the accompanying risks, the European Union has set requirements for economic policy legislation (the Amsterdam Treaty and EMU acquis), economic policy capacity (the capacity to devise and pursue an economic policy programme) and economy as a whole (five Maastricht criteria) for new participants in the euro area. The most significant conclusion of the Maastricht criteria is that the fulfilment of the criteria (nominal convergence) presumes a certain level of the economic development (real convergence). This implies that EMU today (common policy, common currency) is for states with real incomes close to the average of the euro area.

It takes time to check the fulfilment of convergence criteria and the administrative capacity of a potential Member State of the euro area. The official EU position today refers to at least two years following the accession to the European Union. Meanwhile the new Member State will submit its convergence programme and the European Union (the Commission and the "pre-ins") will monitor its fulfilment (achievement of the Maastricht criteria) in two years.

It should be stressed in conclusion that the participation in EMU is not implemented only "at a certain point of time" or that the criteria would "age", etc. On the contrary, all the criteria rise directly from the optimum currency area theory by Robert Mundell, a Nobel prize winner in 1999, describing the successful performance of the Economic and Monetary Union.

2. The Unilateral Adoption of the Euro as a Monetary Reform

Similar to joining the euro area, the euroisation as "the unilateral adoption of the euro" is a monetary reform as well, although completely different in its principles and implementation. Joining the euro area is a collective decision taken by the European Union and a new Member State will automatically participate in the development and implementation of the monetary policy pursuant to rules agreed on in the acquis whereas the unilateral adoption of the euro would be an individual decision taken by the sovereign state. Formally "the unilateral adoption of the euro" is not related to the European Union and Estonia's potential accession to the EU. Therefore, "the unilateral adoption of the euro" should be handled strictly within Estonia's economic policy outlook and the advantages and disadvantages be evaluated in this context.

"The unilateral adoption of the euro" (a similar phenomenon in Latin America is called dollarisation) would in the monetary policy sense mean the following: the state will officially give up its right to issue currency and the sole legal tender in circulation will be the euro (or dollar in case of a similar process elsewhere in the world). Three important steps are taken on the national level: first, the state will accept the payment of taxes only in the foreign exchange (euros); second, the central bank will officially be deprived of the right to issue both cash and account money; third, the foreign cash (in case of Estonia - banknotes of all euro area Member States) will replace domestic banknotes in circulation.

As to the domestic decision-making, the result coincides, in principle, with that upon joining EMU - Estonia will fully give up its right to issue cash and account money as a national economic policy instrument. However, both processes have a substantial difference - joining the euro area, the EU Member State will exchange its decision-making right at the national level against the decision-making right at the European Union level. The creditworthiness of the participation in EMU will be substantially if not qualitatively different from the creditworthiness of the unilateral introduction of the euro (in the first case the ESCB/ECB will be responsible for the monetary and financial system stability on Estonia's territory as well, in the second case, only we ourselves).

On the other hand, as strange as it may look, the euroisation will leave at the disposal of the state and the central bank (regardless the waiver of the issue rights) a set of monetary policy instruments not much different from the set used within the currency board arrangement. The reserve requirement will be retained (certainly the reserve requirement will be met in euros), the central bank will retain its ability to act as the lender of the last resort (1) using its resources as well as to marginal liquidity management in the domestic money market (issuing instruments quoted in euros).

(1) Naturally the lack of issue rights will limit the lender of last resort functions with the amount of formal reserves.

We should not forget that in case of the waiver of the issue rights, the state will automatically give up seigniorage which would (in case of Estonia as well) impose additional obligations on the budget in the medium and long term (ie would increase the tax burden). The waiver of seigniorage would mean crediting of the European System of Central Banks by Estonia.

Let's return to the state waivering the issue rights. When could it happen? The response lies in the optimum currency area theory. First, the state would give up issue rights only upon joining the monetary union, in case of the European Union - the euro area. This requires similar highly developed economies of the Member States, mutual integration of member economies (in the USA and euro area the outward export from the single currency area is only 10 to 15 per cent of the GDP) and sharing of key economic principles. The underlying reason for giving up national currency and national monetary policy is such an integration of economies and economic policies that the higher efficiency of markets enhanced by the single currency would outweigh the loss of monetary policy independence. In other words - the efficiency-generated growth likelihood is higher against the serious economic downfall likelihood (ie effectiveness of a devaluation is reduced to minimum). It is worth underlining two major prerequisites - adequately converged and enough diversified economies, as well as the confidence in the economic policy sustainability after joining the monetary union. The participation in EMU brings along a declining country risk and lower interest rates as the growth potential has an upward inclination and the devaluation risk a downward one. The European Union and the euro area serve as a typical example here.

Another situation when giving up of issue rights is beneficial, would arise when and if the economic and monetary policy has lost any creditworthiness (it is usually followed by a very high inflation) or the state has just emerged. The euroisation would ensure the reinstatement of the money's key functions (as a means of investment, store of value and unit of account) as well as enhance the confidence in the economic policy. The disappearance of the devaluation risk would bring along a sharp fall in interest rates (the country risk would shrink due to higher confidence in the policy), leading to economic recovery and higher foreign investments. The recovery of confidence argument can be illustrated by the examples of Ecuador, East-Timor, Montenegro and by Estonia in 1992 as well.

Between these two extremes there are a number of different economic policy situations with the ratio of euroisation advantages and disadvantages depending on specific circumstances. It is clear that the confidence recovery argument will start to lose importance after the initial stabilisation of the economy and a number of new risks will appear, with the euroisation being insufficient against them, which under certain circumstances could facilitate stagnation (some regions north of England and a few US states serve as classic examples of being parts of single monetary and economic area but remaining less-developed areas for decades). In this case even the low interest level would not attract investments, as the growth potential is low due to structural reasons. There is not much sense in closing eyes to the fact that monetary policy independence per se, ie the exclusive right of issue, is a significant economic policy instrument for any state if used with full responsibility. A parallel could be drawn: assuming that we will never wage a war, we would not need the army either. Whereas the very existence of army is a peace enforcing factor. The same applies to the right of issue as well - if we give it up, we should be convinced of never really needing it. Unless the markets share this opinion in the medium term, this step could bring loss instead of benefit.

Two axioms can be outlined weighing pros and cons of the unilateral euroisation in case of the two above extremities: (i) first, the unilateral euroisation will not fully eliminate the devaluation risk as the national currency could be reintroduced any time and this would be the case in serious economic downfall; (ii) even the partial decline in the devaluation risk would not bring along a decline in the country risk, followed by continuously shrinking interest rates; rather a reverse trend could emerge under certain circumstances (see the following chapter).

It is true that academic communities have recently encouraged discussions on the unilateral introduction of the dollar or the euro. We should stress that such proposals have been made only in the context to increase confidence and in case of a serious economic policy shock. The euroisation (dollarisation) has been recommended to Latin American countries where for decades local pesos, reals, sucres, etc have been associated with high inflation and declining real value. The euroisation has recently been recommended also to the Balkan countries with collapsed economies and local currencies unable to meet any of the key functions of money. Notably the prerequisite of such a monetary reform is an agreement with international financial organisations. It is quite evident that in case of Latin American or Balkan type of the unilateral euroisation there can be no talk about monetary policy cooperation - or if, then in the best case only as a part of the technical assistance and/or as a control function exercised by foreign countries. It should also be underlined that in case of the much discussed dollarisation in Argentina, the latter applied, first and foremost, only for a contractual relation with the US Federal Reserve (as Argentina has no option like the participation in EMU in the introduction of the US dollar) and is less outspoken after the consultations (increasing resources to implement other economic reforms).

3. Voluntary Adoption of the Euro in Daily Transactions

The third dimension in the euroisation discussions is the use of the euro in everyday life. In essence it is very different from the above two. It is not an economic policy, administrative monetary reform but a conventional impact of market mechanisms.

The voluntary adoption of the euro can be implemented in several different ways. The easiest would be to handle it by key functions of money. Firstly, people can have deposits in foreign currency (in euros). Secondly, the foreign currency can be used as a medium of exchange, or as cash on money account. Thirdly, the foreign exchange can be used as a unit of account to measure the value of goods and services, ie prices of goods and services can be quoted in foreign currency.

The voluntary adoption of the euro or any other foreign currency in the private sector today is natural and widespread. As a rule businesses or individuals settle accounts and make payments in currencies with the least transaction costs. Therefore the use of the foreign currency as the medium of exchange is very welcome in some industries and increases the overall economic efficiency (first and foremost lower conversion costs both spot and forward). The foreign exchange is also used as a unit of account in specific sectors, quoting the prices of purchased goods and services in euros, US dollars, etc. Some deposits are also always held in foreign currency.

The above situation is characteristic of the majority of developed countries (including also Estonia) whereas in weaker economies the dollarisation could be more extensive. Due to high inflation (or lasting memories of inflation), most of the businesses and people keep their savings in dollars in Latin American countries (in German marks in some Balkan countries). In case of classical dollarisation the extremely low confidence in domestic currency has led to a situation in which the foreign currency fulfils the store of value, medium of exchange and unit of account functions of money. The domestic currency has a very limited role under such economic policy circumstances. As mentioned above, the extensive dollarisation has been characteristic of several Latin American countries.

The voluntary adoption of the euro in mutual transactions will enhance the efficiency of some industries in the developed economies (the use of the euro will increase the economic efficiency of less developed economies as well, boosting cash savings). Thus, the primary objective of the state is to establish such conditions in which economic agents (businesses, individuals) could freely choose a currency for mutual settlements (it should be stressed that the choice should be really based on the agreement of the parties). In developed countries the freedom of choice is ensured by the liberalisation of foreign currency acts and lifting of restraints on capital flows. Both of these steps are prerequisites for the participation in the Economic and Monetary Union.

In principle the state can take another step to enhance the freedom of choice: the government as the largest participant in the national economic system of any country could permit to pay taxes in foreign currencies. Such a step would significantly reduce the conversion costs of exporting companies.

II ESTONIA'S ECONOMIC AND MONETARY POLICY KEY ISSUES AND THE EUROISATION

Hereinafter all three processes related to the introduction of the euro are handled in the light of Estonia's economic and monetary policy key issues.

4. Estonia Joins the Economic and Monetary Union

Joining EMU is an integral part of the accession process as a whole as Estonia will participate in EMU automatically from the moment of becoming a full-fledged member of the European Union. It is important to stress that Estonia cannot participate in the Economic and Monetary Union before accession to the European Union as a non-member of the European Union cannot participate in EMU. Applicant countries are involved in the EU economic and monetary policy on the basis of the Accession Treaty, providing for the cooperation in developing and implementing the economic policy, the European Union can also give technical assistance to align Estonia's monetary policy with that of the European Monetary System.

As the accession to the European Union is Estonia's national strategic objective, the participation in EMU is our objective as well. Herewith we stress that joining EMU would in the best and most reliable way meet the key function of the central bank - to ensure the stability of the circulating currency and low inflation. As described above, the standard process of joining EMU and the euro area comprises of three stages:

    Estonia's economic and monetary policy preparations to accede to the European Union (from an applicant country to the full EU membership): Copenhagen criteria; harmonisation of the fiscal and monetary policy legislation with EMU principles; free movement of capital, coordination of the economic policy development programme with the European Commission and monitoring of the implementation; simulation of the excessive deficit procedure;
   Estonia as a European Union Member State: to ensure full compliance of the legislation; to devise and implement convergence programme (achieve the Maastricht criteria); formal participation in the exchange rate mechanism (ERM2); Eesti Pank participates in the General Council of ECB. As said above, this period (period from the accession to the European Union to joining the euro area) will last at least two years according to the current EU acquis;
   Estonia joins the euro area: Estonia will participate in the formulation and implementation of the EU monetary policy (ie the central bank will implement ECB monetary policy guidelines and manage the circulation of the cash and account money in euros); the Governor of Eesti Pank will become a member of the Governing Council of the European Central Bank; Estonia will start getting its share of the seigniorage of the euro issue.

Estonia's current position as regards joining EMU, is as follows:

   according to the European Commission Progress Report, Estonia has a functioning market economy and will be competitive in the internal market of the European Union in the medium term; Estonia's monetary policy and framework and currency board arrangement are no obstacles in accession to the European Union and participation in Economic and Monetary Union;
   Estonia's fiscal and monetary policy legislation will be technically fully harmonised with EMU acquis during the years 2000 and 2001 (two key acts in this field are: the Basic Budget Act and the Central Bank Act);
   the Medium-Term Economic Programme (MTEP; for the period of 2000-2003) will be coordinated with the European Commission in the first half of 2000. The implementation will be regularly reviewed together with the European Commission; the European Commission is going to launch a cooperation project to simulate the excessive deficit procedure;
   Estonia's economic policy situation has stabilised and the economic growth recovered; thus, a prerequisite for achieving the balanced budget in 2001 has been set.

Estonia's economic and monetary policy preparations for the accession to the European Union and participation in EMU are systematic. We should stress and recognise that we have taken only the first steps to meet the criteria for joining the euro area. Estonia's economic administrative capacityto cooperate with the European Union has not been tested in practice. Estonia's legislation requires changes. We do not fulfil three out of five Maastricht criteria (budget deficit, inflation and interest rates) as of 1999 whereas there is no need to fulfil them at the current development stage as yet. What's more important - the "second generation" reforms, having a direct implication on the growth potential over the long term, are still uncompleted both at the macroeconomic (budgeting procedure, pension reform, administrative reform) as well as on the business level (energy sector reform, standards, etc). Their success - not the "replacement of the currency" - will directly determine Estonia's economic growth in upcoming years and the increase of real earnings and productivity (real convergence with the European Union and the euro area).

Herewith we should stress that single monetary policy cannot succeed without market confidence. Therefore euro area risks are higher if its members have not been screened properly. Thus, the stringent selection of the euro area members is in full compliance with Estonia's current monetary policy and our strategic interests (ie the stringent screening for the euro area is in our interests as well).

The Economic and Monetary Union chapter has been closed at the accession negotiations, Estonia applies for neither transition periods nor derogations and has also confirmed that we accept the three-stage accession to the Eurosystem according to the current scenario. Estonia's further negotiations in this issue should focus on two key aspects:

   the maintenance of Estonia's currency board and fixed exchange rate peg until the full participation in EMU, inter alia, during Estonia's participation in the exchange rate mechanism (ERM2, the standard fluctuation band 0%);
   should Estonia's accession to the European Union be postponed and our economic stability sustainable, a question could be raised to shorten the two-year interim period.

In principle the monetary and exchange rate policy before the accession to the European Union will be within the competence of applicant countries. The EMU accession scenario does not set formal restrictions on the currency used by the Applicant State. EMU does not set any formal obstacles to the unilateral introduction of the euro and legislative termination of the kroon issue before accession to the European Union. After the accession to the European Union the economic and exchange rate policy will be a matter of common concern, ie the unilateral adoption of the euro after the accession to the European Union should be coordinated with other Member States, the European Commission and the European Central Bank.

Eesti Pank has a firm position that in compliance with the current EU accession negotiations scenario the participation in EMU according to the three-stage scenario would be the best and economically sound scenario for the introduction of the euro. In this case the participation in the euro area would bring us best possible benefits as we have got used to the economic cooperation within the EU, completed major structural reforms and raised real income to the level compatible to the Maastricht criteria (real convergence will facilitate nominal convergence).

5. The Unilateral Adoption of the Euro

The unilateral adoption of the euro (the euro as the sole legal tender and the termination of the central bank's issue rights) is not necessary to enhance the confidence in Estonia's economic policy in the current economic policy situation. To the contrary - money market and loan interests are at their historic low (and real interest rates only moderately positive), the banking system is liquid, well capitalised and has attracted strong foreign investors as strategic owners to Estonia. Thus, the monetary and financial situation is extremely favourable at the beginning of the new economic growth cycle.

The sustainability of Estonia's economic growth cycle and the growth in the upcoming years will depend on the stringent fiscal policy and structural reforms as well as, inter alia, on (well confirmed by the European Commission Progress Report and negotiation partnership priorities):

   the balanced fiscal policy and budgeting and budget procedure reform (new Basic Budget Act) and, in the broader sense, on the decreasing stake of the state in the economy;
   the pension reform and public health reform (having a significant impact on the balancing of the fiscal policy over the medium term);
   restructuring of the energy sector and land reform;
   the harmonisation of national standards and quality requirements with the EU requirements, etc, etc;
   we should also stress that the Russian-crisis-initiated restructuring of some private sector undertakings is still not completed.

The completion of the above reforms in the years 2000-2003 does not depend on changes in the monetary policy (as mentioned above the monetary and fiscal policy environment is extremely favourable for the development and implementation of the last structural reforms).

The unilateral introduction of the euro and waiver of issue rights is exposed to several risks, the most important being the following:

   the investor response to the waiver of issue rights under the current economic circumstances is unclear (considering its impact on the EU accession negotiations as well as risks characteristic of Estonia's economy in the initial phase of the growth cycle);
   the rapid preparation of a new monetary reform without evident economic justification creates uncertainty in the markets and suspends the implementation of economic reforms;
   the impact of the euroisation on the negotiations with the European Union is not clear; it cannot be excluded that some of the necessary legislation is not in compliance with the EU acquis and already closed chapters should be reopened on Estonia's initiative;
   discussions held on the euroisation draws attention off economic concerns and delays solutions.

As mentioned above, a precondition for the unilateral monetary reform is the agreement with international financial institutions, in case of the euroisation, with the European Union as well. It is evident that neither the European Union nor the Central Bank are ready to conclude an agreement today, thus, the unilateral adoption of the euro by Estonia would mean taking the unilateral risk.

Briefly about potential changes in the interest rate. The economy's interest level is determined by the country risk, ie by the probability that state and its largest economic units, first and foremost, its financial system, default. Considering the current economic policy situation in Estonia and major problems facing the economy, the adoption of the euro would leave the country risk as well as the effective interest rate on the previous level or in the worst case would even raise it (see above risks) (2) (3). At the same time the short-term inflow of capital and a temporary drop in short-term interest rates cannot be excluded, having, thus, a potentially destabilising impact on Estonia's financial system.

(2) It can be said that the domestic currency liabilities risk would increase as already by definition as the liabilities grow at the expense of the kroon liabilities.
(3) The above is also confirmed by Standard & Poor's report in 1999 on Argentina's economic problems, stating inter alia: "Standard & Poor's believes that fundamental reforms in the areas mentioned above [fiscal policy, employment, business environment reform] would have considerably more impact on creditworthiness than would full dollarisation."

Therefore our firm position is that the unilateral adoption of the euro would neither accelerate solving of economic problems nor reduce the country risk and would remain neutral against general interest level and foreign investments. Both the government and IMF economic policy forecasts for the years 2000-2003 confirm this opinion, forecasting in case of successful implementation a significant inflow of external capital and growth of 5-6% per annum over the medium term unless the current monetary policy framework changes. This growth rate would correspond to Estonia's economic growth potential in medium term.

Despite of the main conclusion drawn in the above paragraph, the adoption of the euro and waiver of the issue right cannot be excluded from the onset. This issue could become topical in the years 2004-2005 when Estonia's economy will enjoy sustainable growth, be even better integrated with the EU economic space and most of the above-mentioned economic policy reforms will be implemented but the accession to the European Union could be delayed for reasons out of our control. Under these circumstances it could be expedient in order to enhance the efficiency of Estonia's economic system to start negotiations with the European Union to adopt the euro before becoming the full-fledged member of the European Union. An agreement with the European Union will be necessary anyway (as the legislative changes necessary for the unilateral euroisation may not be in compliance with EU acquis).

6. The Voluntary Adoption of the Euro in Daily Transactions

Estonia's current monetary and financial legislation provides for the use of foreign currency in all key functions of money (as a store of value, medium of exchange and unit of account).

Changes in foreign cash and taxes could increase cash circulation efficiency even more. The current legislation prohibits formally the use of foreign cash in mutual transactions. The abrogation of this clause would eliminate the last formal restraint on the use of foreign currency in settlements and other transactions. Herewith we should underline that any use of foreign currency, including foreign cash should be strictly voluntary. Such an amendment would involve not only the euro (in future) but also the US dollar, pound sterling, etc.

Another step the government could consider in order to accelerate money circulation efficiency is paying taxes in euros and maybe in other currencies as well.

III ECONOMIC POLICY SUMMARY

It is also important to draw the attention to some economic policy steps which, if well prepared, could increase the creditworthiness of Estonia's economic and monetary policy over the long term.

7. Accession Negotiations with the European Union

To draft specific monetary policy proposals for Estonia's full participation in the exchange rate mechanism (ERM2) after the accession to the European Union. This is the medium-term objective (in the years 2000-2003) as provided in Estonia's National Programme for the Adoption of the Acquis (NPAA). The task could be best fulfilled in the cooperation of accession negotiations EMU working group and Eesti Pank.

8. The Unilateral Adoption of the Euro

It can not be excluded that in the years 2004-2005 the option of the unilateral adoption of the euro should be analysed once more under the general and economic policy conditions of that period. It should be conducted within the drafting and improvement of Medium-Term Economic Programme by the government and Eesti Pank.

9. The Market-mechanism-initiated Improvement of Efficiency of Foreign Currency Circulation

It would be best to amend the formal rules on the circulation of the foreign cash amending monetary policy legislation in the context of accession negotiations and the introduction of euro notes and coins in 2002. Amendments to the legislation will be introduced in 2001 (a task from the NPAA, by Eesti Pank in cooperation with the Ministry of Finance).

10. Functions of the National Central Bank in Economic and Monetary Union

The central bank functions upon Estonia's accession to EMU can be devided into two groups: before and after joining the Eurosystem.

Before joining the Eurosystem the National Central Bank of the Member State will implement national monetary and exchange rate policy and prepare the financial system for the single monetary policy and for the introduction of the euro. Therefore the functions of Eesti Pank will not change much after the accession to the European Union. Upon Estonia's accession to the European Union, the Governor of Eesti Pank will participate in the General Council of the European Central Bank. The latter's competence includes, inter alia (i) exchange of information on monetary policy issues and advisory functions of the ESCB; (ii) the organisation of statistical information collection principles and as a significant function (iii) the necessary preparations of the Member States with a derogation to join the Eurosystem.

Upon accession to the Eurosystem the functions and devision of labour will be defined in the Statute of the European System of Central Banks and of the European Central Bank (ESCB Statute). The National Central Banks are the owners of the European Central Bank. The subscription to and holding of capital is based on a key established according to the EU Member States' respective shares in the GDP and population of the Community (both weigh 50 per cent).

The Governors of the National Central Banks of the euro area Member States belong the Governing Council of the ECB. The latter is the highest monetary policy body of the ESCB responsible for formulating the policy framework and making key monetary policy decisions, inter alia, on changing key interest rates of the European Central Bank. All members of the ECB's Governing Council have to consider the economic performance of the Eurosystem as a whole in their decision-making, which for smaller Member States means additional requirements in economic and monetary policy analysis and know-how. Summa summarum, the relative international impact of the National Central Banks of small Member States would grow upon participation in the Eurosystem whereas they also face new requirements in monetary policy analysis.

Apart from cooperation in the ECB's Governing Council, specialists from all NCBs participate in the daily work of the ECB. 13 committees have been set up at the ECB (eg monetary policy committee, market operations committee, payment and settlement systems committee, etc) comprised of experts from the ECB and the NCBs of the Member States with the key function to advise the ECB in performing its main responsibilities.

The division of labour between the ECB and NCBs determines the functions as regards the monetary policy infrastructure of the National Central Banks in the Eurosystem. Regarding monetary policy the European Central Bank will make monetary policy decisions and implement them via National Central Banks of Member States. Thus, the ECB and the NCBs have divided their functions in organising the core open market operation as follows: (i) the ECB establishes the timetable for regular auctions and the ECB Governing Council -- the interest rate; (ii) the National Central Banks of the Member States send bids by commercial banks to the ECB; (iii) the ECB determines by bids the total liquidity volume for the market; (iv) pursuant to the decision made by the ECB, the NCBs of the Member States credit commercial banks. The other important set of functions of the NCBs involves holding and managing the official foreign reserves of their own state and the ECB and performing foreign exchange market operations in compliance with the ECB guidelines.

The NCBs of the Member States perform under the Eurosystem all regular functions as regards payment systems, cash issuance and collection of statistical information. For payment systems the ECB defines the standard for Trans-European Automated Real Time Gross Settlement Express Transfer System (TARGET), but the National Central Banks in each Member State shall be responsible for setting up and managing the wholesale payment system in Member States. The NCBs of the Member States shall be also responsible for issuing and circulating cash in euros on the territory of the respective Member State. The NCBs of the Member States shall be responsible for the collection and processing of statistical information necessary for the implementation of the single monetary policy.

The NCBs of the Member States can also perform tasks stipulated in the national legislation. The supervision of the financial sector should be mentioned as it is the responsibility of the EU Member States and implemented by the NCBs of the Member States.

Summa summarum, the NCBs of the Member States continue providing all necessary services for the implementation of the monetary policy whereas smaller Member States shall be facing higher requirements on monetary policy analysis and know-how. The current experience both in Finland and Luxembourg proves that several central bank functions were to be established in order to join the Eurosystem.