On 16 April 2003 Estonia along with nine other acceding countries, signed the Treaty of Accession to the European Union. Membership in the European Union was also approved in a referendum on 14 September 2003. According to the Accession Treaty all new Member States join the European Economic and Monetary Union as Member States with a derogation. They will become full members once they adopt the euro and join the euro area. Eesti Pank regards the eventual adoption of the euro an essential step for Estonia's economy, which is to secure a consistently favourable investment climate, improve our competitiveness, and strengthen the conditions for sustained long-term and balanced economic growth, as well as provide for an increase in the living standard.

The European Union has two primary economic policy objectives: a) stable and sustainable economic growth and b) a low and stable inflation rate. For the purpose of achieving these aims as efficiently as possible the European Economic and Monetary Union (EMU) was set up.

For euro area Member States the EMU signifies common monetary and coordinated economic policies. The aim of the common monetary policy is to secure a low inflation rate (up to 2 per cent a year) throughout the Member States via the common currency, the European Central Bank, and interest rates. Various studies and the decades-long experience of industrial countries have proven that a low, stable, and easily predictable inflation level secures the most favourable conditions for long-term economic growth. This allows businesses and households to plan their investment and consumption decisions more easily and thus allows for a more efficient allocation of resources.

A coordinated economic policy has to support the establishment of a favourable environment for sustainable and stable economic growth. It is the fiscal policy that the EMU Member States and institutions coordinate most closely. This is carried out within the framework set up by the Stability and Growth Pact: the budgets of the Member States must be balanced or show a surplus in the medium-term, while the annual deficit must not exceed 3 per cent of the gross domestic product (GDP). Besides fiscal policy, the EMU Member States and institutions also coordinate most other economic policy areas (e.g., labour market policy, structural policies, etc.).

After acceding to the European Union the countries seeking to become part of the euro area have, first of all, to join the Exchange Rate Mechanism II (ERM II). This is a framework within which the national currency of a country seeking to join the euro area is linked to the euro in the course of multilateral negotiations (Member States, the European Central Bank, the European Commission, and the country seeking to join the euro area). During the period of membership in the ERM II each of the countries seeking to join the euro area must maintain the stability of its national currency against the euro and meet the other Maastricht criteria concerning inflation, interest rates, the exchange rate, budgetary balance, and government debt. Each acceding country has to participate in the ERM II for a minimum of two years, but the actual duration of the period depends on its success in meeting the Maastricht criteria. Therefore, it is crucial for Estonia's own economic policy to support stable and vigorous economic development.

Estonia joined the Exchange Rate Mechanism II on 28 June 2004. From the point of view of Estonian economic stability it was important that joining the ERM II framework was implemented without changing the current monetary policy and currency board principles. The European Union has confirmed that Estonia's current system is in line with the ERM II requirements.

Membership in a monetary union offers benefits first of all to countries whose economies are closely integrated with the other member states. Above all, this means that close trade and financial relations have to exist between the member states so as to secure a consistent impact of the common monetary policy on the economies of all the member states.

Estonia's main trading partners are the EU Member States. After the enlargement, the EU block will account for more than 80 per cent of our trade. Estonia's economy is also closely integrated with the EU economies through multiple services, e.g., tourism. Most of the foreign investments made in Estonia have come from the EU Member States, both as direct investments and through the financial sector.

The readiness of a country seeking to join the monetary union and to participate successfully in the system is assessed by the five Maastricht criteria. From the point of view of meeting these criteria Estonia's economy is in a unique position compared to the other acceding countries. Our exchange rate has remained stable for the past 12 years and the inflation rate and the balance of the national budget are under control. However, meeting all the Maastricht criteria requires consistent efforts.

Regarding the Maastricht criteria, the biggest idiosyncrasy of Estonia's economy is the comparatively low level of income; yet, on the other hand, our economic growth is faster compared to the current EMU members. The current level of GDP per capita in Estonia is around 47 per cent of the respective EU indicator, while the price level is about 56 per cent of the EU average. At the same time, different studies estimate Estonia's GDP growth potential at 5-6 per cent a year where the respective EU rate should be 2-2.5 per cent annually. If the EU economic growth rate turns out to be either faster or slower, the potential growth rate assessment for Estonia should also be revised accordingly. If the current growth rate difference is maintained, the level of income in Estonia should reach the current average EU level in 20 years and converge with the EU Member States in 30 years.

Estonia's strict balance-oriented fiscal policy has established a strong starting position for meeting the Maastricht criteria regarding budgetary balance and government debt. Currently, the debt burden of the Estonian government sector is approximately 5 per cent of GDP - one of the lowest in the EU, while the government sector budget deficit rose above the allowed maximum level only in 1999. It should not be forgotten, however, that meeting the budgetary balance criterion will not in itself guarantee the country successful participation in the monetary union. In the context of a common monetary policy, fiscal policy will become the main economic policy tool that allows the country to independently influence its economic development (e.g., stimulate the economy during a period of slow economic growth). However, a prerequisite for securing sufficient fiscal policy opportunities for such actions is that the consolidated government sector budgets of the Member States should be balanced throughout the economic cycle - posting surpluses during periods of rapid economic growth and showing deficits of no more than 3 per cent of GDP during periods of recession. Therefore, it is also important for Estonia to maintain a responsible and balanced fiscal policy in the coming years.

The Maastricht interest rate criterion shows whether a country seeking to join the euro area is also capable of maintaining balanced economic development in the longer run. If it seems to international financial markets and investors that a country seeking membership has met the budgetary criteria through one-off or unsustainable measures, or should there be other signs in the economy indicating possible problems in the longer run, this country will most probably have difficulties in meeting the interest rate criterion. Hence, it is crucial that the economic policy of a country seeking membership be oriented towards balanced development and meeting the Maastricht criteria in as early a stage as possible.

Due to the different income levels in Estonia and the European Union our price level has remained somewhat lower. However, if Estonia's economic growth remains faster than that of the EU, it will also translate into a higher inflation rate. In principle it means that in line with the convergence of the income level the price level in Estonia and the EU will also converge in the following decades. Furthermore, it is important to stress that adopting the euro will not lead to an automatic growth in prices. The average inflation rate of the euro area has been 2 per cent a year since January 1999 (the beginning of the third stage of the EMU). In 2004 the inflation rate is also expected to remain at the 2 per cent level.

Regardless of the difficulties involved in evaluating the impact of changing the currency, most studies indicate that launching the euro cash did not result in an extensive price rise. Depending on the level of competition and demand in different countries and sectors, higher than usual price rises could, for example, occur in individual service sectors, but according to studies, the overall price rise resulting from the launch of the euro cash remained within the limits of 0.1-0.2 per cent. It is obvious that in the long run adopting the euro will improve price transparency and comparability between the Member States, boost competition, and thus reduce inflationary pressures, which benefits all consumers.

Estonia joined the Exchange Rate Mechanism II on 28 June 2004. However, since each of the countries has to be a member of ERM II for at least two years, the earliest possible time for achieving full membership of the EMU and introducing the euro is the second half of 2006.

A speedy accession to the Economic and Monetary Union is both appropriate and useful for Estonia. Having the Estonian kroon pegged to the euro and enjoying close trading and investment relations with the EU, we are already close to being members of the euro area. The adoption of the euro is therefore a logical continuation of Estonia's current monetary policy. Accession will further reduce currency fluctuation risks, which as a result will narrow down interest rate differences between Estonia and the EU. Further benefits are to be derived from the cessatiob of currency exchange service fees for the businesses employing the euro in foreign trade as well as private persons travelling in the euro area.

It is also important to note that increasingly more decisions affecting the development of the European economy are made in discussions between the full members of the EMU. If Estonia seeks to continuously represent its interests in Europe actively and efficiently, rapid accession to the euro area is a logical step in that direction. Foreign investors and rating agencies are also counting on a rapid accession to the euro area when evaluating the credibility of Estonia's economy. To maintain what we have achieved so far, it is important to secure balanced economic development in the longer perspective with all the available economic policy tools at our disposal.