Category Archives: euro

Scotland and the Euro Convergence Criteria

Scottish euro coin
Scottish euro coin, a photo by viralbus on Flickr.
At the moment, most people seem to think that an independent Scotland should either stay in a monetary union with England, Wales and Northern Ireland or introduce its own currency.

However, very occasionally somebody suggests Scotland should adopt the euro (and of course, Better Together's ubiquitous scaremongers love to pretend Scotland will be forced to join the Eurozone immediately).

It's therefore perhaps worthwhile to examine briefly whether Scotland would actually be allowed to join. To introduce the euro, a country needs to fulfil the convergence criteria:

  • The inflation should be less than 2.5% (the exact figure varies from year to year -- it's based on the inflation figures of the EU member states). The figure for the UK is currently 2.6%, but there's no reason to assume this would be the same for Scotland -- it could be either higher or lower. I don't think we can determine this at the moment; it's possible Scotland will tick this box, but it's quite likely it won't.
  • The budget deficit should be less than 3% of GDP. The UK is currently running a deficit of 6.3%, and although Scotland's finances are better than the UK's, it would require exceptionally high oil prices to push the deficit under 3%. It's probably safe to assume Scotland would need a few years to bring the deficit under control.
  • The debt-to-GDP ratio should be under 60% or falling. The UK's ratio is 90% and rising, so if Scotland inherits its population share of the debt, this criterion will be very hard to fulfil. On the other hand, if the rest of the UK decide to keep all assets and liabilities, Scotland will have a ratio of 0%, so it'd pass this test with flying colours.
  • The country should have been a member of ERM-II (the exchange rate mechanism) for two years. This means that the country needs to have had its own currency for at least two years (using the Pound Sterling doesn't count), and it needs to have been linked loosely to the euro. If we assume that an independent Scotland would continue to use the pound for at least five years after independence day before creating its own currency, the earliest this criterion can be fulfilled is 2023.
  • Finally, the interest rate should be no higher than 4.81%. The figure for the UK currently is 1.62%, so it's likely Scotland's would be much lower than the threshold, too.

To conclude, the main issues are likely to be the national debt (unless the rUK decide to keep all of it in order to safeguard their permanent membership of the UN's Security Council) and the need to have been a member of ERM-II for at least two years. It seems unlikely Scotland would be able to introduce the euro before 2023, even if it became a political priority.

Of course, if Scotland decides not to introduce the euro, staying out of ERM-II is all it takes. This is what Sweden and many of the newer EU members are doing at the moment.

Will Scotland have to join the euro?

Scottish euro coin
Originally uploaded by viralbus

The unionists seem to be in a tizzy about the prospect that Scotland will be forced to join the euro, so let's have a rational look at the most likely scenarios.

To start with, it's entirely possible (perhaps even likely) that Scotland will be allowed to inherit the UK's opt-out. In that case, Scotland will have a formal right to remain outwith the euro indefinitely.

However, what happens if Scotland has to let go of the opt-out as part of the renegotiation of the membership terms? It's not like Scotland would have to introduce the euro at once. Before any member state can introduce the euro, the convergence criteria have to be fulfilled:

  1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing member states of the EU.
  2. Government finance:
    1. Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.
    2. Government debt:The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.
  3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period.
  4. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states.

Currently the UK doesn't pass any of the tests apart from the last one, and as far as I can tell, the same would apply to Scotland at the moment. Therefore, Scotland wouldn't be allowed to join the euro at first, even if the people of Scotland so desired.

It is of course possible (and probably also desirable) that Scotland will fulfil (1) and (2) in the longer term, but criterion (3) requires a deliberate step that Scotland can decide not to take.

This is how the Swedes have managed not to join the euro -- they're technically obliged to join the euro, but they have chosen not to join ERM II, which means that they cannot join. Scotland can do the same, even if it's against the spirit of the treaties.

Finally, by the time the Scottish economy qualifies to join the euro, the European Union and the euro might have changed beyond recognition, and it is entirely possible that there will be a strong desire to join the euro by then.

It's definitely not anything to worry about at this stage.