The wide variety of public finance performances and uneven prospects for speedy adoption of the euro will prove to be key factors influencing the future of government ratings among the 10 new EU members

The wide variety of public finance performances and uneven prospects for speedy adoption of the euro will prove to be key factors influencing the future of government ratings among the 10 new EU members joining on May 1, Standard & Poor's Ratings Services said in a report published Wednesday entitled Sovereign Credit Ratings in the Run-Up to EMU. "Adoption of the euro among the new EU states is likely to occur in three distinct phases," said Konrad Reuss, S&P's managing director for sovereign ratings in Europe, Middle East and Africa. "Early adopters are expected to be part of the eurozone by 2008 and include the three Baltic States - Estonia, Latvia and Lithuania - and Slovenia. An intermediate group comprising Hungary, Slovakia, Malta and Cyprus are expected to join by 2009, while Poland and the Czech Republic are predicted to adopt the euro in 2010 at the earliest." Weak fiscal performance, compared with the Maastricht requirements for EMU accession, will in all cases be the limiting factor preventing earlier EMU entry of the accession countries. Moreover, the fiscal predicament in which acceding countries currently find themselves - especially governments in the larger sovereigns - will not be mitigated by EU membership. Local and foreign currency ratings will converge in the run-up to EMU. Since EMU eliminates balance of payments risk, which tends to weigh on foreign currency ratings, sovereigns with weak external positions, but comparatively strong public finances, will see their foreign currency ratings raised to the level of the higher local currency rating. Conversely, in countries where external vulnerabilities play only a minor role, but where public finances are weak, rating convergence could occur through a lowering of the local currency rating toward the foreign currency rating. This is consistent with local currency downgrades of Hungary, Poland and the Czech Republic in 2002 and 2003.