Convergence Report, June 2024

To examine the state of economic convergence in EU Member States seeking to adopt the euro, the ECB makes use of a common framework for analysis. This common framework, which has been applied in a consistent manner in all European Monetary Institute (EMI) and ECB Convergence Reports, is based, first, on the Treaty provisions and their application by the ECB with regard to developments in prices, fiscal balances and debt ratios, exchange rates and long‑term interest rates, as well as in other factors relevant to economic integration and convergence. Second, it is based on a range of additional backward and forward‑looking economic indicators considered to be useful for examining the sustainability of convergence in greater detail. Some elements of this framework have been enhanced over time. The examination of the Member State concerned based on all these factors also provides important information which helps to ensure that its integration into the euro area will proceed without major difficulties. Boxes 1 to 5 below outline the legal provisions and provide methodological details on the application of these provisions by the ECB.

This report builds on principles set out in previous reports published by the ECB in order to ensure continuity and equal treatment. In particular, a number of guiding principles are used by the ECB (and prior to that by the EMI) in the application of the convergence criteria. First, the individual criteria are interpreted and applied in a strict manner. The rationale behind this principle is that the main purpose of the criteria is to ensure that only those Member States with economic conditions conducive to the maintenance of price stability and the coherence of the euro area can participate in it. Second, the convergence criteria constitute a coherent and integrated package, and they must all be satisfied. The Treaty lists the criteria on an equal footing and does not suggest a hierarchy. Third, the convergence criteria have to be met on the basis of actual data rather than forecasts. Fourth, the application of the convergence criteria should be consistent, transparent and simple. Moreover, when considering compliance with the convergence criteria, sustainability is an essential factor, as convergence must be achieved on a lasting basis and not just at a given point in time. For this reason, the country examinations elaborate on the sustainability of convergence.

In this respect, economic developments in the countries concerned are reviewed from a backward‑looking perspective, covering, in principle, the past ten years. This helps to better determine the extent to which current achievements are the result of genuine structural adjustments, which in turn should lead to a better assessment of the sustainability of economic convergence.

In addition, and to the extent appropriate, a forward‑looking perspective is adopted. In this context, particular attention is paid to the fact that the sustainability of favourable economic developments hinges critically on appropriate and lasting policy responses to existing and future challenges. Strong governance, sound institutions and sustainable public finances are also essential for supporting price stability and sustainable output growth over the medium to long term. Overall, it is emphasised that ensuring the sustainability of economic convergence depends on the achievement of a strong starting position, the existence of sound institutions, resilience to shocks and the pursuit of appropriate policies after the adoption of the euro.

The common framework is applied individually to the six EU Member States under review. These examinations, which focus on each Member State’s performance, should be considered separately, in line with the provisions of Article 140 of the Treaty.

In addition to ERM II participation and nominal exchange rate developments against the euro over the period under review, evidence relevant to the sustainability of the current exchange rate is briefly reviewed. This is derived from the development of the real effective exchange rates and the current, capital and financial accounts of the balance of payments. The evolution of gross external debt and the net international investment position over longer periods is also examined. The section on exchange rate developments further considers measures of the degree of a country’s integration with the euro area. This is assessed in terms of both external trade integration (exports and imports) and financial integration. Finally, the section on exchange rate developments reports, if applicable, whether the country under examination has during the two-year reference period benefited from central bank liquidity assistance or balance of payments support. Both actual and precautionary assistance are considered.

With regard to long‑term interest rate developments, the legal provisions and their application by the ECB are outlined in Box 4.

Article 140(1) of the Treaty requires the ECB (and the European Commission) to report, at least once every two years or at the request of a Member State with a derogation, to the Council on the progress made by the Member States with a derogation in fulfilling their obligations regarding the achievement of economic and monetary union. These reports must include an examination of the compatibility of the national legislation of each Member State with a derogation, including the statutes of its NCB, with Articles 130 and 131 of the Treaty and the relevant Articles of the Statute. This Treaty obligation of Member States with a derogation is also referred to as ‘legal convergence’.

When assessing legal convergence, the ECB is not limited to making a formal assessment of the letter of national legislation but may also consider whether the implementation of the relevant provisions complies with the spirit of the Treaties and the Statute. The ECB is particularly concerned about any signs of pressure being put on the decision-making bodies of any Member State’s NCB which would be inconsistent with the spirit of the Treaty as regards central bank independence.

For the purpose of identifying those areas where national legislation needs to be adapted, the following issues are examined:

• compatibility with provisions on the independence of NCBs, members of NCBs’ decision-making bodies and Governors in the Treaty (Article 130) and the Statute (Articles 7 and 14.2);
• compatibility with provisions on confidentiality (Article 37 of the Statute);
• compatibility with the prohibitions on monetary financing (Article 123 of the Treaty) and privileged access (Article 124 of the Treaty);
• compatibility with the single spelling of the euro required by EU law; and
• legal integration of the NCBs into the Eurosystem (in particular as regards Articles 12.1 and 14.3 of the Statute).

Article 131 of the Treaty requires national legislation to be ‘compatible’ with the Treaties and the Statute; any incompatibility must therefore be remedied. Neither the primacy of the Treaties and the Statute over national legislation nor the nature of the incompatibility affects the need to comply with this obligation.

In November 1995, the EMI established a list of features of central bank independence (later described in detail in its 1998 Convergence Report) which were the basis for assessing the national legislation of the Member States at that time, in particular the NCBs’ statutes. The concept of central bank independence includes various types of independence that must be assessed separately, namely: functional, institutional, personal, and financial independence. Over the past few years there has been further refinement of the analysis of these aspects of central bank independence in the opinions adopted by the ECB. These aspects are the basis for assessing the level of convergence between the national legislation of the Member States with a derogation and the Treaties and the Statute.

Central bank independence is not an end in itself but is instrumental in achieving an objective that should be clearly defined and should prevail over any other objective. Functional independence requires each NCB’s primary objective to be stated in a clear and legally certain way and to be fully in line with the primary objective of price stability established by the Treaty. The pursuit of this objective is served by providing the NCBs with the necessary means and instruments for achieving this objective independently of any other authority. The Treaty’s requirement of central bank independence reflects the generally held view that the primary objective of price stability is best served by a fully independent institution with a precise definition of its mandate. Central bank independence is fully compatible with holding NCBs accountable for their decisions, which is an important aspect of enhancing confidence in their independent status. This entails transparency and dialogue with third parties.

As regards timing, the Treaty is not clear about when the NCBs of Member States with a derogation must comply with the primary objective of price stability set out in Articles 127(1) and 282(2) of the Treaty and Article 2 of the Statute. For those Member States that joined the EU after the date of the introduction of the euro in the EU, it is not clear whether this obligation should run from the date of accession or from the date of their adoption of the euro. While Article 127(1) of the Treaty does not apply to Member States with a derogation (see Article 139(2)(c) of the Treaty), Article 2 of the Statute does apply to such Member States (see Article 42.1 of the Statute). The ECB takes the view that the obligation of the NCBs to have price stability as their primary objective runs from 1 June 1998 in the case of Sweden, and from 1 May 2004, 1 January 2007 and 1 July 2013 for the Member States that joined the EU on those dates. This is based on the fact that one of the guiding principles of the EU, namely price stability (Article 119 of the Treaty), also applies to Member States with a derogation. It is also based on the Treaty objective that all Member States should strive for macroeconomic convergence, including price stability, which is the intention behind the regular reports of the ECB and the European Commission. This conclusion is also based on the underlying rationale of central bank independence, which is only justified if the overall objective of price stability has primacy.

The country assessments in this report are based on these conclusions as to the timing of the obligation of the NCBs of Member States with a derogation to have price stability as their primary objective.

Article 123(1) of the Treaty prohibits overdraft facilities or any other type of credit facility with the ECB or with the NCBs in favour of EU institutions, bodies, offices or agencies, central governments, regional, local, or other public authorities, other bodies governed by public law, or public undertakings of Member States.

Provisions in national legislation (in particular an NCB’s statutes, but also other legislation) which would prevent the performance of Eurosystem-related tasks or compliance with the ECB’s decisions are incompatible with the effective operation of the Eurosystem once the Member State concerned has adopted the euro. National legislation therefore has to be adapted to ensure compatibility with the Treaty and the Statute in respect of Eurosystem-related tasks. To comply with Article 131 of the Treaty, national legislation had to be adjusted to ensure its compatibility by the date of establishment of the ESCB (as regards Sweden) and by 1 May 2004, 1 January 2007 and 1 July 2013 (as regards the Member States that joined the EU on these dates). Nevertheless, statutory requirements relating to the full legal integration of an NCB into the Eurosystem need only enter into force at the moment that full integration becomes effective, i.e. the date on which the Member State with a derogation adopts the euro.

For the adoption of the euro, national legislation must be compatible with Article 6.1 of the Statute, which provides that in the field of international cooperation involving the tasks entrusted to the Eurosystem, the ECB decides how the ESCB is represented. National legislation allowing an NCB to participate in international monetary institutions must make such participation subject to the ECB’s approval (Article 6.2 of the Statute).

In addition to the above issues, for certain Member States there are other areas where national provisions need to be adapted (for example in the area of clearing and payment systems and the exchange of information).

This chapter provides a horizontal overview. Some factors relevant for the overall assessment are not covered here, but in Chapters 4 and 5.

Reflecting challenging economic conditions, limited progress has been made as regards compliance with the convergence criteria since the ECB’s 2022 Convergence Report. In all six countries examined in this report, HICP inflation is above the reference value, and well above it in five countries (Table 3.1). Since April 2022 the 12-month average of long-term interest rate differentials versus the euro area has increased in one country, declined in four countries and remained unchanged in one country. As in 2022, three countries are not compliant with the long-term interest rate criterion, with their rate being above the reference value. The currencies of some of the countries examined in this report have experienced sizeable fluctuations against the euro over the last few years. Public finances improved in most of the countries following the COVID-19 pandemic as their economies recovered and pandemic support measures were phased out. However, in most cases, public deficits and debt ratios remain above pre-pandemic levels, partly owing to the economic impact of Russia’s war against Ukraine and the fiscal policy measures taken in response to the resulting high energy prices.

Over the past two years the EU has been hit by the economic fallout from Russia’s invasion of Ukraine, which led to a significant weakening of economic activity and soaring inflation rates. Since early 2022 Russia’s war against Ukraine has weighed on economic activity in the countries under review owing to the associated uncertainty, trade and supply chain disruptions, and deteriorating business and consumer confidence. At the same time, the surge in energy and commodity prices reduced demand and held back production. The central and eastern European countries under review have been particularly strongly affected by the economic impact of the war given their high energy intensity of production, their economic openness and integration in global supply chains, and their trade with and financial exposures to Russia (see also Section 3.1). In addition, the tightening of monetary policy, which in most of the countries under review started earlier than in the euro area, has weighed on economic activity. The Czech Republic, Hungary and Sweden were particularly strongly affected, with their economies contracting in 2023 as a whole. In the same year, weak growth was recorded in Poland, while the economies of Bulgaria and Romania remained somewhat more resilient, growing at rates of around 2%, supported by relatively strong domestic demand.

Economic activity is expected to strengthen in the near term in all the countries under review, but geopolitical tensions are clouding their economic prospects. The easing of price pressures and supply bottlenecks observed since the beginning of 2023, along with improved confidence and resilient labour markets, is expected to support the economic recovery of the countries under review in 2024. At the same time, economic activity will continue to be dampened by tight financing conditions and uncertainty. A key source of uncertainty is geopolitical tensions, which might exacerbate fragmentation trends, potentially further disrupting trade and investment flows and increasing risk perceptions. The economic outlook is also clouded by losses in price competitiveness over recent years in most of the countries under review and uncertainty surrounding the path of inflation.

Over recent decades the central and eastern European countries under review have made progress in terms of real convergence towards the euro area average. Since 1999 these countries have significantly narrowed their gaps to the euro area average in terms of real GDP per capita (Chart 3.1). However, since 2019 the catching-up process has stalled, or even reversed, in some countries, particularly the Czech Republic, which experienced substantial real exchange rate appreciation between the end of 2019 and spring 2023. At the same time, significant macroeconomic and financial vulnerabilities persist, albeit to differing degrees depending on the country. If not adequately addressed, such vulnerabilities are likely to expose countries to adverse external shocks and slow their convergence progress over the long term. Some of the key challenges related to the long-term real convergence of these countries include (i) a changing and uncertain geopolitical landscape, which might not only affect trade and investment flows in the near future but also shape long-term production trends; (ii) shifting industrial structures, which is typically a challenge for countries moving from middle to high income levels; (iii) persistent labour shortages and adverse demographic developments, particularly the outflow of highly skilled people; and (iv) limited progress on improving the quality of governance, institutional capacity and the business environment.

Chart 3.1

Real GDP per capita

a) Relative to the euro area average	b) Initial level in 1999 compared with subsequent change relative to the euro area average
(index: euro area = 100)	(index: euro area = 100; x-axis: level in 1999; y-axis: change in level in percentage points, 1999-2023)

Regarding the price stability criterion, the 12-month average inflation rate was above the reference value of 3.3% in all of the six countries examined in the report (Chart 3.2). Bulgaria, the Czech Republic, Hungary, Poland and Romania recorded inflation rates well above the reference value, while inflation was slightly above the reference rate in Sweden. In the 2022 Convergence Report, Bulgaria, the Czech Republic, Hungary, Poland and Romania also recorded inflation rates well above the reference value applicable at that time, which was 4.9%.

At the time of publication of this report, Romania is the subject of an EU Council decision on the existence of an excessive deficit. In addition, the European Commission found in June 2024 that Hungary and Poland did not fulfil the deficit criterion of the Stability and Growth Pact. After sharp increases during the pandemic, budget deficits mostly decreased but remained at elevated levels in all the countries except Sweden in 2023. Compared with the 2022 Convergence Report, the budget balance improved in four of the countries under review, while it deteriorated strongly in Poland and to a lesser extent in Sweden. In 2023 the budget deficit was above the reference value in four of the countries under review: in Hungary and Romania, it was significantly above the reference value, at 6.7% and 6.6% of GDP respectively, in Poland it was well above the reference value, at 5.1% of GDP, and in the Czech Republic, it was above the reference value, at 3.7% of GDP (Chart 3.3). In 2024 the deficit-to-GDP ratio is expected to deteriorate in four of the countries, according to the European Commission’s Spring 2024 Economic Forecast, and it is expected to remain above the 3% reference value in Hungary, Poland and Romania. In 2025 the budget balance is expected to improve in four of the countries, but is expected to continue to exceed the reference value in Hungary, Poland and Romania. Regarding the debt criterion, in 2023 the debt ratio was well below the reference value in both Bulgaria and Sweden (Chart 3.4). In the Czech Republic, Poland and Romania it was below the reference value, between 40% and 50% of GDP. Hungary was the only country under review with a general government debt-to-GDP ratio above the 60% reference value in 2023. At the cut-off date for this report, Romania was still subject to a Council decision on the existence of an excessive deficit. An excessive deficit procedure was launched in April 2020, and in June 2024 the Commission found that Romania had not taken effective action to put an end to its excessive deficit situation. At the same time, the Commission also concluded that the government deficit criterion of the Stability and Growth Pact was not fulfilled either in Hungary or Poland, based on their outcomes in 2023 and planned deficits for 2024. Consequently, the Commission announced its intention to propose in July 2024 to the EU Council to adopt a decision under Article 126(6) of the Treaty establishing the existence of an excessive deficit situation in Hungary and Poland.

In May 2024 five of the six countries under review recorded a 12-month average inflation rate well above the reference value of 3.3% for the price stability criterion. Inflation rose sharply in 2021, largely driven by base effects, strong increases in energy prices, supply bottlenecks triggered by the pandemic, and a sharp rise in global demand for goods. Since early 2022 Russia’s war against Ukraine has exacerbated inflationary pressures through higher energy and commodity prices and by adding strains to already stretched supply chains. Consequently, inflation increased further in all countries under review in 2022, albeit to differing degrees owing partly to domestic policies. Since the 2022 Convergence Report, inflation has followed a similar pattern in most of the countries under review; between June 2023 and May 2024 inflation moderated significantly in all countries, but was higher in Bulgaria, the Czech Republic, Hungary, Poland and Romania than in Sweden, mainly reflecting their greater vulnerability to recent adverse global shocks, as well as the tightness of their labour markets. Against this background, these five countries recorded inflation rates well above the reference value, while in Sweden the inflation rate was slightly above the reference value.

Longer-term price developments have mirrored the volatile macroeconomic environment, particularly over the past few years. Over the past ten years both the average rate and the volatility of inflation have varied significantly across the countries examined (Chart 3.7). During this period, average inflation was consistently higher than in the euro area in all the countries under review. Initially, from 2014 to 2016, inflation was subdued in all the countries, mainly reflecting developments in global commodity prices, low imported inflationary pressures and, in some countries, persistent spare capacity, reductions in administered prices and indirect taxes, and a strengthening of the nominal effective exchange rate. Against this backdrop, monetary policy conditions were loosened considerably. From 2017 inflation accelerated owing to the strengthening of economic activity, solid domestic demand, increasingly tight labour market conditions and rising energy and commodity prices, prompting a tightening of the monetary policy stance in some of the countries under review. The outbreak of the pandemic in 2020 resulted in a large drop in economic activity in that year. Inflation slowed in some countries, while it remained more persistent in others, reflecting higher food and services prices, as well as the tightness of the labour market. Inflation increased significantly in all the countries under review in 2021 and 2022, largely driven by sharp increases in energy prices, and by the supply-demand mismatches triggered by the pandemic and the macroeconomic policy responses. Since early 2022 Russia’s war against Ukraine has added to the inflationary pressures. To combat this rise in inflation, most central banks started to strongly increase their main policy rates in 2021, while governments introduced discretionary fiscal support measures to alleviate the burden of high inflation on the economy. In the countries under review, these measures were concentrated in 2022 and 2023, and mainly took the form of increases in subsidies, largely in relation to energy products, and, to a lesser extent, reduced indirect taxes. After peaking around the end of 2022/beginning of 2023, inflation started to fall sharply, driven by previous monetary policy tightening, the fall in global energy prices and the easing of pipeline pressures and supply bottlenecks. Given the moderation in inflation dynamics, central banks in the Czech Republic, Hungary and Poland started to ease their monetary policy stance, while fiscal support measures have gradually been withdrawn in all the countries under review.

Most of the countries under review were particularly exposed to recent global shocks, largely owing to certain structural features of their economies. Countries in central and eastern Europe experienced significantly higher inflation rates than the euro area and Sweden, reflecting their vulnerability to the impact of the war in Ukraine and associated geopolitical changes. First, these countries typically display a higher energy intensity of production than the euro area, mainly owing to larger energy-intensive sectors (i.e. manufacturing and transport) and fewer energy-efficient appliances and buildings. Second, the share of energy and food in their consumption baskets is higher than in the euro area, which can often be seen in economies with lower average incomes. Third, most of these economies were heavily dependent on Russian energy prior to the outbreak of the war, making them more vulnerable to energy supply disruptions. Fourth, these countries are deeply integrated in global supply chains, implying a larger impact of global supply bottlenecks. While external shocks were an important driver of initial inflation differentials, domestic factors also played a prominent role. In particular, labour market conditions have remained tight in most of the countries under review, with historically low unemployment rates and persistent labour shortages resulting in robust wage growth (Chart 3.8, panel a) (see also Section 3.5).

Chart 3.8

Cumulative growth in the HICP, nominal unit labour costs (ULC) and harmonised competitiveness indicators (HCIs) between 2014 and 2023

a) HICP and nominal ULC	b) HCIs based on ULC and GDP deflator
(percentage points; x-axis: cumulative HICP growth; y-axis: cumulative ULC growth)	(percentage points; x-axis: cumulative HCI growth based on GDP deflator; y-axis: cumulative HCI growth based on ULC)

While inflationary pressures are expected to moderate further over the forecast horizon, over the longer term there are concerns about the sustainability of inflation convergence in most of the countries examined. According to the European Commission’s Spring 2024 Economic Forecast, inflation is expected to decrease from 2023 levels in all the countries under review in 2024, owing to the ongoing easing of pipeline pressures and supply bottlenecks and to the past monetary policy tightening. However, inflation is expected to remain elevated in Hungary, Poland and Romania in 2024 and 2025, owing to a recovery in domestic demand and high labour cost growth, while in Sweden it is projected to already converge to the target in 2024. These forecasts are subject to considerable uncertainty given the current circumstances. The risks to the inflation outlook are tilted to the upside in almost all the countries under review, as renewed global supply bottlenecks and tensions in energy markets might result in stronger than expected inflation, which, given the tightness of the labour markets, could also exert further upward pressure on wages. Looking further ahead, since GDP per capita and price levels are still lower than in the euro area in all the central and eastern European countries under review, the catching‑up process is likely to result in positive inflation differentials vis‑à‑vis the euro area, unless counteracted by an appreciation of nominal exchange rates.

An environment that is conducive to sustainable price stability in the countries covered in this report requires stability-oriented economic policies, structural reforms and measures to safeguard financial stability. Achieving or maintaining an environment supportive of price stability will crucially depend on the functioning of labour markets. Looking ahead, an important factor will be how wages react to high realised inflation and how they reflect labour productivity growth and take into account labour market conditions and developments in price and cost competitiveness relative to competitor countries (Chart 3.8). Continued reform efforts are needed to further improve the functioning of labour and product markets and to maintain favourable conditions for economic expansion and employment growth. To this end, measures to support stronger governance and further improvements in the quality of institutions are essential. Given the limited room for manoeuvre in monetary policy, especially for Bulgaria, which participates in ERM II, it is imperative that other policy areas support the capacity of these economies to maintain price stability, cope with country-specific shocks and avoid the build-up of macroeconomic imbalances.

At the time of publication of this report, Romania remains the subject of an EU Council decision on the existence of an excessive deficit, while three other countries also exceeded the deficit reference value in 2023. The deficit in Romania exceeded the 3% of GDP reference value in 2019 and an excessive deficit procedure was opened in April 2020. The deadline for correction of the excessive deficit was later set to 2024. The fiscal deficit-to-GDP ratios of four of the countries under review exceeded the reference value in 2023. The deficits were above the reference value in the Czech Republic, at 3.7% of GDP, well above the reference value in Poland, at 5.1% of GDP, and significantly above the reference value in Romania, at 6.6% of GDP, and in Hungary, at 6.7% of GDP. In Bulgaria and Sweden the deficit remained well below the reference value, at 1.9% of GDP and 0.6% of GDP respectively.

The fiscal deficit in 2023 was below its 2021 level in four of the countries covered in this report on account of the economic recovery after the pandemic and the phasing-out of the fiscal policy measures taken in response to it. After having risen above the 3% reference value in all the countries under review except Sweden in 2020, as the pandemic led to a substantial deterioration in economic activity and fiscal measures were adopted to mitigate its impact, the deficit remained above the reference value in four of the countries in 2021. In 2022 the budget balance improved in most of the countries as their economies continued to recover and parts of the fiscal support measures were withdrawn. However, in 2023 this was partly counteracted by the ongoing economic impact of Russia’s war against Ukraine, the fiscal policy measures taken in response to the resulting high energy prices and the weakening of economic activity, leading to a worsening of the budget balance in 2023 compared with 2022 in five of the countries, most notably in Poland, where the budget deficit in 2023 was 3.3 percentage points higher than in 2021.

For 2024 the European Commission forecasts that the deficit-to-GDP ratio will remain above the 3% reference value in Hungary, Poland and Romania. In 2024 the government balance is projected to deteriorate in four of the countries under review, and it is projected to remain well above the reference value in Hungary and Poland, and significantly above it in Romania. At the same time, it is expected to return to below the 3% reference value in the Czech Republic.

In 2023 the debt ratio was above 60% of GDP in Hungary, while in the other countries under review the debt levels were below or well below this threshold (Table 3.1 and Chart 3.4). The government debt-to-GDP ratio was below its 2021 level in four of the countries under review in 2023, mostly on account of the recovery after the pandemic. While the debt ratio increased notably, by 2.0 percentage points of GDP, in the Czech Republic and slightly, by 0.3 percentage points of GDP, in Romania, it fell by 5.5 percentage points of GDP in Sweden, 4.0 percentage points in Poland, 3.2 percentage points in Hungary and 0.8 percentage points in Bulgaria. Taking a longer perspective, between 2014 and 2023 the government debt-to-GDP ratio increased significantly in Romania (by 9.7 percentage points) and notably in the Czech Republic (by 2.1 percentage points), while it declined in the other countries.

For 2024 the European Commission projects an increase in debt-to-GDP ratios in all of the countries under review. The debt ratio is expected to increase notably in Poland and Romania and moderately in the other four countries. The Commission’s projections indicate that the debt ratio will remain below or well below the 60% reference value in all the countries in 2024, with the exception of Hungary.

At the time of publication of this report, the Bulgarian lev is the only currency participating in ERM II. The currencies of the other Member States under review operate under different exchange rate regimes.

On 10 July 2020 the ERM II parties decided, by mutual agreement, to include the Bulgarian lev in ERM II and it therefore participated in ERM II for the two-year reference period from 20 June 2022 to 19 June 2024. The Bulgarian lev was included in ERM II at a central rate of 1.95583 levs per euro with a standard fluctuation band of ±15%. Bulgaria joined ERM II with its existing currency board in place as a unilateral commitment, thus placing no additional obligations on the ECB. The agreement on participation in ERM II was based on a number of policy commitments made by the Bulgarian authorities (some of which had already fulfilled by the time of the inclusion of the lev in ERM II) with the aim of achieving a high degree of sustainable economic convergence by the time of euro adoption. The ECB and the European Commission have been monitoring the effective implementation of Bulgaria’s post-entry commitments, acting within their respective areas of competence as provided for by the Treaties and secondary legislation. In its role as the supervisory authority, and given its shared responsibility for macroprudential policy, the ECB is closely monitoring the implementation of the commitments related to the financial sector, i.e. the insolvency framework and the anti-money laundering framework, owing to their potential impact on prudential aspects. Bulgaria is currently working towards completing these commitments and is encouraged to accelerate its efforts to fulfil the elements of the Action Plan as adopted by the Financial Action Task Force following the grey-listing of Bulgaria in October 2023. Over the reference period the lev did not exhibit any deviation from the central rate.

The currencies not participating in ERM II traded under flexible or managed floating exchange rate regimes, in most cases amid relatively high exchange rate volatility. The Romanian leu, which traded under a managed floating exchange rate regime, exhibited a low degree of volatility. The other currencies not participating in ERM II traded under flexible exchange rate regimes and were subject to a relatively strong degree of volatility. The Czech koruna, the Romanian leu and the Swedish krona were weaker against the euro in June 2024 than in June 2022. At the same time, the Hungarian forint was trading at almost the same level, while the Polish zloty was stronger.

Over the reference period, three of the six countries under review recorded average long-term interest rates that were above the 4.8% reference value. The countries with the lowest average long-term interest rates were Sweden and Bulgaria at 2.5% and 4.0% respectively. The Czech Republic also recorded an average long-term interest rate below the reference value at 4.2%, while Poland and Romania remained above at 5.6% and 6.4% respectively. The highest average long-term interest rate was recorded in Hungary at 6.8%. In 2022 12-month averages of long-term interest rates continued to rise owing to mounting inflationary pressures following the initial shock related to the impact of Russia’s invasion of Ukraine. Since the beginning of 2023 long-term interest rates in all the countries appear to have stabilised, or even declined somewhat, albeit still remaining at high levels in almost all of them.

Since the 2022 Convergence Report, long-term interest rate spreads vis-à-vis the euro area average have declined in all of the countries under review except Bulgaria. Nonetheless, a significant degree of heterogeneity persists in long-term interest rate differentials across the countries under review, reflecting differences both in the countries’ cyclical positions and in financial markets’ assessments of their external and internal vulnerabilities, including developments in budgetary performance and the prospects for sustainable convergence. In May 2024 Bulgaria’s long-term interest rate was 60 basis points above the euro area level, representing a 0.9 percentage point increase in the differential compared with its level at the beginning of the review period in May 2022. These developments are presumably linked to country risk arising from political instability, as Bulgaria’s banking system is predominantly owned by euro area-based banks and the central bank operates a currency board which de facto imports euro area monetary conditions. Hungary, Poland, the Czech Republic and Romania experienced the largest declines in the interest rate differential over the review period, by between 1.8 percentage points and 2.9 percentage points. Sweden’s interest rate differential declined the least (by 0.8 percentage points).

In May 2024 the 12-month average rate of HICP inflation in Bulgaria was 5.1%, i.e. well above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, as pipeline pressures and supply bottlenecks continue to ease. Core inflation is expected to remain persistently high, mainly reflecting strong wage pressures amid tight labour markets. Unit labour costs grew by 27.4% over the period from 2020 to 2023, which is well above the euro area rate of 9.5%. There are concerns about the sustainability of inflation convergence in Bulgaria over the longer term. The catching-up process is likely to result in positive inflation differentials vis-à-vis the euro area, since GDP per capita and price levels are still significantly lower in Bulgaria than in the euro area.

Bulgaria is currently not subject to a Council Decision on the existence of an excessive deficit. Bulgaria’s general government budget deficit was 1.9% of GDP in 2023, i.e. well below the 3% reference value, and its debt-to-GDP ratio was 23.1%, i.e. well below the 60% reference value.

The Bulgarian lev participated in ERM II in the two-year reference period from 20 June 2022 to 19 June 2024. Over the reference period the lev did not exhibit any deviation from the central rate. The agreement on participation in ERM II was based on a number of policy commitments by the Bulgarian authorities. Bulgaria is currently working towards completing these post-entry commitments and is encouraged to accelerate its efforts to fulfil the elements of the action plan that was adopted by the Financial Action Task Force (FATF) after Bulgaria was placed on the FATF’s “grey list” of jurisdictions under increased monitoring in October 2023.

Over the reference period from June 2023 to May 2024, long‑term interest rates in Bulgaria stood at 4.0% on average and were thus below the 4.8% reference value for the interest rate convergence criterion. The differential between long‑term interest rates in Bulgaria and the euro area (GDP‑weighted) interest rate declined slightly, standing at 0.9 percentage points at the end of the reference period. Capital markets in Bulgaria remain smaller and much less developed than those in the euro area.

Bulgarian law is compatible with the Treaties and the Statute of the ESCB as required under Article 131 of the Treaty, subject to the conditions and interpretations set out in Section 7.1.

In May 2024 the 12‑month average rate of HICP inflation in the Czech Republic was 6.3%, i.e. well above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks. At the same time, the very tight labour market will continue to exert upward pressure on inflation. There are some concerns about the sustainability of inflation convergence in the Czech Republic over the longer term. Unless counteracted by an appreciation of the nominal exchange rate, the catching-up process may result in positive inflation differentials vis‑à‑vis the euro area, since GDP per capita and price levels are still relatively lower in Czech Republic than in the euro area.

The Czech Republic is currently not subject to a Council Decision on the existence of an excessive deficit. The Czech Republic’s general government budget deficit was 3.7% of GDP in 2023, i.e. above the 3% reference value, while its debt-to-GDP ratio was 44.0%, i.e. below the 60% reference value. In June 2024, the European Commission assessed the excess deficit as being temporary since the deficits in 2024 and 2025 were projected not to exceed the reference value. After considering the relevant factors, it assessed the deficit criterion of the Stability and Growth Pact as being fulfilled.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Czech koruna did not participate in ERM II, but traded under a flexible exchange rate regime. The exchange rate of the Czech koruna against the euro exhibited, on average, a relatively high degree of volatility over the reference period. On 19 June 2024 the exchange rate stood at 24.9100 korunas per euro, i.e. the koruna was 0.8% weaker than its average level in June 2022.

Over the reference period from June 2023 to May 2024, long‑term interest rates in the Czech Republic stood at 4.2% on average and were thus below the 4.8% reference value for the interest rate convergence criterion. The differential between long‑term interest rates in the Czech Republic and the euro area (GDP‑weighted) interest rate declined slightly, standing at 1.1 percentage points at the end of the reference period. Capital markets in the Czech Republic are smaller and much less developed than those in the euro area.

Czech law does not comply with all the requirements for central bank independence, the monetary financing prohibition and legal integration into the Eurosystem. The Czech Republic is an EU Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

In May 2024 the 12‑month average rate of HICP inflation in Hungary was 8.4%, i.e. considerably above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks. At the same time, the tight labour market and strong repricing in the services sector will continue to exert upward pressure on inflation. Unit labour costs grew by 34.0% over the period from 2020 to 2023, which is well above the euro area rate of 9.5%. There are concerns about the sustainability of inflation convergence in Hungary over the longer term. Unless counteracted by an appreciation of the nominal exchange rate, the catching‑up process is likely to result in positive inflation differentials vis‑à‑vis the euro area, since GDP per capita and price levels are still lower in Hungary than in the euro area.

The European Commission found, in June 2024, that Hungary did not fulfil the deficit criterion of the Stability and Growth Pact. Hungary’s general government budget deficit was 6.7% of GDP in 2023, i.e. significantly above the 3% reference value, and its debt-to-GDP ratio was 73.5%, i.e. above the 60% reference value. In June 2024, the Commission found that Hungary did not fulfil the deficit criterion of the Stability and Growth Pact and announced its intention to propose to the Council, in July, that a decision be adopted under Article 126(6) establishing the existence of an excessive deficit situation in Hungary.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Hungarian forint did not participate in ERM II, but traded under a flexible exchange rate regime. The exchange rate of the Hungarian forint against the euro exhibited, on average, a very high degree of volatility over the reference period. On 19 June 2024 the exchange rate stood at 396.3400 forints per euro, i.e. the forint was trading almost at the same level (0.1%) as its average level in June 2022.The Magyar Nemzeti Bank entered a repo line arrangement with the ECB in June 2020, under which it could borrow up to €4 billion against high-quality euro-denominated collateral to provide euro liquidity to Hungarian financial institutions. This agreement remained in place over the reference period as it was extended again in January 2024.

Over the reference period from June 2023 to May 2024, long‑term interest rates in Hungary stood at 6.8 % on average and were thus above the 4.8% reference value for the interest rate convergence criterion. The differential between long‑term interest rates in Hungary and the euro area (GDP‑weighted) interest rate declined sizeably, standing at 3.7 percentage points at the end of the reference period. Capital markets in Hungary are smaller and much less developed than those in the euro area.

Hungarian law does not comply with all the requirements for central bank independence, the prohibition of monetary financing, the requirements for the single spelling of the euro and legal integration into the Eurosystem. Hungary is an EU Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

In May 2024 the 12‑month average rate of HICP inflation in Poland was 6.1%, i.e. well above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks. At the same time, the tight labour market will continue to exert upward pressure on inflation. Unit labour costs grew by 22.0% over the period from 2020 to 2023, which is well above the euro area rate of 9.5%. There are concerns about the sustainability of inflation convergence in Poland over the longer term. Unless counteracted by an appreciation of the nominal exchange rate, the catching‑up process is likely to result in positive inflation differentials vis‑à‑vis the euro area, since GDP per capita and price levels are still lower in Poland than in the euro area.

The European Commission found, in June 2024, that Poland did not fulfil the deficit criterion of the Stability and Growth Pact. Poland’s general government budget deficit was 5.1% of GDP in 2023, i.e. well above the 3% reference value, while its debt-to-GDP ratio was 49.6%, i.e. below the 60% reference value. In June 2024, the Commission found that Poland did not fulfil the deficit criterion of the Stability and Growth Pact and announced its intention to propose to the Council, in July, that a decision be adopted under Article 126(6) establishing the existence of an excessive deficit situation in Poland.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Polish zloty did not participate in ERM II, but traded under a flexible exchange rate regime. The exchange rate of the Polish zloty against the euro exhibited, on average, a relatively high degree of volatility over the reference period. On 19 June 2024 the exchange rate stood at 4.3300 zlotys per euro, i.e. the zloty was 6.8% stronger than its average level in June 2022. Between March 2022 and mid-January 2024 Narodowy Bank Polski had a swap line arrangement with the ECB, under which it could borrow up to €10 billion against zlotys in order to address potential euro liquidity needs in the Polish financial system.

Over the reference period from June 2023 to May 2024, long‑term interest rates in Poland stood at 5.6% on average and were thus above the reference value of 4.8% for the interest rate convergence criterion. The differential between long‑term interest rates in Poland and the euro area (GDP‑weighted) interest rate declined slightly, standing at 2.6 percentage points at the end of the reference period. Capital markets in Poland are smaller and much less developed than those in the euro area.

Polish law does not comply with all the requirements for central bank independence, confidentiality, the monetary financing prohibition and legal integration into the Eurosystem. Poland is an EU Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

In May 2024 the 12‑month average rate of HICP inflation in Romania was 7.6%, i.e. considerably above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, driven by past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks. At the same time, core inflation is expected to remain sticky, fuelled by strong wage developments in the context of a tight labour market. Unit labour costs grew by 26.7% over the period from 2020 to 2023, which is well above the euro area rate of 9.5%. There are concerns about the sustainability of inflation convergence in Romania over the longer term. Unless counteracted by an appreciation of the nominal exchange rate, the catching‑up process is likely to result in positive inflation differentials vis‑à‑vis the euro area, since GDP per capita and price levels are still lower in Romania than in the euro area.

Romania is currently subject to an excessive deficit procedure and the European Commission found, in June 2024, that it had not taken effective action. Romania’s general government budget deficit was 6.6% in 2023, i.e. significantly above the 3% reference value, while its debt-to-GDP ratio was 48.8%, i.e. below the 60% reference value. Since April 2020, Romania has been subject to an excessive deficit procedure, as its fiscal position exceeded the 3% reference value in 2019. Its headline deficit in 2023 was much higher than the recommended target. In June 2024, the European Commission assessed that Romania’s response had been insufficient and recommended a Council Decision establishing that Romania had not taken effective action to address its excessive deficit.

Over the reference period from 20 June 2022 to 19 June 2024, the Romanian leu did not participate in ERM II, but traded under a flexible exchange rate regime involving a managed floating of the currency’s exchange rate. The exchange rate of the Romanian leu against the euro exhibited, on average, a low degree of volatility over the reference period. On 19 June 2024 it stood at 4.9768 lei per euro, i.e. the leu was 0.7% weaker than its average level in June 2022. Between June 2020 and mid-January 2024 Banca Naţională a României had a repo line arrangement with the ECB, under which it could borrow up to €4.5 billion against high-quality euro-denominated collateral to provide euro liquidity to Romanian financial institutions.

Over the reference period from June 2023 to May 2024, long‑term interest rates in Romania stood at 6.4% on average and were thus above the 4.8% reference value for the interest rate convergence criterion. The differential between long‑term interest rates in Romania and the euro area (GDP‑weighted) interest rate increased slightly, standing at 3.2 percentage points at the end of the reference period. Capital markets in Romania are much smaller than those in the euro area and are still underdeveloped.

Romanian law does not comply with all the requirements for central bank independence, the monetary financing prohibition and legal integration into the Eurosystem. Romania is an EU Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

In May 2024 the 12‑month average rate of HICP inflation in Sweden was 3.6%, i.e. above the reference value of 3.3% for the criterion on price stability. This rate is expected to decrease gradually over the coming months, driven by a restrictive monetary policy stance, a fall in energy prices and the ongoing easing of pipeline pressures. Consumer price inflation is expected to converge to Sveriges Riksbank’s 2% target in 2024 and remain close to it in 2025. Looking ahead, Sweden’s monetary policy and its stability‑oriented institutional framework should continue to support the achievement of price stability.

Sweden is currently not subject to a Council Decision on the existence of an excessive deficit. Sweden’s general government budget deficit was 0.6% of GDP in 2023, i.e. well below the 3% reference value, and its debt-to-GDP ratio was 31.2%, i.e. well below the 60% reference value. Sweden has never been subject to an excessive deficit procedure.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Swedish krona did not participate in ERM II, but traded under a flexible exchange rate regime. The exchange rate of the Swedish krona against the euro exhibited, on average, a high degree of volatility over the two-year period. On 19 June 2024 it stood at 11.2140 kronor per euro, i.e. the krona was 5.8% weaker than its average level in June 2022. Over the reference period Sveriges Riksbank maintained a swap agreement with the ECB for borrowing up to €10 billion in exchange for Swedish kronor, which has been in place since 20 December 2007.

Over the reference period from June 2023 to May 2024, long‑term interest rates in Sweden stood at 2.5% on average and thus remained well below the 4.8% reference value for the interest rate convergence criterion. The differential between long‑term interest rates in Sweden and the euro area (GDP‑weighted) interest rate declined slightly, standing at -0.7 percentage points at the end of reference period. Capital markets in Sweden are highly developed compared with those in the euro area.

Swedish law does not comply with all the requirements for central bank independence, the monetary financing prohibition and legal integration into the Eurosystem. Sweden is an EU Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty. Pursuant to the Treaty, Sweden has been under the obligation to adopt national legislation with a view to integration into the Eurosystem since 1 June 1998. As yet no legislative action has been taken by the Swedish authorities to remedy the incompatibilities described in this and previous reports.

In May 2024 the 12-month average rate of HICP inflation in Bulgaria was 5.1%, i.e. well above the reference value of 3.3% for the criterion on price stability (Chart 5.1.1). This rate is expected to decrease gradually over the coming months, as pipeline pressures and supply bottlenecks continue to ease.

Over the past ten years the 12-month average rate of HICP inflation has fluctuated within a very wide range, from ‑1.7% to 14.1%. After a prolonged period in negative territory, inflation turned positive again in 2017. Robust economic growth and falling unemployment, together with a longer-term decline in the working age population, as well as administrative and policy factors, led to a sharp rise in nominal wages and unit labour costs. In 2018 and 2019 the annual average rate of HICP inflation rose further, to around 2.5%, owing to upward pressure from both buoyant domestic demand on the back of strong wage growth and hikes in food and services prices. Thereafter, the contraction of the Bulgarian economy as a result of the COVID-19 pandemic and declines in oil and energy prices kept HICP inflation at low levels, averaging 1.2% in 2020 (Table 5.1.1). Rising global energy and food prices, changes in administered prices and the rebound in economic activity and private consumption pushed up prices in the first half of 2021. From September that year the rate of inflation accelerated markedly, owing to high electricity, fuel and gas prices, and the associated direct and indirect effects. Russia’s invasion of Ukraine in late February 2022 exacerbated the increase in global commodity prices and supply bottlenecks, leading to a sharp rise in HICP inflation, which peaked at 15.6% in September 2022 before starting to decrease. As with the other central and eastern European countries under review, Bulgaria has been particularly vulnerable to recent global shocks, owing mainly to certain structural features of its economy and its exposure to Russia (see Chapter 3). By December 2023 annual HICP inflation had slowed to 5% on account of lower commodity prices, easing supply bottlenecks and government measures to mitigate the impact of the energy price rises. These were mainly in the form of transfers to households and firms, and to a lesser extent changes in indirect taxes. The strongest contribution to this decline in HICP inflation came from energy and food prices, the same components that fuelled inflation in the period 2021-22.

In May 2024 the annual rate of HICP inflation reached 2.7%. This is the lowest it has been since the third quarter of 2021 after the 2.5% inflation rate recorded in April 2024. The decline in inflation over the first five months of 2024 can be attributed to lower commodity prices and the easing of supply bottlenecks. Core inflation, defined as HICP inflation excluding energy and food, remains above headline inflation, owing to persistent wage pressures amid tight labour markets, strong domestic demand and limited spillover effects of monetary policy tightening in the euro area in the context of ample liquidity and competition in the banking sector.

The orientation of monetary policy towards price stability has played an important role in shaping inflation dynamics in Bulgaria over the past decade. On 1 July 1997 Българска народна банка (Bulgarian National Bank) introduced a currency board arrangement. The Bulgarian lev was initially pegged at par to the Deutsche Mark and since 1 January 1999 it has been pegged to the euro at a rate of 1.95583 levs per euro. Prudent fiscal policy has supported the stability of the currency board since 1997. Given the limited spillover effects of monetary policy tightening in the euro area, in 2023 Българска народна банка (Bulgarian National Bank) raised banks’ minimum reserve requirements to withdraw some of the excess liquidity from the banking system.

Inflation is expected to continue to decline in the coming months, but over the longer term there are concerns about the sustainability of inflation convergence in Bulgaria. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation will fall to 3.1% in 2024 and 2.6% in 2025. Over the forecast horizon, falling import prices are set to put downward pressure on the energy, food and non-energy industrial goods components in 2024. Core inflation is also projected to decelerate, driven by indirect effects from lower input prices and an expected moderation in wage growth. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation. Risks to the inflation outlook are tilted to the upside, as labour shortages and related wage pressures are expected to continue in the medium term, and an escalation of geopolitical tensions could disrupt trade and cause volatility in energy prices, adding further to inflation. Looking further ahead, there are concerns about the sustainability of inflation convergence in Bulgaria over the longer term, also taking into account the marked increase in unit labour costs and the tightness of labour markets. Unit labour costs grew by 27.4% over the period from 2020 to 2023 – well above the euro area rate of 9.5% – challenging the competitiveness of the Bulgarian economy (Table 3.2). The catching-up process is likely to result in positive inflation differentials vis-à-vis the euro area, since GDP per capita and price levels are still significantly lower in Bulgaria than in the euro area. In order to prevent the build-up of excessive price pressures and macroeconomic imbalances, the catching‑up process must be supported by appropriate policies. In particular, while hourly labour costs in Bulgaria are still the lowest in the EU, growth in wages needs to be consistent with that in productivity, among other things, in order to safeguard price competitiveness and the country’s attractiveness to foreign investors. Moreover, as Bulgaria has been participating in the exchange rate mechanism (ERM II) since July 2020 with its existing currency board arrangement in place, it is important to contain inflationary pressures with appropriate policies, not least to enhance productivity growth, especially in the non-traded goods sector.

Achieving an environment that is conducive to sustainable convergence in Bulgaria requires stability‑oriented economic policies and wide-ranging structural reforms. Given monetary policy’s limited room for manoeuvre under the currency board, other policy areas (fiscal, macroprudential) should provide the economy with the means to cope with potential country-specific shocks and macroeconomic imbalances. This is also of utmost importance for a smooth participation in ERM II, as reflected in a number of Bulgaria’s ERM II post-entry commitments, which are discussed in more detail in Section 5.1.3. In addition, structural reforms to enhance the business and institutional environment are crucial in order to attract foreign direct investment and boost potential growth. These include Bulgaria’s commitment to further reduce corruption, ensure an independent and effective judicial system, and improve the education system. A continued reduction in the declining – but still elevated – corporate debt burden would support corporate profitability and investment. It is also essential to strengthen national policies aimed at enhancing competition in product markets, to proceed with the liberalisation of regulated sectors and to manage a smooth transition to a digital and greener economy. In this context, sustained efforts are needed to build up administrative capacity and to further increase the absorption of EU funds. With long-term unemployment accounting for a large percentage of total unemployment, active labour market policy measures are required to enhance the employability and strengthen the skill level of the workforce, and to promote the economic inclusion of the most vulnerable segments of the population. With regard to macroeconomic imbalances, the European Commission did not select Bulgaria for an in-depth review in its Alert Mechanism Report 2024.

The convergence in banking supervision achieved under the close cooperation framework ensures the application of uniform supervisory standards and thus contributes to safeguarding financial stability. Following the inclusion of the Bulgarian lev in ERM II, the ECB and Българска народна банка (Bulgarian National Bank) have been working together under the close cooperation framework since 1 October 2020. The ECB is responsible for the direct supervision of four significant institutions and the common procedures for all supervised entities, as well as the oversight of 13 less significant institutions. Българска народна банка (Bulgarian National Bank) has been integrated into the Single Supervisory Mechanism and is participating in its structures and networks. With regard to the oversight of less significant institutions, which have a domestic market share of roughly 30%, the ECB is working closely with national supervisors to further harmonise implementation of the rules governing banking supervision, while also ensuring that joint supervisory standards are applied consistently across the system. Given the limited spillover effects of monetary policy tightening in the euro area, lending activity has remained elevated, particularly in the loans to households segment. The stepwise increase in the countercyclical capital buffer rate since 2022 to strengthen the resilience of the banking sector seems appropriate.

Bulgaria’s general government budget deficit was well below the 3% reference value in 2023 and its debt level was well below the 60% reference value. In the reference year 2023, the general government budget recorded a deficit of 1.9% of GDP, thus standing well below the 3% deficit reference value. The general government gross debt-to-GDP ratio was 23.1%, well below the 60% reference value (Table 5.1.2). Compared with the previous year, the general government deficit declined by 1.0 percentage points and the debt ratio increased slightly by 0.5 percentage point. With regard to other fiscal factors, the deficit ratio was below the ratio of public investment to GDP in 2023. The budget deficits in 2022 and 2023 were affected by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

Bulgaria is currently not subject to a Council Decision on the existence of an excessive deficit. Bulgaria has been subject to the preventive arm of the Stability and Growth Pact since 2012. During the period in which the general escape clause under the Stability and Growth Pact applied (due to the COVID-19 pandemic and the invasion of Ukraine by Russia), the European Commission found, in May 2022, that the general government deficit-to-GDP ratio in 2021 had been above and not close to the reference value of 3%, and in May 2023, that the planned deficit in 2024 was also above and not close to the reference value. In both cases, the Commission’s analysis suggested that the deficit criterion had not been fulfilled. However, given the high uncertainty surrounding the macroeconomic outlook, the Commission considered that at that juncture a decision on whether to place Member States under the excessive deficit procedure should not be taken. Bulgaria was once subject to an excessive deficit procedure between 2010 and 2012, while the general government debt has been below the 60% of GDP reference value since 2004.

The budget balance improved over the period 2021-23, but the deficit remains significantly above its level prior to the pandemic. Prior to the pandemic, prudent fiscal policy had allowed Bulgaria to record improving structural balances, turning the deficit of 5.4% of GDP in 2014 into a surplus of 2.1% of GDP in 2019. As a consequence of the pandemic and the government’s fiscal support to buffer its impact, the structural balance deteriorated strongly, reaching a deficit of 3.9% of GDP in 2021. In addition, cyclical factors reflecting the deterioration in the economic situation contributed to the overall increase in the budget deficit by 6 percentage points between 2019 and 2021. The improvement in the budget balance since the pandemic by 2.0% of GDP between 2021 and 2023 was mostly related to an increase in the structural balance by 1.7 percentage points as a result of lower current expenditure. The budget balance in 2023 was 4.0% of GDP lower than in 2019, i.e. the year before the outbreak of the pandemic, which was entirely attributable to a deterioration in the structural balance by 4.0% of GDP.

The government debt-to-GDP ratio has remained well below the 60% reference value over the past two decades. Prior to the pandemic, the debt ratio had declined between 2014 and 2019 by 7.0 percentage points to 20% of GDP, mostly owing to high primary surpluses and, to a lesser extent, favourable interest-growth differentials. After increasing by 4.6% of GDP in 2020 at the start of the pandemic, the debt ratio then fell between 2020 and 2023 slightly by 1.5% of GDP thanks to favourable interest-growth differentials, which compensated somewhat for the debt-increasing impact arising from primary deficits. The debt ratio in 2023 was 3.1 percentage points higher than in 2019.

In the presence of a long-standing currency board, the level and structure of public debt allow Bulgaria to manage its debt effectively. The share of government debt with a short-term maturity has generally been negligible. Taking into account the low share of debt with a variable interest rate and the level of the debt ratio, fiscal balances are relatively insensitive to changes in interest rates. At the same time, the proportion of foreign currency-denominated government debt is high (74.8% in 2023). It is almost entirely denominated in euro – the anchor currency of Bulgaria’s currency board framework. Fiscal balances are thus insensitive to changes in exchange rates other than the euro/lev exchange rate, which is fixed under the currency board.

The European Commission’s Spring 2024 Economic Forecast predicts an increase in the budget deficit and a moderate increase in the public debt ratio. According to the European Commission’s Spring 2024 Economic Forecast, the headline balance deficit is expected to increase to 2.8% of GDP in 2024 and thus remain below the 3% deficit reference value. The budget balance is projected to deteriorate slightly in 2025 and reach a deficit of 2.9% of GDP. The debt ratio is projected to increase moderately to stand at 24.8% of GDP in 2024 and 24.6% of GDP in 2025.

Bulgaria’s fiscal framework has helped it to maintain a low debt ratio, but there is still scope for further improvement. Bulgaria has a large number of fiscal rules at the general government and subnational levels, which comprise budget balance, debt and expenditure rules. While those rules mitigate the risk of increasing debt, in practice they are difficult to implement and therefore need to be streamlined and simplified in order to strengthen their credibility in terms of ensuring continued sound public finances over the longer run. The Public Finance Act was last amended in 2020 as a response to the pandemic. Those amendments were aimed at increasing the flexibility of the fiscal rules in the case of economic downturns, by allowing deviations from the 3% general government deficit ceiling and the expenditure rule in the case of extraordinary circumstances outside the control of the government which seriously impact the fiscal position. Moreover, the ceiling for the cash-based budget deficit was increased from 2% to 3% and the maximum amount of expenditure under the consolidated fiscal programme was effectively increased, as EU funds and national co-financing were exempted from the scope of expenditure, while the maximum amount of 40% of GDP remained. While those revisions lowered the stringency of the two rules, they do not compromise fiscal sustainability if the rules are adhered to. The Fiscal Council was introduced in 2016 in line with EU requirements, and its mandate and the quality of its work have been strengthened over time; further improvements in the areas of its technical and administrative capacities could help to increase transparency. While progress has been made in increasing tax collection and improving tax compliance, further progress is still desirable.

The Bulgarian lev participated in ERM II in the two-year reference period from 20 June 2022 to 19 June 2024. Over the reference period the lev did not exhibit any deviation from the central rate. As implied by the currency board framework, Българска народна банка (Bulgarian National Bank) has continued to exchange on demand domestic currency against the anchor currency (the euro) and vice versa at the fixed rate. Short-term interest rate differentials against the three-month EURIBOR stood at a very low level throughout the reference period. The Bulgarian lev was included in ERM II at a central rate of 1.95583 levs per euro with a standard fluctuation band of ±15% in July 2020. Bulgaria joined the exchange rate mechanism with its existing currency board in place, as a unilateral commitment, thus placing no additional obligations on the ECB.

The agreement on participation in ERM II was based on a number of policy commitments by the Bulgarian authorities, with the aim of achieving a high degree of sustainable economic convergence by the time of the adoption of the euro. These commitments relate to implementing specific policy measures pertaining to the non-bank financial sector, state-owned enterprises, the insolvency framework and the anti-money laundering (AML) framework. The ECB and the European Commission have been monitoring the effective implementation of Bulgaria’s post-entry commitments, acting within their respective areas of competence as provided for by the Treaties and secondary legislation. In its role as the supervisory authority and given its shared responsibility for macroprudential policy, the ECB is monitoring the implementation of the commitments related to the financial sector, i.e. the insolvency and AML frameworks, owing to their importance for the functioning of the financial system. Bulgaria is currently working towards completing these commitments and is encouraged to accelerate its efforts to fulfil the elements of the action plan that was adopted by the Financial Action Task Force (FATF) after Bulgaria was placed on the FATF’s “grey list” of jurisdictions under increased monitoring in October 2023.

The HICP-based real effective exchange rate of the Bulgarian lev has appreciated over the past ten years (Chart 5.1.4). This appreciation reflected developments in the nominal effective exchange rate. However, the relatively high level of inflation following the sharp rise in energy prices in 2021, which was exacerbated in the wake of Russia’s invasion of Ukraine in February 2022, put upward pressure on the real effective exchange rate. However, this indicator should be interpreted with caution, as Bulgaria is subject to a process of economic convergence, which complicates any long-term assessment of real exchange rate developments.

Bulgaria’s combined current and capital account balance has mostly remained in surplus over the past ten years and the country’s net foreign liabilities have declined markedly (Table 5.1.3). From 2014 to 2019 the combined current and capital account balance increased, primarily reflecting a substantial reduction in the goods deficit as a result of the export‑led recovery. However, a deficit was recorded in 2021 and 2022 – two years characterised by high volatility owing to the pandemic and Russia’s war against Ukraine. Over the period 2019-23 the substantial adjustment in the balance of payments was associated with a significant contraction in net direct investment inflows – which fell from double‑digit levels before the global financial crisis to an average of ‑2.8% of GDP, while the balance on other investment was slightly negative. Gross external debt decreased further, falling from 61.3% of GDP in 2019 to 48.3% in 2023. At the same time, the country’s net international investment position, largely consisting of foreign direct investment, continued to improve, rising from ‑30.2% of GDP in 2019 to ‑7.6% of GDP in 2023, on account of a further accumulation of reserve assets. Nevertheless, fiscal and structural policies continue to be important for supporting external sustainability and the competitiveness of the economy, especially in a more volatile environment characterised by geopolitical and commodity price shocks.

The Bulgarian economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 45.2% of total exports, with the corresponding figure for imports standing at 41.8%. In the same year the share of the euro area in Bulgaria’s stock of inward direct investment stood at 64.3% and its share in the country’s stock of portfolio investment liabilities was 73.9%. The share of Bulgaria’s stock of foreign assets invested in the euro area amounted to 49.9% in the case of direct investment and 52.4% for portfolio investment in 2023.

Over the reference period from June 2023 to May 2024, long-term interest rates in Bulgaria increased and stood at 4.0% on average, below the 4.8% reference value for the interest rate convergence criterion (Chart 5.1.5).

Long-term interest rates in Bulgaria increased slightly from 3.5% in January 2014 to 3.9% in May 2024. During the first half of the past decade, long-term interest rates declined almost continuously, converging to euro area levels in 2018. The decline occurred as the diminishing impact of the global financial crisis led to a reduction in macro-financial risk and to a significant improvement in the outlook for the public budget. Domestic and global cyclical factors also contributed to the declining trend in long-term interest rates in the first part of the decade. These included spillovers from low interest rates in the euro area, Bulgarian banks’ continued demand for government debt securities in the context of scarce opportunities for lending to the private sector, a high private savings rate, and the effect of global trade tensions on growth expectations and, consequently, interest rates. In the period 2020-21 the negative impact of the pandemic on global and domestic economic activity and inflation drove long-term interest rates in Bulgaria down to a historically low level of 0.1 % from March to August 2021. Since 2022, in a context of mounting domestic and global inflationary pressures, long-term interest rates have increased significantly in line with global monetary policy and financial market developments. Renewed political uncertainty between the end of 2022 and the spring of 2023 – which resulted in two general elections being held in October 2022 and April 2023 – also contributed to a sharp increase of around 200 basis points in long‑term interest rates over this period. Long-term interest rates in Bulgaria have stabilised since April 2023 and stood at 3.9% in May 2024, up from 1.6% in May 2022, the beginning of the review period (Chart 5.1.5). However, developments in long‑term interest rates in Bulgaria must be interpreted with caution, as the bond used to derive the relevant interest rate was not traded between 20 March and 12 December 2023.The renewed domestic political uncertainty at the end of 2022 caused a sudden spike in the default risk on long-term Bulgarian debt, as measured by ten-year credit default swap spreads. These stood at more than 230 basis points in October 2022, up from 90 basis points in February 2022, when Russia launched its invasion of Ukraine. The spreads then gradually declined to around 115 basis points in May 2024, thus returning to the levels seen at the beginning of the review period in May 2022. Bulgaria’s government debt is rated investment grade by all three main rating agencies (Moody’s: Baa1; S&P: BBB; Fitch: BBB).

The long-term interest rate differential of Bulgarian government bonds vis-à-vis the euro area average stood at 0.9 percentage points in May 2024. Since 2014 Bulgarian long-term interest rates have gradually and almost continuously converged towards the euro area average rate of corresponding maturity (Chart 5.1.6). Initially, the stable and relatively high rates in Bulgaria combined with a decline in the average long-term interest rate in the euro area resulted in some widening of the differential, which peaked at 1.9 percentage points in November 2014 and oscillated between 0.7 and 1.8 percentage points from 2015 until late 2016. The differential then steadily declined and remained quite low – also spending some time in negative territory – until March 2023, when it turned significantly positive. In May 2024 it stood at 0.9 percentage points (1.2 percentage points vis-à-vis the euro area AAA yield).

Capital markets in Bulgaria are smaller and much less developed than those in the euro area (Table 5.1.4). In the past few years there have been only a few indications of a deepening of capital markets compared with early 2014. In recent years stock market capitalisation, as a percentage of GDP, has declined from an average of 15.4% over the period 2014‑18 to 9.3% in 2023. Market‑based debt financing of domestic monetary financial institutions (MFIs) has increased since 2014 to stand at 1.8% of GDP. Over the same period, the access of non‑financial corporations in Bulgaria to the corporate debt market seems to have declined, as outstanding debt securities issued by this sector accounted for 1.7% of GDP in 2023, 1.5 percentage points lower than in the period 2014‑18. In 2023 the reliance of the Bulgarian banking system on euro area banks for its funding needs increased significantly in comparison with the average over the period 2014-18. Euro area banks’ claims on Bulgarian banks increased to 5.7% of the latter’s total liabilities in 2023, up from an average level of 4.4% over the period 2014-18. The degree of financial intermediation remains quite low in Bulgaria compared with the euro area average, although it is comparable to that of peer countries in the region. MFI credit to non‑government residents stood at 50.0% of GDP in 2023, 5 percentage points below its average for the period 2014-18. At the end of 2022 foreign-owned banks continued to play a major role in the banking system in Bulgaria, accounting for around 72% of total banking assets. The banking system is largely funded by resident private non-financial sector deposits. The banking system’s assets vis-à-vis the non-financial private sector were dominated by loans, 76% of which were denominated in local currency.

In May 2024 the 12-month average rate of HICP inflation in the Czech Republic was 6.3%, i.e. well above the reference value of 3.3% for the criterion on price stability (Chart 5.2.1). This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks.

Over the past ten years the 12-month average rate of HICP inflation has fluctuated within a very wide range, from 0.2% to 16.8%. In 2014 and 2015 HICP inflation was close to zero as a result of utility price cuts, relatively muted wage growth and subdued external price pressures. Import price growth accelerated in 2014, owing partly to the exchange rate floor of 27 korunas per euro set by Česká národní banka. In the second half of the decade the Czech economy returned to a path of solid economic growth, which led to a notable appreciation of the koruna against the euro in real effective terms. The outbreak of the COVID-19 pandemic in 2020 resulted in a marked contraction of real GDP and a gradual decline in HICP inflation that year. To counteract the economic impact of the pandemic, Česká národní banka reduced its main policy rate significantly, bringing it down to 0.25%. In 2021 large increases in energy and commodity prices, coupled with global supply bottlenecks, put significant upward pressure on inflation, which was fuelled further by government support measures aimed at stabilising employment and providing emergency liquidity. In 2022, after Russia’s invasion of Ukraine in late February, inflation continued to rise (Table 5.2.1), largely as a result of soaring energy, food and commodity prices. As with the other central and eastern European countries under review, the Czech Republic has been particularly vulnerable to recent global shocks, owing mainly to certain structural features of its economy and its exposure to Russia (see Chapter 3). To counter the rise in inflation, which reached an average of 14.8% in 2022, Česká národní banka had started a monetary policy tightening cycle in June 2021. This resulted in a cumulative 675 basis point hike in its main policy rate, up to 7% in June 2022. The central bank also intervened on foreign exchange markets in 2022 to avert a longer-term weakening of the koruna. After peaking at 19% in January 2023, the annual rate of inflation slowed gradually to 12% for the year as whole. This was due to the tighter monetary policy, government measures to mitigate the impact of the domestic energy price rises (mainly in the form of transfers to households and firms), the fall in global energy prices and the unwinding of supply bottlenecks. Česká národní banka responded to this decline with a rate cut of 25 basis points in December that year.

In May 2024 the annual rate of HICP inflation reached 2.8%. The downward trend in inflation that had begun in 2023 continued in the first quarter of 2024, with inflation approaching the central bank’s 2% target. This trend reflected the waning impact of global shocks, subdued domestic demand pressures amid persistently weak economic growth and the tight monetary policy stance, and the base effect of the phasing-out of the government’s energy savings tariff. Against this background, Česká národní banka lowered its key policy rate again on three occasions by a total of 150 basis points, down to 5.25% in May 2024.

The orientation of monetary policy towards price stability has played an important role in shaping inflation dynamics in the Czech Republic over the past decade. Since 2001 the inflation target has been defined in terms of consumer price inflation, originally as a continuously declining band and since 2006 as a flat point target. The target was set at 3% (±1 percentage point) in 2006 and reduced to 2% (±1 percentage point) in 2010. In November 2013, in order to fulfil its mandate to maintain price stability, Česká národní banka intervened to weaken the domestic currency and set the aforementioned exchange rate floor. When the central bank abandoned its commitment to a minimum exchange rate vis-à-vis the euro in 2017, the related policy shift was smooth, with a gradual appreciation of the koruna. The exit from the exchange rate floor was the first step towards normalising domestic monetary conditions and was followed by several interest rate adjustments in both directions in order to maintain price stability.

Inflation in the Czech Republic is expected to remain close to the 2% target over the forecast horizon. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation is expected to average 2.5% in 2024 and to moderate to 2.2% in 2025. This outlook is based on the expectation that energy prices will moderate, with the past monetary policy tightening and the planned fiscal consolidation package also contributing to disinflationary pressures. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation. Risks to the inflation outlook are tilted to the upside. Given the high degree of openness and high energy intensity of the Czech economy, an escalation of geopolitical tensions could disrupt trade and cause volatility in energy prices, which may result in stronger than expected inflationary pressures in the coming years. These may also be exacerbated by robust wage growth in the context of a very tight labour market. Looking further ahead, unless counteracted by an appreciation of the nominal exchange rate, the catching-up process may result in positive inflation differentials vis-à-vis the euro area. GDP per capita and price levels are still lower than the euro area average in the Czech Republic, despite being relatively high compared with those in the other central and eastern European countries under review. In order to prevent the build-up of excessive price pressures and macroeconomic imbalances, the catching-up process must be supported by appropriate policies.

Achieving an environment that is conducive to sustainable convergence in the Czech Republic requires targeted economic policies, including structural reforms, that are geared to ensuring macroeconomic stability. The Czech Republic is facing the challenge of boosting its economic growth potential by enhancing productivity. Persisting inefficiencies in the business environment and growing labour shortages are weighing on potential growth. Additional efforts are needed to remove unnecessary restrictions on conducting business and firms’ market entry, and to support research and development, and innovation. Moreover, skill mismatches in the labour market need to be addressed by improving vocational education and training, and by removing impediments to flexible working arrangements. Owing to adverse demographic trends, employment creation will also require larger labour market participation of under-represented groups, especially young people, which is lagging significantly behind the EU average. Against this background, it will be important to ensure an efficient and effective absorption of the EU funds allocated to the country. With regard to macroeconomic imbalances, the European Commission did not select the Czech Republic for an in-depth review in its Alert Mechanism Report 2024.

Financial sector policies should be aimed at safeguarding financial stability and ensuring that the financial sector can contribute to sustainable economic growth. The Czech Republic’s banking sector remains broadly resilient to adverse shocks given the relatively large capital and liquidity buffers held by banks. Moreover, banks have remained profitable and levels of non-performing loans contained. Risks in the financial sector relate mainly to exchange rate risk stemming from the higher degree of euroisation in the corporate lending market on the back of the recent widening of interest rate differentials vis-à-vis the euro area. The potential impact of such risks depends largely on firms’ degree of hedging against exchange rate movements. Risks in the housing market have declined, as households’ average gross disposable income has recovered, meaning that they are in a better position to absorb any repricing of mortgages. However, given the high level of interest rates, liquidity-constrained households may still face a greater risk of default on mortgages even for average-priced property. In order to bolster confidence in the financial system, the national competent authorities should continue to improve their supervisory practices by, among other things, following the applicable recommendations from the relevant international and European bodies, and by collaborating closely with other national supervisors of EU Member States within the supervisory colleges.

The Czech Republic’s general government budget deficit was above the 3% reference value in 2023, while its debt remained below the 60% reference value. In the reference year 2023, the general government budget balance recorded a deficit of 3.7% of GDP, thus above the 3% deficit reference value. The general government gross debt-to-GDP ratio was 44%, i.e. below the 60% reference value (Table 5.2.2). Compared with the previous year, the government deficit-to-GDP ratio increased by 0.5 percentage points, while the debt-to-GDP ratio decreased moderately by 0.2 percentage points. With regard to other fiscal factors, the deficit ratio was below the ratio of public investment to GDP in 2023. The budget deficits in 2022 and 2023 were also affected by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

The Czech Republic is currently not subject to a Council Decision on the existence of an excessive deficit. The Czech Republic has been subject to the preventive arm of the Stability and Growth Pact since 2014. On 19 June 2024, the European Commission published a report prepared in accordance with Article 126(3) of the Treaty for 12 Member States, including the Czech Republic, which found that the Czech Republic had exceeded the deficit reference value in 2023. This deficit level was above, and not close to, the reference value and the excess was not assessed to be exceptional. However, the deficit in excess of the reference value was assessed to be temporary, as the European Commission had not projected the deficit to exceed 3% of GDP in 2024 and 2025. Overall, taking into account mitigating relevant factors, the Commission concluded that the Czech Republic fulfilled the deficit criterion of the Stability and Growth Pact. During the period in which the general escape clause under the Stability and Growth Pact applied (due to the pandemic and the invasion of Ukraine by Russia), the European Commission found, in June 2021, May 2022 and May 2023, that the general government deficits in 2020, 2021 and 2022, respectively, had been above and not close to the reference value of 3% of GDP. In all three cases, the Commission’s analysis suggested that the deficit criterion had not been fulfilled. However, given the high uncertainty surrounding the macroeconomic outlook, the Commission considered that at that juncture a decision on whether to place Member States under the excessive deficit procedure should not be taken. Previously, the Czech Republic had been subject to an excessive deficit procedure between December 2009 and June 2014. However, in the subsequent period to 2019, the Czech Republic comfortably met its medium-term objective of a structural deficit of no more than 1% of GDP.

Following the pandemic, the structural deficit has remained large, historically speaking, and cyclical factors are still contributing negatively to the government balance. Prior to the pandemic, the budget balance had improved, from a deficit of 2.1% of GDP in 2014 to a surplus of 0.3% of GDP in 2019 (Chart 5.2.2). With the pandemic shock, the deficit widened to 5.8% of GDP on account of both fiscal measures in response to the pandemic and cyclical factors reflecting the deterioration in the general economic situation. The budget balance improved in the period 2020-22 by 2.6 percentage points as a result of cyclical factors reflecting the economic recovery in 2021 and consolidation efforts implemented in 2022. The deterioration in public finances in 2023 was partly attributable to the large increase in pension spending due to the automatic indexation to inflation and a further deterioration in the economic situation, which led to a deficit in 2023 of 3.7% of GDP, 4 percentage points higher than the level seen in 2019, the year before the outbreak of the pandemic.

The debt-to-GDP ratio decreased slightly in 2023 and remained below the 60% reference value. Prior to the pandemic, the debt ratio had decreased by 11.9 percentage points, from 41.9% of GDP in 2014 to 30.0% of GDP in 2019. This reduction was mostly driven by primary surpluses and favourable interest-growth differentials. Between 2019 and 2021, the pandemic triggered an increase in the debt ratio by almost the same magnitude as the decrease prior to the pandemic, i.e. 12 percentage points. This was mainly on account of large primary deficits, as expenditure increased strongly to finance measures to mitigate the adverse impact of external shocks on households and firms. Since 2021, the debt ratio continued to increase, reaching a new peak of 44.2% of GDP in 2022 before decreasing slightly to 44% of GDP in 2023, 14 percentage points higher than the debt-to-GDP ratio recorded in 2019.

The level and structure of government debt protect the Czech Republic from any sudden changes in market conditions, with the bulk of debt at long-term maturities and most of the debt denominated in local currency. The share of government debt with a short-term maturity is low (2.3% in 2023 – Table 5.2.2). Taking into account also the share of debt with a variable interest rate and the overall level of the debt ratio, fiscal balances are relatively insensitive to changes in interest rates. The proportion of foreign currency-denominated government debt is low (7% in 2023) and since 2019, it has remained below the 2014-18 average (16.3%); it is predominantly denominated in euro (96% of foreign-denominated debt). Considering the size of the debt ratio, fiscal balances are also relatively insensitive to changes in exchange rates.

The European Commission’s Spring 2024 Economic Forecast predicts an improvement in the budget balance but still a slight increase in the public debt ratio. According to the European Commission’s Spring 2024 Economic Forecast, the headline balance is expected to improve, with a deficit of 2.4% of GDP in 2024, and therefore fall below the 3% deficit reference value. The foreseen improvement in the general government balance stems from the phasing-out of energy-related measures and the implementation of a consolidation package. This consolidation package is based mainly on cuts in subsidies, coupled with cuts in operational spending and public wages, increases in tax rates and the streamlining of the VAT structure. The budget balance is projected to improve further in 2025 and reach a deficit of 1.9% of GDP supported by growing momentum in economic activity, while the fiscal stance is expected to remain neutral. The debt ratio is projected to increase slightly to 45.2% of GDP in 2024 and 45.5% of GDP in 2025.

The Czech Republic’s fiscal governance framework is applied effectively, but further progress remains warranted. The national legislation implementing the EU Directive on requirements for budgetary frameworks was adopted in 2017. Since then, the Fiscal Council has become operational and issued reports on long-term sustainability and on compliance with the budgetary rules. Nevertheless, coordination among the various levels of general government remains low and should be further enhanced. Tax compliance has improved over recent years, but there is still room for improvement. For instance, the VAT gap (at 7% in 2021) remains above the EU average. The streamlining of the VAT structure planned for 2024 is a step in the right direction, as opposed to the abolition of the electronic registration of sales, which was only introduced in 2016 but discontinued in 2023.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Czech koruna did not participate in ERM II, but traded under a flexible exchange rate regime. Česká národní banka intervened in foreign exchange markets from May to October 2022 to prevent a longer-term weakening of the koruna in an episode of high inflation. Over the reference period the Czech currency was mostly stronger – but often close to – its June 2022 average exchange rate against the euro of 24.7194 korunas per euro, which is used as a benchmark for illustrative purposes in the absence of an ERM II central rate (Chart 5.2.3). The maximum upward deviation from this benchmark was 5.9%, whereas the maximum downward deviation amounted to 3.0%. On 19 June 2024 the exchange rate stood at 24.9100 korunas per euro, i.e. the koruna was 0.8% weaker than its average level in June 2022. Over the past ten years the Czech koruna has appreciated by 9.3% against the euro.

The Czech koruna exhibited, on average, a relatively high degree of volatility against the euro over the two‑year reference period. From June 2022 to April 2023 the koruna steadily strengthened against the euro, reflecting action by Česká národní banka, including interventions in foreign exchange markets that ended in October 2022. The koruna began to weaken against the euro in May 2023 and this depreciation continued following the ECB’s monetary policy decisions as well as Česká národní banka’s official announcement in August 2023 that it was ending its foreign exchange interventions. From February 2024 the koruna remained broadly stable before appreciating in May that year to levels close to those at the beginning of the reference period, owing mainly to the release of higher than expected inflation data for April. Short‑term interest rate differentials against the three‑month EURIBOR were high until the middle of 2023. Although declining, they remained sizeable and reached 2.3 percentage points in the three-month period ending in March 2024.

Over the past ten years the Czech koruna has appreciated in HICP-based real effective terms (Chart 5.2.4). Overall, this appreciation in real terms mainly reflected developments in the nominal effective exchange rate. However, the relatively high level of inflation following the sharp rise in energy prices in 2021, which was exacerbated in the wake of Russia’s invasion of Ukraine in February 2022, put upward pressure on the real effective exchange rate. Looking ahead, this indicator should be interpreted with caution, as the Czech Republic has been subject to a process of economic convergence in terms of GDP per capita and price levels over the past few decades, which complicates any long-term assessment of real exchange rate developments.

The combined current and capital account balance has recorded a modest surplus over the past ten years, while the country’s net foreign liabilities have declined (Table 5.2.3). The combined current and capital account deficit increased from 1.1% of GDP in 2021 to 4.2% of GDP in 2022, reflecting both a decline in the trade balance and a reduction in the capital account surplus. In 2023, however, it returned to positive territory, mainly reflecting a notable rebound in the goods balance. At the same time, the primary income deficit shrank significantly, albeit remaining large at 4.3% of GDP. On the financing side, the Czech Republic recorded positive net outflows of portfolio investment and other investment on average from 2019 to 2023. However, these net outflows were offset by net inflows of direct investment. The country’s gross external debt continued to decline, falling from 75.7% in 2019 to 62.9% in 2023. At the same time, the country’s net international investment position improved, rising from -29.1% of GDP on average in the period 2014-18 to -16.56% in the period 2019-23. Fiscal and structural policies continue to be important for supporting external sustainability and the competitiveness of the economy, especially in a more volatile environment characterised by geopolitical and commodity price shocks.

The Czech economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 62.4% of total Czech exports, whereas imports of goods and services from the euro area amounted to 49% of the country’s total imports. In the same year the share of the euro area in the Czech Republic’s stock of inward direct investment stood at 76% and its share in the country’s stock of portfolio investment liabilities was 63.8%. The share of the Czech Republic’s stock of foreign assets invested in the euro area amounted to 65.6% in the case of direct investment and 68.9% for portfolio investment in 2023.

Over the reference period from June 2023 to May 2024, long-term interest rates in the Czech Republic stood at 4.2% on average and were thus below the 4.8% reference value for the interest rate convergence criterion (Chart 5.2.5).

Long-term interest rates in the Czech Republic stood at 4.2% at the end of the reference period, about 180 basis points above the level seen at the start of 2014. In the period 2014-16 long-term interest rates in the Czech Republic declined amid a gradual economic recovery, moderate inflation and Česká národní banka’s highly accommodative monetary policy. In the light of rising inflationary pressures – which reflected global developments and an acceleration of economic growth that led to overheating in the domestic labour market – Česká národní banka began to gradually tighten monetary policy in mid-2017. Against this background, long-term interest rates also increased until late 2018. In 2019 the economic environment changed as signs of weakness in the global economic outlook emerged alongside geopolitical tensions such as the trade dispute between the United States and China and the perceived risks of a disorderly Brexit. The outbreak of the pandemic further fuelled the decline in long-term interest rates, which reached their lowest point in the summer of 2020. Furthermore, Česká národní banka implemented decisive interest rate cuts over the period from March to May 2020 that brought the two-week repo rate – the main policy rate – to its lowest level since August 2017. Between the last quarter of 2020 and October 2022, long-term interest rates increased steadily, owing to rising and persistent inflationary pressures driven by domestic demand, the increase in energy prices, the disruption to global supply chains and the risk that Russia’s invasion of Ukraine would lead to higher and more persistent inflation than previously expected. During this period, Česká národní banka gradually and steadily tightened its monetary policy. Since December 2023 the central bank has cut the two-week repo rate four times, bringing it down from 7.0% in November 2023 to 5.25% in May 2024. Since the end of 2022 the moderation in domestic and global inflationary pressures was an important driver of the decline in long‑term interest rates from 5.5% in October 2022 to 4.2% at the end of the reference period. The credit quality of Czech government debt remained rather favourable. Over the review period, credit default swap spreads for Czech government debt were stable at less than 50 basis points, remaining the lowest among the group of peer countries. The Czech Republic’s government debt is rated high investment grade by all three main rating agencies (Moody’s: Aa3; S&P: AA-; Fitch: AA-).

The Czech Republic’s long-term interest rate differential vis‑à‑vis the euro area average has declined from its historical peak of June 2022. The long-term interest rate differential gradually increased from 2014 to reach a historical high in June 2022 (Chart 5.2.6). This was due to both the continuing decrease in the average long‑term interest rate on euro area sovereign debt and the increase in the long-term interest rate on Czech debt, which was fuelled by a persistent and rising inflation differential between Czech and euro area HICP inflation. Since June 2022, when the interest rate differential stood at its peak of 2.9 percentage points (3.6 percentage points vis-à-vis the euro area AAA yield), an increase in euro area government debt yields has led to a gradual decline of the interest rate differential, which stood at 1.1 percentage points in May 2024 (1.5 percentage points vis-à-vis the euro area AAA yield).

Capital markets in the Czech Republic are smaller and much less developed than those in the euro area (Table 5.2.4). Stock market capitalisation in the Czech Republic stood at 10.4% of GDP in 2023, which is below the average value recorded over the period 2014-23. Outstanding debt securities issued by non‑financial institutions, a measure of market‑based indebtedness, have continued to decrease in recent years and stood at 3.6% of GDP in 2023, after averaging over 7.0% in the period 2014-18. Meanwhile, debt securities issued by financial institutions have increased over the past decade to stand at 16.3% of GDP in 2023, which is higher than the average value observed during the period 2014-18. Financial intermediation, as measured by MFI credit to the non-government sector, remained in line with its average value for the period 2014-18 and stood at 54.2% of GDP in 2023, slightly over half the euro area average. In 2023 the Czech Republic’s banking sector reduced the funding it obtains from euro area banks compared with previous years, with claims of euro area MFIs on resident MFIs standing at 13.1% of total liabilities of domestic MFIs. The development of the Czech Republic’s capital markets in terms of size and intermediation capacity remains limited but is comparable with that of other non‑euro area EU Member States in central and eastern Europe.

In May 2024 the 12‑month average rate of HICP inflation in Hungary was 8.4%, i.e. considerably above the reference value of 3.3% for the criterion on price stability (Chart 5.3.1). This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks.

Over the past ten years the 12‑month average rate of HICP inflation has fluctuated within a very wide range, from ‑0.3% to 22.5%. In 2014 and 2015 the average annual rate of HICP inflation was very subdued, owing to utility price cuts, relatively muted wage growth and limited external price pressures. However, from 2016 it accelerated, to reach 3.4% – within the central bank’s tolerance band – in 2019. This increase mainly reflected robust domestic demand and a tighter labour market that fuelled strong wage growth, as well as changes to indirect taxes, most notably excise duties on tobacco products. These factors were only partially offset by a reduction in social security contributions and VAT rates on some food items and services. In 2020 the authorities took strong fiscal, macroprudential and monetary policy measures to mitigate the economic impact of the COVID-19 pandemic. In particular, the Magyar Nemzeti Bank cut its key policy rate to a historical low of 0.6% and purchased government securities in the secondary market. Inflation remained elevated, albeit within the central bank’s tolerance band, at 3.4% in 2020, but rose to 5.2% in 2021 on account of a strong rebound in activity, rising energy prices and the supply bottlenecks triggered by the pandemic. This led the central bank to start a cycle of interest rate hikes in June that year and to gradually phase out its quantitative easing schemes. In 2022 HICP inflation continued to rise, to reach 15.3% on average, largely owing to soaring energy and commodity prices in the wake of Russia’s invasion of Ukraine in late February, drought-related increases in agricultural prices, significant fiscal loosening in the run-up to the elections, the depreciation of the exchange rate and robust wage growth mainly on the back of administrative wage increases alongside additional salary and pension benefits (Table 5.3.1). As with the other central and eastern European countries under review, Hungary has been particularly vulnerable to recent global shocks, owing mainly to certain structural features of its economy and its exposure to Russia (see Chapter 3). In order to further mitigate the effects of the energy crisis, the government also placed temporary price caps on motor fuels and selected basic food items. As inflation accelerated throughout 2022, the Magyar Nemzeti Bank tightened minimum reserve requirements, introduced new liquidity-absorbing facilities and continued its rate hiking cycle, bringing the central bank base rate to a peak of 13% in September that year. In October, following a rapid depreciation of the exchange rate, the central bank introduced one-day deposit quick tenders on a daily basis at an interest rate of 18.0%, which became its key rate for monetary policy. After peaking in February 2023, inflationary pressures abated gradually as energy prices started to decline. The Magyar Nemzeti Bank responded by steadily reducing its central bank base rate, down to 10.75% by the end of 2023, and reinstating it as its key policy rate. HICP inflation averaged 17.0% in 2023.

In May 2024 the annual rate of HICP inflation reached 3.9%. Continuing on a downward trend that had started in 2023, HICP inflation fell further at the beginning of 2024. This decrease was largely due to lower energy and commodity prices, the past monetary policy tightening, the gradual withdrawal of fiscal support measures and the weakness in private consumption resulting from the erosion of households’ purchasing power. Against this background, the Magyar Nemzeti Bank lowered its key policy rate on five occasions by a total of 350 basis points, down to 7.25%, in the first five months of 2024.

Policy choices have played an important role in shaping inflation dynamics in Hungary over the past decade, most notably the orientation of monetary policy towards price stability. Since 2015 the Magyar Nemzeti Bank has defined its inflation target as an annual rate of consumer price inflation of 3% with an ex ante tolerance band of ±1 percentage point. Under this inflation-targeting framework, the central bank has continuously adjusted its monetary policy toolkit to evolving macroeconomic challenges, which at times have been complicated by economic and fiscal policies. Economic policy measures that have had implications for the transmission of monetary policy include, for example, a cap on bank interest rates and on consumer prices for energy and food, and legal provisions restricting the purchase of debt instruments issued by the central bank and therefore its ability to absorb liquidity.

Inflation is expected to decline gradually in the coming years, but over the longer term there are concerns about the sustainability of inflation convergence in Hungary. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation is projected to decelerate in 2024, to a high level of 4.1%, before falling further to 3.7% in 2025. This outlook is based on the expectation that energy prices will moderate as the economic recovery continues, with unemployment remaining at a historically low level and private consumption returning to being the main driver of growth. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation. Risks to the inflation outlook are tilted to the upside, as tensions in energy markets may continue to exacerbate inflationary pressures, and still loose fiscal policies and unfavourable exchange rate developments may add further to inflation. In addition, labour market conditions remain tight, with unit labour costs having grown by 34.0% over the period from 2020 to 2023 – well above the euro area rate of 9.5% – challenging the competitiveness of the Hungarian economy (Table 3.2). Looking further ahead, unless counteracted by an appreciation of the nominal exchange rate, the catching‑up process is likely to result in positive inflation differentials vis‑à‑vis the euro area, since GDP per capita and price levels are still lower in Hungary than in the euro area. In order to prevent the build‑up of excessive price pressures and macroeconomic imbalances, the catching‑up process must be supported by appropriate policies.

Achieving an environment that is conducive to sustainable convergence in Hungary requires stability‑oriented economic policies and wide‑ranging structural reforms. Further improving the quality of public institutions and ensuring that they are free from undue political interference, implementing adequate product market policies and safeguarding the rule of law, are prerequisites for private sector-led economic growth. Enhanced governance, stronger institutions and a better functioning administration at the national level should, among other things, help to improve the absorption of EU funds. In this respect, it is still of utmost importance that the authorities address the concerns over the rule of law expressed by the European Commission under the general regime of conditionality for the protection of the Union budget, to facilitate the full disbursement of EU funds. With regard to macroeconomic imbalances, the European Commission selected Hungary for an in‑depth review in its Alert Mechanism Report 2024 based on concerns related to significant price and cost pressures, both government and external financing needs, and house price developments.

Financial sector policies should be aimed at safeguarding financial stability – and ultimately the functioning of monetary policy transmission – as well as ensuring that the financial sector makes a sound contribution to sustainable economic growth. Efforts to strengthen banks’ balance sheets over the past years have borne fruit, and the banking sector overall has relatively large capital and liquidity buffers. Banks’ profitability has improved and non-performing loan ratios have declined further. Looking ahead, tighter financial conditions, in combination with previously strong private sector credit growth, may nevertheless pose a number of risks. For example, the decline in households’ real disposable incomes, together with the higher level of interest rates, may dampen demand for new loans and thus weigh on banks’ profitability. At the same time, as house prices continue to rise, the risk of overvaluation in the real estate market, particularly in Hungary’s capital region, alongside declining real incomes of borrowers and higher interest rates, may result in increasing debt servicing difficulties. Interest rate caps and mortgage rate freezes distort borrowers’ incentives, squeeze banks’ profitability further and complicate the transmission of monetary policy. Moreover, lending to corporates in foreign currency may lead to significant currency mismatches and heighten banks’ credit risk. In turn, the deterioration in the quality of loan portfolios could put additional pressure on banks’ profitability, which is also being hampered by the slow improvement in the low cost efficiency of the Hungarian banking sector. Boosting the profitability of the banking sector in the long term will also require consolidation in the sector and more financial deepening. In this respect, it remains important to closely monitor macro-financial developments. In order to bolster confidence in the financial system, the national competent authorities should continue to improve their supervisory practices, among other things, by following the applicable recommendations from the relevant international and European bodies, and by collaborating closely with other national supervisors of EU Member States within the supervisory colleges.

Hungary’s general government budget deficit was significantly above the 3% reference value in 2023 and its debt was above the 60% reference value. In the reference year 2023, the general government budget balance recorded a deficit of 6.7% of GDP, i.e. significantly above the 3% reference value. The general government gross debt-to-GDP ratio was 73.5%, i.e. above the 60% reference value (Table 5.3.2). Compared with the previous year, the deficit ratio increased by 0.5 percentage points of GDP and the debt ratio declined moderately by 0.6 percentage points. With regard to other fiscal factors, the deficit ratio exceeded the ratio of public investment to GDP in 2023 by 1.6 percentage points. The budget deficits in 2022 and 2023 were affected by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

In June 2024, the European Commission found that Hungary did not fulfil the deficit criterion of the Stability and Growth Pact. On 19 June 2024, the European Commission published a report prepared in accordance with Article 126(3) of the Treaty for 12 Member States, including Hungary, which found that Hungary had exceeded the deficit reference value in 2023 and was planning for its deficit in 2024 to be above 3% of GDP. These deficits levels were above, and not close, to the reference value and the excess was not assessed to be either temporary or exceptional. The report’s analysis suggested that Hungary did not fulfil the deficit criterion of the Stability and Growth Pact. Based on the conclusions of its report, the Commission announced its intention to propose to the Council, in July, that a decision be adopted under Article 126(6) establishing the existence of an excessive deficit situation in Hungary. During the period in which the general escape clause under the Stability and Growth Pact applied (due to the pandemic and the invasion of Ukraine by Russia), the European Commission found, in May 2023, May 2022 and June 2021, that the general government deficit-to-GDP ratio in 2022, 2021 and 2020, respectively, had been above and not close to the reference value of 3%. In all three cases, the Commission’s analysis suggested that the deficit criterion had not been fulfilled. Moreover, the European Commission found, in May 2023 and May 2022, that the debt reduction benchmark had not been respected in 2022 and 2021, respectively, and therefore the Commission’s analysis suggested that, in both cases, the debt criterion had not been fulfilled. However, given the high uncertainty surrounding the macroeconomic outlook, the Commission considered that at that juncture a decision on whether to place Member States under the excessive deficit procedure should not be taken. Hungary was once subject to an excessive deficit procedure, which was opened in 2004 based on the deficit in 2003, but which was closed in 2013.

Both cyclical and non-cyclical factors relating to the pandemic contributed to a deterioration in the budget balance over the period 2019-21, which was only partly reversed by 2023. Since 2012 and up until the outbreak of the pandemic, the budget deficit had stood at relatively stable levels of between 1.5% and 3% of GDP, and at 2.0% of GDP in 2019, equating to a structural deficit of 3.9%. As a result of the pandemic, the budget balance declined in 2020 by 5.6 percentage points, to reach a deficit of 7.6% of GDP. This was due to cyclical factors, as well as the deterioration in the structural deficit which rose by 3.2 percentage points between 2019 and 2021, reflecting a sharp increase in expenditure to address the impact of the pandemic. Between 2021 and 2023, the budget deficit decreased by 0.5 percentage points on account of an improving structural balance, whereas cyclical factors contributed negatively. The budget balance in 2023 was 4.7% of GDP higher than in 2019, i.e. the year before the outbreak of the pandemic. This was due to a deterioration in the cyclical component, as well as a 2.1 percentage point higher structural deficit.

The government debt-to-GDP ratio has remained above 60% of GDP since 2005. In the lead-up to the pandemic, the debt ratio followed a downward path, underpinned largely by a favourable interest-growth differential and a primary surplus. Having declined by 11.2 percentage points since 2014, the debt ratio reached a trough of 65.3% of GDP in 2019. It then increased markedly on account of the impact of the pandemic, rising by 14 percentage points to reach 79.3% in 2020. Since then, it has declined by 5.8 percentage points on account of economic growth and high inflation, both of which have counterbalanced the primary deficits and the unfavourable deficit-debt adjustments. The debt ratio in 2023 was 8.2 percentage points higher than in 2019.

The level and structure of government debt indicate that fiscal balances are sensitive to interest rate fluctuations and to exchange rate movements. In 2023, the share of debt with a short-term maturity amounted to 7.4%, with an average residual maturity of 5.9 years. However, the share of debt with variable interest rates increased substantially, from 10.6% of the total debt in 2021 to 21.3% in 2023. Therefore, fiscal balances remain sensitive to interest rates changes. Moreover, Hungary increased its proportion of foreign currency-denominated government debt from 20.5% in 2019 to 29.7% in 2023, which is exclusively denominated in euro. Consequently, fiscal balances remain sensitive to changes in the exchange rate vis-à-vis the euro.

The European Commission’s Spring 2024 Economic Forecast foresees an improvement in the budget balance and a slight increase in the debt ratio. According to the European Commission’s latest forecast under a no policy change assumption, the headline deficit is expected to decrease, reaching a deficit of 5.4% of GDP in 2024 and 4.5% of GDP in 2025, therefore remaining above 3%. The debt ratio is projected to increase slightly to 74.3% of GDP in 2024 and to stand at 73.8% of GDP in 2025, therefore remaining above the 60% reference value.

Despite some progress in reforming the fiscal framework, there is scope for further improvement. The latest changes to the national fiscal rules were made in December 2019 when the Hungarian Parliament adopted amendments aimed at increasing their transparency and enhancing their implementation. According to the debt ratio rule, if the general government debt ratio exceeds 50% of GDP, the Parliament may only adopt an act on the central budget which leads to a reduction in the debt level of at least 0.1% of GDP during normal economic times. In spite of this, Hungary’s national fiscal rules and medium-term budgetary framework are among the weakest according to the EU fiscal governance indicator. Stronger emphasis should still be placed on the multi-annual dimension of the budget process. In particular, the incentives to systematically spend budget reserves before the end of the calendar year should be removed, as they can lower the quality of public spending. Furthermore, neither are there any constraints on possible deviations from medium-term plans nor well-defined corrective actions in place in this respect.

Over the reference period from 20 June 2022 to 19 June 2024, the Hungarian forint did not participate in ERM II, but traded under a flexible exchange rate regime. In the two‑year reference period the Hungarian forint was often significantly weaker than its June 2022 average exchange rate against the euro of 396.66 forints per euro, which is used as a benchmark for illustrative purposes in the absence of an ERM II central rate (Chart 5.3.3). The maximum upward deviation from this benchmark was 7.2%, while the maximum downward deviation amounted to 8.6%. On 19 June 2024 the exchange rate stood at 396.3400 forints per euro, i.e. the forint was trading almost at the same level (0.1%) as its average level in June 2022. The Magyar Nemzeti Bank entered a repo line arrangement with the ECB in June 2020, under which it could borrow up to €4 billion against high-quality euro-denominated collateral to provide euro liquidity to Hungarian financial institutions in order to address possible needs owing to the pandemic. This agreement remained in place over the reference period as it was extended again in January 2024. As this arrangement helped to reduce the potential risk of financial vulnerabilities, it may also have had an impact on exchange rate developments over the reference period. Over the past ten years the exchange rate of the Hungarian forint against the euro has depreciated by 29.6%.

The exchange rate of the Hungarian forint against the euro exhibited, on average, a very high degree of volatility over the reference period. Between June and October 2022 the Hungarian forint continued to weaken – a trend that had started with Russia’s invasion of Ukraine – against the background of rapidly rising energy prices, a deteriorating external balance, ensuing inflationary pressures, the worsening economic outlook, and deteriorating international investor sentiment towards the region. The Magyar Nemzeti Bank responded by continuing the rate-hiking cycle it had started in mid-2021, raising its key policy rate on five occasions, by a total of 710 basis points, to stand at 13% at the end of September 2022. In the last quarter of 2022 the forint recovered some of its losses as energy prices receded somewhat from their record highs, while the Magyar Nemzeti Bank maintained its restrictive monetary policy stance and conducted daily overnight deposit tenders at a rate of 18%, and short-term interest rate differentials against the three-month EURIBOR peaked at 14.5 percentage points. The exchange rate of the forint continued to display a very high degree of volatility throughout most of 2023, reflecting the continued uncertainty in financial markets about the evolution of the energy crisis and regarding macroeconomic vulnerabilities in Hungary. The forint started to stabilise towards the end of 2023 as exchange rate volatility declined. In May that year, the Magyar Nemzeti Bank started to cut interest rates. This led to a decline in short-term interest rate differentials, down to 4.0%, and prompted the Magyar Nemzeti Bank to reinstate its central bank base rate as its key policy rate, which it gradually reduced from 13% in September 2023 to 7.0% at the end of June 2024.

The HICP-based real effective exchange rate of the Hungarian forint has appreciated slightly over the past ten years (Chart 5.3.4). While the real effective exchange rate depreciated between 2014 and 2021, mainly reflecting the depreciation of the nominal exchange rate in effective terms, it began to appreciate sharply from 2022. This was because the very high level of inflation following the sharp rise in energy prices in 2021, which was exacerbated in the wake of Russia’s invasion of Ukraine in February 2022, put upward pressure on the real effective exchange rate. Looking ahead, this indicator should be interpreted with caution, as Hungary is subject to a process of economic convergence, which complicates any long-term assessment of real exchange rate developments.

Over the past ten years Hungary’s combined current and capital account balance has remained in surplus and contributed to a reduction in the country’s net foreign liabilities, which, however, remain high (Table 5.3.3). Between 2014 and 2018 Hungary recorded robust combined current and capital account surpluses, averaging 4.3% of GDP over the period. This reflected both a large trade surplus – which more than offset the deficit on income payments – as well as a sizeable capital account surplus which was due to large transfers from the EU budget. In 2019 and 2020 the combined current and capital account balance narrowed to about 1% of GDP, owing to very robust domestic demand which caused the balance of the current account to turn negative. In 2021 the current account deficit widened further, to 4.1% of GDP, as exports declined more than imports during the pandemic, pushing the combined current and capital account into a deficit of 1.6% of GDP. Primarily as a result of the large increases in energy prices following Russia’s invasion of Ukraine, Hungary’s current account deficit increased further in 2022, to 8.3% of GDP. However, it moved into slightly positive territory in 2023, standing at 0.3% of GDP, as a result of energy prices receding from their peak levels and adjustments in energy consumption and domestic investment and consumption expenditure. Until 2019 Hungary’s current and capital account surplus had been mirrored in net financial outflows. Since 2019 the country’s current account deficit has been financed by net inflows of portfolio and direct investment as well as other investment. Against this background, gross external debt gradually decreased from an average of 119.6% of GDP over the period 2014-18 to stand at 98.9% of GDP in 2019. In 2020 gross external debt increased sharply to 156.6% of GDP, largely owing to transactions by a major special-purpose entity – which also led to an approximately equal increase in the country’s gross external assets – and in 2023 it stood at 129.3% of GDP on account of fast nominal GDP growth in the high inflation environment. As a result, Hungary’s net foreign liabilities declined from an average of above 60% of GDP in the period 2014-18 to around 50% in the period since 2019. The international investment position reached -46.6% of GDP in 2023. The country’s net foreign liabilities remain high. Fiscal and structural policies therefore continue to be important for supporting external sustainability and the competitiveness of the economy, especially in a more volatile environment characterised by geopolitical tensions and commodity price shocks.

The Hungarian economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 58.8% of total exports, while the corresponding figure for imports was marginally lower, at 55.1%. In the same year the share of the euro area in Hungary’s stock of inward direct investment stood at 47.9% and its share in the country’s stock of portfolio investment liabilities was 50.9%. The share of Hungary’s stock of foreign assets invested in the euro area amounted to 38.7% in the case of direct investment and 65.4% for portfolio investment in 2023.

Over the reference period from June 2023 to May 2024, long-term interest rates in Hungary stood at 6.8% on average and were thus above the 4.8% reference value for the interest rate convergence criterion (Chart 5.3.5).

The downward path in long-term interest rates in Hungary observed since 2014 was interrupted after the pandemic. Until 2017 domestic factors, such as the improvement in general macroeconomic conditions amid lower global risk aversion, had contributed to the decline in long‑term interest rates. During this period, monetary policy contributed to an easing of financing conditions and, therefore, to a decline in long‑term rates as the Magyar Nemzeti Bank introduced foreign exchange and long-term interest rate swaps, purchased corporate, mortgage and government bonds, and provided cheap financing for small and medium-sized enterprises through its various Funding for Growth measures. Long-term interest rates in Hungary declined from around 6% in early 2014 to around 2% in December 2017. After increasing temporarily in 2018 owing to the rebound in economic activity and a resurgence of inflationary pressures, long-term interest rates resumed their decline in 2019. This reflected the deterioration in the global economic outlook as well as the decline in global yields that was driven by higher levels of global risk aversion, which favoured global portfolio flows into low-risk assets, including Hungarian fixed income assets. In 2020 long-term interest rates fluctuated around 2%, supported by the quantitative easing measures taken by the Magyar Nemzeti Bank. These sought to improve financing conditions in the economy and, in turn, dampen the high financial market volatility caused by the impact of the pandemic and ensure the proper functioning of the monetary policy transmission mechanism. In addition, to counter the negative impact of the pandemic on the economic outlook, the central bank reduced its main policy rate from 0.9% to 0.6% in July 2020. From mid-2021 – following a robust recovery of the economy and, more recently, the acceleration in inflation dynamics, which was also related to Russia’s invasion of Ukraine in February 2022 – the Magyar Nemzeti Bank tightened monetary policy by increasing the policy rate and scaling back its quantitative easing measures. Domestic and global disinflationary pressures from September 2023 led the Magyar Nemzeti Bank to start cutting the key policy rate in October 2023. It stood at 7.0% in June 2024. Long-term interest rates in Hungary peaked at 10% in October 2022 before falling to 6.8% in May 2024. Ten-year credit default swap spreads on Hungarian government debt have increased significantly over the past two years but, after hitting 300 basis points in November 2022, they declined to less than170 basis points in May 2024, 15 basis points higher than their level in May 2022. Hungary’s government debt is rated investment grade by all three main rating agencies (Moody’s: Baa2; S&P: BBB; Fitch: BBB).

Hungary’s long-term interest rate differential vis-à-vis the euro area declined recently after a long period of stabilisation (Chart 5.3.6). Hungary’s long-term interest rate differential declined from around 3 percentage points in 2014 to around 2 percentage points in 2015, where it stayed for the following five years. From May 2020 the long-term interest rate differential increased steadily, initially owing to the relatively sharper decline in euro area interest rates and then, from 2021, to the positive and increasing inflation differential and the relatively larger increase in policy rates in Hungary. Over the period from May 2022 to May 2024 the long-term interest rate differential declined from 5.5 percentage points to 3.7 percentage points, having peaked at more than 7.0 percentage points in October 2022.

Capital markets in Hungary are smaller and much less developed than those in the euro area (Table 5.3.4). Stock market capitalisation, which stood at 17.6% of GDP in 2023, was slightly higher than the annual average during the period 2014-23. In 2023 outstanding debt securities issued by non‑financial corporations remained at low levels, standing at 4.7% of GDP, but were higher than the ten-year average of 2.8% over the period 2014-23. Debt securities issued by financial institutions in 2023 amounted to 12.7% of GDP, which is considerably above the average value recorded over the period 2014-23. Hungarian banks’ borrowing from euro area banks – a measure of banking system integration – increased significantly in 2023, with claims by euro area banks on Hungarian banks standing at 7.3% of GDP, compared with 4.9% over the period 2014-23. The degree of financial intermediation is lower than the euro area average and is among the lowest in the region. MFI credit to non‑government residents stood at 35.1% of GDP in 2023, slightly below the average level recorded over the period 2014-23.

In May 2024 the 12‑month average rate of HICP inflation in Poland was 6.1%, i.e. well above the reference value of 3.3% for the criterion on price stability (Chart 5.4.1). This rate is expected to decrease gradually over the coming months, driven by the past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks.

Over the past ten years the 12‑month average rate of HICP inflation has fluctuated within a very wide range, from ‑0.7% to 15.2%. HICP inflation was notably subdued in 2014 and 2015, reflecting the weakening of domestic economic activity in the preceding years and the significant fall in global commodity prices. In response to the decline in inflation, Narodowy Bank Polski cut its main policy rate to 1.5% in March 2015. From mid-2016 HICP inflation rose gradually on the back of relatively robust economic activity. In line with forecasts of an economic slowdown and a faster than anticipated fall in inflation in 2020 as a result of the COVID-19 pandemic, from mid-March that year Narodowy Bank Polski lowered its main policy rate on several occasions, bringing it down to a historical low of 0.1% in May. In 2021 inflation rose sharply, to 5.2%, on account of surging energy prices, supply bottlenecks triggered by the pandemic, and strong increases in global demand for goods amid a robust rebound in economic activity. Russia’s invasion of Ukraine in late February 2022 exacerbated the increase in global commodity prices and supply bottlenecks, which led to a strong acceleration of HICP inflation to 13.2% that year (Table 5.4.1). As with the other central and eastern European countries under review, Poland has been particularly vulnerable to recent global shocks, owing mainly to certain structural features of its economy and its exposure to Russia (see Chapter 3). To counteract the risk of inflation expectations becoming unanchored from the target, Narodowy Bank Polski implemented a number of decisive policy rate hikes in 2021 and 2022, up to 6.75%. The government also introduced discretionary fiscal support measures, predominantly in 2022 and 2023, to alleviate the high inflation burden on the economy. These measures were mainly in the form of caps on electricity and gas prices and reductions in indirect taxes. After peaking at 17.2% in February 2023, HICP inflation started to decrease notably, owing to the fall in food and energy prices, weaker domestic demand resulting, in part, from earlier monetary policy tightening, subdued economic activity abroad and an appreciation of the Polish zloty. In this context, Narodowy Bank Polski decided to cut its main policy rate in September and October, bringing it down to 5.75%.

In May 2024 the annual rate of HICP inflation reached 2.8%. The strong decline in headline inflation in 2023 moderated in early 2024. This can be attributed to the fading impact of the unwinding of the sharp increases in energy prices a year before and the return of the VAT rate on staple food products to 5% from April 2024. At the same time, inflation excluding food and energy has remained higher than headline HICP inflation amid robust wage growth, labour market bottlenecks and a gradual improvement in economic activity.

Policy choices have played an important role in anchoring inflation expectations in Poland over the past decade, most notably the orientation of monetary policy towards price stability. Narodowy Bank Polski operates a floating exchange rate system and has had an inflation-targeting monetary policy framework in place since 1998. The medium-term consumer price inflation target has been 2.5% (±1 percentage point) since 2004. Despite the high level of inflation recorded since 2021, inflation expectations have remained broadly consistent with the inflation target range over the medium term, supported by the past monetary policy tightening, greater labour market flexibility and increased product market competition, as well as the discretionary fiscal measures implemented in 2022 and 2023 to help to contain inflationary pressures.

While remaining elevated, inflation is projected to decline in 2024-25, but over the longer term there are concerns about the sustainability of inflation convergence in Poland. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation is projected to fall from 10.9% in 2023 to 4.3% in 2024 and 4.2% in 2025. The removal of the measures to contain price pressures could have a significant temporary upward impact on inflation, particularly from mid-2024. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation. Risks to the inflation outlook are tilted to the upside, as renewed global supply bottlenecks could push up prices further in certain product segments, and tensions in energy markets may continue to exacerbate inflationary pressures. In addition, labour market conditions remain tight, with unit labour costs having grown by 22.0% over the period from 2020 to 2023 – well above the euro area rate of 9.5% – challenging the competitiveness of the Polish economy (Table 3.2). Looking further ahead, the catching-up process is likely to result in positive inflation differentials vis-à-vis the euro area, given that GDP per capita and price levels are still lower in Poland than in the euro area, unless this is counteracted by an appreciation of the nominal exchange rate. In order to prevent the build-up of excessive price pressures and macroeconomic imbalances, the catching-up process must be supported by appropriate policies.

Achieving an environment that is conducive to sustainable convergence in Poland requires stability‑oriented economic policies and targeted structural reforms. Although the Polish economy managed to weather the global energy price shock and the decline in global activity comparatively well, a number of structural issues still need to be addressed. It is important that fiscal and structural policies continue to support external sustainability, enhance competitiveness and ensure investor confidence. In order to foster potential growth and resource allocation, efforts are required to boost competition in product markets, and to speed up innovation and infrastructure modernisation. In the labour market, in view of the ageing population, it is essential to increase the labour force participation rate by removing disincentives to work and by pursuing policies to support a better integration of refugees. In the medium term, there is a pressing need for Poland to reduce both its reliance on fossil fuel energy production and its greenhouse gas emissions. Against this background, it will be important to ensure an efficient and effective absorption of the EU funds allocated to the country. With regard to macroeconomic imbalances, the European Commission did not select Poland for an in-depth review in its Alert Mechanism Report 2024.

Financial sector policies should be aimed at safeguarding financial stability and ensuring that the financial sector makes a sound contribution to economic growth. The banking sector remains resilient and banks’ capital positions have improved. Growth in lending to the non-financial sector began to recover in late 2023, partly as a result of the government’s new mortgage subsidy scheme, but could remain relatively subdued in the coming years, owing largely to factors affecting demand. However, long-term loans to non-financial corporations are expected to pick up, among other things, to co-finance investment projects under Poland’s Recovery and Resilience Plan. Credit risk remains at a moderate level owing to the favourable labour market situation and to banks’ still relatively solid capacity to service their liabilities, as well as to their prudential lending policies. Legal risks associated with banks’ exposure to foreign exchange-denominated mortgage loans remain the main challenge facing the banking sector. Banks have actively managed this risk by offering settlements to their customers and by creating loan loss provisions, although the associated costs are squeezing their profitability. In this respect, regulatory changes and any related uncertainty may impair the stability of banking activity and adversely affect long-term business decisions. Untargeted mortgage credit holidays could undermine incentives to service debt and weaken the banking system’s ability to provide credit. In order to further strengthen the financial system, the national competent authorities should continue to improve their supervisory practices, among other things, by following the applicable recommendations from the relevant international and European bodies, and by collaborating closely with other national supervisors of EU Member States within the supervisory colleges.

Poland’s general government budget balance was well above the 3% deficit reference value in 2023, while its government debt remained below the 60% reference threshold. In the reference year 2023, the general government budget balance recorded a deficit of 5.1% of GDP, well above the 3% reference value. The general government gross debt-to-GDP ratio stood at 49.6%, therefore remaining below the 60% reference value (Table 5.4.2). Compared with the previous year, the deficit saw an increase of 1.7 percentage points of GDP, with a slight rise of 0.4 percentage points in the debt ratio. The budget deficits in 2022 and 2023 were significantly influenced by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

The European Commission found, in June 2024, that Poland did not fulfil the deficit criterion of the Stability and Growth Pact. On 19 June 2024, the European Commission published a report prepared in accordance with Article 126(3) of the Treaty for 12 Member States, including Poland, which found that Poland had exceeded the deficit reference value in 2023 and was planning for its deficit in 2024 to be above 3% of GDP. These deficits were above, and not close to, the reference value and the excess was not assessed to be either temporary or exceptional. Overall, taking into account relevant factors, as appropriate, the report’s analysis suggested that Poland did not fulfil the deficit criterion of the Stability and Growth Pact. Based on the conclusions of its report, the Commission announced its intention to propose to the Council, in July, that a decision be adopted under Article 126(6) establishing the existence of an excessive deficit situation in Poland. During the period in which the general escape clause under the Stability and Growth Pact applied (due to the pandemic and the invasion of Ukraine by Russia), the European Commission found, in June 2021 and May 2023, that the general government deficit-to-GDP ratio in 2020 and 2022, respectively, had been above and not close to the reference value of 3%. Moreover, in May 2022, the Commission found that the planned deficit in 2022 was also above and not close to 3% of GDP. In all three cases, the Commission’s analysis suggested that the deficit criterion had not been fulfilled. However, given the high uncertainty surrounding the macroeconomic outlook, the Commission considered that at that juncture a decision on whether to place Member States under the excessive deficit procedure should not be taken. From 2009 Poland had been subject to an excessive deficit procedure, which was subsequently abrogated by the ECOFIN Council in June 2015, one year earlier than the extended deadline, on account of a systemic pension reform. In the subsequent period to 2019, there were some deviations from the requirements of the preventive arm of the Stability and Growth Pact, particularly in respect of the recommended adjustment path towards the country’s medium-term objective.

The budget balance deteriorated significantly over the period 2021-23, with the deficit standing at much higher levels than those prior to the pandemic. Poland’s budget balance had shown a marked improvement prior to the pandemic, with a low deficit of 0.7% of GDP in 2019, which was 3 percentage points lower than in 2014. However, during the pandemic in 2020, the deficit ratio surged by 6.2 percentage points, driven by cyclical factors and fiscal measures to protect the economy. Once the pandemic-related support had been phased out and the economy had begun to recover, the deficit improved significantly, dropping to 1.8% of GDP by 2021. This improvement was short-lived, as the deficit rose again to 3.4% of GDP by 2022, mainly due to measures to address the energy crisis. In 2023 the deficit further deteriorated by 1.7 percentage points, which was attributable to cyclical factors, the impact of inflation indexation, a rise in interest payments and new spending initiatives, including for defence. The budget balance in 2023 was 4.4 percentage points of GDP lower than in 2019, i.e. the year before the outbreak of the pandemic.

Aside from the peak during the pandemic in 2020, the debt-to-GDP ratio has remained relatively stable over the past decade, fluctuating around 50%. Prior to the pandemic, the ratio had been on a downward trajectory, falling from 54.5% in 2016 to 45.7% in 2019, thanks to a very favourable interest-growth differential and modest primary surpluses. The pandemic subsequently led to an increasing primary deficit and negative growth, along with a significant deficit-debt adjustment (5.5% of GDP), resulting in an 11.5 percentage point increase in the debt ratio in 2020, which was above its historical average. Since then, it declined up to 2023 by 7.6 percentage points, reaching 49.6% in 2023, largely on the back of strong nominal GDP growth. While the debt ratio in 2023 was only slightly above its average level, it remained 3.9 percentage points above the 2019 level.

The composition of Poland’s government debt makes it vulnerable to fluctuations in interest rate and exchange rate developments. Since 2023, 23.7% of the government debt has been tied to variable interest rates, while short-term debt has constituted a mere 1.6% of the total debt (Table 5.4.2). Considering these factors, along with the debt-to-GDP ratio, the budget balance is sensitive to shifts in interest rates. Furthermore, a relatively high share of the debt, 24.4%, is denominated in foreign currencies, predominantly in euro, while 66.4% of the debt is held domestically. Given these factors, as well as the debt-to-GDP ratio, Poland’s budget balance is also sensitive to changes in exchange rates.

The European Commission’s Spring 2024 Economic Forecast anticipates a continuation of the high deficits and a notable increase in the debt ratio. The forecast predicts the general government deficit to reach 5.4% and 4.6% of GDP in 2024 and 2025, respectively, which significantly exceeds the 3% reference value. This development is largely structural, with the structural deficit also remaining excessively high and amounting to 4.3% of GDP in 2025. This sizeable deficit reflects persisting high spending pressures, most notably in areas of public wages, social transfers and defence investments. The government debt ratio is projected to increase during this period, yet to remain below the 60% reference value, reaching 53.7% and 57.7% in 2024 and 2025 respectively. One significant factor which contributes towards the divergence between the budget balance and the debt ratio developments has been attributed to substantial stock-flow adjustments, primarily on account of the timing of payments and deliveries of military-related investments.

The Polish fiscal framework is strong overall, but its effectiveness could be enhanced. The constitutional debt limit of 60% of GDP acts as a constraint against the accumulation of excessive debt and, therefore, helps ensure fiscal sustainability. Medium-term budgetary planning is based on the Multiannual State Financial Plan, as well as a permanent expenditure rule established in 2015. This rule limits spending growth in accordance with predefined debt thresholds. However, recent developments have seen several new expenditure categories being funded through extra-budgetary funds which do not fall under this spending rule. Thus far, Poland is the only EU country that does not have an independent fiscal council, a situation which is at odds with the provisions of the fiscal compact. This is expected to change based on intentions expressed by its government.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Polish zloty did not participate in ERM II, but traded under a flexible exchange rate regime. Over the reference period the Polish zloty often traded close to its June 2022 average exchange rate against the euro of 4.6471 zlotys per euro, which is used as a benchmark for illustrative purposes in the absence of an ERM II central rate (Chart 5.4.3). The maximum upward deviation from this benchmark was 8.6%, while the maximum downward deviation amounted to 4.8%. On 19 June 2024 the exchange rate stood at 4.3300 zlotys per euro, i.e. the zloty was 6.8% stronger than its average level in June 2022. Between March 2022 and mid-January 2024 Narodowy Bank Polski had a swap line arrangement with the ECB, under which it could borrow up to €10 billion against zlotys in order to address potential euro liquidity needs in the Polish financial system. As this arrangement helped to reduce the potential risk of financial vulnerabilities, it may also have had an impact on exchange rate developments over the reference period. Over the past ten years the exchange rate of the Polish zloty against the euro has depreciated by 4.7%.

The exchange rate of the Polish zloty against the euro exhibited, on average, a relatively high degree of volatility over the reference period. From June 2022 to March 2023 the Polish zloty fluctuated mostly within a narrow range of between 4.7 zlotys and 4.8 zlotys per euro. However, since the beginning of April 2023 the zloty has appreciated somewhat against the euro. Overall, exchange rate volatility tended to increase in autumn 2023, likely reflecting changes in Narodowy Bank Polski’s monetary policy rates in September and October 2023. The exchange rate has stabilised since the beginning of 2024 at around 4.3 zlotys per euro. There was a notable decline in short‑term interest rate differentials against the three‑month EURIBOR, which gradually decreased from around 6.6 percentage points in mid-2022 to around 1.9 percentage points at the end of 2023. They have remained largely stable since then. Changes in these differentials largely reflected the increases in the key ECB interest rates between July 2022 and September 2023.

The HICP-based real effective exchange rate of the Polish zloty has appreciated somewhat over the past ten years (Chart 5.4.4). The real effective exchange rate weakened until 2016 and then remained broadly stable before recording a strong appreciation from early 2022. Relatively high inflation following the sharp rise in energy prices in 2021, which was exacerbated in the wake of Russia’s invasion of Ukraine in February 2022, put upward pressure on the real effective exchange rate. Looking ahead, this indicator should be interpreted with caution, as Poland is subject to a process of economic convergence, which complicates any long-term assessment of real exchange rate developments.

Poland’s combined current and capital account balance has increased over the past ten years and the country’s net foreign liabilities have tended to decline (Table 5.4.3). After standing virtually in balance on average over the period 2014-18, the combined current and capital account subsequently recorded an increasing surplus which reached a peak in 2020 of slightly above 4% of GDP. It then declined to a deficit of close to 2% of GDP in 2022, largely owing to a reduction in the goods trade balance. However, in 2023 a higher goods balance led to an improvement in the combined current and capital account, which turned into a surplus of 1.8% of GDP. On the financing side, Poland has received net inflows in direct investment over the past ten years, which have tended to increase. Gross external debt increased until 2016, but has steadily declined since then and reached 49.3% of GDP in 2023. Over this ten-year period Poland’s negative net international investment position has also declined gradually, from close to 70% of GDP in 2014 to 31.4% of GDP in 2023. Net foreign liabilities mostly consist of net direct investment. Fiscal and structural policies continue to be important for supporting external sustainability, maintaining Poland’s attractiveness as a target for foreign direct investment and enhancing the competitiveness of the economy, especially in a more volatile environment characterised by geopolitical and commodity price shocks.

The Polish economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 57.2% of total exports, while the corresponding figure for imports was slightly lower at 55.8%. In the same year the share of the euro area in Poland’s stock of inward direct investment stood at 76.7%, and its share in the country’s stock of portfolio investment liabilities was 46.4%. The share of Poland’s stock of foreign assets invested in the euro area amounted to 56.1% in the case of direct investment and 48.4% for portfolio investment.

Over the reference period from June 2023 to May 2024, long-term interest rates in Poland stood at 5.6% on average and were thus above the reference value of 4.8% for the interest rate convergence criterion (Chart 5.4.5).

Overall, long-term interest rates in Poland have increased since 2014, when they averaged around 3.5%. Over the period 2014-20 long‑term interest rates on sovereign bonds fluctuated between 2% and 4% amid a gradual tightening of the fiscal stance by the Polish Government and the diminishing impact of the global and euro area financial crises. From the end of 2014 long-term interest rates in Poland increased for two years as the positive economic cycle led to higher growth and inflation. After peaking at around 4% at the start of 2017, long-term interest rates initially declined only moderately, reflecting falling inflation amid still resilient real economic growth as well as fiscal tightening. The decline accelerated in 2019, with long-term rates being mostly influenced by global trends. They reached around 2% at the beginning of 2020, despite quite robust domestic growth and increasing inflation. In 2020 long-term interest rates declined further and stabilised at historical lows of slightly above 1% in the context of a swift easing of monetary policy. In response to the outbreak of the pandemic, Narodowy Bank Polski cut the monetary policy reference rate to 0.1% in May 2020 and launched quantitative easing measures. The measures were aimed at changing the long-term liquidity structure of the banking sector, ensuring the liquidity of the secondary markets for government securities and government-guaranteed debt securities and enhancing the impact of the Narodowy Bank Polski’s interest rate cuts on the economy (i.e. strengthening the functioning of the monetary policy transmission mechanism). Between 2021 and late 2022, long-term interest rates increased, gradually at first and then more decisively from October 2021, owing mostly to the economic recovery, the rise in inflation, the significant upside risks to inflation and the downside risks to the fiscal position posed by Russia’s invasion of Ukraine. Narodowy Bank Polski responded to rising inflationary pressures by decisively raising policy rates until September 2022. It subsequently cut policy rates in September and October 2023 as incoming data suggested that the inflation outlook had improved substantially amid weaker than expected growth. As a result, the reference interest rate stood at 5.75% at the end of the review period. Long-term interest rates also increased significantly during the review period, reaching 5.7% in May 2024 after peaking at about 8.0% in October 2022. After increasing significantly at the beginning of the review period, credit default swap spreads declined to around 100 basis points by May 2024, around the same level as in May 2022. The spreads thus remain low by historical standards and among the lowest in the group of peer countries in the region, suggesting a benign market perception of sovereign credit risk. Poland’s government debt is currently rated investment grade by all three main rating agencies (Moody’s: A2; S&P: A‑; Fitch: A‑).

Poland’s long-term interest rate differential vis-à-vis the euro area declined significantly during the review period, reaching 2.6 percentage points in May 2024 (Chart 5.4.6). This figure is in line with the long-term average differential over the period 2014-21, which fluctuated between around 1 and 2 percentage points, driven by the dynamism of economic activity and inflationary pressures. Owing to the sharp acceleration in inflation in Poland since the summer of 2021, the interest rate differential widened and reached its historical peak of 4.8 percentage points in May 2022 (up from 1.1 percentage points in April 2020). In May 2024, the end of the review period, the interest rate differential vis-à-vis the euro area AAA yield stood at 3.0 percentage points.

Capital markets in Poland are smaller and much less developed than those in the euro area (Table 5.4.4). The markets for financial and non‑financial corporate debt were still much smaller than the respective markets in the euro area at the end of 2023. Debt securities issued by financial and non-financial corporations stood at 10.0% and 2.0% of GDP respectively. In 2023 stock market capitalisation was 22% of GDP, lower than the annual average over the period 2014-23 but still one of the highest levels among peer countries. Euro area banks’ provision of funds to the Polish banking system is quite limited. The claims of euro area MFIs on Polish banks accounted for 3.8% of Polish banks’ liabilities at the end of 2022.The degree of financial intermediation in Poland, as measured by credit extended by MFIs to the private sector, is in line with that of peer countries in the region, amounting to 40.3% of GDP in 2023 (compared with 99.6% in the euro area). Foreign ownership of banks in Poland, while remaining elevated, has declined markedly in recent years on the back of government initiatives. At the end of 2023 the share of foreign banks in total Polish banking sector assets stood at around 40%.

In May 2024 the 12‑month average rate of HICP inflation in Romania was 7.6%, i.e. considerably above the reference value of 3.3% for the criterion on price stability (Chart 5.5.1). This rate is expected to decrease gradually over the coming months, driven by past monetary policy tightening and the ongoing easing of pipeline pressures and supply bottlenecks.

Over the past ten years the 12‑month average rate of HICP inflation has fluctuated within a very wide range, from ‑1.7% to 13.2%. Starting from a moderate level, HICP inflation slipped into negative territory in June 2015 owing to a series of tax cuts. It remained negative throughout 2016, before turning positive again at the beginning of 2017, partly on account of favourable base effects. In 2018 it continued on an upward trend on the back of strong fiscal stimulus and increases in minimum wages, averaging 4.1% over the year and remaining around that level also in 2019 (Table 5.5.1). HICP inflation then fell significantly in 2020, reflecting the downturn in economic activity as a result of the COVID-19 pandemic. Supply-side shocks, particularly in relation to prices for electricity, natural gas and fuel, and then food price increases, contributed to inflation rising considerably during the second half of 2021 and exceeding the upper bound of the variation band around the target . In response, Banca Naţională a României started a monetary policy tightening cycle in October 2021. Inflation accelerated further following Russia’s invasion of Ukraine in late February 2022, peaking at 14.6% in November that year. This increase was largely due to higher food and energy prices, together with severe bottlenecks in global supply chains. As with the other central and eastern European countries under review, Romania has been particularly vulnerable to recent global shocks, owing mainly to certain structural features of its economy (see Chapter 3). Since the end of 2022 HICP inflation has been falling, down from 12% on average that year to 9.7% in 2023. This decrease was driven by the ongoing easing of pipeline pressures and supply bottlenecks, the monetary policy tightening and government measures to mitigate the impact of the energy price rises (mainly in the form of transfers to households and firms). This notwithstanding, HICP inflation remained at elevated levels owing to domestic price pressures stemming from wage and pension increases. Between October 2021 and January 2023 Banca Naţională a României raised its policy rate on 11 occasions, from 1.25% up to the current level of 7%.

In May 2024 the annual rate of HICP inflation reached 5.8%. After rising in January on the back of hikes in indirect taxes, HICP inflation decreased gradually over the following months, owing to declining food prices alongside falling electricity and natural gas prices in April after the government changed its energy price-related measures. At the same time, core inflation remained sticky, reflecting strong wage developments in the context of a tight labour market and minimum wage increases, as well as higher short-term inflation expectations. Banca Naţională a României has kept its main policy rates unchanged since January 2023 in an attempt to durably reduce inflation.

The orientation of monetary policy towards price stability has played an important role in shaping inflation dynamics in Romania over the past decade. In 2005 Banca Naţională a României shifted to an inflation‑targeting framework combined with a managed floating exchange rate regime. In 2005 the annual CPI inflation target was set at 7.5% and was reduced gradually until 2012. In 2013 the central bank adopted a flat target of 2.5%, with a variation band of ±1 percentage point. Despite the significant increases in monetary policy rates from October 2021 in order to bring inflation back to the target, the prolonged period of loose fiscal policy (see Section 5.5.2) has continued to fuel inflationary pressures, especially since 2022.

While remaining elevated, inflation is expected to continue on a downward trend over the forecast horizon, but over the longer term there are concerns about the sustainability of inflation convergence in Romania. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation is expected to decrease to 5.9% in 2024 and 4.0% in 2025. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation, as renewed global supply bottlenecks and tensions in energy markets could push up inflation further. Risks to the inflation outlook are tilted to the upside, owing mainly to fiscal policy, as well as labour market conditions and wage dynamics. Labour shortages and related wage pressures are expected to persist in the medium term. Looking further ahead, there are concerns about the sustainability of inflation convergence in Romania over the longer term, also taking into account the marked increase in unit labour costs. Unit labour costs grew by 26.7% over the period from 2020 to 2023 – well above the euro area rate of 9.5% – challenging the competitiveness of the Romanian economy, as this differential was not offset by nominal exchange rate developments (Table 3.2). The catching‑up process is also likely to result in positive inflation differentials vis‑à‑vis the euro area, given that GDP per capita and price levels are still lower in Romania than in the euro area, unless this is counteracted by an appreciation of the domestic currency against the euro. In order to prevent the build‑up of excessive price pressures and reduce macroeconomic imbalances, the catching‑up process must be supported by appropriate policies. In particular, wage growth needs to be consistent with productivity growth, among other things in order to safeguard price competitiveness and the attractiveness of Romania to foreign investors.

Achieving an environment that is conducive to sustainable convergence in Romania requires stability‑oriented economic policies and wide‑ranging structural reforms. With regard to macroeconomic imbalances, the European Commission selected Romania for an in‑depth review in its Alert Mechanism Report 2024, highlighting significant concerns related to cost competitiveness, external sustainability and the government deficit. The relative inefficiency of the country’s institutions and governance, as well as its weak business environment, continue to hamper its growth potential in an environment of low productivity. As headwinds related to Romania’s demographic profile and labour market (i.e. its ageing population coupled with high migration outflows) are likely to persist, Romania’s current growth strategy, based on extensive labour utilisation, should be complemented by a growth model that is more focused on fostering innovation, as well as knowledge-based and high-value-added industries (e.g. ICT). Continued reform efforts aimed at fighting corruption, improving competition and enhancing the predictability of the country’s tax, judicial, regulatory and administrative systems are needed, as they would also boost the country’s attractiveness to foreign creditors by increasing trust in domestic institutions. Measures should include upgrading skill levels by improving access to education for the minorities and the under-represented, strengthening the insolvency regime and combating regional disparities in living standards to spur a more inclusive growth. Finally, an efficient and effective absorption of EU funds remains key to fostering economic convergence in the medium term and to guiding the economy in the upcoming green and digital transition.

Financial sector policies should be aimed at safeguarding financial stability and ensuring that the financial sector makes a sound contribution to economic growth. After several profitable years, there appears to be limited vulnerabilities in the banking sector, with banks having built up relatively large capital and liquidity buffers, and non-performing loan ratios having come closer to EU levels. The rise in foreign currency lending to non-financial corporations since 2022 warrants close monitoring. To further strengthen the resilience of the financial system in the light of the high global uncertainty, the Romanian authorities decided to increase the countercyclical capital buffer from 0.5% to 1% from October 2023. In order to bolster confidence in the financial system, the national competent authorities should continue to improve their supervisory practices, among other things, by following the applicable recommendations from the relevant international and European bodies, and by collaborating closely with other national supervisors of EU Member States within the supervisory colleges.

Romania’s general government budget deficit was significantly above the 3% reference value in 2023, while its debt level was below the 60% reference value. In the reference year 2023, the general government budget balance recorded a deficit of 6.6% of GDP, i.e. significantly above the 3% reference value. The general government debt ratio was 48.8% of GDP, i.e. below the 60% reference value (Table 5.5.2). Compared with the previous year, the general government deficit increased by 0.3 percentage points of GDP and the debt ratio increased moderately by 1.3 percentage points of GDP. With regard to other fiscal factors, the deficit ratio exceeded the ratio of public investment to GDP in 2023. The budget deficits in 2022 and 2023 were affected by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

Over the reference period from 20 June 2022 to 19 June 2024, the Romanian leu did not participate in ERM II, but traded under a flexible exchange rate regime involving a managed float of the currency’s exchange rate. Over the two‑year reference period the Romanian leu mostly traded close to its June 2022 average exchange rate against the euro of 4.9444 lei per euro, which is used as a benchmark for illustrative purposes in the absence of an ERM II central rate (Chart 5.5.3). The maximum upward deviation from this benchmark was 2.5%, while the maximum downward deviation amounted to 0.7%. On 19 June 2024 the exchange rate stood at 4.9768 lei per euro, i.e. the leu was 0.7% weaker than its average level in June 2022. Between June 2020 and mid-January 2024 Banca Naţională a României had a repo line arrangement with the ECB, under which it could borrow up to €4.5 billion against high-quality euro-denominated collateral to provide euro liquidity to Romanian financial institutions in order to address possible liquidity needs. As this arrangement helped to reduce the potential risk of financial vulnerabilities, it may also have had an impact on exchange rate developments over the reference period. Over the past ten years the Romanian leu has depreciated against the euro by 13.3%.

The exchange rate of the Romanian leu against the euro exhibited, on average, a low degree of volatility over the reference period. From mid-2022 exchange rate volatility increased somewhat, with the leu seeing several episodes of slight appreciation against the euro followed by more pronounced depreciations. This was against the background of the greater relative attractiveness of investments in domestic currency and the downward correction of the current account deficit in 2023, as well as fluctuations in global risk appetite. Throughout the reference period the Romanian leu continued its steady trend depreciation, given the risks stemming from the fiscal position and external imbalance. Since September 2023 the exchange rate has fluctuated between 4.96 lei and 4.98 lei per euro. Over the reference period short‑term interest rate differentials against the three‑month EURIBOR were wide. After reaching a peak of 7.1 percentage points in the three‑month period ending in September 2022, the interest rate differential came down again and stood at 2 percentage points in the three‑month period ending in March 2024. The recent narrowing of short-term interest rate differentials largely reflects a moderation in the pace of monetary policy tightening by Banca Naţională a României, as well as the increases in the key ECB interest rates which started in July 2022.

The Romanian leu has appreciated over the past ten years in HICP-based real effective terms (Chart 5.5.4). Overall, this appreciation mainly reflected developments in relative prices. The relatively high level of inflation following the sharp rise in energy prices in 2021, which was exacerbated in the wake of Russia’s invasion of Ukraine in February 2022, put additional upward pressure on the real effective exchange rate. Looking ahead, this indicator should be interpreted with caution, as Romania is subject to a process of economic convergence, which complicates any long-term assessment of real exchange rate developments.

Romania’s current and capital account balance has weakened over the past ten years, while the country’s net foreign liabilities have declined gradually but remain high (Table 5.5.3). Following three consecutive EU and IMF financial assistance programmes ending in 2015, the combined current and capital account balance strengthened until 2016, before deteriorating notably in subsequent years. This deterioration reflected a growing trade deficit on the back of a worsening merchandise goods balance in conjunction with a flattening services surplus, as Romania’s export performance weakened and strong domestic demand fuelled import growth. This trend continued after the pandemic, which further worsened the trade balance owing to the emergence of global supply chain disruptions. In 2023 the current account deficit declined as domestic demand growth slowed, import prices of energy declined and services exports continued their upward trend. On the financing side, from 2014 to 2018 net inflows in direct and portfolio investment were more than offset by net outflows in other investment, and gross external debt declined simultaneously. Portfolio investment inflows in the form of debt securities subsequently gained in importance. Given the Romanian government’s fiscal support measures (financed in part by the issuance of international bonds) and the contraction of the country’s economy induced by the pandemic, the gross external debt ratio increased to 57.9% in 2020. After declining over the following two years on the back of high nominal GDP growth, it edged up again to 52.7% in 2023. While the country’s net international investment position has improved steadily over the past ten years, net foreign liabilities remained relatively high at -39.8% in 2023. Hence, fiscal and structural policies continue to be important for supporting external sustainability, maintaining Romania’s attractiveness to foreign direct investors and enhancing the competitiveness of the economy, especially in a more volatile environment characterised by geopolitical and commodity price shocks.

The Romanian economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 55.5% of total exports, while the corresponding figure for imports amounted to 54.4%. In the same year the share of the euro area in Romania’s stock of inward direct investment stood at 79.6% and its share in the country’s stock of portfolio investment liabilities was 53.4%. The share of Romania’s stock of foreign assets invested in the euro area amounted to 66.1% in the case of direct investment and 70.6% for portfolio investment in 2023.

Over the reference period from June 2023 to May 2024, long-term interest rates in Romania stood at 6.4% on average, above the 4.8% reference value for the interest rate convergence criterion (Chart 5.5.5).

Long-term interest rates in Romania stood at 6.3% in May 2024, having reached more than 9% in October 2022, the highest level during the review period. In 2014 and early 2015 long-term interest rates in Romania declined steadily from more than 5% to a historical low of 2.8% in February 2015. This was driven by both domestic factors, such as a decrease in inflation outturns and expectations, and external factors, in particular developments in the euro area, where sovereign bonds gradually priced in the lower risk of euro area member government bonds. For the following five years, long‑term interest rates were affected by imbalances in the Romanian economy, which materialised in positive inflation dynamics, sizeable current account deficits and uncertainty regarding the sustainability of the Government’s fiscal policy. The long-term interest rate in Romania increased steadily and fluctuated between 3% and 4% over the period 2015-17 and between 4% and 5% from 2018 until the outbreak of the pandemic in spring 2020. To counter the negative impact of the pandemic on inflation and economic growth, Banca Naţională a României acted quickly to ease monetary policy. In March 2020 it cut policy rates and decided to conduct government bond purchases in the secondary market. After cumulative rate cuts of 125 basis points between March 2020 and January 2021, policy rates stood at 1.25% until October2021. From then, in a context of rising inflation and supply-side shocks posing upside risks to medium-term inflation expectations – which were then further exacerbated by the impact on food and energy prices of Russia’s invasion of Ukraine in February 2022 – Banca Naţională a României reversed the course of monetary policy and, over time, brought the policy rate up to 7%, where it currently stands. Over the review period, long-term interest rates in Romania declined from a peak of more than 9% in October 2022 to 6.3% in May 2024. This came on the back of declining inflation from the end of 2022 and evidence of a slowdown in economic activity in 2023. During the review period, credit default swap spreads for Romanian government bonds increased to more than 400 basis points in October 2022 before falling to 200 basis points in May 2024. This is one of the highest levels among the group of peer countries in the region and is mainly related to market concerns about the structural sustainability of domestic government finances. Romania’s government debt is rated the lowest investment-grade notch by all three main rating agencies (Moody’s: Baa3; S&P: BBB-; Fitch: BBB-).

After standing at close to 2.5 percentage points over the period 2014-16, the long-term interest rate differential of Romanian bonds vis-à-vis the euro area has since increased (Chart 5.5.6). The increase was driven by persistent macroeconomic imbalances in the Romanian economy. It showed a spike in 2022 before completely reversing. The differential stood at 3.2 percentage points at the end of the review period, having reached 7.3 percentage points in July 2022.

Capital markets in Romania are much smaller than those in the euro area and are still underdeveloped (Table 5.5.4). At the end of 2023 the Romanian corporate debt market was almost non-existent, with outstanding debt securities issued by financial and non-financial corporations amounting to only 1.8% and 0.3% of GDP respectively. Romania’s equity market also remains quite small, with a stock market capitalisation of 13.5% of GDP in 2023, which ranks among the lowest in the region. Foreign‑owned banks play a major role in Romania and accounted for around 66% of total banking assets in 2023. The degree of financial intermediation is quite small and the lowest in the region, with MFIs extending the equivalent of 24.1% of GDP in credit to the private sector in 2023. Over the past decade Romanian banks have gradually relied less on euro area banks for their funding needs. The claims of euro area banks on Romanian banks have declined from an annual average of 6.7% of total liabilities of domestic MFIs over the period 2014-23 to 2.9% in 2023. Since 2014 MFI loans denominated in domestic currency as a share of total loans extended to the private sector have increased consistently, from about 44% at the end of 2014 to 69% in April 2024.

In May 2024 the 12‑month average rate of HICP inflation in Sweden was 3.6%, i.e. above the reference value of 3.3% for the criterion on price stability (Chart 5.6.1). This rate is expected to decrease gradually over the coming months, driven by a restrictive monetary policy stance, a fall in energy prices and the ongoing easing of pipeline pressures.

Over the past ten years the 12‑month average rate of HICP inflation has fluctuated within a wide range, from 0.2% to 9.2%. Owing to the lagged effects of the krona’s depreciation and strong economic growth, HICP inflation picked up in 2015 from the very low levels the year before. This upward trend was also driven by an accommodative monetary policy stance, as that year Sveriges Riksbank had lowered its main policy rate into negative territory and launched a programme of government bond purchases. Between early 2017 and early 2019, HICP inflation hovered between 1.4% and 2.5%, as volatile energy prices contributed to fitful inflation growth. In 2018 and 2019 Sveriges Riksbank raised its repo rate in two steps from ‑0.50% to 0%, in the light of robust economic growth and accelerating core inflation. With the COVID‑19 pandemic-related contraction of the Swedish economy in the first half of 2020, HICP inflation fell significantly, averaging 0.7% over the whole year. In 2021 it rose to 2.7% owing to rising energy prices and a strong rebound in economic activity. Russia’s invasion of Ukraine in late February 2022 exacerbated supply shortages and the scarcity of raw materials, pushing up energy and commodity prices significantly. As a result, HICP inflation peaked at 10.8% in December 2022 and remained well above the 2.0% target until November 2023. In April 2022 Sveriges Riksbank launched a series of interest rate hikes, bringing its key policy rate up to 4.0% in September 2023. In addition, the government introduced energy support measures, including fuel tax cuts (combined with a reduction in the biofuel blending requirements) and electricity price subsidies in 2022. Economic activity started to contract in the second half of 2023, as real disposable incomes were hit by tighter financial conditions and high energy prices, leading to falls in spending, particularly in the household and construction sectors (Table 5.6.1). By December inflation had fallen to 1.9% on the back of a decline in non-energy inflation and energy prices.

In May 2024 the annual rate of HICP inflation reached 2.5%. In the first five months of 2024 both headline and core inflation moderated further, in a context of high interest rates and weak economic activity. In addition, energy prices fell sharply, reflecting lower global energy prices, changes in energy taxation and a reduction in the requirements for mixing biofuel into petrol and diesel. With inflation approaching the target and economic activity remaining weak, Sveriges Riksbank reduced its key policy rate by 25 basis points to 3.75% in May 2024.

Policy choices have played an important role in shaping inflation dynamics in Sweden over the past decade, most notably the orientation of monetary policy towards price stability. Since 1995 Sveriges Riksbank has had an inflation target that is quantified as an annual rise of 2.0% in the consumer price index (CPI). Sweden’s institutional framework, which fosters prudent fiscal policy and wage formation, has lent support to the achievement of price stability. In September 2017, while keeping the inflation target at 2.0%, Sveriges Riksbank decided to switch to an inflation target defined in terms of the CPIF (the CPI with a fixed interest rate) as a formal target variable for monetary policy. It also decided to introduce a variation band of ±1 percentage point to illustrate uncertainty surrounding the development of inflation.

Inflation in Sweden is likely to fall to close to the target over the forecast horizon. According to the European Commission’s Spring 2024 Economic Forecast, HICP inflation is projected to stand at 2.0% in 2024 and to fall to 1.8% in 2025. The near-term outlook for economic activity is subdued. Although base effects for energy prices led to a rise in headline inflation at the beginning of 2024, disinflation is set to continue over the forecast horizon, as domestic wage and price pressures are likely to remain contained. However, these forecasts are subject to considerable uncertainty about the evolution of energy prices and the geopolitical situation. Risks to the inflation outlook are balanced, as there are a number of uncertain factors relating to the international environment and the exchange rate that could drive inflation either up or down. Looking further ahead, monetary policy and the stability-oriented institutional framework should continue to support the achievement of price stability in Sweden.

Maintaining an environment that is conducive to sustainable convergence in Sweden requires the continuation of stability‑oriented economic policies and targeted structural reforms. High levels of private debt coupled with large numbers of flexible interest rate mortgages mean that Swedish households are particularly vulnerable to interest rate fluctuations and economic downturns, which, in turn, poses risks for the housing market and the stability of the Swedish economy. The European Commission selected Sweden for an in-depth review in its Alert Mechanism Report 2024, in particular because of the macroeconomic imbalances stemming from the housing market.

Financial sector policies should be aimed at continuing to safeguard financial stability and ensuring that the financial sector makes a sound contribution to economic growth. Macro-financial volatility has increased in recent years, owing primarily to instability in property prices, elevated levels of household indebtedness and the banking sector’s large exposure to the real estate market. Although the resilience of the banking sector has improved in recent years, as banks have built up liquidity buffers and increased their capital ratios, the Swedish authorities need to address the structural factors behind the volatility in property prices once the business cycle allows, for instance by reforming property taxation and improving the functioning of the rental market. In order to bolster confidence in the financial system, the national competent authorities should continue to improve their supervisory practices, among other things, by following the applicable recommendations from the relevant international and European bodies, and by collaborating closely with other national supervisors of EU Member States within the supervisory colleges.

Sweden’s general government budget deficit was well below the 3% reference value in 2023 and its debt ratio was well below the 60% reference value. In the reference year 2023, the general government budget recorded a deficit of 0.6% of GDP, i.e. well below the 3% deficit reference value. The general government debt ratio was 31.2% of GDP, i.e. well below the 60% reference value (Table 5.6.2). Compared with the previous year, the budget balance decreased by 1.8 percentage points of GDP, while the debt ratio declined notably by 2.0 percentage points. With regard to other fiscal factors, the deficit ratio did not exceed the ratio of public investment to GDP in 2023. The budget deficits in 2022 and 2023 were affected by the economic impact of Russia’s war against Ukraine and the discretionary fiscal policy measures taken in response to the related high energy prices.

Sweden has never been subject to an ECOFIN Council decision on the existence of an excessive deficit. Sweden is currently subject to the preventive arm of the Stability and Growth Pact. The European Commission’s Spring 2024 Economic Forecast assessed that the structural balance remained within the medium-term objective in 2023.

The budget balance improved strongly in 2021 and 2022, following the trough during the pandemic, but deteriorated again in 2023. Prior to the pandemic, Sweden had consistently recorded structural surpluses and most of the time also surpluses in the overall fiscal balance, amounting to 0.5% of GDP in 2019. In 2020, at the peak of the pandemic, the budget balance deteriorated by 3.3 percentage points of GDP due to a deterioration in the cyclical conditions, as well as a deterioration in the structural balance by 1.1 percentage points. As the effects of the pandemic dissipated, the exceptional expenditure measures were gradually withdrawn and the structural balance returned to surplus territory, reaching 0.9% of GDP in 2022 and 0.1% in 2023. Over this period, the budget balance was also helped by a strong cyclical recovery, which partly reversed in 2023 when economic activity began to weaken. The budget balance in 2023 was 1.1% of GDP lower than in 2019, i.e. the year before the outbreak of the pandemic.

Despite the pandemic, the government debt-to-GDP ratio has continued its declining trend and remained well below the 60% reference value over the past ten years. Prior to the pandemic, the debt ratio had declined between 2014 and 2019 by 9.4 percentage points to 35.6% of GDP thanks to a combination of primary surpluses and favourable interest-growth differentials. The fallout of the pandemic was an increase in the debt ratio by 4.6 percentage points in 2020, but by 2022, the ratio had fallen back below the pre-pandemic level, driven by an improved interest-growth differential and primary surpluses. In 2023 the ratio fell further, in spite of a deteriorating economic cycle, to reach the historically low rate of 31.2% of GDP, which was 4.4 percentage points below its level in 2019.

Sweden’s government debt structure shows that fiscal balances are relatively sensitive to interest rate variations but relatively insensitive to exchange rate fluctuations. The share of government debt with a short-term maturity is high (31.5% in 2023). A further noticeable part of its debt with medium and long-term maturities is exposed to variable interest rates (12.0% in 2022 – Table 5.6.2). After taking into account the level of the debt ratio, the fiscal balances remain relatively sensitive to interest rate movements. Furthermore, the share of government debt denominated in foreign currency is low (9.9% in 2023), which leaves fiscal balances relatively insensitive to exchange rate movements.

The European Commission’s Spring 2024 Economic Forecast predicts a moderate deterioration in the budget balance, with a moderate deficit projected for both 2024 and 2025. According to the Commission’s latest forecast, the budget balance is expected to deteriorate, with a deficit of 1.4% of GDP in 2024 and 0.9% in 2025, but remaining well below the reference value of 3% in both cases. The expected moderate deterioration in the general government balance in 2024 stems primarily from weak economic activity, increasing unemployment and the lagged impact of price increases on government expenditure, while the contribution from discretionary spending measures is relatively limited. The government debt ratio is projected to increase moderately to 32.0% of GDP in 2024 and then to moderately decrease to 31.3% of GDP in 2025, thus remaining well below the 60% reference value in both years.

Sweden has a strong fiscal governance framework. Following the last revision of the fiscal framework, which entered into force in 2019, the general government surplus target is now ⅓% of GDP over the business cycle. In addition, a debt anchor was introduced into the fiscal framework in 2019, targeting a debt ratio of 35% (Maastricht definition). A deviation from the debt anchor by 5 percentage points or more in either direction requires the government to submit a report to Parliament explaining the causes of the deviation and presenting an action plan to address it. The debt level of 35% leaves a significant safety margin to the Maastricht reference value of 60% of GDP. The Swedish fiscal framework also includes a three-year rolling nominal expenditure ceiling for central government and the pension system, as well as a balanced budget requirement for local governments. Overall, the national fiscal framework is strong and supports the medium-term sustainability of public finances in line with the requirements of the Stability and Growth Pact.

In the two‑year reference period from 20 June 2022 to 19 June 2024, the Swedish krona did not participate in ERM II, but traded under a flexible exchange rate regime. Over the reference period the Swedish currency was mostly significantly weaker than its June 2022 average exchange rate against the euro of 10.6005 kronor per euro, which is used as a benchmark for illustrative purposes in the absence of an ERM II central rate (Chart 5.6.3). The maximum upward deviation from this benchmark was 2.3%, while the maximum downward deviation amounted to 13.1%. On 19 June 2024 the exchange rate stood at 11.2140 kronor per euro, i.e. the krona was 5.8% weaker than its average level in June 2022. Over the reference period Sveriges Riksbank maintained a swap agreement with the ECB for borrowing up to €10 billion in exchange for Swedish kronor, which has been in place since 20 December 2007, with the aim of facilitating the functioning of financial markets and providing euro liquidity to them if needed. As this agreement helped to reduce the potential risk of financial vulnerabilities, it might also have had an impact on the exchange rate of the Swedish krona against the euro over the reference period. Over the past ten years the exchange rate of the Swedish krona against the euro has depreciated by 23.4%.

The exchange rate of the Swedish krona against the euro exhibited, on average, a high degree of volatility over the two‑year reference period. Overall, the krona weakened steadily against the euro for most of 2022 and 2023, with the exchange rate peaking in September 2023 when the krona traded at historically high levels of just under 12 kronor per euro. Several factors contributed to this weakening, such as global risk sentiment and risk perceptions related specifically to the Swedish economy in connection with the real estate market and the high level of household debt. From late September 2023 the krona began to strengthen against the euro, before depreciating at the turn of the year as the Swedish economy weakened and fluctuating between 11 kronor and 11.7 kronor per euro. During the reference period short‑term interest rate differentials against the three‑month EURIBOR were overall low and stood at 0.1 percentage points in the three‑month period ending in March 2024.

The HICP-based real effective exchange rate of the Swedish krona has depreciated over the past ten years (Chart 5.6.4). This depreciation in real terms mainly reflected developments in the nominal effective exchange rate.

Over the past ten years Sweden has recorded relatively large current account surpluses and has had a large positive net international investment position (Table 5.6.3). In 2023 the surplus in the combined current and capital account of the balance of payments stood at 6.8% of GDP, reflecting surpluses in the goods and primary income balances. The corresponding net capital outflows in the financial account were mainly in direct investment. Gross external debt, which is concentrated in monetary and financial institutions, stood at 166.4% of GDP in 2023. Over the past ten years Sweden has recorded a positive net international investment position on average. In 2018 its net international investment position turned positive and it reached 33.2% of GDP in 2023.

The Swedish economy is well integrated with the euro area through trade and investment linkages. In 2023 exports of goods and services to the euro area constituted 40.7% of total exports, while the corresponding figure for imports was higher, at 50.4%. In the same year the share of the euro area in Sweden’s stock of inward direct investment stood at 56.6% and its share in the country’s stock of portfolio investment liabilities was 40.8%. The share of Sweden’s stock of foreign assets invested in the euro area amounted to 44.1% in the case of direct investment and 33% for portfolio investment.

Over the reference period from June 2023 to May 2024, long-term interest rates in Sweden stood at 2.5% on average and thus remained well below the 4.8% reference value for the interest rate convergence criterion (Chart 5.6.5).

Long-term interest rates in Sweden stood at very low levels over most of the review period but rose towards the end to levels last seen in 2014. After falling to almost 0% between 2014 and mid-2015, partly owing to high levels of risk appetite and a gradual shift from safe to riskier assets, long-term interest rates in Sweden continued to be driven by both the domestic economic cycle and global developments. Long-term interest rates increased moderately between 2016 and 2018, owing to a recovery in economic growth and inflation, before falling again in 2019. Following the global downward trend in 2019 and 2020, long-term interest rates in Sweden declined and fluctuated closely around 0% until the end of 2020, with short spells in slightly negative territory. In 2020 Sveriges Riksbank responded to the pandemic by increasing the envelope of its quantitative easing programme until the end of 2021, including purchases of government and corporate bonds and commercial paper. It also cut the repo rate to 0% in August 2020 – close to its historically low level of -50 basis points set in February 2016. Sveriges Riksbank’s monetary policy stance remained accommodative from August 2020 to April 2022, at which point, against a backdrop of rising and persistent inflation, the central bank began a tightening cycle with a view to stopping high inflation from becoming entrenched in price and wage-setting. Sveriges Riksbank’s last rate increase, at the end of November 2023, brought the repo rate to 4.0%. It remained there until May 2024, when the central bank lowered it to 3.75%. The long-term interest rate has also been increasing since January 2022, standing at 2.4% in May 2024, the end of the review period. Sweden’s government debt is rated the top investment-grade notch by all three main rating agencies (Moody’s: Aaa; S&P: AAA; Fitch: AAA).

Historically, Sweden’s long-term interest rate differential vis-à-vis the highest-rated euro area countries has been negative, or temporarily positive but very small (Chart 5.6.6). Thanks to its sound fiscal policy and its balanced and healthy economy, Sweden enjoys the same credibility as the highest-rated euro area countries. Vis-à-vis the euro area average, the interest rate differential has been historically negative and declined to almost -1 percentage point by the end of 2022. It has since recovered slightly, reaching -0.7 percentage points at the end of the review period (-0.3 percentage points vis-à-vis the euro area AAA yield).

Capital markets in Sweden are highly developed, with corporate bond issuance and stock market capitalisation accounting for a higher percentage of GDP than in the euro area (Table 5.6.4). Relative to GDP, outstanding amounts of debt securities issued by non‑financial corporations in Sweden are more than twice as large as those in the euro area. The size of the Swedish stock market, as a percentage of GDP, is also more than twice that of the euro area. Sweden’s banks tend to fund their activities by borrowing from euro area banks only to a limited extent. Claims of euro area MFIs accounted for 8.7% of Swedish banks’ total liabilities in 2023. The degree of financial intermediation in Sweden is high. At the end of 2023 bank credit to the private sector amounted to 131.3% of GDP, much higher than the figure for the euro area, which was 99.6%.

GFS must comply with the ESA 2010 and reflect decisions and guidelines issued by Eurostat for specific cases involving the general government sector. The borderline classification cases between the financial, non-financial and general government sectors continue to be examined closely by Eurostat and national statistical compilers and may lead to further reclassifications and changes in the EDP and GFS data.

In the Czech Republic and Hungary, there are monetary financial institutions (MFIs) that are reclassified into the general government sector for EDP purposes. These units are classified as part of the financial sector in other statistical data compiled by the NCB (e.g. monetary statistics and securities statistics). The resultant discrepancy in sector classification between those statistics and GFS is well documented and has been made known to users. However, one MFI in Hungary will be reclassified into the general government sector also in financial accounts statistics and balance of payments statistics, with effect from the 2024 benchmark revision.

In Sweden, a public unit is currently classified as part of the financial sector and is on the ECB’s list of MFIs, but may be reclassified into the general government sector subject to the outcome of methodological discussions at the European level.

Article 4 of Protocol (No 13) on the convergence criteria requires interest rates to be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions. While Article 5 assigns the responsibility for providing the statistical data for the application of the Protocol to the European Commission, the ECB, given its expertise in the area, assists in this process by defining representative long-term interest rates and collecting the data from the NCBs for transmission to the Commission. This is a continuation of the work carried out by the EMI as part of the preparations for Stage Three of EMU in close cooperation with the Commission. The conceptual work resulted in the definition of seven key features to be considered in the calculation of long-term interest rates, as presented in Table 6.2. Long-term interest rates refer to bonds denominated in national currency.

The last paragraph of Article 140(1) of the Treaty states that the reports of the European Commission and the ECB shall take account of, in addition to the four main criteria, the results of the integration of markets, the situation and development of the national balance of payments and an examination of the development of unit labour costs and other price indices. Whereas, for the four main criteria, Protocol (No 13) stipulates that the Commission will provide the data to be used for the assessment of compliance and describes those statistics in more detail, it makes no reference to the provision of statistics for these “other factors”.

The following legislation forms the legal basis for Българска народна банка (Bulgarian National Bank) and its operations:

With regard to the independence of Българска народна банка (Bulgarian National Bank), the Law on BNB, the Law on counter-corruption and the Bulgarian Constitution have been examined.

Article 4 of the Law on BNB provides that, without prejudice to Article 37 of the Statute, Българска народна банка (Bulgarian National Bank) may not disclose or transmit to other persons any information related to the ESCB, nor any information obtained that constitutes a banking, professional, commercial or other legally protected secret of the banks and the other participants in monetary and credit transactions. Article 24(1) of the Law on BNB provides that, without prejudice to Article 37 of the Statute, the employees of Българска народна банка (Bulgarian National Bank) shall respect confidentiality concerning negotiations, deals contracted, the amount of assets on customers’ deposits and their transactions, and information received by Българска народна банка (Bulgarian National Bank) , as well as any circumstances concerning the activities of Българска народна банка (Bulgarian National Bank) and its customers, which constitute business, banking, professional, commercial or other legally protected secrets, even after termination of their employment relationship. Under Article 37 of the Statute, professional secrecy is an ESCB-wide matter, which is duly acknowledged in Article 4 and Article 24(1) of the Law on BNB.

In past Convergence Reports the ECB considered that certain provisions of the Law on BNB arising from the particularities of the currency-board regime were incompliant with the monetary financing prohibition. The Law on BNB adopted in 2024 which enters into force on the date stipulated in the Council Decision on the adoption by the Republic of Bulgaria of the euro, has repealed those provisions.

In past Convergence Reports the ECB considered, with regard to legal integration of Българска народна банка (Bulgarian National Bank) into the Eurosystem, that the Law on BNB needed to be adapted in several respects. The Law on BNB, which was adopted in 2024, addresses these elements, as set out below.

Article 2(1) and Article 17, items 3 and 4, and Articles 37, 38, 39 and 43 , which provide for the powers of Българска народна банка (Bulgarian National Bank) in the field of monetary policy and instruments for the implementation thereof, recognise the ECB’s powers in this field.

Article 3(8) and Article 52 of the Law on BNB, which provide for the powers of Българска народна банка (Bulgarian National Bank) relating to the collection of statistics, recognise the ECB’s powers in this field.

Articles 39 to 42 of the Law on BNB, which provide for the powers of Българска народна банка (Bulgarian National Bank) with regard to the management of official foreign reserves, recognise the ECB’s powers in this field.

Articles 3(5) of the Law on BNB, which provides for the powers of Българска народна банка (Bulgarian National Bank) with regard to the promotion of the smooth operation of payment systems, recognises the ECB’s powers in this field.

Article 7(7) of the Law on BNB, which provides that the external auditor is appointed by the Governing Council on the basis of a procedure complying with the Law on public procurement, recognises the Council’s and the ECB’s powers under Article 27.1 of the Statute.

Articles 53 to 57 of the Law on BNB reflect the obligation to comply with the Eurosystem’s regime for financial reporting of NCB operations, pursuant to Article 26 of the Statute.

Article 5(2) and Article 17, items 11 and 12, of the Law on BNB, which provide for the powers of Българска народна банка (Bulgarian National Bank) with regard to international cooperation, recognise the ECB’s powers in this field.

The Law on BNB has been amended to reflect and implement the recommendations made in the ECB’s Convergence Report of June 2022. As a result, and subject to the conditions and interpretations set out in this chapter, the national legislation is consistent with the Treaty and the Statute.

The following legislation forms the legal basis for Česká národní banka and its operations:

With regard to Česká národní banka’s independence, the Law on CNB needs to be adapted as set out below.

Article 2(1) of the Law on CNB provides that in addition to the primary objective of price stability, Česká národní banka’s objective is “to ensure financial stability and the safe and sound operation of the financial system in the Czech Republic”. In line with Article 127(1) of the Treaty, the secondary objective of Česká národní banka should be stated to be without prejudice to Česká národní banka’s primary objective of maintaining price stability.

Article 3 of the Law on CNB obliges Česká národní banka to submit a report on monetary development to the Chamber of Deputies at least twice a year for review; the Law on CNB also provides for an optional extraordinary report to be prepared pursuant to a Chamber of Deputies resolution. The Chamber of Deputies has the power to acknowledge the report or ask for a revised report; such a revised report must comply with the Chamber of Deputies’ requirements. These parliamentary powers could potentially breach the prohibition on giving instructions to NCBs pursuant to Article 130 of the Treaty and Article 7 of the Statute.

In addition, Article 47(5) of the Law on CNB requires Česká národní banka to submit a revised report if the Chamber of Deputies rejects its annual financial report. This revised report must comply with the Chamber of Deputies’ requirements. Such parliamentary powers breach the prohibition on approving, annulling or deferring decisions. Article 3 and Article 47(5) of the Law on CNB are therefore incompatible with central bank independence and should be adapted accordingly.

The Law on CNB is silent on the right of national courts to review a decision to dismiss any member, other than the Governor, from Česká národní banka’s Board who is involved in the performance of ESCB-related tasks. Even though this right may be available under general law, providing specifically for such a right of review would increase legal certainty.

With regard to Česká národní banka’s legal integration into the Eurosystem, the Law on CNB and Law No 2/1969 Coll., establishing ministries and other central administrative bodies of the Czech Republic (hereinafter the “Law on competences”) need to be adapted as set out below.

Article 2(1) of the Law on CNB, the last sentence of which provides that without prejudice to its primary objective, Česká národní banka shall support the general economic policies of the Government leading to sustainable economic growth and the general economic policies in the EU with a view to contributing to the achievement of the objectives of the EU, is not fully compatible with Article 127(1) of the Treaty and Article 2 of the Statute. The Law on CNB should make it clear that the objective of financial stability and the objective of supporting the general economic policies of the Government leading to sustainable growth are subordinate not only to the primary objective of price stability as specified in Section 7.2.2. but also to the secondary objective of the ESCB.

Article 2(2)(a), Article 5(1) and Part Five (namely Articles 23 to 26) of the Law on CNB, which provide for Česká národní banka’s powers in the field of monetary policy and instruments for the implementation thereof, do not recognise the ECB’s powers in this field.

Articles 28, 29, 32 and 33 of the Law on CNB, which empower Česká národní banka to enter into certain financial transactions, also fail to recognise the ECB’s powers in this field.

Article 35(c) and Articles 36 and 47a of the Law on CNB, which provide for Česká národní banka’s powers relating to foreign reserve management, do not recognise the ECB’s powers in this field. Article 4(1) of the Law on competences, according to which the Ministry of Finance is the central administrative body for, inter alia, “foreign exchange affairs including the State’s claims and obligations towards foreign entities” does not recognise the ECB’s powers in this field.

Article 2(2)(c) and Articles 38 and 38a of the Law on CNB, which provide for Česká národní banka’s powers relating to the smooth operation of payment systems, do not recognise the ECB’s powers in this field. Article 4(1) of the Law on competences, according to which the Ministry of Finance is the central administrative body for, inter alia, “payments systems”, does not recognise the ECB’s powers in this field.

Article 2(2)(b) of the Law on CNB, which empowers Česká národní banka to issue banknotes and coins, and Part Four of the Law on CNB, namely Articles 12 to 22, which specify Česká národní banka’s powers in this field and the related implementing instruments, do not recognise the Council’s and the ECB’s powers in this field.

Article 48(2) of the Law on CNB, which provides that Česká národní banka’s annual financial statements are audited by auditors selected on the basis of an agreement between Česká národní banka’s Board and the Minister for Finance, does not recognise the Council’s and the ECB’s powers under Article 27.1 of the Statute.

Article 48 of the Law on CNB does not reflect Česká národní banka’s obligation to comply with the Eurosystem’s regime for financial reporting of NCB operations, pursuant to Article 26 of the Statute.

Article 35 of the Law on CNB, which authorises Česká národní banka to conduct exchange rate policy, does not recognise the Council’s and the ECB’s powers in this field. Article 4 of the Law on competences also fails to recognise the Council’s and the ECB’s powers in this field.

Article 2(3) of the Law on CNB, which empowers Česká národní banka to cooperate and negotiate agreements with the central banks of other countries, international financial institutions and other foreign and international organisations performing similar tasks to those performed by Česká národní banka, does not recognise the ECB’s powers in this field.

Article 37 of the Law on CNB, which provides for the respective legislative powers of Česká národní banka and the Ministry of Finance in areas relating, inter alia, to currency, the circulation of money, the financial market, the adoption of the euro in the Czech Republic, the payment system, foreign exchange management, and the status, competence, organisation and activities of Česká národní banka, does not recognise the Council’s and the ECB’s powers in this field.

Article 46a of the Law on CNB, which sets out the sanctions against third parties which fail to comply with their statistical obligations, does not recognise the Council’s and the ECB’s powers to impose sanctions.

The Law on CNB and the Law on competences do not comply with all the requirements for central bank independence, the monetary financing prohibition and legal integration into the Eurosystem. The Czech Republic is a Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

The following legislation forms the legal basis for the Magyar Nemzeti Bank and its operations:

Article 36 of the Law on the MNB provides that if circumstances arise which jeopardise the financial system’s stability due to a credit institution’s operations, the Magyar Nemzeti Bank may extend an emergency loan to such credit institution subject to observing the prohibition on monetary financing in Article 146 of the Law on the MNB. However, it would be useful to specify that such loans are granted independently and at the Magyar Nemzeti Bank’s full discretion, which may make such extensions conditional if necessary and against adequate collateral, thus introducing an additional safeguard which should minimise the possibility of the Magyar Nemzeti Bank suffering any loss.

With regard to the Magyar Nemzeti Bank’s legal integration into the Eurosystem, the Law on the MNB needs to be adapted as set out below.

Article 3(2) of the Law on the MNB provides that the Magyar Nemzeti Bank supports, without prejudice to the primary objective of price stability, the maintenance of the stability of the financial intermediary system, the enhancement of its resilience, its sustainable contribution to economic growth and the Government’s general economic policies and environmental sustainability policy. This provision is incompatible with Article 127(1) of the Treaty and Article 2 of the Statute as it does not reflect the secondary objective of supporting the general economic policies in the EU.

Article 41 of the Fundamental Law of Hungary and Article 1(2) and Articles 4, 9, 16 to 22, 159 and 171 of the Law on the MNB establishing the Magyar Nemzeti Bank’s powers in the field of monetary policy and instruments for the implementation thereof do not recognise the ECB’s powers in this field.

Although Article 4(6) of the Law on the MNB refers to the Magyar Nemzeti Bank’s obligation to transfer specific statistical data to the ECB in accordance with Article 5 of the Statute, Articles 1(2) and 171(1) and Articles 9, 12, 30 and 160 of the Law on the MNB establishing the Magyar Nemzeti Bank’s powers relating to the collection of statistics do not recognise the ECB’s powers in this field.

Article 1(2), Article 4(3), (4) and (12), Article 9 and Article 159(2) of the Law on the MNB, which provide for the Magyar Nemzeti Bank’s powers in the field of foreign reserve management, do not recognise the ECB’s powers in this field.

Article 1(2), Article 4(5) and (12), Articles 9, 13, 27 and 28, and Article 171 (3) of the Law on the MNB establishing the Magyar Nemzeti Bank’s powers with regard to the promotion of the smooth operation of payment systems do not recognise the ECB’s powers in this field.

Article K of the Fundamental Law and Article 1(2), Article 4(2) and (12), Articles 9, 12, 23 to 26 and Articles 171(1) and 172(2) of the Law on the MNB establishing the Magyar Nemzeti Bank’s exclusive right to issue banknotes and coins do not recognise the Council’s and the ECB’s powers in this field.

Article 144 of the Law on the MNB providing that the President of the State Audit Office must be consulted before the Magyar Nemzeti Bank’s auditor is elected or their dismissal is proposed, Article 6(1) of the Law on the MNB, which provides for the shareholder’s power to appoint and dismiss the auditor, and Article 15 of the Law on the MNB do not recognise the Council’s and the ECB’s powers under Article 27.1 of the Statute.

Article 1(2), 4(4) and (12), Articles 9 and 22 of the Law on the MNB lay down the Government’s and the Magyar Nemzeti Bank’s respective powers in the area of exchange rate policy. These provisions do not recognise the Council’s and the ECB’s powers in this field.

Article 1(2), 135(5) of the Law on the MNB providing that, upon authorisation by the Government, the Magyar Nemzeti Bank may undertake tasks arising at international financial organisations, unless otherwise provided for by a legislative act, fails to recognise the ECB’s powers as far as issues under Article 6 of the Statute are concerned.

Articles 75 and 76 of the Law on the MNB do not recognise the ECB’s powers to impose sanctions.

With regard to Article 132 of the Law on the MNB, which entitles the Magyar Nemzeti Bank to be consulted on draft national legislation related to its tasks, it is noted that consulting the Magyar Nemzeti Bank does not obviate the need to consult the ECB under Articles 127(4) and 282(5) of the Treaty.

The Fundamental Law of Hungary, the Law on the MNB, Law XXVII of 2008, Government Decree 89/2023 and Government Decree 471/2022 do not comply with all the requirements for central bank independence, the prohibition on monetary financing, and legal integration into the Eurosystem. Other Hungarian legal acts do not comply with the requirements for the single spelling of the euro. Hungary is a Member State with a derogation and must therefore comply with all adaptation requirements under Article 131 of the Treaty.

The following legislation forms the legal basis for Narodowy Bank Polski and its operations:

Article 11(3) of the Law on NBP, which provides that Narodowy Bank Polski’s Governor represents Poland’s interests within international banking institutions and, unless the Council of Ministers decides otherwise, within international financial institutions, needs to be adapted to comply with Article 130 of the Treaty and Article 7 of the Statute.

Article 23(1)(2) of the Law on NBP, which obliges Narodowy Bank Polski’s Governor to forward draft monetary policy guidelines to the Council of Ministers and the Minister for Finance, needs to be adapted to comply with Article 130 of the Treaty and Article 7 of the Statute.

Article 9(5) of the Law on NBP regulates the dismissal of Narodowy Bank Polski’s Governor by the Sejm (lower house of Parliament) upon request of the President of the Republic of Poland, if he or she has:

With regard to Narodowy Bank Polski’s legal integration into the Eurosystem, the Polish Constitution and the Law on NBP need to be adapted in the respects set out below.

Article 3(1) of the Law on NBP provides that Narodowy Bank Polski’s primary objective is to maintain price stability, while supporting the economic policies of the Government, insofar as this does not constrain the pursuit of its primary objective. This provision is incompatible with Article 127(1) of the Treaty and Article 2 of the Statute, as it does not reflect the ESCB’s secondary objective of supporting the general economic policies in the Union.

Article 227(1) and (6) of the Constitution and Article 3(2)(5), Articles 12, 23 and 38 to 50a and 53 of the Law on NBP, which provide for Narodowy Bank Polski’s powers with regard to monetary policy, do not recognise the ECB’s powers in this field.

Article 3(2)(7) and Article 23 of the Law on NBP, which provides for Narodowy Bank Polski’s powers relating to the collection of statistics, do not recognise the ECB’s powers in this field.

Article 3(2)(2) and Article 52 of the Law on NBP, which provide for Narodowy Bank Polski’s powers in the field of foreign exchange management, do not recognise the ECB’s powers in this field.

Article 3(2)(1) of the Law on NBP, which provides for Narodowy Bank Polski’s powers in organising monetary settlements, does not recognise the ECB’s powers in this field.

Article 227(1) of the Constitution and Article 4 and Articles 31 to 37 of the Law on NBP, which provide for Narodowy Bank Polski’s exclusive powers to issue and withdraw banknotes and coins having the status of legal tender, do not recognise the Council’s and the ECB’s powers in this field.

Article 69(1) of the Law on NBP, which provides for the auditing of Narodowy Bank Polski, does not recognise the Council’s and the ECB’s powers under Article 27.1 of the Statute. The powers of the NIK to control the activities of Narodowy Bank Polski should be clearly defined by legislation and should be without prejudice to the activities of Narodowy Bank Polski’s independent external auditors, as laid down in Article 27.1 of the Statute.

Articles 3(2)(3) and 17(4)(2) and Article 24 of the Law on NBP, which provide for Narodowy Bank Polski’s power to implement the exchange rate policy set in agreement with the Council of Ministers, do not recognise the Council’s and the ECB’s powers in this field.

Articles 5(1) and 11(3) of the Law on NBP, which provide for Narodowy Bank Polski’s right to participate in international financial and banking institutions, do not recognise the ECB’s powers in this field.

Article 9(3) of the Law on NBP, which specifies the wording of the oath sworn by Narodowy Bank Polski’s Governor, needs to be adapted to comply with Article 14.3 of the Statute.

With regard to Article 21(4) of the Law on NBP, which provides for Narodowy Bank Polski’s rights to present its opinion on draft legislation concerning the activity of banks and having significance to the banking system, it is noted that consulting Narodowy Bank Polski does not obviate the need to consult the ECB under Articles 127(4) and 282(5) of the Treaty.

The following legislation forms the legal basis for Banca Naţională a României and its operations:

With regard to Banca Naţională a României’s independence, the Law on BNR and other legislation needs to be adapted in the respects set out below.

Article 43 of the Law on BNR provides that each month, Banca Naţională a României must transfer to the State budget an 80% share of the net revenues left after deducting expenses relating to the financial year, including provisions for credit risk, and any losses relating to previous financial years that remain uncovered. This arrangement may in certain circumstances amount to an intra-year credit, which in turn may undermine the financial independence of Banca Naţională a României.Article 43(3) of the Law on BNR also provides that Banca Naţională a României sets up provisions for credit risk in accordance with its rules, after having consulted the Ministry of Public Finance. The ECB notes that NCBs must be free to independently create financial provisions to safeguard the real value of their capital and assets.

Article 43 of the Law on BNR should therefore be adapted to ensure that such arrangement does not undermine the ability of Banca Naţională a României to carry out its ESCB tasks in an independent manner.

Pursuant to Article 52(2) of the Law on BNR, the Governor may release confidential information on the four grounds listed. Under Article 37 of the Statute, professional secrecy is an ESCB-wide matter. Therefore, the ECB assumes that such release is without prejudice to the confidentiality obligations towards the ECB and the ESCB.

With regard to Banca Naţională a României’s legal integration into the Eurosystem, the Law on BNR needs to be adapted in the respects set out below.

Article 2(3) of the Law on BNR provides that, without prejudice to the primary objective of price stability, Banca Naţională a României must support the State’s general economic policy. This provision is incompatible with Article 127(1) of the Treaty, as it does not reflect the ESCB’s secondary objective of supporting the general economic policies in the Union.

Article 2(2)(a), Article 5, Articles 6(3) and 7(1), Articles 8, 19 and 20 and Article 33(1)(a) of the Law on BNR, which provide for the powers of Banca Naţională a României in the field of monetary policy and instruments for the implementation thereof, do not recognise the ECB’s powers in this field.

Article 49 of the Law on BNR, which provides for the powers of Banca Naţională a României relating to the collection of statistics, does not recognise the ECB’s powers in this field.

Articles 2(2)(e) and 9(2)(c) and Articles 30 and 31 of the Law on BNR, which provide for the powers of Banca Naţională a României relating to foreign reserve management, do not recognise the ECB’s powers in this field.

Article 2(2)(b), Article 22 and Article 33(1)(b) of the Law on BNR, which provide for the role of Banca Naţională a României in relation to the smooth operation of payment systems, do not recognise the ECB’s powers in this field.

Article 2(2)(c) and Articles 12 to 18 of the Law on BNR, which provide for Banca Naţională a României’s role in issuing banknotes and coins, do not recognise the Council’s and the ECB’s powers in this field.

Article 36(1) of the Law on BNR, which provides that the annual financial statements of Banca Naţională a României are audited by financial auditors that are legal entities authorised by the Financial Auditors Chamber in Romania and selected by the Board of Banca Naţională a României through a tender procedure, does not recognise the ECB’s and the Council’s powers under Article 27.1 of the Statute.

Article 37(3) of the Law on BNR, which provides that Banca Naţională a României establishes the templates for the annual financial statements after having consulted the Ministry of Public Finance, and Article 40 of the Law on BNR, which provides that Banca Naţională a României adopts its own regulations on organising and conducting its accounting, in compliance with the legislation in force and having regard to the advisory opinion of the Ministry of Public Finance, and that Banca Naţională a României registers its economic and financial operations in compliance with its own chart of accounts, also having regard to the advisory opinion of the Ministry of Public Finance, do not reflect Banca Naţională a României’s obligation to comply with the Eurosystem’s regime for financial reporting of NCB operations, pursuant to Article 26 of the Statute.

Article 2(2)(a) and (d), Article 9 and Article 33(1)(a) of the Law on BNR, which empower Banca Naţională a României to conduct exchange rate policy, do not recognise the Council’s and the ECB’s powers in this field.

Articles 10 and 11 of the Law on BNR, which allow Banca Naţională a României to draw up regulations on monitoring and controlling foreign currency transactions in Romania and to authorise foreign currency capital operations, transactions on foreign currency markets and other specific operations, do not recognise the Council’s and the ECB’s powers in this field.

With regard to Article 3(2) of the Law on BNR, which entitles Banca Naţională a României to be consulted on draft national legislation, consulting Banca Naţională a României does not obviate the need to consult the ECB under Articles 127(4) and 282(5) of the Treaty.

Article 57 of the Law on BNR does not recognise the ECB’s powers to impose sanctions.

Article 4(5) of the Law on BNR entitles Banca Naţională a României to conclude short-term credit arrangements and to perform other financial and banking operations with other entities, including central banks, and provides that such arrangements are possible only if the credit is repaid within one year. The ECB notes that such a limitation is not foreseen in Article 23 of the Statute.

The following legislation forms the main legal basis for Sveriges Riksbank and its operations:

With regard to Sveriges Riksbank’s independence, the Instrument of Government and the Law on Sveriges Riksbank need to be adapted in the respects set out below.

With regard to Sveriges Riksbank’s legal integration into the Eurosystem, the Law on Sveriges Riksbank, the Constitution and the Law on exchange rate policy need to be adapted in the respects set out below.

Article 1 of Chapter 2 of the Law on Sveriges Riksbank provides that Sveriges Riksbank’s overriding objective is to maintain permanently low and stable inflation (the price stability objective) and that without neglecting the price stability objective, the Riksbank shall contribute to the balanced development of production and employment, considering the real economy. However, the ECB notes that Article 1 is more limited than the objective of supporting the general economic policies in the Union as set out in Article 127(1) of the Treaty.

Article 13 of Chapter 9 of the Instrument of Government, which establish Sveriges Riksbank’s powers in the field of monetary policy, do not recognise the ECB’s powers in this field.

Articles 4, 5 and 6 of Chapter 2 of the Law on Sveriges Riksbank, which provide for Sveriges Riksbank’s powers in the field of monetary policy, do not recognise the ECB’s powers in this field.

Article 11 of Chapter 1 of the Law on Sveriges Riksbank, which establishes Sveriges Riksbank’s powers relating to the collection of statistics, does not recognise the ECB’s powers in this field.

Chapter 10 of the Law on Sveriges Riksbank, and Article 13 of Chapter 9 of the Instrument of Government, which provide for Sveriges Riksbank’s powers in the field of foreign reserve management, do not recognise the ECB’s powers in this field.

Article 13 of Chapter 9 of the Instrument of Government and Articles 1 to 5 and 8 of Chapter 3 of the Law on Sveriges Riksbank, which establish Sveriges Riksbank’s powers with regard to the smooth operation of payment systems, do not recognise the ECB’s powers in this field.

Article 14 of Chapter 9 of the Instrument of Government and Chapter 4 of the Law on Sveriges Riksbank, which lay down Sveriges Riksbank’s exclusive right to issue banknotes and coins, do not recognise the Council’s and the ECB’s powers in this field.

The Law on Sveriges Riksbank does not recognise the Council’s and the ECB’s powers under Article 27.1 of the Statute.

Article 12 of Chapter 9 of the Instrument of Government and Chapter 10 of the Law on Sveriges Riksbank, together with the Law on exchange rate policy, lay down the powers of the Swedish Government and Sveriges Riksbank in the area of exchange rate policy. These provisions do not recognise the Council’s and the ECB’s powers in this field.

Pursuant to Article 1 of Chapter 6 in the Law on Sveriges Riksbank, Sveriges Riksbank may serve as a liaison body in relation to international financial institutions of which Sweden is a member. This provision does not recognise the ECB’s powers in this field.

With regard to Article 5(2) of Chapter 7 of the Law on Sveriges Riksbank, which provides for the General Council’s right to submit consultation opinions on behalf of Sveriges Riksbank within its area of competence, it is noted that consulting Sveriges Riksbank does not obviate the need to consult the ECB under Articles 127(4) and 282(5) of the Treaty.