MNI INTERVIEW: Cycle May Change With ECB Rates Too Low: Vujcic

By Luke Heighton

     FRANKFURT(MNI) - The European Central Bank risks being caught with its

policy at too loose a setting to be able to respond to an inevitable downturn,

the governor of the Central Bank of Croatia told MNI.

     "If the cycle turns and monetary policy is still in this very long

expansionary cycle, how will it respond?" Boris Vujcic said in an interview

earlier in December. "If interest rates are at, or close to, zero, you won't

have much monetary policy space to react."

     Vujcic, who sits on the ECB's general council as Croatia applies for euro

membership, cited both fiscal indiscipline and structural weaknesses, alongside

a slowing world economy and trade tensions, as key factors retarding eurozone

growth at a time when the end of a cycle sustained by ultra-low interest rates

and quantitative easing might be approaching.

     "Since the beginning of the financial crisis we've had a very long cycle of

very expansionary monetary policy, yet it is difficult to believe that the real

economic cycle can last so long," he said, adding that, with interest rates

already near the lower bound, a downturn might leave little alternative to

another dose of unconventional monetary policy.

     --INCOMPLETE UNION

     The effectiveness of this, however, would be hampered by the incomplete

nature of the eurozone's monetary union. The use of the ECB's largest

unconventional weapon - quantitative easing - has been limited by the lack of a

single eurozone sovereign bond, a constraint not faced, for example, by the

Federal Reserve.

     "In spite of much that has been done to make monetary union more complete

and resilient since the beginning of the crisis, the question of the

completeness of monetary union is still very much alive," he said. "And this is

where this kind of battle of the [economic] cycles will bring, in my view, this

question to the surface at some point which might not be very far away."

     Croatia's own progress towards joining the monetary union is proceeding

apace. The country expects to be able to join the ERM II exchange rate

mechanism, a step prior to euro membership, some time in 2020.

     "In our view Croatia is the country that stands to benefit most from euro

adoption of all countries which are still not members of the currency bloc," he

said, adding that the majority of Croatian bank deposits are already held in the

common currency.

     --EURO ENTRY MAKES DEBT EASIER TO HANDLE

     "We are the smallest country in the EU that has not yet adopted the euro.

We are the most euro-ised of all of them," he said, adding that high levels of

euro-denominated debt will also be easier to manage once the country joins the

currency area.

     "All that risk disappears at the moment of entry," he said, adding that

Croatia "will feel the large drop in the cost of financing with the removal of

that risk."

     In preparation for joining the euro area, Croatia has reduced public debt

ratios and turned a current account deficit into a surplus. But demographic

change has been a problem, with over 150,000 Croats leaving the country since it

joined the EU in 2013. More immigration is required, he said, as well

improvements to the education system.

     "The government is increasing its immigration quotas now, but it's not easy

to find a proper labour force, although there are more and more of them coming,"

he said, adding that both Croatia and the EU needed "a smart immigration

policy."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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