The financial storm, which started in US financial markets in 2008 and immediately spread across the world, refuses to calm down. The global financial crisis has now reached European government debt markets, where Greece has experienced problems rolling over existing debt and placing new debt. The Greek interest rates have increased markedly since the third quarter of 2009. The interest rate on 10-year government bonds hovered around 6-6.5 percent in February 2009, approximately 3 percentage points above the interest rate on similar German bonds.

The difficult situation in Greece is partly the result of investors having less appetite for risk because of the global financial crisis, but investor confidence has also been shaken by a number of specific issues. First, the Greek government surprised the markets in the autumn 2009 by revising the 2009 budget deficit up from 6 to around 12 percent of GDP. This came on the back of a history of substantial deficits even during economic booms. Second, the public debt in Greece has amounted to around 100 percent of GDP for decades and is set to grow substantially. Third, it has emerged that the Greek authorities at times have been hiding parts of the budget deficit using complex financial transactions.

A number of other euro area countries have also experienced increasing government deficits and higher risk premia on government debt. This applies in particular to Portugal, Ireland, Italy and Spain. The PIIGS has become the rather unflattering label of this group (based on the countries’ initials). It is noticeable, however, that Ireland seems to have attained renewed stability after implementing a harsh austerity package with cuts in welfare payments, public sector wages etc.

The debt crisis in Greece has offered new challenges to the European Union in general and the euro area in particular. The crisis has been associated with a recent depreciation of the euro although the improved international competitiveness has been welcomed by many. The main fear is that the Greek crisis spreads to the rest of the PIIGS and possibly also other countries in the EU. At the time of writing (1 March) the euro area countries have expressed support to Greece, but no concrete plans have been put forward.

Estonia aspires to join the euro area in 2011
The Estonian government is seeking membership of the euro area from 2011. The process of accession to the euro area bears many similarities to a beauty contest, in which the focus is on the "essential measurements" and where the contestants are assessed by several judges. In the context of euro area membership, the applicant country must satisfy the Maastricht convergence criteria and this is assessed in convergence reports produced by the European Commission and the European Central Bank. The final decision is made by the Council of Ministers.

The forthcoming convergence reports for 2010 will be published in April or May. At present it seems likely that Estonia will be found to satisfy all of the Maastricht criteria. The fiscal criteria are satisfied as the 2009 government deficit is estimated to 2.6 percent of GDP and the gross government debt will end at around 7.8 percent of GDP (see Figure 1). The price stability criterion is satisfied since Estonia presently has negative inflation. The exchange rate criterion is also satisfied, because Estonia has had a currency board with a fixed exchange rate since 1992. The interest rate criterion cannot be assessed, since Estonia does not issue long-term government bonds.

It is noteworthy that the 2009 government deficit is below the 3 percent threshold of the fiscal criterion given that Estonia experienced a deep recession in 2009 with an estimated GDP fall of 14 percent. This performance reflects several rounds of budget cuts and tax increases, implemented both in 2008 and 2009. While the budget consolidation may have inflicted substantial social costs, it proves that it is possible to restrain government deficits even in adverse times (see also Staehr 2010.)

Estonia is unique among the EU countries by the central government having accumulated reserve funds based on privatisation and other extraordinary revenues as well as budget surpluses. At the end of 2009 the central government reserves amounted to approximately 8.9 percent of GDP (Estonian Ministry of Finance). The reserves have provided liquidity in situations where government borrowing would be difficult or very expensive. The fiscal room for manoeuvre provided by the reserves also allowed Estonia to participate in the IMF-led bailout of Latvia in the autumn 2008. Estonia has pledged to lend 100 million euro to its southern neighbour.