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Larger Europe - stronger Europe?

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EU enlargement will have a considerable impact on the economic growth of the accession countries, but will make little difference to the existing members. Overall, however, it is unlikely that the enlargement will provide a strong spark to the economy or the financial markets, nor will it destabilize the labour markets or the euro. These are the conclusions of the UBS study entitled "Larger Europe - stronger Europe?", which examines the effects of EU enlargement on the economy and the financial markets.

In the next few weeks, Estonia and Latvia will hold their final referendums on whether to join the EU. Following ratification by the parliaments of the 15 current EU countries, the formal accession of the ten new members from Southern and Eastern Europe (AC10) will take place in May 2004. While this step is rightly viewed as a key political milestone, there is considerable uncertainty regarding the economic consequences and the implications for investors. The study, "Larger Europe - stronger Europe?", conducted by the Wealth Management Research department of UBS, discusses these impacts in detail. The study highlights the growth impact in the accession countries which, according to the authors, will be considerable. It also looks at the effects of enlargement on the "old" EU countries. In addition, the study analyzes the development of the financial instruments and markets in the accession countries. The central issue for investors is whether the widespread fears that the euro will be destabilized through the - renewed - enlargement of a heterogeneous group are actually justified.

Larger Europe - higher growth?
The answers regarding the growth prospects for the AC10 are clearly positive: the catch-up process that began in the mid-1990s will continue. But just as in earlier accession rounds, the success of the individual countries will vary. The willingness of a majority of citizens to accept - often painful - reforms and the determination of politicians to pursue disciplined fiscal and monetary policies will be the decisive success factors. Positive reinforcement from the outside world can be expected: countries that offer market-friendly environments will continue to benefit from substantial growth-enhancing foreign direct investment. With stable banking systems in place in most countries, domestic savings will then increasingly be mobilized to support such growth.

The impact of enlargement on the existing EU members will be very limited, simply because the economic size of the accession countries is still very small relative to the incumbents. Primary effects will occur via labour flows and enhanced competition in markets for goods and services, but fears that the labour market in Western Europe may be destabilized are grossly exaggerated. Europe's problem of ageing will not be resolved by EU enlargement but rather exacerbated.

Larger euro - weaker euro?

Euro entry of the AC10 will take place in stages from 2007 onwards. The larger countries will probably delay entry until the end of the decade. This means that some of the AC10 currencies could be subject to even stronger fluctuations over the next few years, however, currency crises such as those seen in the run-up to the creation of the euro in the mid-90s are improbable. Since it can be expected that the Maastricht criteria will be strictly adhered to, fears of a destabilization of the euro are equally exaggerated. In the longer term, the euro may well become stronger because not only will the faster-growing new members enhance overall growth in the euro zone but the European Central Bank will also make sure inflation remains low in future.

Bigger markets - better returns?
The financial markets in the 10 EU accession countries (AC10) are generally far less developed than those of the EU 15. At the local level, therefore, the bond markets are more likely to flourish than the equity markets. The valuations of the bond and equity markets have now largely adjusted to Western European levels. Even though returns in the AC10 equity markets should be able to match those in the major markets, large excess returns seem unlikely. Investments in the AC10 markets are suitable as additions to portfolios, while investments in niche segments such as certain asset-backed securities, real estate and private equity will be of even greater interest over the long term.

Media representatives can order the study from UBS Media Relations. Clients of the bank can ask their client advisors for a copy. A printed version will be available from 8 September 2003.

Zurich / Basel, 1 September 2003