Balance of payments prospects in EMU

The architects of monetary union believed that balance of payments constraints would no longer operate in EMU, but this view underestimates the fact that cross-border financing will still be subject to country credit risk - the risk of widespread debt default by residents of a troubled member state, including the possibilityof secession if serious economic tensions develop at some point. With these concerns in mind the prospects for current account balances of individual EU states are examined through forecasts and simulations using the NiGEM model. In addition special equations are estimated to allocate countries' global current balances between EMU and non-EMU areas, since intra-EMU imbalances are likely to have different financing implications from those with the world outside. The results suggest that whereas most EU states are likely to be in broad external balance or better through the next few years, several seem set to incur substantial current deficits, either with the rest of the area or with the world outside. Particularly at risk are Spain and the UK (whether inside or outside EMU) among the majors and Portugal and Greece among the smaller states. In general these prospects would not be radically affected by mild adverse shocks in the form of a reduction in global demand or a depreciation of the US dollar, assuming they would be unwound by efficient policy action overseas, but if large and protracted shocks were to occur, a number of states could develop deficits on a scale that could hardly be financed smoothly, even in the new regime.