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Euroisation

Why and how was euro introduced as the sole legal tender in Montenegro?


The reasons and effects of dollarisation in Montenegro are explained in detail in the CBCG working paper from 2004 titled “Economic Policy in Dollarised Economies with a Special Review of Montenegro“, from which we have selected:


After the disintegration of SFRY, two former member republics – Montenegro and Serbia formed the Federal Republic of Yugoslavia (FRY) on 28 April 1992. In the new country the monetary system was re-centralized, wherein the National Bank of Montenegro (NBM) lost its autonomy and became a regional office of the National Bank of Yugoslavia whose main office was in Belgrade. Thus, the National Bank of Montenegro was no longer governed by the Governor, who had been previously appointed by the Parliament or the Government of the Republic of Montenegro, but by the Director General who was appointed by the Governor of the NBY in Belgrade.


In February 1992, after the crash of the common market and simultaneous outbreaks of war in two former Yugoslav republics, the monthly inflation rate in Serbia and Montenegro was 50%, reaching 100% in June the same year. This percent represents the general threshold that defines hyperinflation. At the end of 1993, inflation amounted to 3,508,091,786,746%, which represents the longest in duration, and the second highest hyperinflation rate in the world.


Burdened with harder and more chaotic situation in the economy, unsatisfied citizens who, besides the poverty, were affected by the war conditions and sanctions, the government conducted a monetary reform in January 1994 through the program that introduced a “Super Dinar” pegged to the German Mark in a ratio of 1:1 and only a month later 15 zeros were taken off from the old Dinar. As the program continued, the NBY lowered interest rates to 9% and maintained them at that level until July 1994, using them in way as previous monetary authorities – as a support for agriculture. However, banks soon started to compensate for the lost interest by introducing special fees on financial services, demanding high collateral for loans and, finally, by setting higher interest rates than those previously agreed with the NBY. In spite of large fines, the banks soon started paying unofficial premiums of 15%-20% on the Dinar to the German Mark exchange rate thus indicating a devaluation of the Dinar in the near future. It happened first on 26 November 1994, and then again on 1 April 1998. In October 1999, the Dinar was two and a half times weaker in the black market than its official value of 6 Dinars for 1 German Mark (DEM 1 = DIN 15). 


This was a clear signal to the Montenegrin government to start working on monetary independence. A continuation of this agony did not only mean the impoverishment of the state and its citizens, but it also would become a more and more serious political problem.


At the beginning of 1999, the Montenegrin government started looking for a way to establish monetary independence for Montenegro. Starting from the practice of several years of both citizens and the business sector to perform transactions in and save in German Marks, the Montenegrin government chose a dollarization model with the German Mark as the local national currency.


Instead of the Dinar, the world’s worst currency at the time, as estimated by S. Hanke, Montenegro introduced a parallel currency system – one in which the German Mark was made the legal tender and allowed to freely float alongside Montenegro’s other legal money, the Dinar (2 November 1999). The entire process was conducted swiftly. At the time when the German Mark was introduced as the means of payment, the government was operating with a fiscal deficit of about 20% of GDP.


As of January 2001 the German Mark (DEM) became the only legal tender, and since March 2002 the official means of payment has become the Euro. The Monetary Council ran the National Bank of Montenegro of that time from the moment the German Mark was adopted until the establishment of the Central Bank of Montenegro. Until the establishment of the central bank, during 2000 and 2001, this body enacted numerous regulations and acts which enabled the German Mark to be fully accepted as the means of payment, accounting, and hoarding.”


- Decision on the Use of the Deutsch Mark as a Means of Payment with a View to Protecting the Economic Interests of Montenegro
(OGRM 041/99, 043/99, 022/00, 024/00) – Unofficially consolidated translation


- Decision on Taking over Certain Powers from the National Bank of Yugoslavia Aimed at Protecting the Economic Interests of the Republic of Montenegro
(OGRM 041/99 , 043/99, 022/00) – Unofficially consolidated translation



EUROISATION AS THE DESIRABLE MONETARY STRATEGY


In 1999, Montenegro has met all theoretical preconditions for a successful implementation of dollarization:

  • the country was rather small,
  • the country was highly open economy,
  • it had experience of hyperinflation in the past, 
  • revenues from seigniorage were almost non-existent, 
  • the share of foreign trade with the EMU was large, and 
  • substantial flexibility in the labour force (a great number of people were employed outside Montenegro). 


IMPORTANT EVENTS

  • From November 1999 – Dual currency system with the German Mark (DEM) and Dinar;
  • From 1 January 2001 – German Mark becomes the sole legal tender;
  • 15 March 2001 – The establishing of the Central Bank of Montenegro;
  • March 2002 – Full conversion to EUR


STRATEGIC DETERMINATION OF MONTENEGRO

  • The strategic objective of Montenegro is membership in the European Union and the Economic and Monetary Union,
  • National regulatory framework will be fully aligned with the relevant acquis communautaire governing this area to create preconditions for the future membership of the CBCG in the European System of Central Banks (ESCB).


EU accession negotiations


The use of the euro as the legal tender is a part of the accession negotiations for the EU membership specified in Chapter 17 “Economic and monetary policy”, opened at the Intergovernmental Conference on 25 June 2018.


The use of the euro as the legal tender in Montenegro differs entirely from the membership in the euro area. The euroisation in Montenegro is treated as a specific case since Montenegro entered this regime before ECOFIN Council adopted the position prohibiting unilateral euroisation.


The specifics of the monetary regime and the use of euro as the legal tender in Montenegro is sensitive because this is the first time the EU has been negotiating with a country using the euro. However, the message from the meetings with the European Commission is that joint efforts need to be made to find an appropriate and successful and viable medium and long term solutions after joining the EU.



Effects of euroisation on monetary policy and policy of short-term lending assistance to credit institutions


By introducing the euro as the legal tender, that is, as the regime of substituting the national currency, Montenegro has opted for the limited possibility of pursuing an independent monetary policy.


To wit, one of the core functions of each issuing central bank is the possibility to affect the money supply and/or interest rates in the country with the aim to fulfil the set objectives. This includes using all available monetary policy instruments such as open market operations, reference interest rates, and reserve requirement to affect inflation, encourage growth or control the local currency’s exchange rate.


However, with the adoption of the euro, such policies could not be fully applied in Montenegro. The CBCG’s monetary policy remains limited for the following reasons:


  • The CBCG does not have reference interest rates. As Montenegro does not have the national currency, it does not set reference interest rates and its policies rely on the official rates set by the European Central Bank (ECB), given that it is the institution responsible for setting key interest rates in the euro area. This means that the CBCG cannot manage interest rates to respond to domestic economic challenges such as inflation or recession but uses indirect channels to affect the monetary supply and the stability of price trends.

  • The CBCG cannot control the money supply so it cannot influence the money supply in the economy, since the total quantity of euros in circulation depends also on ECB policies and external factors such as various foreign capital inflows, imports and exports trends, remittances, factor income, population’s tendency to hold on to cash, and the like. Given such institutional framework, the CBCG cannot use monetary policy to affect the money supply in Montenegro but has to make adjustments and incorporate ECB policies and “imports” the monetary policy from the euro area.


In addition to the effects on pursuing the CBCG’s monetary policy, unilateral euroisation also affects the possibility of providing emergency liquidity assistance (ELA, as defined in the EU framework) to domestic credit institutions if they encounter short-term liquidity shortages. Since the CBCG is not an ESCB member, it does not have direct access to arrangements available to national central banks that are ESCB members. The EU has created this instrument as a crisis management tool and the ECB uses it in cooperation with national central banks to stabilise financial institutions during the short-term liquidity problems. As Montenegro is still in the process of EU integration, the CBCG will not be able to access liquidity support facilities available to the EU central banks until the country enters the EU.


The CBCG may provide credit support to solvent credit institutions facing short-term liquidity issues under the conditions set out in the Decision on detailed conditions for and the manner of granting loans to credit institutions in case of their liquidity needs.


The conditions provide specific limitations in granting this instrument stemming from the following:


  • CBCG does not issue the euro and thus lacks unlimited lending potential. Unlike central banks of the countries that issue their own currency and can print money to satisfy a range of requirements set in the liquidity policy and other country specific economic policy requirements, the CBCG relies on its own managing of funding sources to support credit institutions without jeopardising the stability of its operations.

  • Limitations concerning collateral: the CBCG accepts only highly credible collateral, limiting not only the type of collateral to be accepted against emergency liquidity assistance loan but also the size of the credit support.


Given these circumstances, the CBCG regularly renews the use of the Eurosystem repo facility for central banks (EUREP) line as a precautionary backstop. This EU instrument established in June 2020 has become available to Montenegro as of 31 July 2020. The instrument enables Montenegro, if necessary, to withdraw funds of up to 250 million euros for the systemic liquidity assistance at short notice. The extension of the deadline is additional security measure to address potential euro liquidity needs in order to maintain the country’s financial system stability and underlines the close cooperation and support between the EU’s monetary institution and the national central banks outside the Eurosystem.


Moreover, the CBCG has provided a renewable repo credit line of 100 million euros from the Bank for International Settlement (BIS) for systemic liquidity support to credit institutions in the case of contingency.