Estimates of Fundamental Real Echange Rates for the Five EU Pre- Accession Countries

Are there indications of the real exchange rate misalignment in the case of five pre-accession countries? Will in these countries stable real exchange rates, required by the two of Maastrich criteria, be in line with economic fundamentals in the pre-EMU period? In order to analyse these questions, we employ the concept of fundamental real exchange rate (FRER) that reflects well specific features of countries in the advanced stage of transition. The FRER model approximates the integration gain by the impact of foreign direct investment on trade and it allows for larger current account deficits if external debt is below safety limit. Model coefficients are calibrated according to our previous econometric work. Sensitivity tests are used to deal with uncertainty about baseline assumptions. According to the FRERs, there were signs of overvaluation for all pre-accession economies, with the exception of Slovenia, in the end of 2001. The second main finding relates to the feasibility of stable real exchange rates in the pre-EMU period. The stability of the real exchange rates will not be automatically in line with economic fundamentals in the forthcoming period and, moreover, FRERs do not move in one direction in all pre-accession countries. This finding suggests that certain flexibility of exchange rates will be needed in the forthcoming period.