FEATURE-Montenegro's first EU step is afterthought to euro

By Ellie Tzortzi

PODGORICA, Oct 15 (Reuters) - For most European Union states, adopting the euro currency is the final step in a long and difficult journey through rigid membership rules and regulations.

For Montenegro, which signed its first accord with the EU on Monday and will need years to become a member, the euro has been a reality since 2002, when it adopted the currency unilaterally.

The euro sign is everywhere in the small Adriatic republic, from billboards advertising loans to cardboard price displays in vegetable markets, making it feel like any formal euro zone state.

Economists say that after teething problems in the first two years, its use motivated the government to apply sound fiscal policies and improved Montenegro's image, directly contributing to a boom in tourism and real estate.

"It's great they have the euro, it makes everything so easy, and it's stable," said Briton Marie-Louise Morrison, leafing through property catalogues in the medieval town of Kotor.

The picture was very different seven years ago. In late 1999, the rump Yugoslav federation of Serbia and Montenegro faced ruin after a decade of war and 78 days of NATO bombing to force Serb forces out of the breakaway province of Kosovo.

Montenegro's government -- not in any case in control of monetary policy, which was decided by Serbia -- weighed its options and decided to adopt the German mark, the currency of choice in a region ravaged by hyperinflation.

AIRLIFT OF HARD CURRENCY

It was a far cry from the process other countries have to follow in qualifying for euro adoption -- first winning acceptance into the EU trading bloc, and then keeping the national currency stable for at least two years while bringing inflation, budget deficits and overall debt within the EU's target ceilings for joining its monetary union.

Independent economist Mila Kasalica said the country went into the experiment of adopting a foreign currency almost blind.

"There were only three, four professional papers on dollarisation published by the IMF, and they were not conclusive as to the long-term development effects," Kasalica said.

"In the end, it was a political decision realised through diplomatic channels." The process was novel, but simple.

"The government approached Commerzbank in Frankfurt with part of our hard currency deposits, our reserves, our gold, as guarantees, and asked for a loan, larger than the original collateral amount, as grounds for a currency delivery contract," Kasalica said.

"Commerzbank had to get approval from the Bundesbank to take the cash out of Germany," Kasalica said. "And then the government brought it into the country, on the plane."

RISK, PRIDE

There was a period when the Yugoslav dinar and the German mark were in parallel use, with the mark becoming sole legal tender and reserve currency on January 1, 2001.

In 2002, just as in Germany and other EU states that changed currency, the euro followed in Montenegro. Some 474 million euros went into circulation in the country of 650,000 people by the time the changeover was completed.

Its adoption widened the emotional gap with Serbia, and the union was dissolved in 2006, when Montenegro voted to go it alone and became the world's newest independent state.

Zorica Kalezic, senior economist at the central bank, said the initial adoption of the mark was a risky move.

"It meant we were limited regarding our monetary policy, the only instruments being the legal reserve requirement (for banks) market operations and short-term liquidity loans," Kalezic said.

"But the aim was to create macroeconomic stability."

And using the euro, thus reducing the foreign exchange risk, did help Montenegro to bring its economy more into line with EU requirements, especially in bringing down inflation.

However, Montenegro's unilateral adoption of the euro could prove a thorny issue as it negotiates to join the EU.

No other country has joined the bloc with a similar currency arrangement, and all new EU members are obliged to work towards adopting the euro through the strict process set out by the Maastricht treaty.

Montenegro's big current account deficit is also an issue, although huge foreign direct investment inflows -- the highest per capita in Europe last year -- offer some protection against a crisis.

"Of course, there is always risk in a dollarised or euroised economy, but that is a risk we took when we adopted the German mark, and seven years later we are quite satisfied," Kalezic said.

"Looking at what is happening now in the real economy, and at the indicators, I think we made the right decision. With a certain degree of pride I may say that we can now talk of Montenegro as a country with a stable economy."

For a factbox on euroisation, click on [ID:nL15217452]

For a table on Montenegro's economic performance against the EU's Maastricht criteria, double click on [ID:nL15263308]