In addition, reforms aimed at removing rigidities and expenditure trigger effects in social welfare transfers would also be appropriate in some countries. The capacity of economies to respond successfully to the challenge of euro adoption would be further enhanced by a greater degree of price and wage flexibility. Generally speaking, the NMS have a satisfactory track record on this count, at least compared with the non-core euro area countries, but the extent to which the existing flexibility is enough to enable a sufficiently rapid catching up process in the context of an increasingly competitive global trading environment is yet to be assessed. An overriding consideration relates to the degree of vulnerability that an economy might experience during its participation in ERM II. This is now generally perceived as a testing period to be entered into once the economy is deemed a credible candidate for euro area membership, but not to be postponed to the extent of unduly retarding the adoption of the euro, with the consequent negative effects on policy credibility. Indeed, the exposure to the international markets which participation in ERM II implies requires NMS to follow even more prudent policies, especially on the fiscal front, compared to existing euro-area countries. This is needed to compensate for the vulnerabilities, not least that arising from capital account openness, which the NMS are facing. This aspect of ERM II appears not to be sufficiently understood by advocates of delayed euro adoption in some of our countries.
In the present scenario, pressures on the current account are being reinforced by the steady upward trend in international oil prices. Markets often view wide current account deficits as a sign of vulnerability, thereby fuelling volatility in capital flows. So far, a number of NMS with a flexible currency arrangement have managed such volatility through exchange rate flexibility, a tool which might, however, be progressively lost in the run-up to the adoption of the euro. Developments in financial intermediation may also pose significant challenges in this regard. Thus far there has been a tendency for credit to be relatively low compared to economic activity in NMS, as banks, which are largely foreign-owned in a number of these countries, have been generally averse to advancing a significant amount of credit to enterprises, although tending to step up lending to households. 7 This implies the possibility that with a further internationalisation of the financial sector on account of the introduction of the euro, there could be a more rapid credit expansion through bank borrowing from abroad, with the attendant dangers of overheating and the formation of asset price bubbles. 4  Schadler et al (2005)  5  Begg et al (2003)  6  For example Cipriani (2000), Kovacs (2002) and Mihaljek and Klau (2003)  7  Schadler et al (2005)  2  BIS Review 53/2006  These considerations have important implications for the maintenance of financial stability in the NMS.