Latvia and Lithuania towards the euro adoption


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In my new contribution I revise the state of convergence in Latvia and Lithuania on the way towards euro adoption.

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Latvia and Lithuania towards the euro adoption

  1. 1. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionLatvia and Lithuania towards the euro adoptionImproving economic and financial conditions in both, Latvia and Lithuania, have taken theobligation of the €-adoption to the centre stage. Macroeconomic conditions in Latvia haveled the government of V. Dambroviskis to submit a request to EC, ECB to evaluate Latvia’sstate of convergence whether all Maastricht criteria are fulfilled and Latvia is ready toadopt the common European currency. Given the positive outcome and agreement amongthe finance Ministers of the Eurozone, Latvia could adopt the common currency as soon asby 2014. This short report briefly oversees the current position of convergence in bothcountries.I. Exchange rate criterionLithuania has adopted currency board, in order to control the exchange rate fluctuations.Lithuanian litas is strictly pegged to the central rate (the euro), since 2nd February 2002and was included in the ERM II since 28th June 2004.Latvian lats is not strictly pegged to the euro though Latvian central bank has adopted thefixed exchange rate system and anchored currency to the Euro since 1st January 2005,switching it from SDR.1 Since 2nd May 2005 the Latvian lats is included in the ERM II.Maastricht criterion allows a fluctuation of 15 per cent around the assigned value; bothlitas and lats fulfil the exchange rate criterion.1 Special drawing rights Justas Mundeikis, Economic analyst +491753887245
  2. 2. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionII. Budget deficitAfter severe recession and sudden plump in tax revenues - Latvia and Lithuania facedtremendous budget deficits reaching up to 9.8 per cent of GDP in 2009 in Latvia and 9.4 percent of GDP in Lithuania respectively. Since 2010 economies started to recover and thebudget deficits were reduced up to estimated 1.5 per cent in Latvia and 3 per cent inLithuania in 2012. Latvia already fulfils Maastricht criterion and Lithuania, given thepositive outlook, can expect the fulfilment in 2013 if not reached yet. Justas Mundeikis, Economic analyst +491753887245
  3. 3. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionIII. Public debtAlthough both countries - Latvia and Lithuania - have increased their governments’ debt toGDP ratios significantly in the last decade, none of them exceed the Maastricht criterion of60 per cent of GDP. Thus not relevant for the euro adoption: once adopted, both countrieswere supposed to bring in funds in to the ESM, what is likely to be financed by furthergovernment borrowing and would increase the government debt to GDP ratio. Justas Mundeikis, Economic analyst +491753887245
  4. 4. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionIV. InflationBoth countries show signs of decreasing 12 month average rate of change of inflation.Latvia already had he third lowest 12 month average inflation in the EU27. Partly due tofiscal adjustments in the summer of 2012, partly due to on-going financial crisis in Europeand price stability in the EU as total. Latvia seeking the euro increased VAT on 1st January2011, which helped to reduce budget deficit on the one hand, on the other the VATreduction in the summer of 2012 reduced the inflation by additional 4 to 5 pp. withoutcausing budget instability.Lithuanian inflation rates are decreasing as well but are yet too high to meet the inflationcriterion. Albeit during the next usual biannual report of ECB to EC, on convergence of the Justas Mundeikis, Economic analyst +491753887245
  5. 5. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionmember states in 2014, this target could be reached (only in case Greece is removed fromthe reference group due to its economic development, than the 12M inflation criterionwould stand at approximately 3 per cent. In that case Lithuania would have tremendouspossibility to meet this convergence criterion).V. Long-term interest ratesNormally, the countries chosen to evaluate the HICP criterion are taken to evaluate thereference value for the long-term government bond interest rate criterion as well. In thiscase: Greece, Sweden and Latvia. But as stated in last biannual convergence report of ECB2:2 Justas Mundeikis, Economic analyst +491753887245
  6. 6. Lithuanian- 2013-04-02 Latvia and Lithuania towards the euro adoptionif any of these benchmark countries is affected by bailout programs and its interest rate issignificantly higher than the average of the EU, than the benchmark rate can be derivedfrom fewer than 3 member states. The benchmark in case of Sweden and Latvia wouldaccount to: 4.89 per cent. And in case Latvia is replaced by Ireland, the benchmark wouldincrease to 5.61 per cent. In both cases Latvia meets the convergence criterion with anaverage long-term interest rate of 4.17 per cent as of February 2013. As well as Lithuaniadoes it with 4.63 per cent.Conclusions:Given the current state of development, Latvia is to adopt the euro on January 1st,2014. Lithuania is on its way to adopt the Euro in 2015, if the budget deficit will nothit the -3 per cent reference value and if price stability can be maintained until April2014. Justas Mundeikis, Economic analyst +491753887245