latvia and lithuania towards the euro adoption

Lithuanian-

Economy.net

2013-04-02

Latvia and Lithuania towards the euro adoption

Justas Mundeikis,

Economic analyst

Lithuanian-Economy.net

[email protected]

+491753887245


Improving economic and financial conditions in both, Latvia and Lithuania, have taken the

obligation of the €-adoption to the centre stage. Macroeconomic conditions in Latvia have

led the government of V. Dambroviskis to submit a request to EC, ECB to evaluate Latvia’s

state of convergence whether all Maastricht criteria are fulfilled and Latvia is ready to

adopt the common European currency. Given the positive outcome and agreement among

the finance Ministers of the Eurozone, Latvia could adopt the common currency as soon as

by 2014. This short report briefly oversees the current position of convergence in both

countries.

I. Exchange rate criterion

Lithuania 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 2002

and 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 the

fixed 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; both

litas and lats fulfil the exchange rate criterion.

1 Special drawing rights http://www.imf.org/external/np/exr/facts/sdr.htm

Lithuanian-

Economy.net

2013-04-02


Justas Mundeikis,

Economic analyst


[email protected]

+491753887245

II. Budget deficit

After severe recession and sudden plump in tax revenues - Latvia and Lithuania faced

tremendous budget deficits reaching up to 9.8 per cent of GDP in 2009 in Latvia and 9.4 per

cent of GDP in Lithuania respectively. Since 2010 economies started to recover and the

budget deficits were reduced up to estimated 1.5 per cent in Latvia and 3 per cent in

Lithuania in 2012. Latvia already fulfils Maastricht criterion and Lithuania, given the

positive outlook, can expect the fulfilment in 2013 if not reached yet.

Lithuanian-

Economy.net

2013-04-02


Justas Mundeikis,

Economic analyst


[email protected]

+491753887245

III. Public debt

Although both countries - Latvia and Lithuania - have increased their governments’ debt to

GDP ratios significantly in the last decade, none of them exceed the Maastricht criterion of

60 per cent of GDP. Thus not relevant for the euro adoption: once adopted, both countries

were supposed to bring in funds in to the ESM, what is likely to be financed by further

government borrowing and would increase the government debt to GDP ratio.

Lithuanian-

Economy.net

2013-04-02


Justas Mundeikis,

Economic analyst


[email protected]

+491753887245

IV. Inflation

Both 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 to

fiscal adjustments in the summer of 2012, partly due to on-going financial crisis in Europe

and price stability in the EU as total. Latvia seeking the euro increased VAT on 1st January

2011, which helped to reduce budget deficit on the one hand, on the other the VAT

reduction in the summer of 2012 reduced the inflation by additional 4 to 5 pp. without

causing budget instability.

Lithuanian inflation rates are decreasing as well but are yet too high to meet the inflation

criterion. Albeit during the next usual biannual report of ECB to EC, on convergence of the

Lithuanian-

Economy.net

2013-04-02


Justas Mundeikis,

Economic analyst


[email protected]

+491753887245

member states in 2014, this target could be reached (only in case Greece is removed from

the reference group due to its economic development, than the 12M inflation criterion

would stand at approximately 3 per cent. In that case Lithuania would have tremendous

possibility to meet this convergence criterion).

V. Long-term interest rates

Normally, the countries chosen to evaluate the HICP criterion are taken to evaluate the

reference value for the long-term government bond interest rate criterion as well. In this

case: Greece, Sweden and Latvia. But as stated in last biannual convergence report of ECB2:

2 http://www.ecb.int/pub/pdf/conrep/cr201205en.pdf

Lithuanian-

Economy.net

2013-04-02


Justas Mundeikis,

Economic analyst


[email protected]

+491753887245

if any of these benchmark countries is affected by bailout programs and its interest rate is

significantly higher than the average of the EU, than the benchmark rate can be derived

from fewer than 3 member states. The benchmark in case of Sweden and Latvia would

account to: 4.89 per cent. And in case Latvia is replaced by Ireland, the benchmark would

increase to 5.61 per cent. In both cases Latvia meets the convergence criterion with an

average long-term interest rate of 4.17 per cent as of February 2013. As well as Lithuania

does 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 not

hit the -3 per cent reference value and if price stability can be maintained until April

2014.

latvia and lithuania towards the euro adoption

Economy & Finance