Baltic euro introduction amid financial crisis

In the midst of euro crisis, the idea of Eurozone enlargement is alive, gathering speed and in fact has never been abandoned. After a sequence of accessions (Slovenia in 2007, Slovakia in 2009, Estonia in 2011), now we have two candidates of Lithuania and Latvia enthusiastic for euro accession in 2014.

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Photo: http://tvnewsroom.consilium.europa.eu

Worth knowing that EU member states aiming to introduce a European single currency have to fulfil certain conditions linked to sustainable levels of public debt, interest rates, budget deficit and price stability (as based on harmonised index of consumer prices). The latest two – budget deficit and inflation – are the ones mostly discussed.

The reference value for inflation criterion is calculated by an average of three EU member states with lowest inflations added to 1.5 percentage points. As for now Latvia is doing well with enough reserves in meeting the reference, while Lithuania is in a close call, which is similar to a situation in 2006 (see chart below).

In 2005-2008 the economies in the Baltic region were experiencing a nearly double-digit growth followed by a relatively higher inflation. This phenomenon can be explained by a Balassa–Samuelson effect arguing that consumer price levels tend to follow a country’s prosperity because of productivity gains.

Today we observe a similar economic cycle of a recovering growth, which is more subdued, however with higher productivity gains after economic readjustment in 2009-2011. This period of economic slow-down also made new opportunities to fast growing economies to maintain price levels below inflation target. Therefore we have all necessary elements in place with economic fundamentals better than they were five to seven years ago.

Budget deficits in contrast to the price stability were much more antagonistic. With a financial crisis peaking its highs in 2009-2010, Estonia was among very few that managed to keep a budget deficit below the target of 3 per cent of GDP, while deficits of other EU member states, including the Baltics, were shooting up.

Facing an unprecedented economic recession Latvia had to apply for a credit line from the International Monetary Fund (IMF), however by the end of 2011 it managed to close the IMF programme by reducing a budget deficit below 3 per cent with a comfortable margin. Lithuania’s economy was also affected by recession but to a lesser extent than Latvia and basically due to the austerity Government in power had some breathing space to seek funding in the financial markets by issuing government bonds. As a consequence Lithuania’s strategy was more moderate to expenditure cuts, aiming at just below 3 per cent target.

Today, with a financial nightmare behind, we have two Baltic states next to Estonia (some would say – also to Finland) with a perspective of joining an area of single currency and reinforcing further economic ties within the Baltic region. In turn this will add a momentum to a regional ambition claiming for a Nordic hub of economic growth and investments in the European Union. With new opportunities and, as we see it, thanks to the crisis.

prices in baltics

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