European Central Bank issued a convergence report on Latvia, commenting that the country is economically and legally within the reference values of the convergence criteria for Eurozone accession. The economic criteria include low inflation, low long-term interest rates, stable exchange rate and low public debt and deficits. Shortly after the announcement European Commission expectedly also gave a green light for Latvia’s euro adoption.
Practically Latvia is set to become the 18th Eurozone member as of January 1 2014. The final stage of the formal process will be the approval of the Economic and Financial Affairs Council (ECOFIN) in July. PM Valdis Dombrovskis already said that the final decision is expected to be positive, while FinMin Andris Vilks believes it is certain that Latvia is adopting euro as planned. Vilks marked the decision as “truly significant” in the recognition of Latvia’s efforts to overcome the crisis.
Indeed, Latvia complies with the Maastricht criteria with a large margin. According to the ECB report, over the reference period of May 2012-April 2013 average 12-month inflation was at 1.3%, below the reference value of 2.7%. Government budget deficit was 1.2% of GDP in 2012, below the reference value of 3% of GDP. General government debt to GDP stood at 40.7%, below the reference of 60%. Long-term interest rates in the reference period averaged to 3.8% below the reference of 5.5%. ECB believes that maintaining a low inflation will be challenging in the medium-term.
At the same time ECB warns that a comprehensive policy toolkit is crucial for dealing with risks to financial stability. The risks include from high reliance of a significant part of the banking sector on non-resident deposits as a source of funding. Other recommendations include continuing with comprehensive fiscal consolidation, locking competitive gains achieved recent years and avoiding a renewed increase in unit labour costs’ growth. Despite strong economic adjustment capacity, progress is still to be made in improving quality of institutions and governance.
Another issue to be tackled by the government until the end of this year is low euro approval rates that do not rise above 30%. FinMin is expected to launch a communication campaign on euro benefits and tackling some of the “myths” of Eurozone accession. Head of the Bank of Latvia Ilmars Rimsevics previsuly believes that by the end of summer Latvia the approval rate for euro is going to reach at least 50%.
Chief EBRD economist Erik Berglof wrote for Financial Times that Latvia’s transition from the economy most damaged by the crisis to the fastest-growing European economy is “nothing short of remarkable". At the same time Berglof stresses that the progress Latvia made should not be oversimplified as austerity vs. stimulus debate. Apart from “internal devaluation” of lowering domestic costs and tight fiscal policies important structural reforms have improved Latvia’s investment attractiveness, he argues.
EBRD economist echoes Bank of Latvia’s arguments for euro adoption: that currently Latvia’s LVL is pegged to euro and that the economy is heavily “euro-ised”, while not enjoying any benefits of Eurozone membership.
This week Fitch Ratings said that the final decision of ECOFIN whether or not to invite Latvia (BBB/Positive) to join Eurozone will trigger country’s sovereign rating review. Agency maintains that euro adoption would deliver net benefits for the Latvian economy and is likely to lead to a rating upgrade.
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