Valdis Dombrovskis | The Riga Conference 2012
In 2008, when Latvia became the worst victim of the global economic crisis, our story made the headlines of media all around the world. Distinguished US economist Paul Krugman famously said that “Latvia is the next Argentina”, meaning, in his opinion, the inevitable default of the small Baltic state. In 2012, after three years, an international bailout package of €7.5bn and fiscal adjustment of 17% of GDP, Latvia’s economy is back on track and in a better shape than many other EU countries. In 2012, Paul Krugman commented that since the crisis “essentially nobody has managed to regain confidence of markets, except for Latvia”.
The aim to join the eurozone has been an important part of Latvia’s strategy for overcoming the crisis. Latvia’s currency – the Latvian lats has been pegged to the euro since 2005, which essentially means that whatever happens to the euro, will happen to the lats, as well. One of the lessons we have learned is that in every crisis situation one has to have a clear exit strategy. For us the exit strategy was and still is joining the eurozone in 2014. During the crisis there was a strong internal and external pressure to devaluate the Latvian currency. Me, the government and the coalition saw that in our situation it was not necessary as overheating was largely due to the excessive short-term capital inflows. In addition, for small and open economies such as the Baltics, prices are largely determined by the surrounding markets. Therefore, the benefits of devaluation would disappear very quickly and devaluation would not effectively enhance the country’s competitiveness. Instead, Latvian authorities have put in place an exit strategy that aims to join the eurozone in 2014, which, first of all meant keeping to a fixed exchange rate and focusing on measures that would allow Latvia to comply with the Maastricht criteria in due time. The peg of the Latvian lats to the euro also means that we already have all the disadvantages of the euro without any of its advantages. We have carefully studied the experience of our neighbour Estonia, which joined eurozone on January 1, 2011 – you might say right in the middle of the debt crisis. Yet, it is clear that the benefits of the euro introduction in Estonia have clearly outweighed the few downsides. Joining the eurozone for Estonia has served as a strong signal for financial markets and investors about stability and trustworthiness of the Estonian economy, thereby improving its competitiveness in attracting FDI and creating new jobs.
We expect that joining the eurozone will bring similar effects in Latvia, as well. Even more – as our starting position is somewhat lower than that of Estonia, positive effects of the euro introduction are likely to be more manifested. Arguably, also the negative effects on inflation can be expected to be less pronounced, since unlike any other currency that has been replaced by the euro, the Latvian lats is worth more than the euro. It means that on January 1, 2014, numbers on price tags will increase, causing consumers to become more cautious and critical. Therefore, businesses will be less inclined to seek any artificial means of raising prices.
Another aspect, of course, are the practical benefits – less transaction costs for people and businesses, no need to exchange currency when traveling within the eurozone, more price-transparency. Cheaper interest rates for borrowing and servicing the state debt are another important benefit since in 2014 and 2015 Latvia will have to refinance a bulk of its IMF and EC loans. Also, introduction of the euro will put an end to all speculations about devaluation of the lats, which was an important issue during the first quarters of the crisis in 2008 and 2009. About 75% of mortgages and bank loans in Latvia are issued in euros, therefore another benefit of joining the eurozone will be reduced currency risks for borrowers and banks.
Of course, since all we hear about the euro these days is crisis, crisis and crisis, the public attitude towards the euro is becoming more negative. Nevertheless,
if you take a close look at the situation in Europe, you can see that it is not a euro crisis but rather a crisis in some particular eurozone countries.
Of course, we are following very closely the developments in the eurozone and we support all steps that are being taken to help countries solve their problems – for example, Latvia was one of the first countries to ratify the EU Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (fiscal compact).
Latvia’s place is in the core of the European Union. We do not want to be a periphery or a gray zone on the EU’s Eastern border. Therefore, joining the eurozone is another way of strengthening our commitment to Europe, but we want to join a monetary union that is strong and stable. In the last few years Latvia has done its part in restoring its fiscal discipline, implementing the necessary austerity measures, structural reforms and decreasing the budget deficit, which will be less than 2% this year and below 1.4% in 2013. If a country wishes to qualify for euro-membership, its economy and fiscal situation has to be in a very good shape, but the same strict rules have to apply to the euro-club countries, as well. This is a simple principle of fair and equal treatment of all the members.
We believe in the euro and in the capability of the eurozone members to tidy their house prior to the arrival of new members.
Currently, people in Latvia can feel much more secure about their future than residents of many other EU countries. I am sure that in the next few years Latvia along with Estonia, Lithuania, and other Baltic Sea region states will form the most stable and dynamic region in Europe and a safe place for investments.