Turkey treads water

Turkey treads water

Investors retreat in face of political instability

Big Bond Squeeze

Big Bond Squeeze

The elephant in the room…

April 2013

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Latvia’s Vilks defends euro decision

January 2014 targeted for adoption; Moody’s boosts sovereign to Baa2.


Andris Vilks, Latvia’s finance minister
Andris Vilks, Latvia’s finance minister
Latvia’s finance minister has defended his government’s decision to apply for eurozone membership, saying in mid-March the single currency was “much stronger” than before the financial crisis.

“The debt crises in eurozone member states and the market reaction to them have prompted a long-overdue policy action to strengthen the coordination of fiscal policy and accelerate reforms,” Andris Vilks tells Euromoney.

Latvia’s decision came as Lithuania announced in February that it is targeting adoption in January 2015. Poland also recently reiterated its commitment to the single currency, although without setting a date for the transition.

The timing of Latvia’s application to the European Commission raised eyebrows, coming just one week after the single currency wobbled because of the Italian election results – and shortly before the Cypriot crisis intensified. Still, speaking on March 14, Vilks insists doubts on the euro’s viability had been “convincingly dispelled” by the recent actions of eurozone policymakers.

“The decision of the European Central Bank to emerge as lender of last resort has greatly reduced the risk of potential break-ups, while the adoption of the fiscal compact has ensured that fiscal policy in the euro area will be conducted in a clear, counter-cyclical framework,” he says.


Euro peg

The lat has been tightly pegged to the euro since May 2005, when Latvia joined the ERM II. Double-digit inflation in the run-up to the financial crisis prevented early adoption of the single currency.

The bursting of a real estate bubble then plunged the Baltic state into a deep recession: the economy shrank by 17.7% in 2009. Under prime minister Valdis Dombrovskis, however, Latvia has staged a recovery with a stringent programme of front-loaded austerity measures.

GDP growth has averaged 5.5% over the past two years, putting Latvia at the top of EU rankings. Growth of around 3.5% is forecast for 2013. Meanwhile, average annual inflation has stabilized around 2%. The budget deficit for 2012 was 1.5% of GDP and debt-to-GDP ended the year at 42%.

Those metrics put Latvia comfortably within the Maastricht criteria for euro adoption, and most analysts expect the European Commission to recommend Latvia for membership when it reports on its application by early June.

If the EC’s assessment is positive, the recommendation will then be put to the Council of Ministers, which could ratify the decision as early as July – paving the way for Latvia to adopt the euro on January 1 2014.

That means a relatively short timeframe for the Latvian government to convince a sceptical public – only 36% of which supports euro adoption – of the benefits of the single currency.

Vilks says popular worries had faded, partly thanks to the precedent set by Estonia, which adopted the euro in January 2011. He admits the government has to reassure Latvians of the situation in the eurozone periphery but insists a recently launched PR campaign could convince Latvians “the worst of the crisis is over”.

According to a Eurobarometer survey published in April 2012, Latvians were more concerned than the citizens of any other potential eurozone member about loss of national identity, loss of control over national finances and abusive price setting during the transition to the euro.

Nevertheless, Vilks says he is confident Latvians can be persuaded that the benefits in the event of further economic disruption will justify the costs of joining the European Stability Mechanism, estimated at €220 million over five years. “We view our contributions as equivalent to buying an insurance policy,” he says.

Plea of mitigation

Vilks says a key part of the government’s message will be that euro membership would have mitigated the effects of the global downturn in Latvia. “We would definitely have seen a less severe contraction of the economy, lower unemployment, lower emigration and more financial sector stability,” says Vilks.

That verdict seemed to be endorsed by the ratings agencies: the day after Vilks spoke to Euromoney, Moody’s upgraded Latvia one notch to Baa2. It cited Latvia’s application to join the euro area as one of the key factors in maintaining a positive outlook on the sovereign.

Vilks adds that the pro-euro campaign would stress that Latvia is already effectively using the single currency, thanks to the currency peg, but without benefiting from the eurozone’s support mechanisms or having a say in shaping monetary policy.

“Eurozone membership would have provided vital liquidity shock absorption to the Latvian banking sector via access to the ECB’s support instruments, which could in turn have avoided the need to bail out the largest domestically owned bank [Parex Banka]. With euro adoption we will finally be able to have an impact on issues that are crucial for our economy,” he says.