Baltics: Lithuania seeks solace in eurozone

Single currency set to cut debt costs; Diversifying trade from rampant Russia

Joining the eurozone will help Lithuania attract new investment and diversify trade flows away from Russia, according to the country’s finance minister.

Rimantas Sadzius told Euromoney in mid-December that euro adoption should give a big boost to Lithuania’s investment climate. "We are a small country with limited financial resources, so foreign investment is very important for us. Euro membership will open new opportunities for our business as the common market and the single currency provide higher resilience to stress."

Lithuania, which is due to join the eurozone on January 1, will be the 19th country to adopt the single currency and the last of the three Baltic states. Estonia became a eurozone member in 2011, while Latvia joined at the start of 2014.

Sadzius says bringing Lithuania into line with its northern neighbours will enhance the investment appeal of both the country and the sub-region. "Foreign investors usually treat the Baltics as one region," he says. "With Latvia and Estonia already in the eurozone, we need to be on the same level in order to be competitive in attracting investment."

Rimantas Sadzius, Lithunaian finance minister
With Latvia and Estonia already in the eurozone, we need to be on the same level in order to be competitive in attracting investment

Rimantas Sadzius, Lithuania's finance minister

By reducing the cost of trade with western European markets, he adds, euro adoption should also provide opportunities for Lithuania to reduce its reliance on Russia. Before the start of the Ukrainian crisis last year, Russia accounted for around 17% of Lithuania’s exports, a large chunk of which – equivalent to 2.7% of the Baltic state’s GDP – was made up of food products.

Those flows ground to a halt last autumn after Russian president Vladimir Putin banned food imports from the European Union (EU) in retaliation for western sanctions. The move echoed a ban on dairy imports from Lithuania that Russia imposed in October 2013, an action that was seen at the time as punishment for the Baltic state’s sponsorship of the EU’s Eastern Partnership summit at which Ukraine was due to sign an association agreement.

It was also followed in November by Russia’s renewed tightening of border procedures for Lithuanian goods, which prompted the country’s foreign ministry to lodge a formal complaint with the Russian embassy.

Under the circumstances, says Sadzius, it makes sense for Lithuania to diversify away from Russia. "The current sanctions regime is not the first time we have had this sort of situation with Russia, so it is definitely encouraging businesses to rethink their export strategies and look for other markets," he says.

Other expected benefits from Lithuania’s adoption of the euro include a big reduction in borrowing costs in both the public and private sector. According to the country’s central bank, the average interest rate on government securities should drop by 0.8 percentage points in the first year of eurozone membership, while households and businesses could see a reduction in rates of 0.49-0.55 percentage points. Over the next eight years, that could equate to savings on debt servicing of more than €460 million for the state and as much as €666 million for private sector borrowers, Sadzius adds.

Rating agency Moody’s, which upgraded the outlook on Lithuania’s Baa1 rating to positive from stable in September, also notes that joining the eurozone will almost halve the government’s foreign currency liabilities, from around 75% of the total at end-2013 to closer to 40%.

Exchange rate risk has, however, been minimized by the fact that the litas has been tightly pegged to the euro since February 2002, two years before Lithuania joined the EU. The Baltic state had hoped to join the single currency in 2007 but the European Commission turned it down for narrowly failing to meet the required inflation target.

By the start of 2014, however, when the government renewed its application for membership, Lithuania was comfortably meeting the Maastricht criteria on inflation, budget deficit and debt to GDP ratio, which remains well below the eurozone average at around 42%.

Lithuania is also one of the best performers in the both the eurozone and the wider EU in terms of economic growth. Its economy was expected to expand by around 3.0% in 2014 and is forecast to grow even faster this year – although Sadzius warns that the uncertainty in the external environment means that risks to the downside cannot be ruled out.

"The geopolitical conflict between Russia and Ukraine, and the mutual EU and Russian sanctions, could result in slower economic development in key foreign trade partners and a greater reduction in opportunities for Lithuanian exports than is envisaged in our basic economic development scenario," he says. "We are monitoring the situation and are ready to take measures if necessary."