Latvia: Introduction of the Euro to go ahead despite lack of public support

Latvia will become the 18th Member State to introduce the euro on 1 January 2014, but with less than 40% support from its citizens. The Latvian Prime Minister, Valdis Dombrovskis, has admitted: “The public now is less convinced than it was a few years ago.”

Latvia joined the European Union (EU) on 1 May 2004, and part of the accession deal was to adopt the euro. The small Baltic country will become the fourth post-communist country to introduce the euro, following Slovenia in 2007, Slovakia in 2009 and Estonia in 2011.

The EU institutions have claimed that smooth transition from the lat to the euro should proceed in January 2014 as Latvia has achieved a high degree of “sustainable economic convergence” by fulfilling the necessary conditions enshrined in the Maastricht Treaty.

According to the Convergence Report, Latvia’s inflation is at 1.3%, whilst the deficit of 1.2% in 2012 is not expected to change in 2013. The country’s debt reached 40.7% GDP in 2012.

Latvia has also adjusted its external balance, increased exports, improved competitiveness, attracted foreign direct investment, and has a flexible and mobile labour market. The European Central Bank (ECB) is pleased about Latvia’s compliance with the legal convergence on monetary issues regarding the central bank’s independence.

Brussels and the Latvian Prime Minister have argued that people would benefit from a credible monetary framework and a continuously growing economy, creating new economic opportunities and jobs in the country. The euro is projected to stimulate Latvia’s growth, but it might be moderate due to the stagnation in the Eurozone.

Dombrovskis has also argued that introducing the single currency is a natural step for Latvia because the lat has been pegged to the euro since 2005. On the other hand, the adoption of the euro is symbolic for the post-Soviet country: the single currency marks a completion of EU accession and distancing itself from Russia. By the same token, this symbol will be the prize for the Eurozone, as it shows confidence in the single currency despite the debt crisis.

Surprisingly, less than 40% of the Latvian people share the same enthusiasm for the euro. According to the Eurobarometer, their concern is geared more towards the internal market, unemployment, rising prices, increased taxation and lower social security, and, of course, the Eurozone debt crisis.

In the wake of the 2008 financial crisis, Latvia suffered a severe economic decline, with GDP shrinking by 17.7% in 2009 as consumption and investment in real estate were the driving force of the pre-crisis growth. Its debt, one of the lowest in the EU at the time, rose from 9% in 2007 to 43.9% in 2010, and deficit to 9.8% in 2009 from 0.4% in 2007.

The government received €7.5bn from the IMF and EU, in order to overcome the crisis and foster growth. Latvia has implemented structural reforms to improve competitiveness and restore trust in the country by internal devaluation. Harsh austerity measures followed from 2009 to 2012, with wages falling by an average of 30% in the public sector.

Benefits and spending were cut, and taxes increased, which has encouraged the growth of the shadow economy, something the government wanted to overcome. Unemployment reached 15.2% in 2012 and more than 100,000 people sought employment abroad within the same period.

Income inequality and poverty in Latvia are among highest level in the EU, which could be increased by the introduction of the euro as prices are likely to go up. Although the lat is currently fixed at €0.702804, prices could increase by a certain percentage as has been demonstrated by retailers in all Eurozone Member States, following the adoption of the single currency. This would be reflected in higher prices of basic necessities, such as food, which is one of the greatest worries for Latvians on low income. However, Madis Müller, deputy governor of the Bank of Latvia, has offered them conciliation: “There was a campaign that retailers and companies signed up to: we shouldn’t try to round up numbers and generate a little price increase.”

As all Eurozone members, Latvia is required to contribute €320m to the European Stability Mechanism (ESM), the Euro bailout fund, paid in annual instalments of €40m over the next five years. The concern with the current debt crisis persists among people and they fear implications the instability within the currency bloc could bring them. They would prefer to wait and see how events in the Euro area will unfold; he possibility of rescuing the Southern Eurozone states is unpopular among the Latvians.

Many have also tried to draw attention to an inflow of Russian deposits to Latvia that could bring the banking sector down and cause more instability similar to the case of Cyprus in 2013, which saw a haircut on deposits.

Although Latvia’s financial sector is smaller than in Cyprus, its reliance on non-resident deposits accounts for 40% of GDP. Dombrovskis has claimed that Latvia has put “safeguards in place” and banks have passed stress tests, but the European Central Bank (ECB) has expressed its concern. Qualifying for the euro according to the criteria may not be sufficient in judging a country in question, but potential problems in the financial industry should be taken into account.

The opposition parties, The Harmony Centre and The Union of Greens and Farmers, have argued that joining the euro should be postponed, as in the Czech Republic, Poland and Lithuania. However, the government seems willing to go ahead regardless, despite the low public support, because no referendum is required.

The Latvian Prime Minister knows how the majority of people in his country feel about joining the euro. Although people will appreciate some of the benefits gained from the euro, they might need more convincing.