Latvia Steps Toward a Tarnished Prize, the Euro

FRANKFURT — The small Baltic nation of Latvia received official endorsement for membership in the euro currency union Wednesday, in a move that European leaders clearly hoped would demonstrate the endurance of the euro zone despite its dismal economic performance and damaged reputation.

“Latvia’s desire to adopt the euro is a sign of confidence in our common currency and further evidence that those who predicted the disintegration of the euro area were wrong,” Olli Rehn, the European Union’s commissioner for economic and monetary affairs, said in a statement.

Both the European Commission, the European Union’s main policy-making body, and the European Central Bank said that Latvia had met the requirements for membership, which include limits on inflation and government debt. Latvia also had to demonstrate that its laws on issues like central bank independence are in line with European Union standards.

Latvia’s application still requires review by the European Parliament and endorsement by European Union political leaders, a process that is likely to result in formal approval in July.

Latvia would join on Jan. 1, becoming the 18th European Union country to adopt the euro.

The country, with 2.2. million people and economic output last year worth about 20 billion euros, is often held up as a model for advocates of austerity because the country responded to a severe banking crisis in 2008 by slashing government spending.

Economic output plunged, unemployment soared and wages fell, but the Latvian economy gradually recovered. The country’s economy grew 1.2 percent in the first quarter of 2013 compared with the previous quarter, second only to neighboring Lithuania among European Union countries.

“Latvia’s experience shows that a country can successfully overcome macroeconomic imbalances, however severe, and emerge stronger,” Mr. Rehn said.

However, opinion polls indicate that most Latvians are reluctant to join the euro, even though they have a powerful political incentive to do so. Like Estonia, another Baltic nation, which was the most recent country to join the euro in 2011, Latvia is anxious to tie itself to Europe and distance itself from its former Russian masters.

The Latvian government did not hold a voter referendum on euro membership. In many ways, the country is already a de facto member. The country has kept its currency, the lat, closely tied to the euro. And Latvian bank loans are commonly denominated in euros.

In its report, the European Commission said it had concluded that Latvia “has achieved a high degree of sustainable economic convergence with the euro area.”

The European Central Bank was also generally positive about Latvia, but expressed some concerns about the country’s readiness.

About half the deposits in Latvian banks come from outside the country, primarily Russia. That raises the risk of a sudden exodus of money in the event of a crisis. Earlier this year, Cyprus, another tiny euro zone member, was forced to limit withdrawals to prevent a bank run by Russian depositors.

But Latvia is considered less vulnerable to a Russian deposit flight than Cyprus because most of the money is linked to genuine business ties. Cyprus was regarded as a place where Russians parked their money to avoid taxes or because of fears that Russian authorities might one day seize assets.

The European Central Bank also expressed some concern whether Latvia could continue to meet the inflation targets required of euro members. While inflation has been well below 2 percent lately, Latvia has experienced huge swings in prices during the last decade, the central bank said, ranging from deflation to annual inflation of more than 15 percent.

The governor of the Latvian central bank will automatically join the European Central Bank’s governing council and have a vote in decisions on interest rates and other monetary policy issues. It is unclear who that person will be, since the term of the current governor, Ilmars Rimsevics, expires at the end of this year.

Historically, though, Latvia has stuck to the kind of conservative policies favored by Germany, Finland and other northern European countries. Government debt last year equaled about 41 percent of gross domestic product, well within limits set by treaty and much lower than Western European countries like France or Italy.

Still, recent experience with countries like Greece and Ireland has shown that nations can have trouble maintaining fiscal and economic discipline after they have joined the euro club.

“The temporary fulfillment of the numerical convergence criteria is, by itself, not a guarantee of smooth membership in the euro area,” the European Central Bank said in its report.

James Kanter reported from Brussels.

Article source: http://www.nytimes.com/2013/06/06/business/global/latvia-is-endorsed-to-adopt-the-euro.html?partner=rss&emc=rss