By Roberts Zile - 28th March 2013
Latvia has recorded the strongest growth levels in the European Union for the past two years
Latvia’s solid economic fundamentals and careful preparation for single currency membership should reinvigorate the eurozone, writes Roberts Zile.
Latvia is on track to join the eurozone by 1 January 2014. At the beginning of March the government requested the European commission to deliver a convergence report on the country’s readiness to join the monetary union. From the Latvian point of view, the report should be positive as the country fulfils all the eligibility criteria. To name but a few, our 2012 inflation level was 2.3 per cent and is falling, reaching just 0.3 per cent in February. At the same time, the government deficit for 2013 is forecast to be 1.4 per cent, while the debt levels are just over 40 per cent. It is clear that Latvia has done its homework and it should rather come as a surprise to most if for whatever reason either the commission or later the council of ministers say no to Latvia’s accession efforts. Fortunately, there are no signs of that so far.
There are, of course, some who worry that Latvia could repeat the same mistakes that some of the southern European countries made after joining the eurozone. Namely, that after achieving monetary union membership, interest rates in Latvia will fall, the country will be flooded with cheap credit fuelling some sort of credit bubble which will lead to, as a side effect, prices and wages rising, and the country will become much less competitive and eventually the good times will be followed by hard times in the not too distant future.
Latvia is a different case. We have already experienced the boom years as well as the difficult times that followed. The country was hit hard by the recent financial crisis. Painful and very unpopular reforms needed to be implemented. It is debatable whether the government made all the right decisions and if better alternatives could sometimes have been chosen. Nevertheless, Latvia is back on the growth path which proves that we have learned to overcome the difficulties.
In fact, Latvia has recorded the strongest growth levels in the European Union for the past two years and is likely to replace neighbouring Estonia, which joined the euro area in 2011, as the fastest growing eurozone economy, according to a recent analysis by Ernst & Young. As such, Latvia will join the euro club as an already strong and growing economy while being part of the monetary union will help Latvia consolidate its recent macroeconomic achievements and will ensure sustainable growth levels in the future.
To put it differently, Latvia is not looking at the eurozone as a prize to be won, but – once a member of it – will appreciate the benefits the euro area offers; and to a small country there are many. During the financial crisis, Latvia was left by itself to defend its currency against attacks, while the banking sector was weakened and reduced lending. It might be politically challenging to explain to our citizens that we need to contribute to the European stability mechanism (ESM), which would also be used to bail out countries where minimum monthly salary is at least twice as high as that in Latvia. Nevertheless, when in the eurozone, Latvia and its banking sector – if problems were to arise – would benefit from help by the European Central Bank and could qualify for support from the ESM. It can also be hoped that the single supervisory mechanism will bring better banking supervision standards to Latvia, where two banks have failed during a four-year period.
The eurozone is also about geopolitical security. Being more closely integrated in the European core reduces some of the risks that could arise from direct or indirect third-country influence. However, at this point it must also be noted that around one half of all deposits in Latvia come from non-residents – of which 80-90 per cent are from the commonwealth of independent states, according to the IMF. The trend is only going to increase when Latvia joins the eurozone, unless our financial watchdog and the government implement some much-needed measures to reverse the trend. Taxing those deposits is just one idea that could be given thought.
There are also other reforms that need to be accomplished, preferably before the introduction of euro. To single out one issue, our current tax system is vastly unfair to those earning small salaries. The minimum monthly net salary is 20 per cent below the subsistence level, yet the government has no plans to differentiate the income tax rate. Even though we do not expect high inflation after joining the eurozone, it is not in the country’s interests to maintain such a regressive tax system within the monetary union.
Nonetheless, Latvia could not join the euro at a better time. Together with Estonia, and hopefully soon Lithuania, Latvia is going to be a breath of fresh air within the monetary union – a country confident about its fundamentals and ready to help in building a stronger Europe together.
Roberts Zile is a Latvian MEP and economist