Feb 28

Latvia Likely to Postpone Euro Adoption

Posted by Kristjan Velbri | Posted in Currencies, Europe | Posted on 28-02-2010

Quite a few members of European Union are eager to join the eurozone to boost confidence in the eyes of foreign creditors and investors. Any talk about ‘confidence’ and ‘the euro’ in the same sentence might raise a few eyebrows in the light of Greece’s problems and the recent fall of the euro exchange rate, but compared to sovereign currencies of the former Soviet-occupied bloc the euro is a big step forward. Sovereign currencies carry the risk of devaluation and rapid depreciation due to an aftershock flight of capital. Of course, the same can happen to the euro, but with smaller currencies with no reserve currency status (the euro is a reserve currency) the risks are much higher. Perceived risks, anyway. So in essence, the countries of Eastern Europe are eager to join the eurozone because they figure it makes more sense to stand among the strong, even if they themselves are weak, currency-wise at least.

Latvia debt to GDP ratioLatvia GDP projection by the IMFOne of the criteria that a country looking to join the eurozone has to fulfill is a debt to GDP ratio of less than 60%*. According to IMF data, Latvia’s debt to GDP ratio will reach a maximum of 89% in 2013, after which it will start a slow decline. This projection is made on the basis of a weak economic recovery (13.9% cumulative growth in 2010-2014), but even with a strong recovery, the outlook is gloomy indeed. The 2009 GDP data for Latvia is not out yet, but it’s very likely that Latvia will have breached the 60% threshold due a combination of rising government debt and contracting GDP. There is not telling whether IMF’s debt to GDP projection for Latvia is accurate in terms of the ratio reaching 90%, because the IMF has already made a number of missing projections due to nature of Latvia’s economic decline. However, there is a high probability that Latvia’s debt to GDP ratio will remain above or close to the threshold for an extended period. In any case, it looks likely that Latvia will have to work harder than ever before to join the eurozone. It might have to shift the date five or even ten years into the future.

The data and charts were taken from CEPR’s report on Latvia from February 2010: Latvia’s Recession: The Cost of Adjustment With An “Internal Devaluation”.

*Just to be clear on this, here is a link to the Maastricht criteria, also known as euro area convergence criteria.

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