Latvia received the green light from the ECB and the European Commission to become the eighteenth member of the euro area, despite the two institutions differing on the prospects of the Latvian economy within the single currency.
The small Baltic nation, a member of the EU since 2004, has been trying to join the common currency for several years. After a series of booms and bailouts following the collapse of the banking system in 2008, Latvia seems to have finally embarked on the path of abandoning the national currency, the lats, as of January 1, 2014. This was only the first step, EU finance ministers will take the final decision in July. The ECB, in Convergence Report published last June 5, announced that Latvia has met all the necessary conditions for entry, but at the same time pointed the finger at a far from solid profitability, partly caused by the strong dependence on capital flows from abroad, and about maintaining low inflation rates. The Commission, in a separate report, shared with the ECB the concern about potential money laundering risks, despite the evident high degree of economic convergence with the Eurozone.
Local authorities expect that the process of adopting the single European currency lowers interest rates and raises the rating, thus promoting the country's economic growth and eliminating exchange rate risks. Latvia's desire to join the Monetary Union reflects the sentiment of small states that wish to adhere to the greater development possibilities given, in a global perspective, by entering into common institutional scenarios on a regional and continental level. In fact, neighboring Estonia entered the Eurozone in 2011, while Lithuania is forging ahead by looking towards 2015. According to Olli Rehn, this represents a sign of confidence in the single European currency in the face of forecasts of disintegration of the Euro Area. In this scenario, however, it becomes necessary overcome the lack of local political consensus, whereas the results of the polls carried out in the Baltic republic in May indicate that only a third of the population welcomes the adoption of the euro.
Over the past twenty years Latvia has followed a harsh austerity program, mainly characterized by large cuts in public spending, which fueled the recovery against the more advanced economies. According to the latest EU forecasts, Latvia's public debt as a proportion of its economic output is expected to be about half the EU average in 2013, as is the budget deficit. A key role was played by internal devaluation of the Latvian economy, made possible by a flexible labor market and relatively low dependence on exports to the euro area. These measures resulted in the drastic cut in the level of wages and public spending, capable of removing the specter of recession within two years (2009-2011) and generating the fastest growth rate in the whole EU, thus reducing inflation and unemployment rate, given the competitiveness of the domestic level of prices and wages.
The ECB, in a clear allusion to Cyprus and the recent bailout of the local banking system, underlined how deposits by non-residents account for about half of the total in Latvia, affecting 40% of GDP. However, the measures taken by the authorities were encouraging, containing the risks associated with deposits, also in light of the bankruptcy of Parex Banka in 2008, the second largest banking institution and now under public control.
As regards the maintaining low inflation rates in Latvia, this will be a challenge in the medium term, given the limited room for maneuver in monetary policy. Experience during the 2005-2007 boom shows how difficult it can be to control domestic price pressures, as well as the risks posed by uncontrolled economic euphoria. Local authorities, however, guarantee that the Latvian economy has been strongly linked to the monetary policy of the Eurozone since 2005, when Latvia established a narrow corridor within which to fix the fluctuation of the lat against the euro.
Ma the most important challenge is given by the structural situation of the country, where the effects of an efficient privatization policy during the XNUMXs still weigh heavily, especially if one looks at the size and scope of theunderground economy, a source not only of lost public revenues, but also of strong limits to competition and damage to competitiveness, thus reducing the flows of productive investments from abroad. If, in neighboring Estonia, reformist promptness and depth guaranteed Tallinn a competitive advantage in the finance and research and development sectors, what scenarios open up in Latvia, where in the course of the XNUMXs it was above all structural inflation generated by an inefficient allocation of resources between industry and services? I sign that successes in terms of fiscal consolidation and price and wage competitiveness cannot be separated from an efficient production strategy capable of generating added value in terms of inter-sector competitiveness, an essential factor in the long-term economic development of a country and the underlying reason for Latvia's failure to enter the Eurozone after the boom of 2005-2007.
