Readers Question: Is it a good idea for the Baltic states to adopt the Euro before they have met the convergence criteria?
Latvia and Lithuania have a target date of 2013 for joining the Euro. Estonia by Jan 1 2011.
The four main convergence criteria for the joining the Euro are:
- Low inflation
- Low Government borrowing
- Stable Exchange Rate – no devaluations in past 2 years
- Interest rates – close to ECB interest rates
- more details at: convergence criteria
Problems of Joining Euro before Convergence Criteria are met
Interest rates unsuitable for Economy. Membership of the Euro involves a common interest rate for the whole Eurozone area, but, this interest rate may be unsuitable for countries who have not converged with the Eurozone.
Until 2008, Latvia was the fastest growing economy in Europe, with Real GDP growth touching double figures. This fast rate of growth may require a higher interest rate to prevent inflation. In 2007, Latvian inflation was running at 20%.
Since 2008, Latvia experienced a dramatic decline in output. Latvia’s GDP has declined 20%, with an extra 16% fall suggested. The IMF have suggested a devaluation to help stabilise the economy.
With such a volatile economy, joining the Euro could create significant problems. It would reduce the number of policy options available to Latvia
Also, Latvia has seen a rapid growth in government borrowing. Fears of bankruptcy have caused a credit rating downgrade to BB+. This means that it is more expensive to finance Latvian debt because of the greater risk involved.
It seems the Baltic countries are not just narrowly missing the convergence criteria but are facing a real economic crisis.
Joining the Euro may give an impression of exchange rate stability, but, it wouldn’t solve the underlying economic problems and imbalances. If anything, membership of the Euro would give less flexibility in dealing with its problems.
Also, if Latvia joined it would have implications for the existing Eurozone area.
Related
“Stable Exchange Rate – no devaluations in past 2 years” ?
Did you mean to say depreciation?
No, since they are in ERM2, I think the correct term here is devaluation. If they have floating exchange rates it would be depreciation.
https://www.economicshelp.org/blog/trade/devaluation-and-depreciation-definition/
When would you want to own a business that sells price elastic products?