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The euro – what’s to fear about it?

Nov 14, 2012
By Charo Navarro Mateo

The euro – what’s to fear about it?

RIGA ' The question is: do you support the introduction of the  euro into Latvia? For 59 percent of Latvians, the answer to this question is “no.”
Regarding the latest polls, released in September by the Center of Sociological Studies (SKDS), more than half of the population is against the introduction of the euro in the next few years. Only 13 percent of the surveyed were in favor of the euro now. The most active support for the euro in Latvia was recorded in 2005, when 35 percent of the population was then in favor of entering into the eurozone. Since then, euro adoption has been regarded negatively.

Do you agree with the introduction of the euro in Latvia?
“I am against the euro because for me, the lats currency is a Latvian value and tradition,” says Katrina, an employee at Tine Salons souvenir store in Riga. This is one of the main reasons why Latvians are against the euro: they are proud about their national symbols, and the currency is one of them, but is one which would be lost with the euro.
According to Andris Ruselis, head of the Money and Payment Systems Working Group, the Latvian national characteristics will continue, even after the euro introduction. “I fully understand people’s concerns about the loss of our national pride and a symbol of independence; however, I have to say that Latvian euro coins will continue to display Latvian national pride,” says Ruselis.

But, apart from national pride, Latvians are also concerned about inflation. “Many people consider that the euro will raise prices,” says Katrina.
From the Latvian National Association for Consumer Protection (LPIAA), the opinion is in favor of euro, which is beneficial for consumers given that it will eliminate foreign exchange commissions. However, they are also concerned about risks. “There are some risks of rising prices, without a doubt, but it is quite possible that credit will become cheaper with the euro. There will be no need for currency exchange anymore, and this is positive for consumers because finally it will show in [stable] prices,” says Tekla Zabova, chairman of the council at LPIAA.

Many analysts forecast the consequences of the euro introduction in Latvia by comparing what happened in Estonia in 2011, when that country introduced the euro. Inflation rose from day one, although less than in previous years. “We can see that the rate of inflation, for those countries that entered to the eurozone in 2002, was on average 0.23 percent, which is not high, [otherwise] our goal is to be sustainable in inflation and that is why we have a working group managing our Monitoring Prices plan,” says Dace Kalsone, Euro Plan for Latvia manager.

Many European countries have experienced since then an incremental increase in inflation. “Consumers may have a perception that they have lost purchasing power as a result of the changeover. The result could be employees then pushing for generous pay increases, and this could lead to inflation,” says Juris Ulmanis, a professor at Riga Business School.

What Ulmanis and other experts worry is that retailers, therefore, could take the opportunity to “round up” prices. “I have heard that this was the case in Estonia. It is a fact not just for experts, but also for the business sector,” says Ulmanis.
“We guess that prices will rise, because people from business want to earn money and as it has happened in Estonia, prices will rise a little bit,” says Dace, owner of Krogs Miga and Hotel Sala, a family business. For this family, the euro is beneficial for the Latvian business sector, and especially in the field of services: businesspeople and consumers won’t have to pay commissions from having to make foreign exchange transactions.  

Missed message
What seems clear, however, is that the channels of communication right now are not effective. According to Kalsone, there is still so much to do regarding the information channels. “During the year, the population will have public information in all the institutional offices, through practical guidelines and seminars within the Latvian regions in the countryside,” she adds.
The people are still waiting for more information about such things as how to exchange money, or if they will lose purchasing capacity. Another of the risks that people are concerned about is dual pricing of goods and services, mostly at the retail level, at least initially. Bearing in mind that the euro is fixed at a very precise rate by the Bank of Latvia (1 euro = 0.702804 Latvian lats), though it can vary within a narrow band, it is not easy to mentally calculate what prices should be in euros. And the answer won’t be a simple round number.
 
Fiscal and structural reforms
Joining the European Economic and Monetary Union is not free. To do so, countries must meet the Maastricht criteria, which means covering four economic targets related to public debt, inflation, the exchange rate and long-term interest rates.
To fullfill the requiriments for Europe, Latvia went through a disciplinary policy of fiscal and structural reforms to get the sustainability demanded. Nowdays, Latvia seems ready for the euro as it has met the criteria. However, in spite of the fact that the Latvian government made strong efforts to meet the European economic discipline with satisfactory results, there could still be more fiscal and structural reforms ahead. According to the International Monetary Fund (IMF), structural reforms and productivity improvements are essential to maintain competitiveness under the fixed exchange rate or to stay in the euro area.

The IMF also insists on the necessity of maintaining financial stability and to reassuring depositors in the banking system. This goal makes necessary good management of the liquidation of the failed Krajbanka, and the sale of Citadele Bank (formerly the failed Parex Bank) and the commercial part of MLB (Mortgage Land Bank). “If the authorities fail to meet their commitment to prevent MLB from attracting new deposits once the commercial assets and liabilities are sold, there is a risk that the bank could later re-emerge as a threat to financial stability and a source of fiscal uncertainty,” says the last Financing Assurances Review of the IMF.
Other financial sustainability risks surrounding euro entry concern the now state-owned company airBaltic, which will require more government bailouts if efforts to restructure the airline prove unsuccessful. The problems at airBaltic point to problems in state enterprise governance and the risk of uncovered losses that, in the end, the government - meaning taxpayers - will pay.

Financial risks
From the Bank of Latvia and the Latvian government, focus is on preventing any kind of financial risks, those mainly related to euro bond issuances.
The IMF reports that Latvia needs to issue large amounts of bonds (compared to recent transactions involving eurozone countries) to be able to repay official creditors in 2014 and 2015. If Latvia joins the eurozone, domestic debt in euros becomes more attractive to new investors, which means that Latvia is better positioned to maintain low interest rates. But experts advise that the current turbulence in international capital markets make it recommended to make the repayments as soon as possible.

Latvia plans to issue around 3.8 billion euros in bonds in 2013-14 in order to repay external debt of 3.9 billion euros to its creditors, including the International Monetary Fund, the European Union and private bondholders, over the next four years. The introduction of the euro means having improved ratings and lower interest rates, which helps a country repay its public debt in a less costly way. The savings for Latvia would be around 900 million euros over the next decade.
Many risks are now being attended to. The Bank of Latvia is especially focused on implementing the change-over of money smoothly while maintaining the payment systems. “The state sector expects to spend some 8-10 million lats for this, and figures for IT and similar one-off adjustments in the private sector vary, but the Central Bank estimates show that the financial gains would outweigh any costs on the national level already during the first year of eurozone membership,” says Martin Gravitis, press secretary at the Bank of Latvia.

Tension in the eurozone
How can the current and uncertain eurozone crisis affect the process of joining the euro? “All the analysis from other European countries about the Latvian economy points to our huge discipline in fiscal and monetary stability, as was asked by the European Union. That is why we [now consider] the introduction of the euro. With discipline and stability we face the situation with strength and with so many positive things to get from Europe,” says Kalsone.

The Bank of Latvia is prepared to face the possibility of a worsening, or second wave, of the debt crisis in the eurozone, as any serious recession in Europe, and the eurozone in particular, would hit Latvia hard. Nonetheless, Latvia sees its strength in that it already started the integration process with the EU in 2004. In this sense, what the Bank of Latvia worries about is the possibility of more austerity to assist Southern European members of the union. “The total payment of capital into the European Stabilization Mechanism (ESM) for Latvia would be a total of 150 million lats during 5 years, something one could look forward to earning dividends [from] if the crisis abates. ESM membership should be treated as an insurance policy. We have to be prepared to assist others to know that we could rely on similar treatment if the need would arise,” says Gravitis.

Business has taken this risk into account, but it prefers to focus on the benefits of euro introduction, notes Hans Wind, owner of Donigans Pub in Riga’s Old Town, and an IT company with activities abroad. “There is a negative discussion about the eurozone crisis and its effects in Latvia when the euro is introduced. Nevertheless, it is not justified that the people are against the euro. Latvia, a tiny country, has to have the euro to be connected to Europe, to become more international,” says Wind.

Connections to the rest of Europe bring profits in many ways to Latvia, but the country needs to watch the eurozone situation closely, given the fact that the Latvian financial sector is linked to Europe. The main priorities then are to have policies to prevent, or lessen these risks, and to protect and ensure that those activities related to exports and economic growth are encouraged.
The IMF has mentioned the possibility of repatriation of assets by Swedish banks and outflows of non-resident deposits in times of crisis. One of the clear benefits of the euro will be to convince investors of Latvia’s close, and strengthening ties to its fellow European community.

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