Politicians calling for discontinuation of currency peg

  • 2008-07-09
  • Staff and wire reports
VILNIUS -  Lithuanian Prime Minister Gediminas Kirkilas' comments that the country's central bank has done too little to rein in inflation have prompted some politicians to push for abandoning the country's currency board system.
The finance minister and central bank members, as well as numerous financial analysts, argue that there is no sense in scrapping the currency board arrangement now, and that such a move would be harmful to the country's international reputation. "Moves to end the currency board regime and un-peg the litas from the euro are harmful for the country and may trigger panic on financial markets," President Valdas Adamkus said.

The controversy began July 1, when the Lithuanian parliament adopted a resolution on "immediate measures to rein in the rise in prices and inflation." The resolution called on the government to enable the central bank to implement "an active state monetary policy." The former chairman of the parliamentary National Security and Defense Committee, Algimantas Matulevicius, initiated the resolution.
Matulevicius confirmed that the resolution urged the cabinet to discontinue the currency board regime and to discontinue the currency peg. "Poland, for example, has a floating currency, and there is nothing bad in it. The national bank may therefore exert more influence on monetary policy," he said.

Asked about the Bank of Lithuania's responsibility and the possibility of amending the Litas Credibility Law, Kirkilas asserted that the government is currently discussing the matter but that "the Bank of Lithuania is independent and no one can tell it what to do. The Bank of Lithuania has taken certain measures, but perhaps [it was] too little too late."
Birute Visokaviciene, assistant professor at the Economic Policy Department of Vilnius University, said that the Bank of Lithuania "disappeared from the country's life" after the currency board arrangement was put in place in 1994, pointing out that the central bank today has little effect on the country's economic policy.
The Litas Credibility Law was adopted in 1994, "establishing the currency board arrangement and providing a foundation for macroeconomic stabilization and structural economic reform," writes Stasys Skropas, Director of International Relations of the Bank of Lithuania.

The currency board system is an instrument for achieving price stability through anchoring a country's currency to that of a larger, stronger economy, such as that of the U.S. The litas was initially pegged to the U.S. dollar at a fixed rate, and in 2002 it was re-pegged to the euro at a rate of 3.4528 to one.
In a currency board system, the central bank gives up its ability to change interest rates, relinquishing a tool with which to influence the economy.

Lithuania's monetary policy is now effectively tied to that of the European Central Bank. In the higher inflationary environment of Lithuania, some suggest that inflation might decline if the central bank were free to raise interest rates. Instead, monetary policy is tied to the lower interest-rate policy of the Eurozone.
Nonetheless, Bank of Lithuania head Reinoldijus Sarkinas said that he doubted that scrapping the currency board regime could help fight inflation, saying, "The currency board can only be abolished by abolishing the Litas Credibility Law, but that would hardly produce any positive results at the moment. An abolition of the currency board may trigger a negative reaction. People and businesses now know that the litas exchange rate is stable and will remain so in the future."

Raimondas Kuodis, director of the monetary policy department at the Bank of Lithuania, noted that scrapping the currency board would only contribute to the cutting of inflation if the litas went on a strong run after its un-pegging from the euro. And even this could harm exporters.
Lithuania also committed itself in 2004 to maintaining the currency board arrangement and a stable litas when it joined the Exchange Rate Mechanism II, a sort of waiting room for Eurozone membership.
Finance Minister Rimantas Sadzius maintains a firm position on the issue, saying that "This question has been decided once and for all . . . until euro adoption. Nobody will eliminate this arrangement. I am absolutely confident about that, because that would be worse for everybody 's the litas' exchange rate would go out of control and people's legitimate expectations would be undermined."

Sadzius added, "We must retain all the levers of the currency board arrangement. This arrangement helped us to avoid hyperinflation when it was introduced in 1994." The country's annual inflation rate reached 188.9 percent in December 1993. It was brought down to 45.1 percent in 1994 and to 35 percent in 1995. The government expects inflation to decelerate to around 6.8 percent this year from 8.1 percent in 2007.
Financial analysts also say that the scrapping of the currency board would send a signal that the country is laying the groundwork for a devaluation of the litas. "Any talk about the currency board abolition would be interpreted by foreign investors as a risk to the litas' stability and preparation for a devaluation of the currency," said Rimantas Rudzkis, chief analyst at the bank DnB NORD.

Kestutis Glaveckas, a member of the parliament's budget and finance committee, also said that it was not time to eliminate the currency board arrangement. "We must switch to the euro, not un-peg the litas or do away with the currency board," he said.