Brace yourselves. Latvia is two months away from joining the euro. The Baltic State becomes the 18th European country to do so on Jan 1. Morten Hansen, head of the economics department at the Stockholm School of Economics in Riga tells us what we can expect.
1. All lats (deposits, debts, cash) will be converted at the rate of 0.702804 lats per euro. This is the parity rate that prevailed on the day Latvia pegged its lat to the euro in January 2005, and around which it has been allowed to fluctuate by a maximum +/- 1% since then.
2. A fair conversion of prices should be about 1.42 euros per lat (or, 1/0.702804). Latvia has an “Honest euro introducer” program that promotes this conversion rate.
3. Difficult to compare prices with what they were in lats after Jan. 1? That should not be the case, as most firms now list prices in both lats and euros. They have been obliged by law to do so since Oct. 1, and must do so for at least another half year after euro introduction.
4. Whereas many of us will still struggle to do price conversions, say 3.50 euros into lats (it is 3.50 x 0.702804 = 2.46 lats), it should be easy to get used to euro coins and banknotes – except for the 200 euro banknote, Latvia has all the other denominations of the euro in lats.
5. Latvia may join the eurozone, but it has had one foot there for a long time already – with the euro introduction, the mismatch in terms of salaries in lats, but loans in euros, will automatically be resolved.
6. Being inside the eurozone will by definition remove the discussion of devaluation. A lat was worth 1.42 euros but this could have been changed by the central bank if it had wished so – and financial markets did their best to impose a devaluation in 2009. After euro introduction, a “Latvian” euro and a “German” euro will be just that – a euro. The exchange rate, if one may speak of such, will be irrevocably fixed at one to one.
7. Many seem to have opposed devaluation, but many also oppose euro introduction, although this is the only way to 100% rule out a devaluation. A fixed exchange rate is only fixed for as long as it is fixed, and is not the same as a monetary union.
8. But it should also be remembered that the eurozone was not built for an exit. Fixed exchange rates can be changed. Membership of a monetary union is much harder to quit. This will require prudent fiscal policy and a vigilant eye to competitiveness.
9. Do you think Latvia has created unsustainable government debt during the crisis and can never repay? Latvia will be a second Greece? Actually no – government debt is a smaller share of GDP in Latvia than in, e.g., Denmark and Finland, countries that can hardly be characterized as on the verge of default.
10. Membership in the eurozone implies membership also in the European Stability Mechanism (ESM). We will be forced to bail out richer Greeks and Spaniards! True, Latvia must join ESM, but ESM is meant as a lending facility – lending under strict conditionality. OK, I am not sure if strict conditionality is always so strict, but I think the risk of a bailout is small given the head of ESM, Klaus Regling, being an arch-conservative German.