The euro has had so few ringing endorsements over the past four years that the accession of Latvia to the single currency on 1 January must feel like manna from heaven.
By Europe Editor Tony Connelly
This week the triumvirate of José Manuel Barroso, Olli Rehn and Herman Van Rompuy will be in the capital Riga to celebrate, but ordinary Latvians are not wholeheartedly sharing the ardour which will undoubtedly be expressed by the European Commission president, the economic affairs commissioner and the president of the European Council respectively.
Opinion polls have found that 50% of Latvians oppose membership, while only 20% are in favour, although there has been a pick-up in support for the euro in recent weeks.
For the moment, though, the government’s decision to press ahead with eurozone membership is being hailed as another sign that the crisis is abating.
The fact that Latvia, alongside Ireland, has been regarded as a poster child for austerity has, furthermore, enhanced the belief among eurozone officials that the economic orthodoxy of the past few years has been the correct one.
In 2008 a credit and housing bubble burst following years of wayward loans mostly from Scandinavian banks. As a result the government was forced into an excruciating fiscal adjustment which saw the economy shrink by 20% from its boomtime peak – the world’s deepest recession. Public salaries were cut by 25%, scores of schools closed, and unemployment rose to over 20%.
Riga, once a haven for stag parties and BMW X5-driving entrepreneurs, had to turn to the EU and IMF for a €7.5 billion loan, although not all of it was drawn down.
After two years of crippling austerity, Latvia returned to modest growth. Bucking the universal trend elsewhere, and despite protests and rioting, the government of Valdis Dombrovskis was re-elected in November 2010, with an increased majority.
When I visited Riga at that time many locals were suffering from the harsh new economic realities, but noted stoically that their parents and grandparents had suffered a lot worse under Soviet occupation.
Today Latvia’s economy will be the fastest growing of the (now 18-member) eurozone.
The ratings agency Fitch estimates that GDP growth was 4.0% in 2013, taking the three-year average to 4.8%, with a forecast of 4.1% in 2014.
The eurozone’s forecast for this year as a whole is only 0.9%.
Perhaps that is one reason why support for the new currency is anaemic at best. Latvians are joining the euro chastened by their recent experience, but also sporting among the healthiest debt and deficit levels in the class.
Latvia’s public debt is around 35% of GDP (compared to Ireland’s which will peak this year at 124%) and Fitch puts its budget deficit last year at 1.4% (the official deficit level was 1.3% in 2012).
For that reason Latvians are anxious about being pulled under should any major eurozone crisis flare up again, especially in the southern periphery.
It is joining a club of 330 million Europeans, but one in which five countries sought a financial bailout.
“We don’t know how the solvency crisis will affect us,” says Peteris Strautins, a macroeconomic analyst with DNB Bankas in Riga. “Politicians can’t speak openly about these things, but economists certainly have their concerns.”
On the face of it, Latvia does not run many of the risks taken by the first wave of euro members, namely Ireland, Spain, Greece and Portugal, who ran amok with the low interest rates that eurozone membership brought.
There are few signs of any property bubbles outside several pockets of property speculation in the capital involving wealthy Russian investors. Furthermore, Latvia’s population is declining, so there is no expanding cohort of new families putting pressure on the housing stock.
Latvia is, of course, subject to the same raft of new rules on deficits and preventing macroeconomic imbalances (ie, housing bubbles) as all other eurozone members, and has been for some time.
Of some concern, though, is the growing number of deposits in Latvian and parent company banks from non-residents, estimated to be around 40% of GDP. Latvia has seen a significant inflow of Russian deposits, even before many Russians were burned by the Cyprus banking fiasco in March of last year.
Fitch has pointed out that the presence of such a large number of non-resident deposit holders “exposes the system to liquidity risk in the event of shocks, although this is mitigated by prudential liquidity and capital buffers and access to ECB financing if required”.
For the moment, Latvians are having to get used to the new currency, and are somewhat sore that the government chose not to hold a referendum on joining, not to mention fearful that it will mean higher prices.
Adjusting to the EU-IMF bailout programme has also associated euro membership in the eyes of many with poverty and emigration, despite the recent surge in growth.
The Bank of Latvia will mint new euro coins with the image of a Latvian folk maiden (the actual minting takes place in Baden-Wurtenburg in Germany), with the smaller cent coins showing the Latvian Republic’s coat of arms.
The outgoing currency, the lats, was cherished by the population since it was only re-introduced in 1993 once Latvia gained its independence from the Soviet Union. Moscow had imposed the Russian rouble since 1945.
However, many Latvians may feel that the presence of the Russian Federation on its doorstep is reason enough to eventually tolerate, if not embrace, the euro, especially given President Vladimir Putin’s muscle-flexing over Ukraine.
“No-one believes Russia is going to attack,” says Peteris Strautins. “But certainly the ruling elite, which is westward-leaning, is conscious of the possibilities through which Russian influence can be felt in hidden ways.”