Yesterday, the European Commission published its 2013 Convergence Report on Latvia, together with a citizen’s summary that briefly explains the report and the rationale behind it. The Commission concludes that Latvia has achieved a high degree of sustainable economic convergence with the euro area and proposes that the Council decide on Latvia’s adoption of the euro as from 1 January 2014.
Olli Rehn, Commission Vice-President responsible for Economic and Monetary Affairs and the Euro said, “Latvia’s experience shows that a country can successfully overcome macroeconomic imbalances, however severe, and emerge stronger. Following the deep recession of 2008-9, Latvia took decisive policy action, supported by the EU-IMF-led financial assistance programme, which improved the flexibility and adjustment capacity of the economy within the overall EU framework for sustainable and balanced growth. And this paid off: Latvia is forecast to be the fastest-growing economy in the EU this year.”
He added: “Latvia’s desire to adopt the euro is a sign of confidence in our common currency and further evidence that those who predicted the disintegration of the euro area were wrong.”
The Convergence Report concludes a positive assessment of Latvia’s economic performance against the convergence criteria set out in the EU Treaty as follows:
The average inflation rate in Latvia in the 12 months to April 2013 was 1.3%, well below the reference value of 2.7%, and it is likely to remain below the reference value in the period ahead. While short-term factors (notably the VAT cut last July) have contributed to the particularly low current level of inflation, the analysis of underlying fundamentals and the fact that the reference value has been met by a wide margin support a positive assessment of the fulfilment of the price stability criterion. Latvia will need to remain vigilant to keep inflation at a low level, including by maintaining a prudent fiscal policy and keeping domestic demand on a sustainable path.
Public finances (deficit and debt)
The general government deficit-to-GDP ratio reached 8.1% in 2010, but decreased to 1.2% in 2012 and is projected to remain at 1.2% in 2013 according to the Commission’s latest Spring Forecast. The general government debt stood at 40.7% of GDP at end-2012. The Commission considers that the excessive deficit has been corrected in a credible and sustainable way and has recommended that the EU Economic and Financial Affairs Council (ECOFIN) close the excessive deficit procedure for Latvia (see MEMO/13/463). If this is done, Latvia will fulfil the criterion on the government budgetary situation.
Latvia’s average long-term interest rate over the year to April 2013 was 3.8%, below the reference value of 5.5%. The spreads vis-à-vis euro area long-term benchmark bonds have been declining markedly since 2010, which reflects market confidence in Latvia.
The Latvian lats has participated in the Exchange Rate Mechanism (ERM II) since 2 May 2005, which is considerably more than the minimum two years. When it joined ERM II, the Latvian authorities committed to keep the lats within a ±1% fluctuation margin around the central rate. During the two years preceding this assessment, the lats exchange rate did not deviate from its central rate by more than ±1% and it did not experience tensions.
Other factors have also been examined, including balance of payments developments and integration of labour, product and financial markets. Latvia’s external balance adjusted significantly during the crisis, supported also by improvements in its external competitiveness. Latvia’s economy is well integrated within the EU economy through trade and labour market linkages, and it attracts sizeable levels of foreign direct investment. The integration of the domestic financial sector into the EU financial system is substantial, mainly due to a high level of foreign ownership of the banking system.
Finally, Latvia’s legislation in the monetary field is compatible with EU legislation.
This assessment is completed by the European Central Bank’s (ECB) own convergence report, also published today.
Throughout the crisis, Latvia has successfully managed a difficult macro-economic adjustment process. Determined implementation of the EU-IMF-led financial assistance programme helped the country to steer out of a deep recession and to return to economic growth.
According to the EU Treaty, the Commission and the ECB report every two years or upon request by a Member State with a derogation on the subject. On 5 March this year, Latvia formally asked the Commission to deliver an extraordinary convergence report with the aim of joining the euro from 1 January 2014.
The conditions for euro adoption consist of four stability-oriented economic criteria regarding the government budgetary position, price stability, exchange rate stability and convergence of long-term interest rates which need to be fulfilled in a sustainable manner. National legislation on monetary affairs must also be in line with the EU Treaty.
According to the Treaty, additional factors also have to be taken into account in the assessment (balance of payments, market integration) as indicators that the integration of a Member State into the euro area will go ahead without problems and to broaden the view on the sustainability of convergence.
ECOFIN Council will take the final decision on the adoption of the euro in Latvia in July, after the European Parliament has given its opinion, euro area Finance Ministers have given a recommendation and EU leaders have discussed the subject at the European Council meeting on 27-28 June.
The procedure will be fully completed once the Council of Ministers, acting by unanimity of its euro area Member States and Latvia, has irrevocably fixed the exchange rate of the lats to the euro.