Thursday, March 5, 2015

Lithuania Joins the Eurozone

This article appeared in the February 2015 print edition of the Diplomatist.

by Lindsay Ozburn and Matthew A. Rosenstein

Lithuania entered into the Eurozone on January 1, 2015, becoming the 19th European Union Member State and last Baltic country to join the single European currency. Like Latvia’s entry in 2014, Lithuania joins the Eurozone at a very critical moment for the euro, the EU, and Lithuania itself. The euro’s value fell to a nine-year low, with the inflation rate in the Euro Area moving into negative territory at -0.2% in December, sparking concerns of another debt crisis. Greece continues on its tumultuous economic path, with leaders of the main opposition party Syriza, ahead in polls just weeks before national elections, threatening to have Greece leave the Eurozone if debts are not erased. Tensions with Russia are at an all time high over the annexation of Crimea and heavy sanctions imposed as a result, making further integration with the West by Lithuania, as a former Soviet country, a sore point for Russia. These concerns aside, Eurozone membership provides Lithuania with opportunities to reap substantial economic benefits.

State of the Euro

With disconcerting deflation hitting the Eurozone, many ask if 2015 was truly a good time for Lithuania to switch to the euro? In a January 14 report, the World Bank announced growth in 2014 had been disappointing, citing that recovery did not gain traction in the Euro Area as expected. They warned that if the Eurozone “slips into a prolonged period of stagnation or deflation, global trade could weaken even further.” The World Bank has also urged the European Central Bank to implement a stimulus program to boost growth. The value of the euro fell to its lowest level since the middle of 2010 after ECB president Mario Draghi hinted that the bank might heed the World Bank’s advice and start a quantitative easing (QE) – by way of printing money hoping to buy sovereign bonds – to stimulate the Eurozone economies. The legality of this QE is of serious concern for Germany, the most economically dominant country in the Eurozone. After Draghi’s comments were made public, the euro fell 0.4% to $1.2034; it fell further still by mid-January to levels below its 1999 launch value of $1.1747.

There are widespread fears that deflation could reignite the 2009 debt crisis – fears further perpetrated by the threat of Greece leaving the euro and returning to the drachma. While consumers are rejoicing over the extra funds in their budget due to uncommonly lower gas and oil prices, many fear adverse economic effects once the initial excitement and increased consumerism subsides. Lower prices now mean lower expectations for prices in the future. This reduces revenue for the oil industry which leads to lost jobs, reduced wages, another substantial drop in consumerism, and further economic decline. Debts will be harder to keep under control, especially for companies who rely on high oil prices or for economically unstable countries, such as Greece, whose debt burden continues to increase.

Instability in the Greek government shook the Eurozone further in January 2015. As part of their political platform, the left-wing anti-austerity Syriza party led by Alexis Tsipras called for a renegotiation of the terms of Greece’s 240 billion euro bailout, threatening to pull the country out of the Eurozone upon election if the ECB does not comply. With Tsipras demanding a write-off of at least fifty percent of Greece’s debt, reports circulated that German Chancellor Angela Merkel supported Greece’s exit from the currency, inciting further uncertainty about the future of the euro and, along with low oil prices, causing Eurozone bond yields to plummet to record lows on January 6. Merkel subsequently affirmed the policy position that Greece should remain in the Euro Area. However, on January 14 Finland’s Prime Minister Alexander Stubb expressed intent to deny Greece’s debt forgiveness demands. Similar to Scotland’s 2014 referendum on leaving the UK, the prospect of Greece’s departure from the Eurozone threatens the euro’s governing principles of membership. If leaving the currency proves successful, other debtor countries could soon follow. However, compared to this same scare in 2012, the EU is likely more equipped to handle a “Grexit” – a Greek exit – than before. In reality, the complexities and costs involved with leaving the Eurozone would likely dissuade the Syriza party from following through with their threat. Moritz Kraemer, chief ratings officer at Standard & Poor’s, suggests that Greece has very few bargaining chips to renegotiate its debt, and a “Grexit” would “not be so dramatic for its creditors.” However unsubstantiated, the situation has caused another wave of panic.

Lithuania’s Concerns of Joining the Eurozone

Despite the current turmoil within the Eurozone, Lithuanian President Dalia Grybauskaite expects membership in the currency union to give the country a competitive edge in international trade, attract investments, and significantly reduce borrowing costs. At her press conference on January 7, President Grybauskaite announced that, “the euro is merely a means for us to continue this [pragmatic and responsible fiscal] policy while the euro area demonstrates Lithuania’s recognition and reliability in the international arena.” Despite concerns over the small size of their economy, analysts project that Lithuania will have the highest increase in GDP of all three Baltic States in 2015 at 2.6%.

Lithuania’s citizens are not as confident about joining the euro, however. According to a Eurobarometer opinion poll of Lithuanian citizens conducted in September 2014, roughly fifty-five percent of respondents opposed the adoption of the euro. More than six out of ten respondents feared the country would lose its hard fought identity by joining the euro. Eighty-four percent of respondents believed adopting the euro would result in a higher cost for goods and services. With Lithuania’s hourly wages already among the lowest in the European Union – €4.80 compared to the EU-15 €20.40, according to a May 2014 Commission report – higher costs would likely provoke the persistently high unemployment rate reported by Eurostat at 11.5% in November 2014.

Euro Is Good for Lithuania – But Is Lithuania Good for the Euro?

As a former Soviet bloc country, Lithuania is still in the process of building their economy and relies on Russian trade to do so. As this last Baltic country solidifies its shift to the West, EU-Russian relations continue to strain. Lithuania’s move to the euro is followed by greater energy and trade independence from Moscow, as well as requests for more NATO troops in the country. President Grybauskaite announced military aid to Ukraine in November 2014, sparking further tension and fears they could be next in Russia’s quest to ‘protect’ the pro-Russian citizens of this former Soviet country. In response to the military aid, Russia held a surprise military exercise in their enclave Kaliningrad in December 2014 with approximately 9,000 troops and 55 ships. Russia additionally imposed another round of sanctions on Lithuania, hurting several Lithuanian industries. Since loss of the Russian market is EU-wide, Lithuania must now compete with other member states to export their goods. This has the potential to negatively impact their GDP by at least a few percent annually. Strategically situated between Russia and the EU, Lithuania is typically able to reap the benefits of Russian tourism. Since the value of the rouble has been rapidly declining due to heavy sanctions, Russian tourism into Lithuania is following suit. With the EU already facing trade losses due to its imposition of sanctions against Russia, this situation with Lithuania throws another log on the fire.

Lithuania has additionally been plagued with a serious emigration problem since their 2004 EU accession, leaving the country with very few young professionals to help boost economic production. Students, in particular, leave the country to procure higher educations from other EU member states but tend not to return. The UNESCO international student mobility in tertiary education datasets from 2012 show approximately 12,364 Lithuanian students were studying abroad at the time, with over half of them at British, Danish and German universities. Lithuanian business owners frequently mention their inability to find workers, even when offering higher wages.  There are hopes that joining the Eurozone will stop this brain drain and bring students back from other EU countries. In its current economic state, Lithuania is likely to be the beneficiary in this Eurozone relationship.

Future of the Currency

Ten years after the 2004 enlargement, we are now starting to see the product. Lithuania’s joining the Eurozone solidifies the relationship between all the former Soviet Baltic states and the EU. Donald Tusk’s new position as President of the European Council is the highest any Eastern European official has risen in the EU political sphere to date, helping to blur the infamous “Old Europe” and “New Europe” line former U.S. Defense Secretary Donald Rumsfeld alluded to in 2003, even while relations with Russia simultaneously threaten to redraw it in 2015. These circumstances mark an important shift in EU politics, giving more weight to the voices of Eastern European countries within the EU and hinting at a brighter future for internal EU cooperation.

While the Maastricht Treaty does require the remaining member states that joined the EU in or after 2004 (Bulgaria, Croatia, the Czech Republic, Hungary, Poland, and Romania) to adopt the euro, there is no set timetable for these changes. New Eurozone members are unlikely to surface for the foreseeable future amid fears of a “Grexit”, further deflation, and confrontation with Russia.

Authors
Lindsay Ozburn is a Graduate Assistant and Foreign Languages and Area Studies Fellow at the European Union Center at the University of Illinois, USA.


Dr Matthew A Rosenstein is Senior Associate Director of the European Union Center at the University of Illinois.

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