On January 1, 2015, Lithuania became the 19th country to share the European common currency in spite of the Eurozone’s waning prestige and stubbornly slow growth.
Lithuania’s entry in the Eurozone highlights the conflicting attitudes about the euro in a region that threw off communism a quarter-century ago. Lithuania was among nine eastern European countries that joined the European Union (EU) in 2004 and committed to adopting the common currency after meeting the entry criteria. Estonia, Latvia, Slovakia, and Slovenia have already joined the euro, while Romania has set a deadline of 2019 for joining. Hungary, Poland, and the Czech Republic have instead abandoned adoption targets and stopped taking concrete steps toward accession. According to the Eurobarometer survey, 55 percent of Poles oppose surrendering the zloty for the euro, versus 32 percent in favor. Fewer than 20 percent of Czechs back the euro entry, with 76 percent opposed; in contrast, only 23 percent were against the switchover in 2004. This is not surprising. East European economies have used their currencies as effective tools to manage the weaknesses of their economies. Giving up this strong tool is not an attractive proposition for them, especially in light of the problems facing the Eurozone.
So why would Lithuania—a fast-growing, low-debt country—want to join a club that very few are eager to join?
The most obvious answer is that Lithuania is required to join. All members of the EU except the United Kingdom and Denmark, which secured formal “opt-outs” two decades ago, are required by the Maastricht Treaty to join the single currency. Sweden is currently “living in sin” and enjoying the easy trade and travel that comes with EU membership without the straitjacket of the euro. For Lithuania, however, the euro promises to be both a political and economic boon, even if the changeover would cost 600 million euros through 2020 in contributions to the EU budget, costs to commercial lenders, and other expenses. That is a substantial sum in a country of 3.3 million people and whose entire economic output equals less than half a year’s revenue at Apple. Yet the cost is probably worth the benefit; as opposed to Poland and Hungary, Lithuania has not had an independent monetary policy for the past twenty years because of its currency pegs. Joining the euro would relieve the central bank of the stress of having to defend the value of the litas on currency markets, and it would give Lithuania a say in the decision-making of the European Central Bank (ECB), as well as access to the ECB single-resolution fund and cheaper borrowing costs.
Less obviously, the euro might provide a shield amid heightened security concerns stemming from Russia’s actions in Ukraine and President Putin’s interests in the Baltic states. Lithuania is an ex-Soviet nation just a short flight from Moscow, and about five percent of the population is Russian-speaking, a group that Vladimir Putin has shown an inclination to “protect.” Moscow held surprise military exercises in Kaliningrad, its enclave bordering Lithuania, in December 2014, with 9,000 troops and 55 ships, and it has been sending patrols of military aircraft over the Baltic Sea; Lithuanians interpret these gestures as an attempt to intimidate them. Lithuania believes that President Putin may be more cautious in provoking a country that is a member of NATO, the EU, and the Eurozone. In the words of Vitas Vasiliauskas, the governor of the central bank: “We are almost a front-line country; everything that pegs us to the West makes us safer.”
Lithuania’s move to join the euro also coincided with steps taken to secure energy independence from Moscow, as well as even more vocal denunciations of Russia’s political and economic abuses. Last October, Lithuania’s first floating liquefied natural gas import terminal began operations; this marked the end of the Baltic state’s sole reliance on Russian gas by allowing it to import from Norway. Finally, the euro gives Lithuania more freedom in business negotiations with Russia. Noting this, Prime Minister Algirdas Butkevicius recently stressed that some businesses in the country still do not appreciate the risks of dealing with Russia, and that they would be better off working in markets that pose less risk and thus provide better long-term stability. Similar geopolitical considerations may prompt Hungary, Poland, and other countries in eastern Europe to revisit their options and seek the euro as a strategic priority, recognizing that it could provide political certainty in addition to economic benefits.
There are other reasons for Lithuania to join the euro, some obvious and some less so. Finance Minister Rimantas Sadzius stated that Lithuania’s entry in the euro would complete the Baltic region’s economic integration, make the country more attractive for foreign direct investment, and help develop new markets in countries like Germany that would give it access to the West. With the adoption of the euro, investors believe that economic policymaking would become more predictable. What is more, Lithuania’s banks and central bank would gain access to ECB funding in case of an economic emergency, which would reduce the government’s cost of borrowing. The Eurozone is Lithuania’s biggest trading partner; using the single currency would boost trade further. This has assumed new importance because Russia, which normally accounts for 30 percent of Lithuania’s exports, has recently imposed sanctions on Lithuanian goods. For Lithuanian business, adopting the euro removes the administrative burden and cost of money-changing, estimated at €40 million a year, and eliminates any residual risk of a currency crisis. Lithuanians are already benefiting from low interest rates, another byproduct of euro membership, which protects them from attacks by currency speculators. The central bank reckons that the euro is likely to boost the country’s GDP over the long term by about 1.3 percent, even if decline in consumer purchasing power in Russia, competition in the Eurozone, and weak investment in manufacturing will continue to challenge the country’s economy.
Euro membership could, however, exacerbate the country’s economic weaknesses. Lithuania is one of the world’s most export-intensive economies, but the productivity of Lithuania’s workers is one-third the Eurozone average. Cheap labor helps to make its exports competitive, but real wages have grown by 5 percent this year, far above the Eurozone rate of about 1 percent. In part, that is due to last year’s 25 percent hike in the minimum wage. Lithuania’s odd labor market is also responsible. For years, emigration, particularly of young people, has been high, with the population falling by 20 percent since 1990. Worse, a tenth of adult Lithuanians cannot work for lack of even basic skills. The talented workers that remain are very well rewarded, and a lot of investment would be needed to raise productivity. Wages are therefore expected to outpace productivity for the next few years, despite the government’s promise to use EU funds to boost skills. Wage growth, in turn, could lead to rising prices, and to Lithuanian inflation exceeding that of the Eurozone for the next few years, meaning that over time Lithuanian goods may become relatively more expensive. The worry is that history will repeat itself. Lithuania may gradually lose competitiveness, just as Greece and Portugal did before the euro crisis.
This would be a pity, as Lithuania’s GDP has been growing by 4.3 percent per year, and its ratio of government debt to GDP is among the lowest in the EU. Moreover, this impressive performance is the result of the sort of “root and branch” reforms most Eurozone countries have shirked, and that Lithuania implemented in response to a domestic financial crisis in 2009: a hangover from a credit bust in which GDP dived by 15 percent and unemployment hit 18 percent. From 2009 to 2013 the government slashed spending by 10.5 percentage points of GDP, more than any other country in the EU, by cutting public sector wages 20–30 percent and reducing pensions by as much as 11 percent. Even then-Prime Minister Andrius Kubilius took a pay cut of 45 percent. And the government didn’t stop there. It raised taxes on a wide variety of goods, like pharmaceutical products and alcohol; corporate taxes rose from 15 to 20 percent, and the value added tax rose from 18 to 21 percent. The net effect of these measures was to slim Lithuania budget deficit from 9.3 percent to 2.6 percent of GDP, making the country’s economy healthier than most EU economies. However, the governor of the central bank, Mr. Vasiliauskas, believes that his country should not rest on its laurels, and that it should move forward with reforms in the education and health sectors, and take advantage of opportunities the euro would bring.
The euro remains a divisive issue, with polls showing close to 40 percent of the population still not convinced that dumping the litas is a good idea. Many equate the litas with stability after a series of economic crises and currency overhauls since the country’s independence from the Soviet Union in 1990. Almost two-thirds of Lithuanians fear their country is losing part of its identity by switching to euro; they have been vocal about the fact that the euro makes pensions and salaries look exceptionally low. In Lithuania, the average gross monthly salary is €699 while the average pension is €240, and although the difference in salaries between Lithuania and Western Europe has always been widely known, the direct comparison seems to be having a stronger negative psychological effect than the government anticipated. Almost everybody expects prices to rise after adopting the euro. Prices did go up in anticipation of the euro, but the increases were largely contained, thanks to a period of dual-pricing and businesses signing public memoranda promising that they would not make the euro an excuse for raising prices. Nigel Farage, leader of both the British UKIP and the Euroskeptic group in the European Parliament, agrees with the Lithuanians who think their country is making a mistake by joining the euro. In a recent interview in Vilnius, he pointed out that
the euro is a short-term temptation of the Lithuanian political class believing they will be part of a bigger club and that this will lead to lower interest rates. But I doubt you’ve been told that by joining the euro you are entering a full economic and monetary union with Greece, Italy, Portugal, Spain and Cyprus. You will finish up having to pay a higher portion of the bill.
The Prime Minister, Minister of Finance, and the governor of the central bank insist that the longer Lithuania stayed with the litas, the more it would have spent on higher interest rates, higher risk premia on bonds, and exchange fees, and that public support will rise as people get used to the new currency and see the benefits, as happened in neighboring Latvia and Estonia, which are already Eurozone members. They are also hopeful that the adoption of the euro would change Lithuanians’ marked preference for using cash as opposed to bank cards, which in turn would also weaken the country’s rather large informal economy. SEB Bank disclosed that on December 29, 2014, four times more cash than usual was deposited in its branches, and the number of customers was twice the average. Joining the Eurozone has apparently stirred up the cash flows and made Lithuanians take the cash from under the mattress and deposit it in their accounts. ECB data also show that Lithuanians take twice as much money out in cash as do Estonians or Latvians, and that this cash is mostly used as “under the counter” money, as interest rates for time deposits in commercial banks are very low.
Lithuania may be the last new member of the Eurozone until the end of the decade, or perhaps even longer. Reading the ECB convergence report, it is hard to escape the impression that countries like Sweden or the Czech Republic are not yet being invited to join because they are not even trying. So, Lithuania’s lone admittance among the current outsiders serves more as a reminder of the tarnished dream of a single currency than as confirmation of the euro’s continuing appeal.