Four risks associated with Lithuania’s euro adoption

Four risks associated with Lithuania’s euro adoption

Lithuania is on track to become the 19th member of the eurozone, given that the country has finally met all convergence criteria. Yet the intense desire for further integration in the EU has more of a political than  economic rationale.  

In early June, Lithuania received the preliminary green light from both the European Commission and the European Central Bank to become the last Baltic country to adopt the euro. It is proposed that the country join in January 2015, should a formal positive decision be taken in the second half of July by the EU Council of Ministers. The Lithuanian government and President Dalia Grybauskaite insist on the numerous benefits of euro adoption, like eliminating currency exchange expenses, price stability, lower interest rates and attracting investment.

But the risks that go hand in hand with the monetary integration of a peripheral, ‘‘catching up’’ economy, and an already problematically structured economic union consisting of clear leaders and followers, remain strong. Here are four risks that could come out of Lithuania adopting the euro:

1. Asymmetric shocks

The main obstacle when joining a monetary union is how to deal with asymmetric shocks, in the absence of a national monetary policy. Once part of an economy within a common currency area is hit by a boom or slump, its macroeconomic policy needs change. Hence one-size-fits-all monetary policy would be at odds with any attempts to alleviate the shock. The loss of a mechanism for adjustment makes monetary integration difficult. As adjustment through currency depreciation is no longer an option, economies hit by a shock need to implement internal devaluation in order to reduce labor costs and restore their international competitiveness. But this sort of comparable adjustment is slow and painful, and leads to high levels of unemployment.

Moreover, the existence of structural differences (heterogeneity) and low correlation of business cycles among member states of a monetary union makes the possibility of asymmetric shocks even higher. The fact that, among Baltic countries, Lithuania is found to have the least correlated business cycle with the euro area makes the option of euro adoption even riskier.

2. Low public support

Although the Lithuanian parliament approved the common currency with near unanimity, the venture lacks public support. Most Lithuanians are not really convinced about the benefits of euro adoption- a fact that comes as a logical consequence of the recent euro zone debt crisis which has hit countries of the periphery (i.e Greece, Spain etc.) since 2009. In particular, according to the recent Euro barometer survey, support for euro adoption fell to 34% in March from 40% in November, while more than half of Lithuanians oppose the switch.

3. Price level increase

The most common argument against the common currency among eurosceptics is the price hikes that the changeover could trigger. The risk of a rise in prices does exist but it is expected to be quite modest. According to the Bank of Lithuania ‘‘the introduction of the euro should have a short-term, one-off impact on the price level of approximately 0.2 -0.3 %.”

4. The euro is not as stable as it used to be

The recent euro zone crisis highlighted in the worst possible way the fragility of the European institutions. Measures have already been taken to increase integration to shield the monetary union from future speculative attacks, (e.g., ESM and Banking Union).

But growth prospects are projected to be low in the long run. And the fact that the European Central Bank is cutting rates at even negative levels indicates that any stimulus attempt is not capable of boosting the European market.

Given the current situation of the Union and the excessive debt that many countries maintain, there are considerable chances that once a member of the euro zone, Lithuania, although relatively poor, may be obliged to financially contribute to richer, albeit indebted countries.

But if this is the case, why is Lithuania so willing to undertake these risks? There is no straightforward answer. Besides, strong arguments in favor of euro adoption also exist. However, it is clear that there are causes of a purely political nature that push Lithuania towards the West.

Stronger tie to Western Europe distances Lithuania from its longtime adversary, Russia, an argument that should not be underestimated especially in light of the recent developments in Crimea. Lithuania also wants to decrease its natural gas dependency on its eastern neighbor and fully integrating into Europe would help.

Risks from euro zone membership do exist, but Lithuania sees this potential as the only way to safeguard its economic independence from the east.



Categories: Economics, Europe

About Author

Evita Souri

Evita previously worked with the European Commission, dealing with EU external relations as well as with other governmental institutions. Her expertise is in European Union affairs and the former Soviet Union countries. Evita graduated with an MSc European Political Economy from the London School of Economics (LSE). She also holds a 1st - class honours Master's degree in Economics from the Aristotle University of Thessaloniki where she also completed her undergraduate studies in Economic Science.