June 5 (Bloomberg) -- Five countries on emergency aid, six consecutive quarters of economic contraction and 19 million people out of work haven’t dimmed the euro’s allure for small states that, like Latvia, have nowhere else to turn.
Latvia today was put on the path to becoming the 18th country to use the euro at the start of 2014, binding it deeper into the western European economy and providing an extra layer of insulation against Russia, its former imperial overlord.
“Latvia doesn’t have another choice,” Roberts Zile, a former Latvian finance minister who is now in the European Parliament, said in a telephone interview. “It’s a signal that we are going to the West. It’s also important for the euro zone to say, look, small countries which are coming out of the crisis are going to join the euro, even if the euro is in trouble.”
Latvia’s entry into the currency bloc will come after debt-encumbered Greece dodged leaving it and a newly elected government in Iceland decided that joining would be a bad idea.
In making its endorsement, the European Commission said Latvia is already “well integrated” with the broader European economy. European finance ministers, who have never overturned a commission recommendation on euro eligibility, will make the final decision on Latvia on July 9.
“I don’t think this says that the euro zone is out of trouble,” Simon Johnson, a professor at the Massachusetts Institute of Technology and a Bloomberg View columnist, said on Bloomberg Television’s “Surveillance” with Sara Eisen and Tom Keene. “It says that the euro zone is becoming more Germanic, more northerly in its orientation, in its attitude, perhaps in its culture. There are still big problems in the peripheral parts of Europe, particularly around the Mediterranean.”
The 2 million Latvians are veterans of the boom-bust cycle, replete with a European Union and International Monetary Fund bailout, that besets countries along Europe’s southern rim. Latvia rebounded from Europe’s deepest recession, with the economy shrinking 17.7 percent in 2009, to notch its fastest growth, 5.6 percent, last year.
The underside is an unemployment rate of 12.4 percent in March, with 21.9 percent of young Latvians looking for work and many emigrating to find it. Around 40 percent of Latvians risk “poverty or social exclusion” in the country’s downsized welfare state, the commission said last week.
Social tensions are part of the price Latvia paid for wrestling its budget deficit down to 1.2 percent of gross domestic product in 2012, below the euro’s 3 percent limit. Latvia also passed tests for inflation, debt, currency stability and long-term interest rates.
While raising no objections to Latvia, the European Central Bank said today that it will be “challenging” for the country to maintain its track record in keeping inflation down. Latvian cost-of-living increases averaged 1.3 percent in the 12 months to April, below a 2.7 percent target.
Latvia will follow its northern neighbor, Estonia, as the only countries to move into the euro’s orbit since the Greece-sparked debt crisis exposed the flaws in the currency’s management and fueled speculation that it might break up.
Both countries and southern neighbor Lithuania, once barred from the euro and now set to reapply to join in 2015, form a Baltic bloc that spent a half century as fiefs of the Soviet Union until becoming independent after communism collapsed in eastern Europe.
“All three Baltic states are inside or are well on their way to the economic and political core of Europe, and that’s indeed great,” EU Economic and Monetary Commissioner Olli Rehn told reporters in Brussels. He called the currency’s expansion “further evidence that those who predicted a disintegration of the euro were indeed behind the curve and simply wrong.”
By entering the EU and NATO, the Baltic states have taken out insurance policies against falling back under the sway of Russia, which has schemed to restore its influence during Vladimir Putin’s 13-year reign. Adopting the euro strengthens that buffer.
Addressing Putin yesterday, EU President Herman Van Rompuy said that after over three years of crisis fighting and 496 billion euros ($648 billion) in emergency loans, the single currency is here to stay.
“I emphasized the restored financial stability in the euro zone,” Van Rompuy told reporters after an EU-Russia summit in Yekaterinburg. “The euro is no longer under an existential threat.”
No Polish Target
The combination of factors that make it attractive to the Baltic states, however, are absent elsewhere, at least for the moment. Poland, the largest eastern European economy, has resisted setting a target date for joining as the debt crisis endures. Poland’s deficit, at 3.9 percent of GDP last year, also tops the euro ceiling.
In western Europe, Denmark is caught between the currency’s gravitational pull and the political downside of being associated with it. While successive Danish governments have shown no inclination to embrace the euro after voters rejected it in 2000, the country pegs its currency to the euro, effectively outsourcing domestic interest-rate policy to the ECB.
For now, Denmark is alone in that halfway house. Other countries that have formally linked to the euro -- Greece, Estonia, Lithuania, Slovenia, Cyprus, Latvia, Malta and Slovakia -- have done so because it was a necessary first step to full absorption in the monetary union.
“It would just make logical sense to go into the zone that we’re pegged to anyway,” Krisjanis Karins, a former Latvian economic minister who also sits in the EU Parliament, said in a telephone interview. “It’s a little bit like being the small ship tethered by a rope to a large tanker: if that tanker is being rocked by the waves, our boat is being rocked no less. We are not protected in any way by being outside of the euro zone, but by being inside, we can benefit from the upside.”
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