Euro-Area Expansion Set for Pause After Lithuania’s Entry

Updated on

Lithuania’s euro adoption tomorrow is drawing a curtain on a round of expansion into eastern Europe as larger economies in the region cling to their currencies after the monetary union’s crisis dimmed its appeal.

The nation of 3 million, passed up for membership in 2006, will become the 19th country to share Europe’s common currency, putting the entire Baltic region in the bloc after neighboring Latvia’s accession a year ago and Estonia’s in 2011. While Romania has set 2019 for joining the euro, other ex-communist members of the European Union, including Poland, the Czech Republic and Hungary, have abandoned adoption targets.

“The larger eastern European economies have used their currencies as a tool when the economies have been weak,” said Liza Ermolenko, an analyst at Capital Economics in London. “Giving up this strong tool for them is not very attractive, especially given the problems in the euro zone and the fact that using the euro also brings sufficient costs.”

Lithuania’s entry highlights the conflicting attitudes in a region that threw off communism a quarter-century ago, with the euro area’s sovereign debt crisis shaking public confidence in the currency. Political turmoil in Greece, which faces snap elections next month, has roiled financial markets anew, reviving memories from 2012 when its euro membership was in jeopardy.

Euro Commitment

Lithuania was among the eight eastern European countries that joined the EU in 2004 and committed to adopting the common currency after meeting the entry criteria. The group also included Hungary, Poland, the Czech Republic, Estonia, Latvia, Slovakia, and Slovenia. The last four have already joined the euro.

“Lithuania will indeed likely be the last addition to the bloc for years to come,” said Otilia Dhand, an analyst at Teneo Intelligence in London. “Other central and eastern European countries appear to be taking no concrete steps toward accession.”

Central banks in the rest of eastern Europe are seeking to retain independence to fine-tune their policies and ride out economic turmoil.

Having control over its own currency has allowed the Czech National Bank to weaken the koruna by intervening in foreign-exchange markets in November 2013 for the first time in 11 years as it fought off deflation risks.

Dangerous, Risky

Poland’s independent monetary policy helped it become the only EU economy to avoid recession since the debt crisis erupted in 2009. Polish central bank Governor Marek Belka said last week his country’s economy wouldn’t be better off in the euro area, making it “very dangerous and risky” to join right now.

The euro-area economy risks a renewed slowdown, with the European Central Bank estimating growth at 0.9 percent this year and 1.6 percent in 2015. That compares with better-than-forecast gains in Poland and the Czech Republic, where gross domestic product last quarter expanded 3.3 percent and 2.4 percent, respectively. Hungarian GDP rose 3.2 percent in the third quarter from a year earlier.

While support for the euro has grown in Lithuania, polls show the public opposed to joining the bloc in nearby countries.

Backing for the euro surged to 53 percent in Lithuania last month, according to a central bank-sponsored poll of 1,002 people, which didn’t provide a margin of error. That compares with 31 percent support in March 2006.

Czechs, Poles

Fewer than 20 percent of Czechs back euro entry, with 76 percent opposed, according to a survey taken by the Czech Academy of Sciences in April. Only 23 percent were against the switchover in 2001.

In Poland, 55 percent oppose surrendering the zloty, 32 percent favor euro entry and 13 percent are undecided, according to an Oct. 16-21 survey by the polling company Ipsos for the Finance Ministry in Warsaw published this month.

The central bank governor in Romania, the only country in the region to set a target date, describes the goal as “ambitious.”

Euro adoption “is a symbolic moment not only for Lithuania, but also for the euro area itself, which remains stable, attractive and open to new members,” Valdis Dombrovskis, European Commission vice president for euro policy and a former Latvian premier, said in statement on the commission’s website. “I am convinced that the Baltic states’ membership in the euro area will strengthen the economy of the region by making it even more attractive to businesses, trade and investment.”

‘New Thing’

For Lithuania, the euro promises both a political and economic boon. The country, which has had no independent monetary policy for 20 years because of its currency pegs, gains a say in the ECB’s decision making, access to Europe’s bank resolution fund and cheaper borrowing costs.

“We were in fact importing the monetary policy of the European Union before we even joined it,” Lithuanian central bank Governor Vitas Vasiliauskas said in an interview. “It’s a new thing for us.”

The prospect of euro adoption has already lured investors. Lithuania in October sold 1 billion euros ($1.2 billion) of 12-year bonds, its longest-ever maturity, at record-low yields.

Lithuania’s 10-year borrowing costs are hovering around 1.6 percent. Bond holders are charging Lithuania 115 basis points more than Germany to borrow, compared with 113 basis points for Latvian debt and 95 basis points for Poland.

Security Shield

“The euro is not a magic wand, it’s a chance,” Lithuanian Finance Minister Rimantas Sadzius said on LRT radio today. “It’s a chance for easier access to export markets and a chance to get cheaper borrowing costs. If we use this accession fully, we’ll help create a better base for the lives of our children and grandchildren.”

Europe’s single currency is also seen as a shield amid heightened security concerns stemming from Russia’s actions in Ukraine. The Baltic nation, which will celebrate 25 years of independence from the Soviet Union in March, put military units on high-alert for five days this month to respond to increased Russian military activity close to its borders.

“There’s also a geopolitical reason that is more relevant for the Baltic states than for any other EU country,” Lithuanian Prime Minister Algirdas Butkevicius said.

Similar considerations may prompt other countries in eastern Europe to revisit their options. Poland must seek the euro as a “strategic” priority, President Bronislaw Komorowski said in September at the swearing-in ceremony for Prime Minister Ewa Kopacz’s government.

“What’s interesting is how the Ukraine crisis has also caused Poland to reconsider its stance regarding the euro,” said Ermolenko at Capital Economics. “There’s more talk about how the euro gives political certainty along with economic benefits.”

(Updates with EU comment in 16th and Lithuanian finance minister in 21st paragraph.)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE