Lithuania Joins Eurozone– A Geopolitical Move with Economic Consequences

Eurozone’s overall economic problems have not dissipated, yet Lithuania joined Europe’s single currency zone adopting the euro in January 2015 – the third and last Baltic state (after Estonia and Latvia) to do so. Why? It had an obligation to do so under the European Union (EU) rules when it entered the bloc in 2004 now that the country meets the criteria for joining the single currency. Euro adoption provides Lithuania with a geopolitical shield against Russia, like joining the NATO, though this comes with economic ramifications as Europe’s crisis remains one of the biggest threats to the global economy in 2015.

Lithuania and Eurozone’s Real GDP Growth: 2008-2020

Lithuania GDP Growth

Source: Euromonitor International from national statistics/Eurostat/OECD/UN/International Monetary Fund (IMF), World Economic Outlook (WEO)

Note: Data for 2015-2020 refer to forecasts. 

A political and economic boon for Lithuania

Being part of the eurozone does come with certain advantages for the bloc’s second fastest growing economy in 2014 that grew by 3.0% year-on-year in real terms:

  • Euro adoption will boost foreign trade. The EU has a more powerful voice globally than a single country and as a result, Lithuania will benefit from being part of a ‘single market’ making trade more efficient;
  • Lithuania’s deep-rooted trade connections with Russia are a potential threat to the sustainability of its external balance and increasing trade with the EU will counter balance this effect. In 2014, Russia accounted for over 20.0% of the country’s total exports and imports respectively;
  • The euro offers member countries lower transactions costs, increases price transparency and eliminates exchange rate uncertainty. Since 2004, the litas was pegged to the euro at LTL3.5 per €, allowing for a +/- 15.0% deviation;
  • After over 20 years of no say in its monetary policy, the country can voice its opinion in the European Central Bank’s (ECB) policy making. In addition it gets access to Europe’s bank resolution fund and makes borrowing costs cheaper;
  • Inward investment into the Baltics will increase as they can be viewed as one investment destination. In 2013, Estonia, Latvia and Lithuania together attracted €1.7 billion (US$2.3 billion) of foreign direct investment inflows or 0.9% of the eurozone’s total investments.

Eurozone troubles are not over   

A geopolitical shield from Russia might be a high price to pay for Lithuania with the eurozone heading into a new crisis phase in 2015. Despite all measures, the EU authorities have been unable to cease the malaise and the eurozone has ended up with very high unemployment and very low inflation:

  • The eurozone slumped into deflation when its annual inflation reached -0.2% in December 2014 – a huge concern for the bloc. Germany – the bloc’s biggest economy recorded an annual inflation rate of only 0.1%. Prolonged low inflation will not only increase the debt burden but also ward off private investment and consumer expenditure;
  • The ECB announced in late January 2015 a monthly €60.0 billion (US$70.0 billion) private and public bond-buying programme starting March 2015 and lasting up to September 2016 to uplift low inflation. This move might be viewed as too ‘stimulatory’ for Germany where anti-euro popularity is on the increase. The conflict over austerity measures is causing political upheaval in many member economies as well;
  • Resurfacing problems in Greece are undermining the eurozone. The victory of radical left-wing Syriza party in the 2015 Presidential elections has sparked uncertainties as to whether Syriza will honour previous Greek agreements with the EU and IMF and could even trigger the collapse of major Greek banks that are still dependent on €11 billion in eurozone bailout bonds, with serious disruptive consequences across the eurozone;
  • On 19 January 2015, the euro fell to €0.87 per US$, its lowest level in 11 years. This was triggered by the move to scrap its three-year-old pledge to limit the value of the Swiss franc to CHF1.20 per € by the Swiss National Bank (SNB) in mid-January 2015. SNB’s move clearly signaled the challenges ECB faces.

Europe’s dismal prospects 

In 2015, eurozone’s real GDP growth is forecast at 1.1% year-on-year and annual inflation at 0.6%. Inflation in core economies Spain and Italy is expected to come in at just 0.5% and 0% respectively in 2015. The bloc’s tumbling currency, prolonged low inflation and high unemployment rates clearly suggests that the eurozone crisis is back and can pose as a major risk to the global economy in 2015.

As for Lithuania, annual real GDP growth is forecast at 2.9% in 2015 (slightly down from 3.0% in the previous year). But given eurozone’s grave uncertainties, Lithuania’s membership in the single currency union may not have the desired effect of boosting trade and investment in the course of 2015, and such GDP forecast may prove to be a little too optimistic.

 

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