Latvia is expected to adopt the euro on January 1, 2014. There are high expectations that adopting the euro will lead to benefits like low inflation, high growth, and rising foreign investment. However, other eurozone countries' experiences show that underlying competitiveness, institutions, politics, and policymaking are more important determinants of success than joining criteria. Slovenia joined the eurozone in 2007 and experienced slowing growth as it struggled with institutional readiness. Slovakia joined in 2009 at an overvalued exchange rate but was able to avoid major negative impacts due to previous economic reforms. Estonia's transition to the euro in 2011 went smoothly.

1. 4
T
here are high expectations in Latvia
with the adoption of the euro,
expected Jan. 1, 2014. Latvia has
officially applied for eurozone membership;
the final decision should be made by
eurozone finance ministers in July.
From the general talk around town,
one would expect the euro to deliver
miracles: low inflation, high growth, low
unemployment, rising foreign investment,
better living standards for all. It can do all
this, but not by itself. The euro will need
help from a good government, and an
inviting investment and business climate.
A part of Latvia’s cherished identity – the
lats – will disappear Jan. 1, hopefully forever.
That means companies need to be preparing
their accounting systems, pricing, etc. for the
changeover. Latvia will be joining a currency
bloc with a combined 9.5 trillion euros
in output last year. What can we expect?
For local companies that trade with the
eurozone, adopting the euro will eliminate
currency risks. The same can be said for
eurozone companies looking to invest in
Latvia – currency fluctuations will not be
a consideration, important in long-term
planning.
Currency transaction costs will also be
eliminated – no need to exchange euros to
lats, and pay a commission, when receiving
payment for products sold to eurozone
customers. And no need to keep forecasting
your currency needs, or hold both currencies
on deposit in the bank.
Price transparency among euro neighbors
– Estonia is our closest – will benefit
consumers. A Latvian living near the
Estonian border may see that a refrigerator,
for example, in Estonia is priced lower than
at home; this comparison made easier as
both are listed in euros. This should increase
price competition within the region.
Will the euro bring inflation with it? There
will be a one-time, transitional inflationary
impact, as companies, in changing pricing
from lats to euros, will round up, rather than
down, euro prices. The Latvian authorities
say they will be watching for this, with stiff
penalties for those, say at the retail level,
that take advantage of the changeover
confusion and try to raise prices excessively.
Nonetheless, the inflationary impact should
be minimal, around 0.2-0.3 percent.
Bank deposits, debts will be automatically
exchanged into euros at the official rate:
0.7028 lats/euro +/- 1%. However, though
this is the target exchange rate now on the
table, it could change. It will be important
that the officials get the exchange rate
right. Too high and Latvia’s producers are
not competitive; there will then be pricing
adjustments. Too low is good for exports, but
we’ll be in for inflation.
Joining the eurozone should boost
confidence with non-eurozone investors
looking to build, say manufacturing facilities,
in Latvia, as the euro represents stability
(despite the current problems) and a large
economic community. It can also be seen
to strengthen a rules-based economy,
with a stronger hand in Latvia’s financial
management from the European Central
Bank and other institutions.
Academic Paul De Grauwe agrees that
investors, company management would
prefer certainty to uncertainty, and that
they, therefore, would prefer to eliminate
exchange rate risk. This is because uncertain
future exchange rates mean uncertain future
company sales volumes for an international
firm. However, he adds that profits for a firm
will be higher when there is exchange rate
theziedonisfinancialreport
Latvia Closes in on the Eurozone
By Dorian Ziedonis, dziedonis01@inbox.lv
Sourcing of premium construction services and construction materials from Eastern Europe,
Russia, Ukraine and the Baltic Countries. www.jlbaltic.lv

2. Spring/Summer 2013 – issue #41
5
theziedonisfinancialreport
uncertainty. This is because when the price
is high, the firm will increase production and
sell more at a higher profit. When the price
is low, the firm will cut back on production.
So, in general, exchange rate uncertainty
may increase the firm’s average profits.
Will adopting the euro increase economic
growth in Latvia? Everyone says ‘Yes.’ The
answer should be ‘Yes, but only a temporary
increase, a direct result of a drop in interest
rates.’
In addition, due to the previous analysis,
by eliminating exchange rate uncertainty,
expected future profits are also reduced:
the expected return on investments made
by firms is lower, so there is less incentive to
invest.
Well, that’s the theory. Can Latvia expect a
large foreign investment surge, and stronger
GDP growth due to the euro? We may be
expecting too much. After all, billions of
euros in investment have already been
flowing into Latvia for the past 20 years,
from the little candle maker, to all the
multinationals, and we didn’t need the euro
for this.
With the euro, will Latvia be an attractive
place to invest? A better question may be:
is Europe a good place to invest? Consulting
firm Grant Thornton in a recent report issued
this warning: companies in Europe since
2009 have lost $2 trillion due to the ongoing
euro crisis, as well as costly regulation. This
has made the eurozone a less favored place
to invest. However, the report adds that
the Baltics may still be attractive due to its
emerging market status.
Experiences from other euro
adopters
Slovenia was first to join
Slovenia joined the eurozone in 2007, three
years after joining the EU. It was the first ex-
communist country to join the euro group of
countries. The mechanics of adoption went
smoothly, with a “Big Bang” transition period
in which the euro immediately replaced the
tolar following an extensive public education
period, wrote the Financial Times.
Fears that introducing the euro would lead
to inflation due to the “rounding-up” effect
proved to be unfounded, as has been the
case in other countries joining the euro. The
actual initial level of euro-induced inflation
in Slovenia was 0.3 percent, and prices
actually fell in January and February 2007.
The larger problem was with Slovenia’s
institutional readiness, and timing, to join
the common currency. It went in at the peak
of the global economic boom, with GDP
growth averaging at around 4 percent, but
the country was also weighed down with
a generous pension system, a rigid labor
market and a weak corporate environment.
That translated into sharply slowing GDP
growth as the country had a difficult time
remaining competitive. The economy grew
by 6.8 percent in 2007, dropping to 3.6
percent in 2008 and the crisis year of 2009
saw the economy contract by 8 percent.
The Financial Times article says that “The
lessons of Slovenia show that underlying
competitiveness, institutions, politics and
policymaking are actually far more important
determinants of success than the specifics of
joining criteria [or the Maastricht criteria].”
Latvia won’t have the institutional readiness
problem that Slovenia had. The country has
gone through a restructuring of government,
its spending priorities, with the IMF and EU-
led assistance, and is in much better position
today if the euro-economy deteriorates
further.
15 January 2007 - Celebration ‘A Welcome to the
Euro’. Mr. Janez Janša, the Prime Minister of the
Republic of Slovenia. Photo: Primož Lavre/Salomon
2000
Specialist in ground source heat pump systems, an energy efficient way of heating your
home. www.divine.lv

3. 6
Bad timing for Slovakia
Slovakia was the next ex-communist country
to join, in 2009, and did so at an exchange
rate that was seen as overvalued and much
less favorable than Slovenia’s, the result
of a strong appreciation trend in the final
months of the economic boom. But fears
that Slovakia had made itself uncompetitive
proved to be overblown, thanks to the
deep economic reforms that the country
undertook at the end of the 1990s that
made it one of the world’s best-performing
economies.
Robert Fico, the left-wing prime minister
who steered the country into the common
currency, ended up calling the euro a
“shield” which defended his country
from the wild currency swings that hit
the rest of Central Europe in late 2008.
Although Slovakia did not get the boost
from depreciation enjoyed by countries
like Poland and Hungary, which maintained
floating currencies, it quickly returned
to growth after suffering a 4.9 percent
contraction in 2009. By 2010, growth was
back at 4.2 percent.
When joining the euro, Fico was very careful
about the prospect of a spike in inflation,
even setting up a commission to monitor
prices and running a program called: “We’re
changing the currency, not the price.”
For several months after adopting the
euro, prices were listed in both euros and
korunas to allow shoppers to make easy
price comparisons, and inflation was not a
problem.
After the initial expected rise in inflation,
longer term the euro has served to tame
inflation. Vladimir Vano, an economist with
Slovakia’s Volksbank, points to the inflation
benefits of being in the euro. Ever since
joining the single currency in 2009, Slovakia
has clocked in lower inflation rates than its
neighbors – Poland, the Czech Republic,
and Hungary. “That means Slovaks have not
seen deterioration in their buying power,” he
says. “The adoption of the euro has brought
us undeniable benefits. We have had no
currency weakening, [we have] low inflation
and lower transaction costs.”
Leading up to euro adoption, analysts
generally were in agreement that the euro
would be beneficial to Slovak citizens as well
as businesses. Eliminated were transaction
and administration costs on trades estimated
at 0.36 percent of GDP, according to the
National Bank of Slovakia.
When looking at manufacturing for Slovakia,
the Czech Republic and Hungary, Slovakia
tracked the other countries fairly closely
during the 2009 downturn, but then actually
did better in the 2010 recovery. As the first
wave of the crisis receded, the advantages of
being in the euro grew for Slovakia, primarily
because foreign investors faced no currency
risk when putting their money into the
country. Other CEE countries have seen their
currencies sag against the euro, but swings
in the forint, zloty and koruna have been
quite wild, adding an element of uncertainty
to investment decisions.
Andreas Tostmann, then head of
Volkswagen’s operations in Slovakia, said
that the country’s status as a eurozone
member was one of the key factors in
deciding to increase investment in the
company’s factory there.
Slovakia has seen a sharp increase in foreign
direct investment, which rose from 123
million euros in 2010 to 518 million euros
last year. Not all of this can be attributed
to the euro, but the euro is in the decision-
making process.
Smooth transition for Estonia
Estonia joined the euro on Jan. 1, 2011, after
successfully retaining its fixed currency peg
against the euro. During the crisis, many
economists advised Estonia, as well as Latvia
and Lithuania, to drop their pegs as a way
of regaining competitiveness – essentially
to devalue the currency. Instead, all three
countries undertook very painful internal
theziedonisfinancialreport
Unveiling the Slovak Euro coin design.
Photo: European Commission.
Leader of providing economising systems of continious power supply and power energy and
maintainance in the Baltic States. www.energolukss.lv

4. Spring/Summer 2013 – issue #41
7
theziedonisfinancialreport
devaluations, slashing wages and boosting
competitiveness, and the programs worked.
Estonia undertook a fiscal consolidation
totaling about 14 per cent of GDP and saw
a contraction of 14.3 per cent in 2009, but
was back to growth by 2010. In 2011, its first
year in the eurozone, the economy grew by
7.6 percent.
For Estonia, there was little reason to hang
on to the kroon because its currency board
system meant that it had no independent
monetary policy anyway, and the country did
not want to devalue. It’s the same for Latvia.
Again, fears of an inflationary spike proved
to be exaggerated, with short-term price
variations of only about 0.2 percent during
the changeover. Estonia also saw some
benefits from joining, such as a drop in
interest rates.
For Estonia, which still has fresh memories
of being a Soviet colony, the main imperative
of being in the euro is not economic but
strategic – cementing itself fully into West
European institutions to prevent the danger
of Russian revanchism. “The euro is a long-
term strategic project. It is not just a device
to steer our macroeconomic policies,” said
Marten Ross, former deputy governor of
the Estonian Central Bank, in the Financial
Times.
Estonia kept its budget in order; it is the only
eurozone country with a budget surplus,
wrote Globalpost in a recent review of the
country’s economic performance. National
debt is just 6 percent of GDP, compared to
81 percent in Germany, or 165 percent in
Greece. Cutting-edge tech firms complain
they can’t find people to fill their job
vacancies.
The country continued with three years of
painful government belt-tightening after
the crisis, says Peeter Koppel, investment
strategist at SEB. As well as slashing public
sector wages, the government responded to
the 2008 crisis by raising the pension age,
making it harder to claim health benefits and
reducing job protection.
It still has its share of economic problems.
The average monthly take-home pay of 697
euros is among the lowest in the eurozone
and unemployment at 11.7 percent is still
above the bloc’s average. The jobless rate is
falling however, thanks in part to a thriving
tech sector.
Estonia has also paid close attention to the
fundamentals of establishing a favorable
business environment: reducing and
simplifying taxes, and making it easy and
cheap to build companies. Its location —
with quick access to Nordic, German and
Russian markets — has also helped. Overall,
the euro transition has gone well for Estonia,
with public support in the ascendency.
About Dorian
Ziedonis
Current position:
Editor-in-Chief at the weekly
newspaper ‘The Baltic Times’
Education:
New York University - Leonard N. Stern
School of Business
Experienced and appreciated partner in fields such as infrastructure development, rural development, water supply
and education. www.hifab.se