February 20, 2015

Lithuania’s accession to the eurozone: Timing, motives, expectations

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A picture shows a detail of a banner welcoming Lithuania into the Eurozone hung on the European Commission headquarters in Brussels on January 5, 2015. Lithuania became on January 1, 2015, the 19th member of the eurozone, switching currency from the Lithuanian litas to the euro, ten years after it joined the European Union.
A picture shows a detail of a banner welcoming Lithuania into the Eurozone hung on the European Commission headquarters in Brussels on January 5, 2015. Lithuania became on January 1, 2015, the 19th member of the eurozone, switching currency from the Lithuanian litas to the euro, ten years after it joined the European Union.

Accession to the Eurozone may run the risk of the political elite letting its guard down.

Lithuania joined the eurozone in January 2015. It was the last of the Baltic States to introduce the euro, despite the original intention of the country’s political elite in 2004 to accomplish this as soon as possible. When, after joining the Exchange Rate Mechanism II (ERM II) in June 2004, Lithuania asked the EU to assess the country’s readiness to introduce the euro in 2007, it was given a negative assessment based on non-compliance with inflation criteria. It took a decade after accession to the EU to achieve this goal, despite the fact that, due to the existence of the Currency Board since 1994 and pegging the Lithuanian litas to the euro at a fixed exchange rate since 2002, the country’s monetary policy depended on the decisions of the European Central Bank (ECB) and its economy functioned as a quasi-member of the eurozone. This article discusses the main motives for joining the eurozone, the reasons for failing to accomplish this in 2007 and succeeding in 2015, and, finally, the expectations of political leaders and the population linked to membership of the eurozone.1

The first attempt and why it failed

When Lithuania joined the EU and NATO in 2004 and thus achieved its two strategic foreign policy goals set soon after the re-establishment of independence in 1990, the country’s political elite put in place new strategic priorities for its European and broader foreign policy. First, following a parliamentary resolution adopted upon EU accession, in the context of approaching parliamentary elections in autumn 2004 an agreement was signed between parliamentary parties on foreign policy priorities. Among other things, both documents referred to the need to deal with “pre-accession leftovers” such as joining the eurozone and the Schengen area. Based on the assumption that the status of “temporary derogation” was not beneficial for the country, the goal became to introduce the euro “as soon as possible”. Due to the requirement to participate for at least two years in ERM II, Lithuania joined it a month after joining the EU and maintained its pegged exchange rate regime.
With 2006 approaching, the debate on joining the eurozone in 2007 intensified. However, it was mostly the diplomatic efforts of Lithuanian foreign-policymakers and central bank officials that became more intense as the date of Lithuania’s assessment in spring 2006 approached. The public was less interested in the reasons for joining the eurozone than in receiving reassurances that Lithuania would get a positive assessment despite accelerating inflation in the country. It should be noted that, although Estonia also initially intended to ask for an assessment of its readiness to join the eurozone in 2007, it later withdrew the application. Lithuania and Slovenia were the two countries in the group that joined the EU in 2004 that asked to be assessed. Slovenia was assessed as meeting all convergence criteria. Lithuania, however, was assessed as not being ready due to the failure to meet inflation criteria.
Although the government at the time downplayed the significance of the failure to introduce the euro in 2007, it was the first significant failure of Lithuania’s European policy since joining the EU. The main reasons for this failure are to be found both in the country’s domestic politics and in broader EU politics. Domestically, with the economy growing at 7–8 percent a year—one of the fastest growth rates in the EU—the government was enjoying the fruits of the rapid convergence process by increasing budgetary expenditure rather than trying to constrain inflationary pressures. In addition, in 2005 and 2006 a number of regulatory policy decisions were made that resulted in an increase in regulated prices for electricity and public transportation. The price of imported oil also increased around this time, contributing to higher inflation. All these measures pointed to a lack of coordination between different institutions and public policies which were not aligned with the goal of joining the eurozone in 2007. This lack of coordination was itself a result of some ambivalence in the ruling coalition at the time about the rapid introduction of the euro, possibly because the majority of the population surveyed expressed concern about potential consequent price increases. There was also a lack of expert consensus on the measures required to meet the convergence criteria, especially how to manage inflationary pressures, while business associations—although supporting the introduction of the euro in principle—were concerned about possible tax increases because introducing the new currency was associated with a need to balance the state budget.
In the EU, the European Commission and the ECB took a very strict approach towards Lithuania’s assessment and whether it complied with the convergence criteria, prompting criticism from many prominent economists.2
Unofficially, concerns were expressed that poorer EU member states should not be allowed into the eurozone before they converged with richer states, as they might not be able to maintain their competitiveness without needing to devalue their currencies. Another concern was linked to the possible creation of a precedent for the future accession of larger candidate economies such as Poland. Lithuania’s failure to join the eurozone “as soon as possible” was thus due to a combination of domestic and EU-wide factors.

Economic crisis and the successful second attempt

The second target date for introducing the euro was set only at the end of 2012. In order to understand the reasons for the success of the second attempt, one has to take into account not only domestic and EU politics, but also the effects of the economic crisis of late 2008 and 2009. This saw Lithuania’s economy decline by almost 15 percent in 2009. At first, this significantly worsened the business situation and public finances, with the budget deficit increasing to almost 10 percent of GDP. Importantly, there was a strong consensus among the country’s political elite about the need to maintain the litas’ fixed exchange rate with the euro and to restore the country’s competitiveness and public finances instead by domestic adjustment measures (so-called “internal devaluation”). This implied cutting wages and reducing prices, as well as reducing budgetary expenditure and some changes to tax policy.3
As early as 2010, the economy started growing, credit ratings improved and the country returned to the path of economic convergence, which, by the end of the first decade of EU membership, had become the fastest of all EU member states.
The experience of the economic crisis was important in several respects. First, it showed to the European Commission and ECB officials that Lithuania (and the other Baltic States) was able to adjust to major economic shocks without resorting to devaluation and by following an adjustment path similar to that in countries within the single currency union. Soon after the recovery, the Baltic States became the favourite examples of EU officials talking about how eurozone members should cope with economic crises. For the Baltic States, joining the eurozone became the final step out of the crisis. Although it temporarily worsened the public finance situation, it pushed down inflation and, with fiscal consolidation measures underway, created a “window of opportunity” to meet the convergence criteria. Estonia, which also benefited from its prudent fiscal policy before the crisis, used this opportunity in 2011. Latvia joined the eurozone in 2014. Lithuania followed one year later, the delay explained partly by slower fiscal adjustment and uncertainty about meeting inflation criteria, partly by domestic politics (with political elites reluctant to discuss the issue before parliamentary elections in autumn 2012), and partly due to the increased risk of a “Grexit” and the state of the wider eurozone in 2012. These factors explain why it was not until the end of 2012 that President Dalia Grybauskaitė and Prime Minister (of a newly formed coalition government) Algirdas Butkevičius declared 2015 as the target date for euro introduction. Although some members of the ruling coalition publicly stated their reservations over this date, actual voting in parliament on euro-related laws showed quite strong support across both governing and opposition parties for achieving this goal.
The consensus of the political elite about the introduction of the euro in 2015 is reflected in survey data among the group: around 92 percent of respondents supported the proposal.4
Interestingly, a similar share of respondents indicated that their opinion on the date for euro introduction should not be affected by events in Ukraine. This suggests that the geopolitical motive was strong even before these events. However, the survey also revealed that geopolitical concerns were not the most important motive for the introduction of the euro. The most frequently indicated reason had to do with the economic benefits of Lithuania joining the eurozone, followed by the need to participate in eurozone decision-making (to have “a seat at the table”) and the geopolitical motive (the assumption that the country’s security would be strengthened by being linked through the single currency to its other 18 members). Although such motivation might seem puzzling—given the conventional wisdom that the creation of the euro was itself mostly motivated by political rather than economic reasons—it can be explained by the history of the fixed exchange rate in Lithuania. The potential economic benefits of Lithuania’s membership of the eurozone were also underlined by the Bank of Lithuania’s own assessment.5

Popular expectations and concerns

The public at large has not been as supportive of euro introduction as the political elites. According to the Eurobarometer survey, in April 2013, when the date of euro introduction in 2015 had already been announced by the government, only 35 percent of respondents agreed that the euro would be beneficial to Lithuania, while 55 percent felt that it would have negative consequences.6
However, the gap between those holding negative and positive views narrowed during 2013 and 2014, reaching 48 percent and 44 percent respectively in September 2014. By January 2015, the share was 63 percent positive to 20 percent negative. According to the same survey, a majority (83 percent) of respondents thought that euro introduction in Lithuania had proceeded smoothly.
This shows that popular attitudes to the introduction of the euro improved during the preparations for it and the first weeks of using the single currency, although popular support for eurozone membership is still lower than that among political elites. With concern about possible price increases disappearing (partly influenced by the effects of the fall in world oil prices in late 2014), the future condition of the eurozone remains the key concern in Lithuania. The situation in Greece and revival of fears of a “Grexit” after the elections in January 2015, together with the security situation to the east, remain the key issues dominating public debate in Lithuania. This implies that accession to the eurozone is just one episode in the constantly changing economic and security environment in Europe. Eurozone membership by itself does not guarantee economic and security benefits; rather, it poses a risk that the political elite might relax and focus only on the next elections rather than the continuation of prudent policies. Fiscal policy and progress with structural reforms in the run-up to the parliamentary elections in autumn 2016 will show whether Lithuania’s political elites learned from the experience of the first decade of EU membership.
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1 This article is based on the author’s research conducted within the framework of the project “Lithuania in the European Union: Transformation or imitation?”, funded by the Lithuanian Science Council (No. MIP-010/2013). The survey of Lithuanian political elites referred to in this article was conducted in May–June 2014 specifically for this project.
2 See, for example, Ahearne, A., Pisani-Ferry, J. The euro: only for the agile, Bruegel Policy Brief, 2006/01; Buiter, W., Sibert, A., “When should the new EU members from Central Europe join the Eurozone?” Bančni vestnik – The Journal for Money and Banking, Bank Association of Slovenia, Special Issue, “Small Economies in the Euro Area: Issues, Challenges and Opportunities”, 11/2006, pp. 5–11; Begg, I. “Economic Governance in an Enlarged Euro Area”, European Economy, Economic Papers 11, March 2008; De Grauwe, P. “The politics of the Maastricht convergence criteria”, 15 April 2009, <www.voxeu.org/article/politics-maastricht-converge…; (accessed 1 November 2014).
3 For a detailed discussion of a reaction to the crisis, concrete measures and their effects on consolidating public finances and structural reforms in Lithuania, see Vilpišauskas, R., Nakrošis, V., Kuokštis, V., “The politics of reacting to the crisis in Lithuania from 2008 to 2013: exiting the crisis, entering politics as usual?”, in K. Bukovskis (ed.), The Politics of Economic Sustainability: Baltic and Visegrad Reponses to the Economic Crisis, Riga: LIIA, 2014, pp. 38–63.
4 The political elite surveyed included mostly members of the Lithuanian parliament from both governing and opposition parties, and senior officials from public institutions.
5 For a detailed assessment of economic costs and benefits of euro introduction in Lithuania, see www.lb.lt/impact_of_the_euro_adoption_on_the_natio… (accessed 5 February 2015).
6 See Flash Eurobarometer No. 412, “Lithuania after the euro changeover”, January 2015, ec.europa.eu/economy_finance/articles/pdf/fl412_re…, (accessed 6 February 2015).

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