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Lithuania’s Euro Adoption Strengthens Western Ties

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When Lithuania adopted the euro on January 1, the third of the Baltic states to do so, it became the 19th member of the currency bloc and strengthened its ties with the West. The move came at a critical time, considering the European Union’s sanctions against Russia over the latter’s move into Crimea and the uneasy atmosphere in the Baltic region.

Lithuania has been rightfully concerned about the effects of its larger neighbor’s actions, to the extent that it has issued a manual on what to do in case of foreign occupation. Such concerns may not be at all extreme, either, given that in December Russia conducted a military drill in Kaliningrad, a Russian enclave located between Lithuania and Poland on the Baltic Sea. The drill encompassed not only land but sea maneuvers that involved 9,000 soldiers and more than 55 naval vessels.

“The examples of Georgia and Ukraine, which both lost a part of their territory, show us that we cannot rule out a similar kind of situation here, and that we should be ready,” said Juozas Olekas, Lithuanian defense minister, in published reports.  “When Russia started its aggression in Ukraine, here in Lithuania our citizens understood that our neighbor is not friendly.”

One of the attractions of closer Western ties has been the opportunity to join NATO—something it did in 2004 after it had gained its independence from the Soviet Union. It also joined the EU in the same year, although it took longer to adopt the joint currency; in 2006 Lithuania was actually rejected from the euro zone because its inflation target was over the currency bloc’s requirements by 0.1%.

Still, Lithuania has worked hard since then to be able to finally adopt the euro, and hopes that its closer association with the EU will help its economy to continue to grow while giving it more access to Western business. This is particularly true now that the plunge in the Russian ruble has pretty much eliminated Russia as a good market for Lithuanian dairy products and other goods.

Growth is something Lithuania has been experiencing. Indeed, according to Fitch Ratings, in 2014 it was one of the fastest growing in the EU, with that growth to continue at an expected rate of 3.5% of GDP for 2015–2016. Improvements in the labor market and in wages are only part of what Fitch expects for the months to come; increased investment activity from outside the country, thanks to its adoption of the euro, is also anticipated.

Not that Fitch expects it to be a smooth ride. “[W]e expect some negative impact on Lithuania’s agricultural and transportation sectors from Russia’s latest international trade restrictions, with further risk from negative spillovers on domestic demand,” according to Finch analysts in research. “As a small and open economy, Lithuania is vulnerable to external shocks. A history of large boom-bust cycles means Lithuania’s volatility of GDP and five-year average real GDP growth is significantly worse than both the A and AA median,” the analysts said.

In addition, the threats posed by Russia’s actions “could negatively affect our real GDP forecasts.” Twenty percent of Lithuania’s merchandise exports go to Russia, but Russian trade restrictions affect approximately a fifth of that, Fitch said. Agriculture and transportation, which make up about 4% and about 11%, respectively, are also expected to feel the sting of Russian activities.

The country’s unemployment levels are also an area of concern, since they’re higher compared with the country’s rating peers. Although the situation has improved significantly, “structural unemployment remains a key challenge for the government.” Still, “[r]elative to its Baltic peers and EU average, Lithuania’s unit labor costs are highly competitive, which should help maintain an attractive business environment.”

Also on the positive side, Lithuania’s banking sector is both “well capitalized and liquid,” with the “dominating presence of Nordic banks in the domestic sector” a positive influence, “given their financial strength and high home supervision standards.”

Despite worries in the region over how Russia’s actions may affect its neighbors, Lithuania hasn’t been letting the grass grow under its feet. It’s been wooing foreign investors, among them Turkish firm Elite World Hotels, which has just visited several sites in the Lithuanian capital of Vilnius with an eye toward building a five-star hotel. The firm has already launched two five-star hotels in St. Petersburg, Russia, and is planning another in Riga, Latvia.

The country already plays host to a number of foreign companies, with its workers voting foreign employers top places to work in a number of categories in an online poll in December and January. And according to Invest Lithuania figures, some 69% of Lithuanians ages 18–35 want to work for a foreign capital company. Eurozone membership may provide more of them with a chance to get their wish, particularly since, according to Fitch, Lithuania rates an A- for ease of doing business in the country and for trade openness.

The country’s entry into the euro zone won’t just affect the country’s own economy and monetary policy. It will have a broader effect on the currency bloc as well, since Lithuania is now able to vote at the European Central Bank. While the change in the vote rotation appears small—the five largest economies get four votes, which they share, while the other 14 countries must parcel out 11 votes amongst themselves—the frequency with which each country gets to vote will likely have the most negative effect on Germany—something that doesn’t necessarily sit well in Berlin.

Those five economies with the largest financial sectors have more say in ECB policy than the smaller ones, and Germany of course is used to wielding its influence on a regular basis. Adding more members to share a fixed number of votes will dilute the influence of smaller countries, but every fifth month, Germany will have to sit on the sidelines. While the change is not likely to have a huge effect on ECB policy, it will definitely influence how things play out—particularly, perhaps, in commentary from member nations on their views and votes.


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