Euro, I Find You Very Attractive. Yours, Lithuania.

Common currency should not be blamed for the misfortunes of some of the euro area member states

Greek Prime Minister Alexis Tsipras said that “Grexit” would be “the beginning of the end of the eurozone.” This statement sparked renewed debates as to how the eurozone would look like if Greece—the cradle of European civilization— were to leave. Would it be just a removal of the weakest link of the chain or would it lead to a domino effect resulting in the eventual disintegration of the eurozone? However, it is more often than not that those that shout the loudest (undeservedly) attract much more public attention. Indeed, Google search engine returns more than 15 million mentions of the word “Grexit”—more than the number of people living in Greece.

If we move exactly 2,000 kilometers to the north, we end up in silent forests of Lithuania— the country, which quietly entered the eurozone in January 2015. No shouting—no publicity. Yet, with three times lower pensions, two times less sunshine hours and just as many lakes as there are islands in Greece, Lithuania nevertheless could and should be considered as the role model for any eurozone country (or at least—the German version of it). During his visit to Lithuania, ECB President Mario Draghi rightly pointed out the two key benefits the eurozone will receive from “Litentrance:” “First, Lithuania has shown that adjustment is not only necessary, but also possible—even without currency devaluation; second, Lithuania’s decision to join the euro area demonstrates that our common currency is attractive.”

Indeed, Lithuania achieved a spectacular economic recovery after experiencing the largest GDP contraction (-14.8% in 2009—the highest in the EU). Lithuanian GDP per capita (measured in PPS) jumped from 57% of EU average in 2009 to 74% in 2014 and surpassed that of crisis-hit Greece and recession-free Poland. Moreover, Lithuanian budget deficit declined from 9.1% of GDP in 2009 to a mere 0.7% in 2014, while debt stabilized at around 40% of GDP—well below the threshold of 60%. Interestingly enough, Lithuania is among the five eurozone countries (out of 19) that meet both deficit and debt criteria outlined in the Stability and Growth Pact. European Commission in its latest Alert Mechanism Report (2015) included Lithuania among the group of the ten EU countries that do not have excessive macroeconomic imbalances. Even though these results were not achieved without sacrifice (high emigration, long- term unemployment and punitive borrowing rates that reached as much as 9.375% for a 5-year EUR 500 million bond issued in mid-2009), Lithuania definitely deserves to be called “a good euro girl” and a case study to educate “the bad euro boys,” such as Greece.

What Can Eurozone Give to Lithuania?

To paraphrase the famous quote of John F. Kennedy, Mr. Draghi could have also considered asking “not what Lithuania can do for the eurozone, but what the eurozone can do for Lithuania.” The fact that Lithuania joins eurozone may not mean that the “common currency is attractive”— it may just mean that all the other alternatives are uglier. So what makes euro so attractive for Lithuania and what lessons could be learned for other perspective and existing eurozone countries?

Lithuania is positioned on the tectonic geopolitical shift between the West and the East. Hence, first and foremost the euro is a symbol of Lithuanian comeback journey to a free, prosperous, tolerant and democratic Western European civilization and away from the impoverished Post-Soviet Eastern European space. In this respect, euro can be perceived as a continuation of a journey towards the West, which started in 1990 after Lithuania regained independence from the Soviet Union and culminated in 2004 when Lithuania became the member of NATO and the European Union.

Comparing the ongoing financial and economic crisis in Russia and the resilient eurozone economy makes the euro idea as appealing as never before economically, while an ongoing military conflict in Ukraine compels us to remember the often forgotten European virtues—peace, mutual trust and dialogue. Regrettably, these benefits are often overlooked by the Westerners, since they are used to living in peace and prosperity for generations and some of them simply take it for granted. Greece is a good example of a victim of this sort—it was not euro per se, but the unrealistic expectations about the euro that inevitably pushed the country into the subsequent economic hardships (Lithuania did most of these mistakes even without being in the euro area).

In spite of this, Greeks went so far as to elect ultra-left and “anti-everything” parties to the parliament. But make no mistake there: the Lithuanians know all too well that Eastern model is not working as well as the Western one. The difference between Lithuanian and Russian GDP per capita figures may not be so large (Lithuanian is a mere 27% higher), but oil with gas distort the statistics here. Better look at Moldova—another former USSR country with no oil and gas resources, but plenty of remaining pro-Soviet and pro-Eastern mentality. The difference in GDP per capita between Lithuania and Moldova is 7 times (not percent!), although the starting point was not much different. Frankly speaking, Scandinavia looks like much better idea—even recession-hit Finland that does not shout, complain, or break rules, and even openly admits that “Sick Finland is ready for austerity medicine” (A. Stubb, June 2015). After all, Finland’s GDP per capita is three times higher than that of Lithuania.

Switzerland Does Not Have Euro… or Does It?

Another great benefit of euro adoption is that it completely eliminated the risk of currency devaluation, which, however small, was still present even though Lithuania had long ago (since 2002) pegged its currency to the euro. Lithuania was particularly lucky in a sense that it joined the eurozone just before the devaluation and revaluation issues became ever more acute in the East and in the West. In the East, Russian ruble lost 25% of its value against the euro in just one week, while in the West the changes were even more extreme with Swiss franc appreciating against the euro by as much as 30% in just a couple of minutes. It is a perfect illustration that independent monetary policies are becoming not so independent in times of economic and financial turbulence. The notorious example is Swiss central bank that moved from being one of the most trusted into one of the most distrusted once it messed up with Swiss franc pegging & de-pegging from the euro and lowering policy rate to -0.75%, which further risks damaging the whole banking system. Central banks of Sweden, Denmark and Czech Republic also resorted to Swiss-type “unconventional” monetary policy methods in messing with exchange rate regulation, negative interest rates or both. For these countries, introduction of the euro would probably be more economically rational than desperately trying to counterbalance negative spill-over effects from an aggressive ECB QE policy. Keeping onto their national currencies is becoming increasingly expensive for them.

Another dissatisfaction with the euro was its strength versus other major currencies that negatively affected international competitiveness of eurozone exporters. However, with US dollar and Chinese renminbi yuan strengthening against the euro, it is exactly this currency that starts to be blamed instead for the very same reason by other major international competitors (remember Switzerland). Lithuania was again lucky enough in joining euro on the eve of the largest QE program to date.

Only a Cup of Coffee Got More Expensive

The lack of public support for the euro was primarily related to euro-driven inflation fears. However, experience of Estonia and Latvia, which introduced euro in 2011 and 2014 respectively, show that these fears were largely unjustified and that public support for the euro increased considerably just a few months after the adoption of the euro. For example, four months before the introduction of the euro as much as 34% of Estonian citizens were fearful of rapidly rising inflation, whereas four months after the introduction the proportion fell to a mere 12%. A couple of years later the same story repeated in Latvia with the proportion of Latvian citizens fearful of rapidly rising inflation dropping from as much as 35% four months prior to the euro adoption to a mere 11% four months after. Not surprisingly, the same story repeated in Lithuania: in July 2014 (i.e. just after the announcement that Lithuania will join euro in 2015) the proportion of citizens fearful of rapid price increases jumped to 44% i.e. similar to the levels seen in 2008 when actual inflation was as high as 12% (!). Five months after the introduction of the euro, it is -0.1% deflation rather than inflation bothering the consumers, while citizens fearful of rapidly rising inflation fell to a mere 22% (it is common in Lithuania that around one fifth of citizens tend to be fearful of virtually everything—perhaps it comes from reading too many headlines of yellow press). Only a cup of coffee, a haircut and cinema tickets got a bit more expensive, but it’s peanuts compared to a double- digit inflation levels in neighboring Belarus and Russia or 1,400% (one thousand four hundred) annual inflation rate experienced in Lithuania in 1992 after the collapse of Soviet Union.

Euro Is Not Ugly at All

Lithuanian accession to the eurozone will be highly beneficial both to the eurozone and Lithuania itself. The absence of currency exchange costs and excess volatility facilitates free movement of goods, services, capital and labor within the eurozone and helps better utilize the benefits of the huge eurozone market. Additionally, Lithuania will get an opportunity to shape ECB policies, which is a great achievement for such a small country. And last but not least, all three Baltic States—Lithuania, Latvia and Estonia— will together with Finland eventually enjoy one common currency (Nordic euro), making this region more integrated, more attractive for foreign investors and less vulnerable to the events in the East. The aforementioned reasons in general and the latter in particular, in turn, may encourage other Central European countries, like Czech Republic, Poland or Romania to join the eurozone. Finally, euro is also a good promotional tool to increase international awareness. Lithuanian national symbol Vytis (armor-clad knight on horseback holding a sword and shield), which is inscribed on the back of every Lithuanian euro coin is conquering the wallets of citizens of the whole euro area: from Portugal to Finland and from Ireland to Cyprus. Euro is not so ugly after all, at least less ugly than Russian ruble.

Perhaps the biggest challenge for Lithuania will be not to fall victim of “post-euro” euphoria and keep control of public as well as private sector debt levels. However, Estonian and Latvian examples are highly encouraging: even after introduction of the euro these countries manage to keep one of the lowest public deficit rates in the whole European Union. This again shows that euro should not be blamed for the misfortunes of some of the euro area member states. After all, euro is just a unit of measure—and just as the distance between Paris and London does not change whether you measure it in kilometers or miles, the deficit does not improve whether you measure it in euros or litas.

Žygimantas Mauricas

Chief Economist at Nordea Bank Lithuania and Lecturer at ISM University of Management and Economics.

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