Greece Outside In: Latvia: the eurozone member-elect whose growth is the envy of them all

Tuesday, June 11, 2013

Latvia: the eurozone member-elect whose growth is the envy of them all

The third poorest country in the EU was hit harder than most by the financial crash, but its politicians have managed to drag the economy to 5% growth without social unrest or a bailout in sight

In the centre of Riga, a copper figure of Latvia's mythical maiden soars skyward holding three golden stars. Nicknamed Milda, she stands at the top of the Freedom Monument, symbolising the Baltic country's hard-won liberty and independence.

From next January Milda will become a more familiar face across Europe when her likeness is stamped on to €1 and €2 coins to mark Latvia becoming the 18th member of a single currency zone which may, or may not, be emerging from a three-year period of fighting for its life.

For Greeks or Portuguese, the euro may have seemed like a prison in recent years. But for Latvia, or at least for its government and elite, the maiden-faced currency will symbolise freedom and independence, reinforcing the vulnerable small country's integration in the west and another big step in liberating itself from its historical tormentor, Russia.

The European Commission (EC) and the European Central Bank (ECB), in their "convergence reports" last week, gave a green light to Latvia to join next January. EU finance ministers are expected to rubberstamp that decision next month. Ratings agency Standard & Poor's responded by raising its rating on the country's debt this week, up from triple-B to triple-B-plus – three levels above junk.

Estonia, on Latvia's northern border, adopted the currency 30 months ago. Lithuania to the south intends to follow suit in 2015. While a year or two ago the smart money was on the eurozone shrinking to 15, within a couple of years the likelihood is a membership of 19, plus a campaign gearing up in Poland to take the club to 20.

For Valdis Dombrovskis, Latvia's prime minister, joining the euro makes economic sense. It will bring budget savings, promote foreign direct investment and underpin the recovery from an economic collapse in 2008-9 that foreshadowed calamities to come elsewhere, especially in Ireland and Spain.

But it's not all finance and economics. For the Baltic states, long at the mercy of an imperial Russia, whether tsarist or communist, and perennially wary of Vladimir Putin, the euro is also intensely political.

Dombrovskis agrees with Olli Rehn, the economics commissioner in Brussels who when giving the green light stressed that Latvia would gain rather than forfeit sovereignty by having a seat at the ECB and in the meetings of eurozone finance ministers.

It might be an argument that would fall flat in Athens or Lisbon, but Latvia's national currency, the lats, has been pegged to the euro for eight years – meaning monetary policy has been effectively set in Frankfurt without Riga having any say.

Nonetheless, the opinion polls consistently show a majority against joining the euro. Dombrovskis brushes aside opposition calls for a referendum, arguing that the voters made their choice clear for Latvia's entering the EU in 2004 and the entry terms included a commitment to joining the currency when the time was right and criteria were met.

There is no doubt Latvia passes muster; indeed the economic data puts most current eurozone countries to shame, Germany included. At just over 40% of gross domestic product (GDP), the national debt is well below the eurozone's 60% ceiling, while the budget deficit is a mere 1.2%, comfortably within the 3% rule that in any case these days is honoured mainly in the breach.

Riga initially wanted to join the currency area in 2008 but was floored by the financial collapse in the EU. The country of two million was the first in the EU to seek a bailout – from Brussels and the International Monetary Fund – of €7.5bn (£6.4bn) when a housing and consumption bubble, fuelled by cheap credit from the Swedish and Danish banks that dominate the Baltic banking sector, burst and sent the economy into a tailspin.

In 2008-9 the economy shrank by a colossal 25%, civil service jobs were slashed, wages cut, social, education, and health services axed. Unemployment quadrupled; property prices collapsed by up to 70%; an estimated 10% of the population, mainly young people, emigrated.

In five years the country has been from boom to bust and, relatively speaking, back to boom. The third poorest country in the EU, it is also the fastest growing, notching up 5% growth last year.

Dombrovskis argues that the recovery is solid and sustainable, based on manufacturing and exports and not the easy credit of the boom years of the last decade. The EC and the ECB appear to agree, but the ECB in particular is worried about Latvia being a potential money-laundering Trojan horse within the eurozone. It points to the high level of foreign deposits in Latvian banks, some €10bn – half of their total deposits and worth 40% of GDP.

The deposits are overwhelmingly Russian, as Latvia is also a playground for Russian oligarchs and underworld figures who feel at home in a country where one in four are ethnic Russians. The US state department has warned of "a systemic money-laundering risk" while the EC has previously complained that the banking sector was vulnerable to "complex economic, financial, money-laundering and tax evasion crimes."

Similar concerns about Russian money played a large part in the recent Cyprus disaster, but the scale of the problem is quite different. Bank deposits in Cyprus amounted to eight times the country's GDP; in Latvia the equivalent figure is 1.5.

Latvia's recovery from an economic collapse as steep as Greece's and its current status as the EU's fastest growing economy has spurred talk that it is the model to follow for stricken eurozone countries. But it seems very specific and very different from the likes of Greece. Despite the savage austerity, the increase in poverty and the collapse in living standards, there has been no social unrest.

Indeed, Dombrovskis has achieved something no other eurozone leader has managed to pull off, whether on the creditor or on the bailed-out side. He inflicted austerity measures and spending cuts as tough as any in the eurozone without being forced to do so by a "troika" of anonymous eurocrats and won re-election.

From Finland to Greece, governments have fallen across the eurozone over the past three years. But not in Latvia.