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WorldJanuary 5 2015

Lithuania prepares for life in the eurozone

From dealing with the knock-on effects of the US and EU sanctions on Russia to preparing for the adoption of the euro, Lithuania's finance minister Rimantas Šadžius has been kept busy this year. But, despite the headwinds, Lithuania has managed to record one of the highest GDP growth rates in Europe.
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Lithuania prepares for life in the eurozone

Q. Lithuania is introducing the euro from January 1, 2015. How have you prepared for this?

A. Almost immediately after the introduction of the litas in 1993, we pegged it to the dollar. For such a small country, it is too luxurious to have our own monetary policy. We are an open economy, we are exporting and importing a lot, so we are dependent on the [economic health] of our counterparts, and one of our main partners in trade exchange is the eurozone.

Lithuania started thinking about joining the eurozone as early as 2002. It was in February 2002 that we pegged our currency to the euro. From that time onwards, we were making efforts to adjust our economy to improve our fiscal stance to be compliant with the level of development of eurozone member states. When we joined the EU in 2004, we joined the exchange rate mechanism too, which is a necessary condition to introduce the euro.

Of course, in all the practical preparation work, one of the most important parts is persuading our citizens that this is a necessary and beneficiary step. From August 2014, we have already displayed prices [in shops] in two currencies for people to get used to the euro and the new scale of prices. This rule will oblige businesses, service companies and shops to show prices in two currencies until June 2015, for the convenience of the population to psychologically adapt to the new currency.

Already, by the beginning of April 2014, we have had half of the population in favour of euro introduction. I think, by the end of 2014, this figure will have increased, and Estonia's experience – Estonia introduced the euro in 2011 – shows that it takes approximately two years for the population to get used to the new currency. Now, the support for the euro in Estonia is at 80% of the population.

Q. What would you say are the advantages of joining the eurozone?

A. It is evident that savings on interest and currency exchange operations could help the economic position of our businesses. Of course, they will have some expenses, but our estimates show that the benefits of introducing the euro significantly exceed the expenses.

Plus, better conditions for exporting our products is what we really expect to see, and better conditions for payments between [us and] the eurozone countries after joining the eurozone, making full use of the Single Euro Payments Area system. All these things should help us to be more successful in the destination markets of our exported produce.

And this means, of course, gross domestic product [GDP] growth and benefits for people working in the enterprises, as well as an increase in living standards. But, it also means better tax collection and more possibilities for the state to help those who should be helped by the state: pensioners, children and disabled people.

Q. You mentioned GDP growth. What economic impact do you expect as a result of the introduction of the euro?

A. The euro isn’t a magic wand that alone fuels a country's economy to grow faster but, of course, it is evident that when we join the eurozone, international trade costs with the eurozone countries will be significantly reduced. And, interest rates are already falling. Lithuania successfully issued a €1bn Eurobond in the international capital markets and will pay the lowest coupon in the country’s history – 2.125% [for 12 years].

But, the main advantage of joining the eurozone is the huge step [it will represent] in improving the investment climate. Lithuania is a small country without huge financial resources in place, and it needs foreign investment. Investment is already coming, and we hope it will be coming much more willingly once we have joined the eurozone.

Also, in our region, there are three small countries – Lithuania, Latvia and Estonia – two of which are already in the eurozone. So, to be competitive in attracting investment, we had to join the eurozone as well.

Q. What impact does the current geopolitical situation have on Lithuania?

A. The tensions between Russia and Ukraine, or even between Russia and the rest of the world, not only have political consequences, which also impose on us the necessity to increase defence spending. They have quite clear economic consequences as well.

In 2013, Lithuania’s export of goods to Russia accounted for a bit more than 12% of GDP, with 2% of GDP accounted for by Lithuanian-origin goods, because a huge part of our total exports was [related to] the re-export of goods from other countries, such as Poland and some western European countries.

Here, two sectors were hit by sanctions on the Russian side, limiting our possibilities to export goods to Russia. First of all, our agricultural sector really suffered and businessmen had to rethink their export strategies and look for other markets. We are already successful in finding new markets in all parts of the world.

Another sector that was hit quite hard was the transport sector, because transport services for goods being transited through Lithuania were quite an important part of the economy. Businessmen [operating in this sector] are struggling. So far, our businessmen have showed quite good skills in finding work in very difficult situations. I hope they will be successful this time as well.

In 1998 [when Russia suffered a financial crisis], we had the first Russian crisis when Lithuanian producers and exporters had to think carefully about how to rearrange their plans, but they managed to change export markets in 15 to 18 months. To my mind, this was the first real economic step of very organic integration of Lithuania into the western European economies.

We have experienced businessmen, we are helping them on behalf of the government by making use of some European structural funds to help them look for markets for the realisation of their products. Still, the economy in Lithuania is growing quite fast in European terms, at about 3% or more of GDP annually, and Lithuania is going to remain among the fastest growing European economies in the medium term.

Q. Bearing in mind both additional defence expenditure and eurozone entry, what is your fiscal policy strategy going forward?

A. We did stick to a strict fiscal policy from the beginning. That is why we had to have internal devaluation in real terms [in 2009/10]. We had a real decrease in nominal wages as well as social benefits and pensions – not all of them were deemed lawful by our constitutional court, so we have some trouble with compensations for unlawful cuts.

Still, we were successful in decreasing our huge deficit, which occurred because of the economic downturn in 2009. In 2013, the public deficit was 2.2% of GDP, at the end of 2014, we will have less and, for 2015, we are aiming at 1.2% – a downward trend in our public deficit, with a view to balance our books by 2017.

Of course, in the eurozone we will have another mechanism of ex-ante evaluation of the state budget, and this exercise will be undergone by Lithuania in 2015. I believe this is a very good experience and a really good instrument for the coordination of fiscal policies of eurozone countries to make the economic and monetary union even stronger.

Up until now, we have had a comparatively low defence expenditure level, but there is an interparty agreement by all the parliamentary parties to allocate 2% of GDP to defence spending in the medium term. Of course, this would mean a huge increase in our defence spending for the next years. Counting defence spending across all ministries, we have increased spending to 1.3% to 1.35% of GDP in 2015, which is still quite far off the target level of 2% of GDP, but it is up in comparison with 2014.

We are increasing financing in all-important areas of the budget, but defence spending increased the most. It was an absolute necessity, but, of course, it causes some other areas to have less extra finance.

Rimantas Šadžius is the finance minister of Lithuania. 

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