Lithuania – kept out of euro on a technicality

Date: 11/05/06

On 16 May the European Commission and the European Central Bank (ECB) will meet to consider the applications of Slovenia and Lithuania to join the Eurozone on 1 January 2007. The hot tip is that Slovenia will be accepted, but Lithuania will not.

Formally, these will only be recommendations. The actual decision will be taken some time later by the Council of Ministers, but few expect them to go against findings which are based on a strict interpretation of the Maastricht Treaty.

This set out four criteria which must be met:

• currency stability within the narrow band of the ERM (exchange rate mechanism);
• not to be running an excessive budget deficit;
• long-term interest rates no higher than 2% more than the average of the three best performing member states;
• inflation, over the previous year, not more than 1.5% of the average of the three best performing states.

Both countries easily meet the first three; Slovenia meets all four, but Lithuania loses out over inflation by the narrowest of margins.

The reference level for inflation is 2.63%, based on an average of just under 1.2% for the three best performing states - Poland, Sweden and Finland.

Lithuania's inflation rate in 2005 was 2.7%, 0.07% above the target, but much lower than that achieved by existing members of the eurozone, such as France, Germany, Italy, Belgium and Greece.

The Lithuanian government argued forcefully, in a letter which Prime Minister Algirdas Brazauskas recently sent to Commission President Jos�anuel Barroso and ECB President Jean-Claude Trichet, that the reference inflation rate should be rounded up to 2.7%, which would mean it would clear the hurdle.

An even stronger argument was that it was unfair to include Sweden and Poland in the calculation, as they are not members of the eurozone. If the three best performing members of the eurozone were taken as the benchmark, Lithuania would clearly qualify, he argued.

Brazauskas's argument received heavyweight backing from two distinguished London-based economists in an article in the Financial Times on 3 May. Citing the Shakespearean maxim that "the law is an ass", the two authors, Professors Willem Buiter and Anne Sibert, argue that it was against the spirit if not the letter of the Maastricht Treaty to enforce "a harmful and senseless rule".

Not only Lithuania, but Slovakia and Estonia (which recently put back its application until January 2008) would qualify for immediate entry if this common-sense interpretation of the criteria were followed, they assert.

The Commission and the ECB have not publicly responded to these arguments, but are believed to consider that they have no alternative but to stick to the letter of the treaty, which clearly specifies "three member states", rather than eurozone members as the reference base.

They also doubt the sustainability of Lithuania's low rate of inflation, which is forecast, both by the International Monetary Fund (IMF) and by the Commission, to increase to 3.5% later this year. Economic and Monetary Affairs Commissioner Joaqu�n Almunia earlier visited Lithuania to warn that there might well be an inflation problem.

There is also a distinct disinclination to bend the rules, after the experience of admitting Greece to the eurozone, in 2001, on the basis of what later turned out to be seriously inaccurate statistics. There have also been serious retrospective doubts as to whether it was wise to accept Italy and Portugal when the eurozone was first set up.

Brazauskas may well raise the issue at the European Council meeting on 15-16 June, which is - in any event - likely to review the situation in the light of the anticipated applications of other new member states, all of which, except Poland, have now set their own targets for entry (see table).

Euro ambitions

• 2007 Slovenia, Lithuania
• 2008 Estonia, Malta, Cyprus, Latvia*
• 2009 Slovakia
• 2010 Czech Republic, Hungary*

*Likely to be postponed

• Dick Leonard is a former assistant editor of The Economist.

Major analysis feature in which the author anticipates a recommendation to be issued by the European Commission and the European Central Bank on 16 May 2006 on the eligibility of certain new EU Member States for the adoption of the Single currency. The author argues that Lithuania's application - unlike that of Slovenia - was expected to be turned down on the basis of the way the inflation criterion was calculated. The final decision was to be taken by the Council of Ministers.