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  Vol. 11, No. 4, 2003
Watch out for the Baltic Tiger

Economic indicators are favourable in the run-up to joining the EU

Ramūnas Vilpišauskas

There have been a number of success stories in Central and East European countries during the last 12 years of reforms. While the first reformers, such as Poland, Hungary and the Czech Republic, came under the spotlight in the early 1990s, recently, however, it has been the Baltic states which have earned the most praise for the performance of their economies.

Lithuania, with the best macroeconomic indicators, was recently even dubbed the “Baltic Tiger” by Leszek Balcerowicz, the well-known architect of Polish reforms. Indeed, for this and the other two Baltic economies, the last couple of years have been a period of spectacular economic growth.

Lithuania currently has the fastest-growing economy of the three, with most of its sectors, in particular energy, construction, manufacturing and retailing, expanding their activities and their value added. The Ministry of Finance forecasts economic growth for 2003 at 6.1 per cent.

Accelerating growth amidst economic stagnation in Europe

It should be noted that economic development in the Baltic states has been among the highest in Europe. Most European, as well as other world economies, have been experiencing very sluggish growth recently.

For example, according to Eurostat figures, in the first quarter of 2003, GDP growth in the EU has been at one per cent (it was even lower, at 0.8 per cent, in eurozone economies). Longer-term recent statistics for the EU show similarly low trends.

Although the economic slowdown in the EU, which is the main export market for the Baltic states, has had some impact on the growth of the latter’s exports, it has been relatively small, and reflected mainly in lower growth compared to sales in other markets. Domestic demand has been on the rise in Lithuania, accounting for a significant part of economic activity.

At the same time, exports have increased significantly, recording growth of 25.9 per cent in the first quarter of 2003 compared with the same period in 2002. The negative balance of trade was reduced by about 30 per cent during the same period. This has resulted in the current account deficit coming down to the low level of 3.7 per cent of GDP in the first quarter of 2003. (The figures for Latvia and Estonia are 5.7 and 14.4 per cent of GDP respectively.)
Although part of the increase in exports has been thanks to the oil refinery, which accounts for a significant part of production and trade, the overall picture does not change significantly if we eliminate its influence.

Overall exports of Lithuanian products have been growing, both to current EU member states and to future members. It is expected that this trend will continue after the final (mostly non-tariff) barriers are removed with the next round of EU enlargement in May 2004.

Ready for the eurozone?

With accession to the EU in May of 2004 looking increasingly likely, and the participation of policymakers and bureaucrats from the Baltic states working at EU institutions, there has been more talk about joining the eurozone.

The Lithuanian authorities have been quite outspoken in their intention to become part of the eurozone and to introduce the currency as soon as possible after accession (which could be as early as two years after joining). The European Central Bank and the European Commission have been somewhat reluctant to accept this position, treating the issue with a great degree of caution.

If we take a look at the convergence criteria required to become a member of the eurozone, most are well within the limits set by the EU.

In May, the annual inflation rate in Lithuania was minus 0.2 per cent. (Inflation in eurozone economies was 1.9 per cent, and 1.8 per cent in the EU-15.)

At the end of May, the national debt was 24.4 per cent of GDP. (The limit set by the EU for countries wanting to join the eurozone is 60 per cent of GDP.)

Similarly, the fiscal deficit is below the 3 per cent of GDP limit set by the EU.

Long-term interest rates have also gone down significantly in recent years.

Although some of these economic indicators, for example, inflation, are higher for the other two Baltic economies, they too are doing well compared to the eurozone economies.
The accession of the Baltic states to the eurozone may also be facilitated by their exchange rate regimes. For example, under the currency board regime, Lithuania has its currency pegged at a fixed rate of 3.45 litas to one euro. The other two Baltic states also have their currencies pegged to the euro or to a basket of currencies.

This makes it easier to take part in the Exchange Rate Mechanism, which aims to reduce fluctuations before a country joins the eurozone. As the litas is already pegged to the euro at a fixed rate, actual participation in it would not bring any significant changes in economic policy.
Although further economic growth and EU membership itself are likely to have an impact on prices and on some other indicators, we might conclude that the sound and stable monetary policies pursued by the Baltic states currently make them the most likely of all acceding countries to join the eurozone as early as possible.

Accession: joining and converging?

Every government prefers to view the good economic performance of the country as the result of its policies.
However, current economic trends in the Baltic states are clearly the results of the economic reforms which have been kept up during the last decade or so. Often the efforts to meet EU membership criteria have also provided some sort of guidelines for reforming economic policies, and given more room to entrepreneurial drive in these countries.

With accession approaching, there are more and more debates about its effects on the economies of new members. The EU’s single market might not bring sudden changes in terms of an increase in competition, because the Baltic states are relatively open in their trade regimes with the EU and other trading partners.

In fact, in this respect, the final liberalisation of trade among acceding countries might prove to be as important as it will be with the current member states.

EU membership will prevent protectionist actions of the kind that the Latvian government undertook in July 2003 when it reintroduced barriers to imports from Lithuania and Estonia to protect its pork producers.

In the long term, however, it is likely (and desirable) that competition pressures will further increase, pushing companies to increase their productivity and acting as the main cap on prices. What exactly the next step for the Baltic Tiger will be will depend on the incentives to compete and innovate, as much as on the regulatory and tax policies undertaken at national and EU levels.

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