Fulfilling the Maastricht criteria - Swedbank

Swedbank Analysis August 1, 2012 

Fulfilling the Maastricht criteria – 

mission possible for Latvia and Lithuania? 

 

 

 

There are five main criteria for the ECB and the EC to 

use in judging whether a candidate country is ready to 

adopt the euro: price stability and interest rates (the 

moving-target criteria, as their reference values 

change), government budget deficit and debt, and exchange 

rate stability. Compliance with all of them 

should be done in a sustainable manner. Despite the 

well-known shortfalls of these criteria, they are unlikely 

to be changed in the near future. 

Calculation and interpretation of the moving-target criteria 

have been uncertain and not always done in a 

symmetric way for all criteria, and, hence, the outcome 

is difficult to predict. Moreover, the so-called other 

relevant factors used to supplement the five main criteria 

to evaluate sustainability of the convergence and 

readiness to join the EMU have not until recently been 

explicit and the stance of the ECB and the EC has 

sometimes differed. 

Both Latvia and Lithuania have good chances of fulfilling 

Maastricht criteria in April 2013 to be able to adopt 

the euro in 2014. The chances of meeting the criteria 

are somewhat bigger for Latvia, since it has more 

room for manoeuvre in terms of the price stability and 

budget deficit criteria, as well as stronger political resolve. 

Whether both countries will fulfil the interest rate 

criterion remains uncertain, since it depends on which 

countries are used for the criterion calculation. 

While Latvia has officially stated euro adoption in 2014 

as the national target, the Lithuanian government has 

yet to decide on it; most likely it will by the end of this 

year. Even if the criteria are met, there is an opportunity 

for both countries to postpone euro adoption if the 

euro area does not achieve sufficient progress on addressing 

its fundamental problems. 

Economic Research Department 

Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000 

E-mail: ek.sekr@swedbank.com www.swedbank.com 

Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720

Latvia and Lithuania joined the European Union (EU) in May 2004 and 

are obliged to adopt the euro eventually. The first target was 2007 for 

Lithuania and 2008 for Latvia, but neither of these was accomplished due 

to high inflation and overall macroeconomic imbalances. Latvia has 

stated that 2014 is its official euro introduction target date, and there is a 

strong political will to fulfil it. Although the Lithuanian government has 

repeatedly expressed its determination to introduce the euro in 2014, no 

formal national target has been set yet. Due to the upcoming elections in 

October 2012, politicians and the government are trying to avoid the unpopular 

subject of the euro; Lithuania will probably decide whether or not 

to target euro adoption in 2014 by the end of this year, depending on the 

chances of meeting the criteria and how the economic and political situation 

in the euro area evolves. Unsurprisingly, though, 2012 convergence 

reports showed that neither of the two countries had fulfilled all the necessary 

criteria by March 2012 due to high budget deficits and inflation 

rates. 

There have been vast discussions on whether Maastricht criteria are 

sensible, whether they measure the right things, etc. The treatment 

among the different criteria has not always been symmetric and their interpretation 

varied over time. Still, the criteria are unlikely to be changed 

any time soon; thus, neither Latvia nor Lithuania should expect more favourable 

terms than the existing criteria. Taking into account that some of 

the criteria are moving targets, it is still uncertain what benchmarks a 

country will need to hit early next year to be able to adopt the euro. In this 

analysis, we try to assess what the benchmarks could look like in 2013 

and whether Latvia and Lithuania will be able to fulfil them. 

1. What are the criteria for euro adoption? 

According to Article 140(1) of the Treaty on the Functioning of the European 

Union (hereinafter, the Treaty), at least once every two years, or at 

the request of a member state with a derogation, the European Commission 

(EC) and the European Central Bank (ECB) assess the progress 

made by the euro area candidate countries in fulfilling their obligations to 

enter the Economic and Monetary Union (EMU). The ECB and the EC 

then publish their conclusions in respective convergence reports. 

The process is further organised as follows: 

On the basis of its assessment, the EC submits a proposal to the 

European Council which, having consulted with the European Parliament, 

and after discussion in the Council, a meeting among the 

heads of state or government decides whether the country fulfils 

the necessary conditions and may adopt the euro. If the decision is 

favourable, the Council, based on a Commission proposal, having 

consulted the ECB, adopts the conversion rate at which the national 

currency will be replaced by the euro, which thereby becomes 

irrevocably fixed. 1 

According to the Treaty, besides the necessary legal compatibility (e.g., 

law concerning independence of the national central bank, prohibition of 

monetary financing, etc.), there are five main criteria for the EU member 

Five main criteria need 

to be met for adopting 

the euro 

1 http://ec.europa.eu/economy_finance/euro/adoption/who_can_join/index_en.htm. Usually 

the central rate is used as the conversion rate. Historically parity rates were changed 

only three times (one for Greece and two for Slovakia), but it had always happened before 

the Council actually adopted the conversion rates for replacement with the euro (i.e., that 

were not decisions by the Council). 

2 Swedbank Analysis • August 1, 2012

state to be able to enter the EMU (the Maastricht criteria, also known as 

the convergence criteria). They are presented in the table below. 

The main five Maastricht (convergence) criteria 

What is measured? By what? Convergence criterion 

Price stability 

Durability of convergence 

achieved by 

the member state 

Sound public 

finances 

Harmonised consumer 

price index (HICP) 12- 

month average annual 

inflation 

Average nominal longterm 

interest rates for 

government bonds or 

comparable securities 

over the latest 12-month 

period for which HICP 

data are available 

Government deficit as 

% of GDP (ESA methodology, 

i.e., on accrual 

basis) 

No higher than average value of 

the three best-performing EU 

member states +1.5 percentage 

points 

(note: correction for outliers is possible) 

No higher than the average value 

of the three best-performing EU 

member states in terms of price 

stability +2 percentage points 

(note: correction for outliers is possible) 

Deficit of no more than 3%, unless 

either (i) the ratio has declined 

substantially and continuously and 

reached a level that comes close 

to the reference value, or (ii) the 

excess is only exceptional and 

temporary and the ratio remains 

close to the reference value 

Sustainable public 

finances 

Exchange rate 

stability 

Government debt as % 

of GDP 

Debt of no more than 60%, unless 

the ratio is diminishing and approaching 

the reference value at a 

satisfactory pace 

Fluctuation within a Two years of participation in exchange 

rate mechanism of the 

band of +/- 15% around 

ERM II with no serious problems 

the central rate, i.e., visà-vis 

the euro peg 

Source: http://www.ecb.int/ecb/orga/escb/html/convergence-criteria.en.html, for more details 

see also ECB (2012) 

Compliance with the above five criteria is evaluated against their sustainability, 

i.e., they cannot be met by accident or by one-off measures. Note 

that there is no clear-cut definition of what is meant by “sustainability,” 

though. Convergence reports evaluating progress of the member states 

in fulfilling their obligations regarding the achievement of EMU are written 

independently by the EC and the ECB, and their views on the interpretation 

of sustainability may differ. 

According to Article 140 of the Treaty, when evaluating EU countries’ 

economic integration and convergence “other relevant factors” (see 

ECB, 2012) are also examined – integration of markets, the situation and 

developments of the balance of payments on the current account, unit 

labour costs, and other price indices. However, until recently there have 

not been particular benchmarks, and therefore the assessment of these 

“other relevant factors” by the ECB and the EC has been rather vague 

and varied. 2 

Interpretation of 

sustainability is not 

clear-cut 

“Other relevant factors” 

are also considered in 

evaluating candidate 

countries 

2 Undoubtedly both institutions have a vast amount of in-house research on these issues, 

but it has not been explicit in convergence reports. 

Swedbank Analysis • August 1, 2012 3

As of December 13, 2011, detailed rules for multilateral surveillance 

came into force “to ensure closer coordination of economic policies and 

sustained convergence of the economic performances of the Member 

States” 3 under the so-called Six Pack. The surveillance framework includes 

an alert mechanism for early detection of macroeconomic imbalances 

(both external and internal) in all EU member states and is called 

the macroeconomic imbalance procedure (MIP). The detailed design and 

economic rationale of the scoreboard for the surveillance of macroeconomic 

imbalances can be found in EC (2012b). 

The scoreboard includes numerical indicative thresholds, which are reported 

in the table below. If a country surpasses these thresholds, it is 

subject to an in-depth review by the EC, the outcome of which may include 

recommendations of preventive measures or corrective measures 

(in most serious cases, an extensive imbalance procedure can be initiated 

under the surveillance of the EC). Note that assessment of imbalances 

does not derive from mechanical application of the scoreboard 

indicators; additional information and country-specific circumstances are 

also taken into account. 

Surpassing of the thresholds by a member state is not a reason per se to 

reject membership to the EMU, since an evaluation of convergence is not 

the aim of the MIP; however, 2012 convergence reports include a discussion 

on results from the alert mechanism report (EC, 2012a). ECB (2012, 

p.19) also mentions that “EU member states with a derogation that are 

subject to an extensive imbalance procedure can hardly be considered as 

having achieved a high degree of sustainable convergence.” Thus the 

MIP framework supplements discussion and evaluation of whether convergence 

is sustainable for prospective euro area members, although 

appraisal of the scoreboard results is still ambiguous for the purposes of 

convergence reports. 

A new surveillance 

framework for macro 

imbalances was 

introduced in December 

2011 

The surveillance 

scoreboard includes 

specific numerical 

thresholds 

MIP framework 

supplements discussion 

on “other relevant 

factors” of sustainable 

convergence 

Scoreboard for surveillance of macroeconomic imbalances 

Indicator Threshold 1 

Current account balance, % of GDP (3-year average) -4.0/+6.0% 

Net international investment position, % of GDP -35% 

Real effective exchange rate, HICP deflated (3-year percentage 

change relative to 35 trading partners) 

±11% 

Export market shares (5-year percentage change) -6% 

Nominal unit labour costs (3-year percentage change) +12% 

House prices, consumption deflated (annual percentage 

growth) 

+6% 

Private sector credit flow, % of GDP +15% 

Private sector debt, % of GDP +160% 

General government debt, % of GDP +60% 

Unemployment rate (3-year average) +10% 

1 

Either a range or a suggested lowest (-) / highest (+) acceptable value of the particular 

indicator. 

Source: EC (2012a) 

3 http://www.europarl.europa.eu/oeil/popups/summary.do?id=1180860&t=f&l=en 


2. Shortfalls of the existing convergence criteria 

There has been much criticism regarding what Maastricht criteria measure, 

and, more important, what they do not measure (e.g., Buiter, 2004 

and Šikulova, 2007). Furthermore, many EMU countries themselves do 

not comply with these criteria. For instance, in March 2012 only eight 

countries out of seventeen fulfilled the price stability criterion; the budget 

criterion for 2011 was met by only six euro area countries. Even before 

the crisis, in March 2007, four of the current euro members did not comply 

with the price stability and deficit criteria (the latter for 2006). However, 

it is also clear that changing the criteria is extremely difficult and, 

even if politically agreed upon, might take years to be actually implemented. 

It can be seen that, although the criteria are called convergence criteria, 

all of the variables included in the five main numerical criteria are nominal. 

Until recently, real convergence (e.g., GDP and productivity growth 

and their levels, and labour market indicators) formally has not been 

measured at all, although discussed in the “other relevant factors” section. 

Although the MIP framework now includes thresholds of, e.g., the 

unemployment rate and unit labour costs, these are not considered as 

strict criteria to be met. 

Many EMU countries 

themselves do not meet 

Maastricht criteria 

Real convergence 

measures are not 

included in the five main 

criteria 

Price stability is probably the most widely discussed criterion. Undoubtedly, 

price stability is vital for a country entering the EMU – under a fixed 

exchange rate regime, inflation that is substantially higher than that of the 

trade partners is likely to undermine external competitiveness. However, 

the existing five numerical Maastricht criteria might indirectly imply putting 

the brakes on economic growth (e.g., to achieve lower inflation rates) to 

gain access to the EMU. For instance, if a country experiences rapid productivity 

growth and, thus, convergence with more advanced EMU 

economies, it may also experience more rapid inflation without losing 

competitiveness or endangering sustainability. 

One of the illustrations is the Balassa-Samuelson (BS) effect. This is the 

mechanism of the catching-up process, when faster productivity growth in 

tradable sectors than in nontradable ones causes quicker wage increases, 

which are later transmitted through competition for labour into 

the nontradable sectors and cause higher overall inflation in the catchingup 

countries. The BS effect in Central and Eastern Europe has been 

widely analysed. Although many studies find empirical support for this 

hypothesis, e.g., Lojschová (2003), Coudert (2004), and Mihaljek and 

Klau (2009), the overall evidence is rather controversial both as to the 

existence of the effect and its possible size due to data reliability questions 

(e.g., the empirical split between tradable and nontradable sectors). 

Still, it has been often argued that the BS effect should be taken into consideration 

when evaluating compatibility with the Maastricht criteria; see, 

e.g., De Grauwe and Schnabl (2004) and EEAG (2007). 

As an economy catches 

up, its productivity and, 

price levels rise… 

There are yet other processes that can lead to higher inflation without 

endangering competitiveness. For instance, as producers in a catchingup 

country penetrate foreign markets, where prices are higher, they raise 

prices of their output also in local markets (given their constrained capacity). 

However, if access to foreign markets at the same time improves the 

quality of production, competitiveness is likely not to suffer. 

There is thus nothing wrong in price convergence per se if prices and 

wages do not increase faster than productivity and do not undermine 

competitiveness and sustainability. However, this is not taken into ac- 

…which might well be 

sustainable and not endanger 

competitiveness 


count by the existing five main criteria. In addition, price convergence is a 

long term process – e.g., for a country with a price level at half of the EU 

average, it will take years and even decades to converge to the average. 

It should be considered that maintaining a balance between productivity 

and price convergence may be a very hard task for such a long time period. 

Under the current framework of evaluating the convergence of candidate 

countries the interpretation of whether price and productivity developments 

are sustainable is uncertain, may vary from report to report, and 

has been arbitrary at times. For instance, in its 2010 convergence report, 

when evaluating Estonia’s readiness to adopt the euro, the ECB was 

much more sceptical about inflation developments than the EC, pointing 

specifically to the catching-up potential as the main factor that could push 

inflation up in the medium term (thus implying that the fulfilment of the 

price stability criterion was not sustainable). 

Another issue that affects whether a country meets the price stability criterion 

is that less advanced economies are often more energy intensive 

(less energy efficient) and thus more exposed to volatility in global oil 

prices. The same applies to global food commodity prices, since inhabitants 

in catching-up countries spend more on food than those in advanced 

countries. As a result, the harmonised index of consumer prices 

(HICP) can grow more rapidly when global commodity prices go up – 

something that a country in the short run can do almost nothing about. 

Thus, core inflation (i.e., HICP excluding unprocessed food and energy) 

is perhaps a more appropriate indicator to use for the criterion calculation. 

At least, it should be considered when evaluating the sustainability 

of the price stability criterion’s fulfilment. 

To sum up, there are several possible ways to improve the existing criteria. 

First, analysing real convergence more explicitly and including it in a 

better way into main criteria, for instance, taking into account the BS effect 

and productivity convergence. Another option is to use core instead 

of headline inflation for comparison. One more way to lessen the effect of 

short-term events may be to formally evaluate price developments for a 

longer period of time (say, three or five years instead of the current two 4 ). 

Another debatable question is whether to use EMU or all EU countries for 

evaluating convergence of candidate countries – since there are large 

trade flows not only inside the EMU, but also within the EU, e.g., price 

and currency developments in other EU countries certainly influence the 

competitiveness of prospective euro area members, but is it fair to compare 

prospective euro area members to countries with flexible exchange 

rates. Overall, there is room for more explicit and reasonable way to 

comparing candidate countries with other EMU (or EU) members and 

more symmetric approach across the criteria, see next sections for more 

details. 

3. Interpretation of the moving-target criteria 

The treatment of the inflation and long-term interest rate criteria by the 

ECB and the EC has differed over time and has not always been symmetric 

across these criteria. These criteria are moving targets, and their 

calculation and interpretation (i.e., economic judgement) remain quite 

uncertain. This has been pinpointed by many researchers, e.g., see 

Buiter and Sibert (2006) and Schadler at al (2005). 

First, there is no clear definition of an outlier, and while sustainability issues 

are evaluated for a candidate country, they are not looked at so 

Core inflation might be a 

better indicator to judge 

price stability 

Evaluation of price 

stability might be done 

for a longer period of 

time 

Uncertain treatment of 

outliers 

4 Since the existing criterion includes 12-month average annual inflation, it in fact takes 

into consideration price changes over the last 24 months. 


closely for possible reference countries. That is, a very low inflation in 

chosen “best-performing” countries might actually be due to temporary 

factors. For instance, in the 2004 convergence report, Lithuania was considered 

to be an outlier because it experienced deflation due to countryspecific 

circumstances (-0.2%). At the same time, a very low inflation rate 

in Finland (0.4%) was considered “normal,” while the average of the euro 

area at that time was 2.1%. 

In 2010, due to the global economic and financial crisis, deflation was 

considered to be something “normal” (the three best performers chosen 

showed an average of -0.5%). At the time, Ireland was excluded from the 

calculation and treated as an outlier because there was a substantial difference 

between its deflation rate (-2.3%) and that of the euro area average 

(0.3%) and other EU countries. 

However, until now, nowhere has it been written what the margin is, exceeding 

which a country is considered to be an outlier. Note that, with 

respect to the price stability criterion, if an outlier is indeed recognised, 

the next three countries with the lowest inflation are taken (this was the 

case both in 2004 and 2010, when outliers were recognised). 

Furthermore, the moving-target criteria depend on developments not only 

in the euro area (which potential candidates are supposed to join), but 

also in other EU countries – for calculating criteria, “best-performing” EU 

members are considered. The more countries join the EU, the larger is 

the chance of getting an “odd one” (which will not necessarily be treated 

as an outlier). Moreover, this implies that a candidate country may be 

evaluated against itself. In 2010, this was actually the case for Estonia. 

Second, the treatment of outliers may be asymmetric across different 

criteria. For instance, regarding the interest rate criterion, the first time an 

outlier was recognized was this year, when Ireland was excluded from 

the calculation because it was (and still is) in the bailout programme and 

had a very limited access to borrowing in international financial markets. 

One could assume that the same treatment will be applied again, going 

forward. However, Ireland was not excluded when calculating price stability 

criteria. It did not have the lowest inflation, but one could argue that 

being in the bailout programme implies country-specific circumstances 

(like austerity measures, undermined economic growth, and, thus, deflationary 

pressures). Thus, the asymmetric treatment of outliers across different 

criteria adds to the uncertainty of meeting the criteria. 

Comparison against EU, 

not euro area, members 

Asymmetric treatment 

across different criteria 

Note that, contrary to the price stability criterion, an outlier is excluded 

from the interest rate criterion calculation without picking up the next performer 

in the row (this was the case in 2012 and also in 2010, when Estonia 

was excluded from the calculation of the interest rate criterion due 

to lack of an appropriate benchmark). Thus, theoretically it is possible 

that all three “best performers” in terms of inflation are under bailout programmes 

and there is none to compare interest rates with. It is not completely 

impossible, since the number of countries that ask for financial aid 

is increasing. 

It is thus not clear how Greece, Portugal, and Ireland (those currently under 

bailout programmes) will be treated next year, and even less clear 

how Spain and Cyprus (countries that have asked for financial aid, but so 

far are not under formal bailout programmes; Spain still can borrow in 

international financial markets) will be treated. If these countries experience 

very low inflation rates due to suppressed domestic demand under 

Uncertain treatment of 

countries under bailout 

programmes 


austerity, will they still be included in the calculation of the price stability 

criterion? 

Uncertain treatment of outliers, especially under the current unprecedented 

bailout programmes and conditions, creates room for the EC and 

the ECB to manoeuvre and there is a risk that the economic judgement 

may be politicised. There is a possibility that the euro area will not be willing 

to accept new members due to its current problems. In such a case, 

the asymmetry characterizing the way the criteria are interpreted may be 

used by policy makers in the euro area and make decision-making process 

less transparent. 

4. What could the benchmarks look like in March 

2013? 

Euro adoption in 2014 is currently the official national target in Latvia. 5 In 

Lithuania, it is not so far the target – the decision on this is likely to be 

made after the parliamentary elections in October 2012. The applications 

of Latvia and Lithuania (if the latter indeed chooses to go for the euro in 

2014) to be evaluated under the convergence report are expected to be 

submitted in April 2013, i.e., when the government budget data for 2012 

according to ESA methodology are published. Therefore, the moving targets 

– inflation and long-term interest rate criteria – will be evaluated 

based on data published in April 2013, i.e., data for March. 

It is hard to say what the moving-target criteria will look like at that time, 

though. First, there is high political and economic uncertainty in the euro 

area and, thus, elevated interest rate volatility. Amongst the still unanswered 

questions are the following: will the financial aid to Spain be considered 

as a bailout package, will Greece exit the euro area (under current 

legislation, it would then need to leave the EU as well), etc. Second, 

as already outlined in the previous section, there is uncertainty about the 

way to calculate the criteria. 

High political and 

economic uncertainty in 

the euro area 

According to the spring EC forecast (see European Commission, 2012d), 

the countries with the lowest 12-month average HICP inflation in the first 

quarter of 2013 are forecast to be Greece (-1.4%), Sweden (1.3%), Ireland 

(1.7%), Spain (1.7%), and France (1.9%). The differences between 

the indicators in the latter three countries are very small. Note that there 

are great risks to this forecast (e.g., deeper recession in the euro area, 

commodity prices etc.), and the reference countries might well be different. 

For instance, if Spain raises its value-added tax (VAT) base rate from 

18% to 21% as of September 1 (as is planned) to reduce the budget 

deficit, then its 12-month inflation is likely to be somewhat higher in 

March 2013 than the EC forecast suggests. 

Most likely, Greece, if it stays within the euro area and the EU, will be 

considered to be an outlier in price stability terms due to forecast deflation 

(and it should be, as it is not in a “normal state of play”). If Sweden, 

together with Ireland and Spain (or France), is considered for the price 

stability comparison, the criterion might be about 3% (see the next section 

for more details). But other countries may well be amongst the best 

performers. For instance, if the latest HICP developments are considered, 

Bulgaria may be amongst countries with the lowest inflation in 

March 2013 – in the first five months of 2012, its average annual HICP 

growth was 1.9%. 

Price stability criterion 

might be at about 3% 

5 http://ec.europa.eu/economy_finance/euro/adoption/who_can_join/index_en.htm 


HICP annual inflation, % 

7.5 

5 

3Q 4Q 1Q 

2.5 

0 

-2.5 

IE GR ES SI 

SE LV LT FR 

-5 

2010 2011 2012 2013 

Source: Eurostat, quarterly Swedbank forecasts for LV and LT, EC forecasts for other countries 

There is even more ambiguity with respect to interest rates. There are no 

forecasts available, and the current high political and economic uncertainty 

in the euro area (resulting in high interest rate volatility) does not 

allow sensible predictions to be made. Judging from the 2012 convergence, 

Ireland could be excluded from the calculation of the interest rate 

criterion (because it is under the bailout programme) 6 . If financial aid to 

the Spanish banking sector is not considered as a bailout package and 

this country is still able to borrow in financial markets, it is likely to be included 

in the interest rate criterion. However, if it is excluded from the 

markets, then Sweden might be the only country used for interest rates 

comparison (with the possible inclusion of France, if it has lower inflation 

than Spain); this would make the criterion extremely challenging to fulfil. 

Sweden is one of the strongest EU economies; it is perceived as one of 

the few “safe havens” and enjoys very low bond yields. Moreover, it is 

paradoxical and ironic to compare EMU candidate countries with Sweden, 

since it is not even in the euro area and has a floating exchange 

rate. 

Great uncertainty 

regarding interest rate 

criterion 

Long-term government interest rates (EUR), % 

15 

ES SI SE 

12 

LV LT FR 

9 

6 

3 

0 

2006 2007 2008 2009 2010 2011 2012 

Source: Eurostat 

6 Ireland has already successfully issued 3-year government bonds in February (EUR 3.6 

billion) and 5-year government bonds in July 2012 (EUR 3.9 billion). 


5. Prospects for Latvia and Lithuania 

Will Latvia and Lithuania be able to comply with the Maastricht criteria in 

2013? The most difficult part of answering this question seems to be 

foreseeing what the moving-target criteria will look like. 

In the table below, we provide a summary of possible values of the price 

stability criterion for March 2013, depending on which countries are included, 

the long-term interest rates as of June 2012, and forecasts for 

public finances situation in 2012. 

Compliance with the criteria: outlook for March 2013 (except for interest 

rates) 

Reference value 

Criterion (countries included) Latvia Lithuania 

HICP inflation 

1 

Long-term 

interest rate 

(June 2012) 3 

Government 

deficit (2012) 

Government 

debt (2012) 

Participation 

in ERM II 

3% (IE, SP, SE) 

3.1% (FR, SP, SE or 

FR, IE, SE) 

2% (IE, SE, GR) 

2% (SP, SE, GR) 

5.7% (SP, SE) 

5.5% (FR, SP, SE) 

4.4% (FR, SE) 

3.9% (SE) 

2.6% 2 2.6% 2 

5.5% 5.2% 

3% of GDP 2.2% 2 3.0% 2 

60% of GDP 41.3% 2 40.0% 2 

2 years, fluctuation 

band of +/- 15% 

around the central 

rate 

Since 2005, 

fluctuation band 

of +/- 1% around 

the central rate 

Since 2004, currency 

board – 

hard peg without 

foreign exchange 

fluctuations 

1 

The criterion calculated by Swedbank based on the EC forecast for 12-month average annual 

HICP inflation in 1Q 2013, depending on which countries are considered to be outliers. 

2 

Swedbank forecast (April 2012). 

3 

12-month average. No forecast available. 

5.1 Price stability 

Latvia: The 12-month average HICP annual inflation rate is expected to 

be about 2.6% (Swedbank's April 2012 forecast) in March 2013. The EC 

spring forecast is 2.4%. A pickup in oil prices in the beginning of 2012 

has also been reflected in higher administratively regulated prices, 

namely, gas and heating tariffs as of July (adding about 0.2 percentage 

point to the annual inflation). However, since these tariffs are linked to the 

nine-month-average heavy oil price, the rise in regulated prices is smaller 

than the global oil price hike. Moreover, oil prices have retreated from 

their highs and are not expected to exert upward pressures on consumer 

prices in the second half of the year. Food price inflation has decelerated 

substantially in line with global trends, although possible bad harvests 

this year (e.g., drought in the US) may again push food prices up. Still, 

domestic demand pressures are muted – core inflation (excluding energy 

and unprocessed food) remains below 2%, which is lower than the headline 

inflation rate. 


Owing to the improved budget situation, previous tax hikes are being reversed. 

There was a base VAT rate cut from 22% to 21% on July 1, 2012 

(which has not yet been considered in our forecast). This tax cut is likely 

to reduce consumer price inflation even more, although the overall effect 

on prices is expected to be rather muted. As of January 1, the personal 

income tax will also be lowered by 1 percentage point to improve labour 

competitiveness, but no significant effect on prices is expected because 

of this. 

Lithuania: We forecast average annual HICP to be around 2.8% at the 

end of this year, and to decline further to 2.6% by March 2013. The EC 

spring forecast is 3.1%, but this outcome seems increasingly unlikely, 

considering the price trends during the first half of this year and recent 

developments in global commodities markets. The main drivers of inflation 

in Lithuania are the same as in Latvia – developments in global 

goods and commodities markets. Domestic factors will remain muted – 

high unemployment will keep employee negotiation power low, and productivity 

growth will be in line with wage growth this year and the next. 

The government has decided to increase the minimum monthly wage by 

LTL 50, or 6.25%, starting on August 1; this is below the hike of LTL 100 

(or 12.5%) that we considered in our April forecast. Most important the 

monopoly Lithuanian Gas decided (and the regulator agreed) to increase 

gas prices for households by about 22% as of July 1. This was due to 

higher oil prices (the import price of gas is directly indexed to the price of 

oil); however, this increase now seems to be excessive, considering the 

steep decline of oil prices during the past few months. Our estimates 

show that this will add about 0.35 percentage point to annual inflation, but 

the effect on the March average annual inflation figure will be smaller. 

The price of heating in some major cities will go up in the second half of 

2012, and public transport will become more expensive in Vilnius as of 

August 15. The biggest impact, however, on inflation will be from developments 

in commodities markets, which have so far been favourable for 

Lithuania (except maybe for oil). The already-contracting producer prices 

indicate a further decline in consumer inflation. Thus, we think our April 

inflation forecast is accurate and average annual HICP will trend towards 

2.6%. But, as in Latvia, due to global trends there is a risk of higher food 

price inflation in the second half of the year. 

If the price stability criterion is calculated using Ireland, Spain, France, 

and Sweden (any three of them) based on the EC forecast, neither Latvia 

nor Lithuania should experience problems in fulfilling it. It seems that 12- 

month average inflation in both countries will fall under 3%. The interpretation 

of sustainability may vary, though. Wage growth is still in line with 

productivity gains; unit labour costs have risen only marginally. In the 

medium term, however, risks for labour market pressures could cause 

more rapid inflation. Realising the catching-up potential might also support 

price growth in the longer term, but this should not be a problem if 

price convergence is going hand in hand with productivity convergence 

(see Section 1 for more details). It is highly uncertain how these issues 

will be treated by the EC and the ECB – ultimately, the risk of making a 

more political than economic judgement will increase. 

Latvia and Lithuania are 

likely to fulfil the price 

stability criterion 

All in all, due to smaller increases in regulated prices, it seems that Latvia 

will be slightly better positioned if external or domestic factors push the 

price stability criterion lower than currently forecast by the EC. 


5.2 Interest rates 

Latvia: In June 2012, the long-term interest rate for Latvian government 

debt 7 was 5.1%, down from 5.9% a year ago. A similar tendency is observed 

for shorter-term bonds’ interest rates – e.g., two- year bond yields 

are already below 2%. As economic growth continues and the budget 

deficit diminishes, interest rates are expected to continue retreating as 

well. We forecast the government budget deficit to decline from 2.2% this 

year to 1% the next. Public debt levels continue to be low and retreating 

(see below). 

Lithuania: In June 2012, the long-term interest rate for Lithuanian government 

debt was 5%, marginally lower than a year ago. Continued economic 

growth and the decline of the budget deficit will probably push the 

yield downwards – a clear trend can already be seen in shorter-term 

bonds yields, some of which are already below the pre-crisis level. Currently, 

there might be some risk premium related to the uncertainty connected 

with the election outcome and the new government’s determination 

to continue fiscal austerity. The risk premium should decline once the 

government confirms the budget for 2013. We forecast that the budget 

deficit will fall to 2% of GDP next year and to 1% of GDP in 2014. 

Despite continuous improvement, it is still uncertain whether Latvia and 

Lithuania will be able to fulfil the interest rate criterion in April 2013. If 

Spain and France, together with Sweden, are considered in the calculation 

of the criterion, Latvia and Lithuania are likely to fulfil it. However, 

fulfilling the criterion would become an almost impossible task if only 

Sweden is considered (and very challenging even if Sweden and France 

together are taken), since Sweden’s interest rates are likely to remain 

substantially below Latvia’s and that of the euro area. For instance, if the 

criterion were calculated in June 2012, neither Latvia, nor Lithuania would 

fulfil it (since Ireland and Greece would be excluded from calculation, and 

only Sweden considered). 

High uncertainty 

regarding the interest 

rate criterion 

5.3 Government deficit 

Latvia: The EC forecasts a 2.1% government budget deficit for 2012. 

The Swedbank forecast stands at 2.2%, owing to increased government 

spending pressures (including wage increases in the public sector) due to 

better-than-expected economic growth in the beginning of the year. Currently, 

it looks like the deficit is likely to be even lower than that. Tax 

revenues exceeded the plan by 9% in the first half of 2012 (up by nearly 

15% from a year ago). In July, the government conceptually approved an 

additional LVL 70 million to be spent, which is a bit less than a half of 

what the ministries have requested. A supplementary budget is planned 

to be submitted to the parliament by the end of August. The government 

continues to be highly committed to keeping spending under control (it is 

not raising the budget deficit for this year), and, under the base scenario, 

Latvia should not experience any problems in fulfilling this criterion. 

Lithuania: We forecast the general government budget deficit to decline 

to 3.0% of GDP this year and be exactly at the margin of this convergence 

criterion. The EC forecasts a slightly worse fiscal position – a deficit 

of 3.2%. However, recent data suggest that the risk of not meeting this 

criterion is low – national budget revenues during the first half of this year 

grew by 4.6% over the same period last year and exceeded the plan by 

7 Issued by the central government, maturity close to 10 years, fixed coupon. Data from 

Eurostat (Maastricht criterion bond yields). 


2.4%. Still, the risk of slower growth and lower budget revenues (due to 

the euro area woes) during the second half of this year remains. The government 

is still very determined to keep spending under control and to 

reduce the budget deficit to at least 3.0% of GDP, and President Dalia 

Grybauskaite stresses the importance of fiscal austerity. The government 

is not planning any additional austerity measures this year, but, as the 

budget revenues are ahead of the plan, we do not see the need for such 

measures and feel that excessive austerity would cause unnecessary 

downward pressure on the economy. 

Overall, Latvia has an ample reserve for fulfilling the budget deficit criterion, 

and Lithuania still has a good chance of meeting it as well. It is important 

to note that both Latvia and Lithuania have managed to cut their 

budget deficits drastically – from 9.8% and 9.4% of GDP, respectively, in 

2009 to below or close to 3% of GDP this year. The budget deficit convergence 

criterion suggests that it can be sufficient that “the ratio has declined 

substantially and continuously and reached a level that comes 

close to the reference value.” However, if the target of below 3% is not 

met straight on, it opens up discussions and possible interpretations on 

the acceptability of the progress and thus may preclude EMU membership. 

Latvia is better prepared 

to fulfil the budget deficit 

criterion than Lithuania, 

but both countries are 

likely to meet it 

5.4 Government debt 

For Latvia, the EC forecasts a 43.5% government budget debt for 2012; 

Swedbank's forecast stands at 41.3%. There is a comfortable reserve, 

and it is clearly no problem for Latvia to fulfil this criterion. For Lithuania, 

Swedbank forecasts its general government debt to be 40.0% of GDP 

this year, slightly lower than the EC forecast of 40.4%. In both countries, 

there is a comfortable reserve and thus no risk of not meeting this criterion 

in 2012. 

Latvia and Lithuania 

comfortably meet 

government debt 

criterion 

5.5 Exchange rate 

Latvia already fulfils the exchange rate criterion. It has been in Exchange 

Rate Mechanism (ERM) II since 2005, and the lats is pegged to the euro 

with +/- 1% fluctuation allowed around the central rate. Lithuania also 

fulfils the exchange rate criterion. It has been in ERM II since 2004, and 

the litas is pegged to the euro under the currency board arrangement (no 

fluctuations). Also, neither Latvia nor Lithuania is expected to experience 

problems with fulfilling the exchange rate criterion next year. Both countries 

proved that their currencies are stable and were able to hold the exchange 

rate fixed throughout the latest crisis. 

No problems with 

exchange rate criterion 

5.6 Legal compatibility 

There are still a few legal compatibility issues to be solved (e.g., regarding 

the laws about the central bank, etc). Latvia is aware of this and plans 

to harmonise its legislation accordingly in due time. In Lithuania, there is 

more uncertainty – the official euro adoption target date has not been set 

yet, and the Bank of Lithuania seems to be sceptical about both the prospects 

for complying with all the criteria and the need to “rush” into the 

euro area. 

5.7 Sustainable convergence and macroeconomic imbalances 

Regarding the scoreboard of macroeconomic imbalances, in 2011 both 

Latvia and Lithuania did not comply with only 2 indicators out of 10: the 

net international investment position and the unemployment rate. Na- 

Remaining macro 

imbalances in some 

areas should not be an 

obstacle to joining the 

EMU. 


tional statistical data suggest that Latvia and Lithuania do not surpass the 

thresholds of the “n/a” indicators for which data were not included in the 

convergence report. With deleveraging continuing, the net international 

investment position will become less negative, while increasing economic 

activity will reduce unemployment. Nevertheless, Latvia and Lithuania are 

unlikely to comply with these benchmarks by next year – improvement in 

both these areas will not be that fast. Provided that progress in the right 

direction continues and given that the aim of the MIP is not to evaluate 

readiness to adopt the euro, this situation, however, should not become 

an obstacle to joining the EMU. Both countries are on the right track, and 

former imbalances have been by and large been corrected. 

Scoreboard for surveillance of macroeconomic imbalances, 2011 (according 

to the 2012 convergence report) 

Indicator Threshold Latvia Lithuania 

Current account balance, % of GDP 

(3 year average) 

Net international investment position, 

% of GDP 

Real effective exchange rate, HICP 

deflated (3-year percentage change 

relative to 35 trading partners) 

Export market shares (5-year percentage 

change) 

Nominal unit labour costs (3-year 

percentage change) 

House prices, consumption deflated 

(annual percentage growth) 

-4.0/+6.0% 3.5% 1.5% 

-35% -72.5% -52.2% 

±11% -0.6% 3.5% 

-6% 24.7% 26.4% 

+12% -15.1% -9% 

+6% n/a n/a 

Private sector credit flow, % of GDP +15% n/a n/a 

Private sector debt, % of GDP +160% n/a n/a 

General government debt, % of 

GDP 

Unemployment rate (3-year average) 

+60% 43% 39% 

+10% 17.1% 15.6% 

1 

Either a range or a suggested lowest (-) /highest (+) acceptable value of the particular 

indicator. 

Source: ECB (2012) 

5. Conclusion 

Both Latvia and Lithuania have a good chance of fulfilling the Maastricht 

criteria in April 2013. However, the probability of adopting the euro in 

2014 is somewhat bigger for Latvia, since is has more room for 

manoeuvre and also stronger political resolve. 

Latvia has a slightly 

better chance than 

Lithuania to fulfil the 

criteria in March 2013 

For Latvia, the most challenging criterion currently is interest rates, since 

it involves the largest uncertainty regarding which countries will be used 

for comparison. Under the muddling-through baseline scenario of the 

global economy, no problems are expected with other criteria, although 

the treatment of sustainability issues remains uncertain. For Lithuania, 

inflation is also a hurdle, especially if global food prices go up in the 

second half of the year; whereas the budget deficit criterion may be 

breached if the euro area recession worsens and budget revenues suffer 

during the second half of this year. 


Taking into account that the calculation and interpretation of movingtarget 

criteria are uncertain and not always symmetric, unpleasant 

surprises are still possible. Ambiguous economic judgement thus gives 

more room for political judgement, as at the end of the day the decision of 

whether to accept a new member to the EMU is taken by politicians. 

If by any chance Latvia and/or Lithuania do not fulfil some of the criteria 

for 2014 membership, the countries are likely to pursue the target in the 

following year. In Lithuania, however, political determination is less 

certain. As public support for the euro is weak, few politicians want to 

discuss openly Lithuania’s prospects. Some are openly sceptical of 

whether Lithuania needs to “rush into the ailing euro area to help 

Greece.” President Dalia Grybauskaite has recently also adopted a more 

conservative “wait-and-see” approach. There seem to be a more 

unanimous agreement to meet Maastricht criteria for the sake of stability, 

but not necessarily in order to adopt immediately the euro. Thus, there is 

a probability that Lithuania will not apply formally for euro adoption in 

2014 – much of this will depend on election results in October, as well as 

the euro area’s progress towards a sustainable solution. 

Public support for euro adoption is low in both countries, most likely 

resulting from negative media news about the euro area crisis. The 

Eurobarometer results for April 2012 show that 46% of respondents are 

in favour of euro adoption in Latvia (9% very much in favour) and 44% in 

Lithuania (10% very much in favour). 8 However, only 9% of respondents 

in Latvia and 14% in Lithuania would like to see adoption of the euro as 

soon as possible. 

Political resolve towards 

euro adoption is stronger 

in Latvia 

Public support for the 

euro is low, reflecting 

negative media news 

about the euro area 

crisis 

Nevertheless, in Latvia there is a broad understanding of the benefits of 

joining the EMU by both the government and businesses. Major industry 

associations in both countries are in favour of euro adoption by a massive 

margin. Better communication of the euro advantages to households 

should be made. Activities in this area are being undertaken – e.g., 

Latvian Finance Minister Andris Vilks recently signed a partnership 

agreement on euro changeover communication activities with the 

European Commission. 

As for the policy issues Latvia and Lithuania must pursue, we think both 

countries should aim to meet the Maastricht criteria; however, the 

situation in the euro area should be monitored. If the fundamental 

problems of the monetary union are not tackled (or at the least adequate 

progress is not made) and things turn from worse to worst, there is 

always an opportunity for both Latvia and Lithuania to postpone euro 

adoption. 

Suggested strategy for 

Latvia and Lithuania: 

meet the Maastricht 

criteria and then decide 

whether to join the EMU 

Lija Strašuna 

Mārtiņš Kazāks 

Nerijus Mačiulis 

8 http://ec.europa.eu/public_opinion/topics/euro_en.htm 


Abbreviations 

BS effect – Balassa-Samuelson 

effect 

DG ECFIN – European 

Commission's Directorate-General 

for Economic 

EA – Euro area 

EC – European Commission 

ECB – European Central Bank 

EMU – European Monetary Union 

ES – Spain 

ESA – European System of 

Accounts 

EU – European Union 

FR – France 

GR – Greece 

HICP – Harmonised index of 

consumer prices 

IE – Ireland 

LT – Lithuania 

LV – Latvia 

MIP – Macroeconomic imbalance 

procedure 

SE – Sweden 

SI – Slovenia 

Treaty – Treaty on the Functioning 

of the European Union 

VAT – value added tax 

References 

Buiter, Willem H. (2004), “En Attendant Godot? Financial instability risks 

for countries targeting Eurozone membership” 

Buiter, Willem H., Anne Sibert (2006), “Beauties and the Beast. When will 

the new EU members from Central and Eastern Europe join the 

Eurozone?” 

Coudert, V. (2004). Measuring the Balassa-Samuelson effect for the 

countries of Central and Eastern Europe? Banque de France Bulletin Digest. 

De Grauwe, Paul, Schnabl Gunther (2004), “Nominal versus real 

convergence with respect to EMU accession. How to cope with the 

Balassa-Samuelsson dilemma”, EUI Working paper RSCAS No. 2004/20 

EC (2010), Convergence report 2010. European Economy 3/2010 

EC (2012a), “Alert Mechanism Report”, COM(2012) 68, February 2012 

EC (2012b), “Scoreboard for the surveillance of macroeconomic 

imbalances”, European Economy, Occasional Paper 92, February 2012 

EC (2012c), Convergence report 2012. European Economy 3/12 

EC (2012d), European Economic Forecast Spring 2012, European 

Economy 1/12 

ECB (2010), Convergence report, May 2012 

ECB (2012), Convergence report, May 2012 

EEAG – European Economic Advisory Group (2007), “The EEAG Report 

on the European Economy 2007”, Chapter 3: The new EU members 

Lojschová , A. (2003). “Estimating the Impact of Balassa-Samuelson 

Effect in Transition Economies” 

Mihaljek, D. and Klau, M. (2009). “Catching Up and Inflation in the Baltics 

and Southeastern Europe: the Role of Balassa-Samuelson effect” 

Schadler, Susan et al (2005), “Adopting the Euro in Central Europe 

Challenges of the Next Step in European Integration”, IMF Occasional 

Paper 

Šikulova, Ivana (2007), “Maastricht inflation criterion and price 

convergence in the new member states” 


Economic Research Department 

Sweden 

Cecilia Hermansson +46 8 5859 7720 cecilia.hermansson@swedbank.se 

Group Chief Economist 

Chief Economist, Sweden 

Magnus Alvesson +46 8 5859 3341 magnus.alvesson@swedbank.se 

Head of Economic Forecasting 

Jörgen Kennemar +46 8 5859 7730 jorgen.kennemar@swedbank.se 

Senior Economist 

Anna Ibegbulem +46 8 5859 7740 anna.ibegbulem@swedbank.se 

Assistant 

Estonia 

Annika Paabut +372 888 5440 annika.paabut@swedbank.ee 

Chief Economist, Estonia 

Elina Allikalt +372 888 1989 elina.allikalt@swedbank.ee 


Teele Reivik +372 888 7925 teele.reivik@swedbank.ee 


Latvia 

Mārtiņš Kazāks +371 67 445 859 martins.kazaks@swedbank.lv 

Deputy Group Chief Economist 

Chief Economist, Latvia 

Lija Strašuna +371 67 445 875 lija.strasuna@swedbank.lv 


Lithuania 

Nerijus Mačiulis +370 5 258 2237 nerijus.maciulis@swedbank.lt 

Chief Economist, Lithuania 

Lina Vrubliauskienė +370 5 258 2275 lina.vrubliauskiene@swedbank.lt 


Vaiva Šečkutė +370 5 258 2156 vaiva.seckute@swedbank.lt 



Disclaimer 

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