Audit Committee Bulletin: January 2014

Latvia’s accession shows Eurozone’s attractiveness

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Despite the struggles of the past five years and the prospect of a weak recovery, joining the Eurozone remains an attractive prospect for Eastern European economies. Latvia became the Eurozone’s 18th member on 1 January 2014, and we expect Lithuania to follow in 2015.

Joining the Eurozone remains an attractive prospect for Eastern European economies, because many already send a large chunk of their exports to the single currency area, so membership removes the exchange rate risk.

Latvia will be the fastest-growing Eurozone country this year, with GDP forecast to rise by close to 4.5% and accelerate to over 5% in 2015–17. Lithuania may post slightly faster rates of growth,well ahead of other Eurozone countries, although both countries experienced recentdeep recessions..

Joining the Eurozone to lower risk

  • Joining the Eurozone remains an attractive prospect for Eastern European economies. Many already send a large chunk of their exports to the single currency area, so membership removes the exchange rate risk.
  • The loss of control over monetary policy in joining a currency area is a potential risk to small and open economies. However, taking into account earlier substantial internal devaluation and structural reforms, we think that both Latvia and Lithuania are well placed to adapt to Eurozone membership.

The Eurozone continues along the road to recovery …

  • After falling by an expected 0.5% in 2013 as a whole, we forecast Eurozone GDP will grow by 0.9% in 2014 and then by about 1.6% a year in 2015–17.

…..and now looks less vulnerable to external shocks

  • The resilience of financial markets in the face of political turmoil in Italy and fiscal issues in the US  proved a pleasant surprise. This reflects faith in the European Central Bank (ECB) as a backstop for Eurozone bond markets and greater confidence in the outlook now that the economy has returned to growth.
  • But this resilience cannot be taken for granted. The next big test is the ECB’s asset quality review and the subsequent restructuring of the banking sector. Policy-makers must ensure that — at the very minimum — the relatively modest expectations of the markets are met so as not to threaten the region’s current stability..
  • The ECB will also have a key role to play in 2014 in setting policy to counter any tightening in credit conditions imported from the US once the Federal Reserve starts tapering.

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