EMU enlargement: Lithuania - looking forward to a no-no ?

George Parker and Ralph Atkins in FT (13/06/2006, “Lithuania set to become victim of tough EU single currency stance”) confirm the determination of the Baltic State to join the single currency – its central bank is expected to apply for euro membership amid warnings that its application will be rejected. Joaquim Alumnia the EU monetary affairs commissioner warned against the “unpleasantness” of getting a negative answer.

Lithuania aims at joining the Euro together with Slovenia on the 1st of May, but higher inflation expected at the end of the year would breach the benchmark MC levels.

The authors justly underline the fact that the sharp contrast of the scrutiny the Baltic States are subject to with the politically fueled rush that at the wake of the formation of the common currency at the beginning of the 1990s.
They also quote Bruegel, a Brussels think-tank that claims the undervaluation of the adverse side of “premature” EMU entry, allegedly the case of Italy and Portugal, and the loss of the possibility to devalue currency as a response to shocks may be problematic in the case of rapidly growing Baltics. Needless to say, the currency board experience of Lithuania shows it does not tend to rely on the devaluation tool. Moreover, there is not much evidence that the Lithuanian currency is undervalued at the moment - the CA is in deficit, mainly due to rising imports of services.
If due to rapid growth the real exchange rate (RER) appreciated and was to adjust because of mounting pressures we must compare the effects of a sudden devaluation of the currency with nominal price and wage adjustments, be it inside or outside the euro. On the other hand, as the Baltics claim, their CA deficits are in large part due to FDI inflows, and once the effect of such investments kick in, exports should rise and close this gap. Moreover, as visible in Charts 7 and 8 of the report by Alan Ahearne and Jean Pisani-Ferry (The Euro: only for the agile ) the cumulative RER appreciation is lower in the Baltics than in most NMS – being a source of the recent inflation.
Whether Lithuania is trying to signal its commitment, hoping for luck, be it in lower-than-expected inflation or in putting some pressure on loosening of the EC stance, that is a different question, though betting against an explicit rejection may turn out costly – unless one is willing to go as far as to adopt the euro unilaterally.