Estonia tomorrow becomes the first former Soviet republic to join the euro, putting at least a temporary cap on the currency bloc’s expansion as the sovereign debt crisis ripples through Europe.
Wedged between Russia and Latvia on the Baltic Sea, Estonia will at midnight become the 17th country to switch to the currency. Gross domestic product of 14 billion euros ($19 billion) makes it the second smallest euro economy after Malta.
As Europe grapples with the financial crisis, Estonia is likely to be the last addition to the euro club for several years. Lithuania and Latvia, the next in line, are aiming for 2014 and bigger eastern countries have shied away from setting target dates.
“The euro is still generally seen as a positive for the applicant countries as long as the conversion rate is somewhat competitive,” Elisabeth Gruie, an emerging-markets strategist at BNP Paribas SA in London, said in an email. High deficits are keeping Poland out and an “inner desire for independence” is the obstacle in the Czech Republic, she said.
Debt estimated by the European Union at 8 percent of GDP in 2010 will make Estonia the fiscally soundest country in a currency bloc plagued by budget woes that forced Greece and Ireland to fall back on European and International Monetary Fund aid.
Confidence in Euro
“It is a sign of the confidence of Estonia toward the euro, despite the current difficulties, which will be a positive signal to the markets,” Joseph Daul of France, floor leader of center-right parties in the European Parliament, said in an e- mailed statement.
Estonia’s central bank chief, Andres Lipstok, 53, will join the European Central Bank’s policy-setting council, taking part in his first interest-rate vote on Jan. 13 in Frankfurt.
Some 85 million euro coins featuring a map of Estonia and 12 million banknotes go into circulation tomorrow, according to the central bank, starting a two-week phase out of the national currency, the kroon. One euro buys 15.6466 krooni.
The 1.3 million Estonians have little experience of monetary autonomy. In June 1992, less than a year after regaining independence from the Soviet Union, Estonia shifted from the Russian ruble to a national currency that it immediately pegged to the German mark. The exchange rate was locked to the euro when the first 11 countries began using it in 1999.
Western Anchor
Estonia in 2004 was in the initial wave of eastern European countries to join the EU, seeking a western anchor as an insurance policy against Russia. It entered the North Atlantic Treaty Organization the same year.
“Estonian policy has been to distance itself as quickly as possible from the former Soviet space or Russia and to integrate itself as completely as possible into western European organizations,” said Andres Kasekamp, a politics professor at Tartu University. “It was more aggressive than the other two Baltic states in this.”
Economic growth averaged 7.2 percent between 1995 and the onset of the global financial crisis in 2007. Reliant on foreign investment, Estonia was hit harder than most in the global slump, with the economy shrinking 5.1 percent in 2008 and 13.9 percent in 2009, the sharpest contraction since its transition to a market economy at the beginning of 1990s.
At the same time, inflation soared to 10.6 percent in 2008, missing one of the five economic tests for euro entry. The other targets are for deficits, debt, long-term interest rates and exchange-rate stability.
Fiscal Corset
While the deficit, at 2.8 percent of GDP in 2008, was under the euro’s 3 percent limit, Prime Minister Andrus Ansip’s government kept up the austerity drive. Tax increases, spending cuts and higher dividend collection from state-owned companies whittled the shortfall to an EU-estimated 1 percent in 2010. Poland’s deficit was 7.9 percent.
Unlike in Latvia or Lithuania, Estonia’s neighbors along the Baltic coast, the belt-tightening steps didn’t provoke public unrest. Growth rebounded to 2.4 percent in 2010 and will reach 4.4 percent next year, the EU predicts.
“The Estonian government early in the crisis realized that it provides a great window of opportunity,” Kasekamp said. “The austerity and cuts in the public sector were necessary anyhow, but to make it more palatable, the government created a vision that these cuts are in the name of joining the euro, so this became a light at the end of the tunnel.”
Kroon Nostalgia
Backing for the euro ebbed to 52 percent this month from a record 54 percent in November, according to a government- sponsored poll of 501 people with a margin of error of 4 percent. The Finance Ministry on Dec. 21 blamed the slippage on an early case of nostalgia for the soon-to-be abolished kroon.
By contrast, support for the single currency is plunging in Germany, which designed the euro as the successor to the low- inflation deutsche mark. Some 49 percent of Germans want to bring back the mark and only 41 percent want to keep the euro, according to a Bild newspaper poll last month.
“Estonia is too small to allow itself the luxury of full independence,” Finance Minister Jurgen Ligi said in Tallinn, the capital, on Dec. 21. “All European countries are in fact too small for this. We are not gambling anything.”
To contact the reporter on this story: Ott Ummelas in Tallinn at oummelas@bloomberg.net
To contact the editor responsible for this story: Willy Morris at wmorris@bloomberg.net
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