Euro introduction in Lithuania: BoL approach

1. Euro introduction in Lithuania: BoL approach Presentation by Darius Petrauskas Deputy Governor Bank of Lithuania / Lietuvos bankas Capital Markets Day SEB Eastern European Banking March 21-22 Vilnius

2. Outline • Reasoning behind the euro introduction • Economic convergence criteria • Main elements of the changeover • Conclusions

3. Benefits of € introduction (1) • Elimination of the exchange rate risk; • Abolishment of the risk premia included in interest rates; • Hedging activities become redundant; • Elimination of currency exchange transaction costs; • Payments across the euro area become easier, faster and cheaper.

4. Benefits of € introduction (2) • Incorporation of Lithuanian financial market into the seconddeepest financial market in the world; • Direct access for domestic banks to Eurosystem’s refinancing operations; • Some financial instruments more accessible, further expansion of banking products and services; • Fundamental benefit – stronger and more resilient to shocks financial system – stronger foundations for the country’s macroeconomic stability and growth.

5. Hardly any €introduction drawbacks (1) • Introduction of the single currency does not narrow our economic policy choices: • Monetary policy is not used as a macroeconomic management tool; • Fixed exchange rate regime precludes looser fiscal policies (or wider budget deficits);

6. Hardly any €introduction drawbacks (2) • Inflationary processes are not related to the euro introduction: • monetary reform creates no more, no less money; • due to remaining large difference in the level of prices, somewhat higher inflation in new member states is inevitable over the medium to long term, irrespective of the euro introduction • The pure effect of the euro introduction in other countries was negligible – only 0.1-0.3 percentage points;

7. Hardly any€ introduction drawback (3) • Monetary reform entails some costs… • Though net cost effect is significantly lower than calculated straightforwardly; • Lithuania assumed obligation to introduce the euro and sooner or later these costs would have to be borne; • After all, the benefits of early introduction of the euro by far outweigh the costs of technical preparation and implementation of the changeover.

8. Economic convergence criteria

9. Prospects of meeting the criteria (1) • Litas exchange rate will remain absolutely stable – criterion will be met; • Price stability criterion will be the most difficult to meet for any new member state; • Developments of oil prices are particularly worrisome: • Greater weight in national HICP; • Lower absolute excise on gasoline; • Greater dependence on energy resources; • Exceptionally low inflation in “three best performing member states” (Finland, Denmark, Sweden).

10. Prospects of meeting the criteria (2) • BoL estimates about 2.6 % twelve-month average annual inflation rate around mid-2006; • Right on the edge of expected reference value; • Fair prospects to meet the price stability criterion under the base line scenario, provided that the national authorities will stand ready for policy measures, such as rigid control of administered prices and fiscal consolidation.

11. Prospects of meeting the criteria (3) • The budget deficit is expected to be 2.5 % in 2005 and 1.8% in 2006, which is bellow the reference value – criterion will be met; • The general government debt will remain around 20% of GDP, which is significantly lower than the reference value – criterion will be met; • Long-term interest rate criterion will be met, provided other criteria are within or close to the set bands.

12. Main elements of € introduction plan (1) • Law on the Introduction of the Euro in Lithuania • Draft will be released by the BoL in the first half of 2005; • Adoption in the course of 2005; • ECB and European Commission Convergence Reports around mid-2006; • Shortly afterwards Council’s decision on the date and irrevocably fixed change rates; • 1st January 2007 targeted euro introduction day.

13. Main elements of €introduction plan (2) • As of 1st January 2007 payment and securities settlement systems will accept and execute payments only in euros; • Payments for goods and services in cash would also be accepted in litas (dual circulation) for a period of two weeks – until 14 January 2007 [still preliminary provision]; • The BoL will exchange litas banknotes and coins into euros free of charged for unlimited period of time;

14. Main elements of €introduction plan (3) • It is envisaged that commercial banks will exchange litas into euros free of charge for a period of several months; • Front loading of euro banknotes and coins; cash collection and distribution arrangements; adjustment of bank working hours, etc. – measures to make the cash changeover as smooth as possible.

15. Main elements of €introduction plan (4) • As of 1st January 2007 all bank accounts, loans, other financial liabilities would be redenominated using irrevocably fixed exchange rate; no fees in whatever form would be allowed; • Dual display of prices (in litas and euros) well in advance of the euro introduction day and for some period thereafter; • A large scale euro information and communication campaign.

16. Public opinion on the reform • Business community favors euro introduction: • 66% of company top manages support euro introduction; 25% against it; • 63% of them feel adequately informed; 33% lack information; • As much as 78% of large scale company top managers favour euro introduction; • 44% of population favour euro introduction; 41% are still skeptical about it.

17. Other areas of BoL preparation • Approved design of national side of euro coins; Lithuanian Mint satisfies production criteria; • Access to Target: intense internal preparation; system testing with counterparties scheduled for Q2 2006; • Adoption of the Eurosystem’s operational framework (“Forex window” remains operational up to the final day before euro introduction).

18. Conclusions (1) • Euro introduction is undoubtedly beneficial for the country; • Fulfillment of economic convergence criteria and adoption of the euro as soon as from the beginning of 2007 is verylikely; • However, national authorities will need to carefully monitor macroeconomic developments and pursue prudent policies to be granted this gift; • Public opinion, particularly that of business community, is favorable to euro introduction, but still more needs to be done.

19. Conclusions (2) • All elements of the changeover directed to facilitate as swift replacement of money as possible; at the same time litas will be available for exchange into euros at the BoL at no fees for unlimited time. • The preparation for monetary reform has been carefully planed and is already on the way... • ... what makes us feel confident is that all tasks will be completed in time, despite rather challenging remaining time frame.

20. Q/A