Pegging the Lats to the Euro
Pegging the lats to the euro means that as of establishing the peg, i.e., on 1 January 2005, the exchange rate of the lats has been fixed against the euro following the peg to the SDR basket of currencies under the previous arrangement effective for 10 years. In the 1990s the Bank of Latvia started forming an independent monetary policy and had to decide on the most appropriate exchange rate arrangement. As of 1993, Latvia has been implementing a stabilisation programme based on a fixed exchange rate. In February 1994, the Bank of Latvia pegged the lats to the SDR basket of currencies that is comprised of the four major world currencies: the US dollar, the euro, the pound sterling and the Japanese yen. The durable and credible peg contributed to the reduction of uncertainties, restriction of currency risk and creation of a sound footing for enterprises for planning and pricing purposes. Investments and international trade were also thereby promoted, which was very important for the competitiveness of the small and open Latvian economy.
On 1 May 2004, Latvia joined the EU. As of the same day, the 10 new EU Member States have also been participating in the Economic and Monetary Union as Member States with a derogation, i.e., they are not yet full-fledged members of the EMU and do not meet the criteria set out in the EC Treaty. After a Member State has ensured compliance with the criteria set out therein, it becomes an EMU member and introduces the euro (like Slovenia, Malta and Cyprus that joined the euro area on 1 January 2007 and 1 January 2008 respectively). Pegging the lats to the euro for at least two years before the planned introduction of the single currency, thereby ensuring possibly small fluctuations of the exchange rate of the lats against the euro, is among the mandatory criteria set out in the Treaty.
Consequently, the pegging of the lats to the euro was the first necessary step towards the adoption of the euro as the local currency in the future. This step was also logical because the Latvian trade and economy in general were increasingly linked with the EU countries. Containing the exchange rate volatility of the lats against the euro reduced exchange rate risks and the costs of transactions with these countries. The decision to re-peg the lats, switching from the SDR basket of currencies to the euro, soon after Latvia's joining the EU was therefore not conflicting and has served well to the long-term development trends and needs of the Latvian economy.
On 30 December 2004, the Bank of Latvia set the exchange rate of the lats against the euro at 1 EUR = 0.702804 LVL. The relation was calculated according to the market exchange rates that were fixed by the European Central Bank on 30 December 2004 using the SDR valuation formula – as it had been daily practice since the beginning of 1994 when the lats was pegged to the Special Drawing Rights of the IMF at 1 XDR = 0.7997 LVL. Starting 1 January 2005, the Bank of Latvia has unilaterally been maintaining the fluctuation band of the lats against the euro of ±1% around the central rate. It means that the customary fluctuation band of the lats against the euro, which is also understood and accepted by the financial market, is preserved. Thus the actual arrangement of a fixed exchange rate was not changed as it has contributed to the development of Latvia as a small and open economy.
On 1 May 2004, Latvia joined the EU. As of the same day, the 10 new EU Member States have also been participating in the Economic and Monetary Union as Member States with a derogation, i.e., they are not yet full-fledged members of the EMU and do not meet the criteria set out in the EC Treaty. After a Member State has ensured compliance with the criteria set out therein, it becomes an EMU member and introduces the euro (like Slovenia, Malta and Cyprus that joined the euro area on 1 January 2007 and 1 January 2008 respectively). Pegging the lats to the euro for at least two years before the planned introduction of the single currency, thereby ensuring possibly small fluctuations of the exchange rate of the lats against the euro, is among the mandatory criteria set out in the Treaty.
Consequently, the pegging of the lats to the euro was the first necessary step towards the adoption of the euro as the local currency in the future. This step was also logical because the Latvian trade and economy in general were increasingly linked with the EU countries. Containing the exchange rate volatility of the lats against the euro reduced exchange rate risks and the costs of transactions with these countries. The decision to re-peg the lats, switching from the SDR basket of currencies to the euro, soon after Latvia's joining the EU was therefore not conflicting and has served well to the long-term development trends and needs of the Latvian economy.
On 30 December 2004, the Bank of Latvia set the exchange rate of the lats against the euro at 1 EUR = 0.702804 LVL. The relation was calculated according to the market exchange rates that were fixed by the European Central Bank on 30 December 2004 using the SDR valuation formula – as it had been daily practice since the beginning of 1994 when the lats was pegged to the Special Drawing Rights of the IMF at 1 XDR = 0.7997 LVL. Starting 1 January 2005, the Bank of Latvia has unilaterally been maintaining the fluctuation band of the lats against the euro of ±1% around the central rate. It means that the customary fluctuation band of the lats against the euro, which is also understood and accepted by the financial market, is preserved. Thus the actual arrangement of a fixed exchange rate was not changed as it has contributed to the development of Latvia as a small and open economy.
