The Bank of Latvia

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Bank of Latvia

1. What does pegging the lats to the euro mean?
2. Why does the lats need to be pegged to the euro?
3. When and at what rate was the lats pegged to the euro?
4. Why was the pegging of the lats necessary?

1. What does pegging the lats to the euro mean?
Pegging the lats to the euro means that the lats value against the euro is fixed from the moment of pegging, similarly as was the case in the last 10 years with the peg to the SDR currency basket.

Changing the lats' peg does not mean a currency changeover or implementing the euro. The single currency of the European Union will be introduced in Latvia several years later.
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2. Why does the lats need to be pegged to the euro?
Pegging the lats to the euro is the first step necessary towards introducing the euro as our own currency in the future. One of the criteria for implementing the euro stipulates that a national currency has to be pegged to the euro and its exchange rate against the euro may not fluctuate excessively for at least 2 years in advance of the implementation.

Just like the other new EU member states, Latvia has agreed to introduce the single European currency, the euro, upon joining the Community. This obligation is stipulated in the EU Treaty. As of the moment of their accession, the new EU member states have also become members of the Economic and Monetary Union (EMU), which is the highest stage of the EU member states' economic integration with the single currency, the euro. Before the introduction of the euro, these countries, including Latvia, are considered member states with a derogation. Latvia will become a full-fledged member of the EMU once it has met meets its obligation to implement the euro. This has to be done following a specific procedure, by reaching economic convergence in accordance with a set of criteria. No specific date has been set for the transition to the euro; nevertheless, according to the preliminary plan approved by the Latvian Government it may happen in 2008.

Pegging the lats to the euro is also a logical step as the Latvian trade and economy at large develop more and more links with the EU countries. Limiting the lats exchange rate volatility against the euro will reduce currency risks and costs in business with those countries and contribute to achieving the goal of price stability.

It should therefore be obvious that the decision to re-peg the lats from the SDR currency basket to the euro now that Latvia has acceded to the EU, is not likely to create any problems and is in line with the long-term development trends and needs of the Latvian economy.
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3. When and at what rate was the lats pegged to the euro?
The Bank of Latvia on December 30, 2004, has fixed the peg rate of the lats and the euro at 1 EUR = 0.702804 LVL, which took effect on January 1, 2005 in line with the government approved plan for Latvia's preparation for full-fledged membership in the Economic and Monetary Union (EMU).

The exchange rate of the lats against the euro was calculated by applying market rates set by the European Central Bank (ECB) to the SDR rates formula, similarly as it has been done every day since the beginning of 1994 when the Latvian currency was pegged to the SDR, the unit of accounting of the Internationally Monetary Fund (1 XDR = 0.7997 LVL).

As of January 2005 the Bank of Latvia will unilaterally limit the lats' exchange rate against the euro to ±1% of the central rate. The hitherto existing width of the fluctuation band against the peg currency, which is easy to understand and traditional in the financial markets, would thus be maintained. The actually fixed exchange rate regime, which has been favourable to the small open economy that Latvia is, will not change.

After pegging the lats to the euro, the Bank of Latvia sets the daily lats exchange rates against other currencies according to the fixed lats/euro rate and the rates of the respective currencies at the particular moment.

4. Why was the pegging of the lats necessary?
Commencing the implementation of an independent monetary policy in the early 1990s, the Bank of Latvia had to decide on an exchange rate regime. Since 1993, Latvia has been using the fixed exchange rate based stabilisation programme. In February 1994, the Bank of Latvia pegged the lats to the SDR basket consisting of the four major currencies: the US dollar, the euro, the British pound sterling and the Japanese yen. Such a durable and credible peg has served to reduce uncertainty, eliminate currency risk and provide businesses with a sound basis for planning and pricing. It fostered international investment and international trade, which are of a particular importance for the ability to compete of the small, open economy that Latvia is.
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