Latvia caps years of austerity with euro zone membership

By Aija Krutaine and Nerijus Adomaitis RIGA (Reuters) - Latvia joined the euro zone on Wednesday, banking on its experience of austerity to bring it prosperity in a currency union where other economies have floundered. The Baltic country of just 2 million people became the bloc's 18th member at midnight (2200 GMT), taking a step further out of the shadow of neighbouring Russia a decade after joining the European Union and NATO. Latvia's acting prime minister, Valdis Dombrovskis, who led his country through its worst economic crisis since it left the former Soviet Union in the early 1990s, said euro adoption was an opportunity, but not a guarantee of wealth, and the country should not relax its fiscal policy. "It's not an excuse not to pursue a responsible fiscal and macroeconomic policy," he said after withdrawing the first euro banknote after midnight from a cash machine in Riga. The euro switchover ceremony took place at a site where Latvia's crisis began - the former headquarters of the collapsed Parex bank, now headquarters of state-owned Citatele bank, which emerged from Parex's ruins. Parex, the country's second-biggest bank by assets, went bust at end-2008, forcing the Baltic state to seek an international rescue to keep its currency, the lat, pegged to the euro at the same rate. Its economy shrank by a quarter during 2008-2010, but then grew at the fastest pace in the EU, expanding by 5.6 percent in 2012, after the government slashed spending and wages and hiked taxes in one of the harshest austerity programs in Europe. Latvia's efforts have won praise from EU policymakers, who have pointed numerous times to the Baltic state as an example that austerity can work. "Thanks to these efforts ... Latvia will enter the euro area stronger than ever, sending an encouraging message to other countries undergoing a difficult economic adjustment," European Commission President Jose Manuel Barroso said on Tuesday. Still, a few concerns remain. The European Central Bank has warned Latvia that the high level of foreign deposits, mostly from Russia, in Latvian banks, as in Cyprus, was a risk factor. Latvia also enters the euro zone without a permanent government after Dombrovskis resigned in December, taking political responsibility over a supermarket collapse in Riga that killed 54 people. Latvia enters the euro zone as the single currency bloc marks its 15th anniversary, and the euro is now used by 333 million Europeans. Even so, neighbouring Lithuania is the only remaining EU country showing much enthusiasm for euro admission after the temptations and strains of sharing a currency forced Greece, Ireland, Portugal, Spain and Cyprus to seek international bailouts for their government finances or their banks. Estonia joined the euro zone in 2011, and Lithuania aims to do so in 2015. Among the ex-Communist EU countries that have yet to adopt the euro, Croatia is stuck in recession while bigger economies such as Poland, the Czech Republic and Hungary have become reticent about currency union. Latvia, which becomes the fourth smallest economy in the euro zone after Malta, Estonia and Cyprus, expects the euro to lower its borrowing costs and encourage investors by eliminating currency risk. Both Standard & Poor's and Fitch have raised the country's credit ratings in anticipation of its euro entry. But opinion polls show ordinary Latvians are divided on the euro's merits, with many worried that its adoption will be an excuse to raise prices. "In all other countries which had switched to the euro, prices rose. Most likely, they will rise here as well, which is bad," said Oleg Bachurin, 62, a pensioner. Latvia's central bank expects euro zone entry to lift consumer prices by 0.2-0.3 percentage point in 2014, taking inflation to 2 percent. "I'm not worried (about euro adoption). I believe it's progress. We should not look back, we should go forward," said Anita Linde, 57, a retailer. (Additional reporting by John O'Donnell in Brussels; Editing by Niklas Pollard, Ruth Pitchford and Eric Walsh)