Latvia is ready to become the 18th country using the euro from the start of next year, the European Commission announced yesterday, a decision that will be formally approved by European Union finance ministers on July 9.

Maintaining low inflation rates in Latvia will be challenging in the medium term

“The Commission considers that Latvia fulfils the conditions for the adoption of the euro,” the Commission, the EU’s executive, said in a report on the country’s preparations.

Earlier, the European Central Bank welcomed Latvia as the next member of the euro but said high foreign deposits in its banks were a risk to financial stability.

In its convergence report, the eurozone’s Central Bank said Latvia had met all the criteria to join the common currency. These include low inflation and long-term interest rates, a stable exchange rate and low public debt and deficits.

But it expressed concerns about the high proportion of foreign deposits held in the small Baltic country’s banks.

“The reliance by a significant part of the banking sector on non-resident deposits as a source of funding, while not a recent phenomenon, is again on the rise and represents an important risk to financial stability,” the ECB said.

At the end of the first quarter, deposits in Latvian banks from outside the EU totalled just under €7 billion, or about one-third of the country’s GDP, ECB data showed. The data does not show where the deposits come from, but given the country’s close ties to Russia, most are believed to come from there.

Large foreign deposits can be a risk to financial stability, as they can be quickly moved away.

Latvia foreign deposits are much smaller than was the case in Cyprus, whose economy is of similar size and where such deposits accounted for more than 1.5 times GDP prior to its bailout earlier this year.

Before the debt crisis, EU member states that were not yet part of the currency union were queuing up to join, but interest has since waned. Of the countries reviewed in the convergence report, only Latvia and Lithuania have been part of the exchange rate mechanism II (ERM II) for more than two years – a prerequisite for joining the euro.

The ECB also said Latvia must keep prices in check.

“Maintaining low inflation rates in Latvia will be challenging in the medium term,” the ECB said. “It may be difficult to prevent macroeconomic imbalances, including high rates of inflation, from building up again.”