Country Report Lithuania
Following successful internal devaluation and economic rebalancing, Lithuania currently ranks among the EU’s fastest-growing members. Its new government remains committed to fiscal consolidation in order to qualify for euro accession by 2015.
Strengths (+) and weaknesses (-)
(+) Proven track record of ability for swift and substantial economic rebalancing
Following several pre-crisis years of sizeable macroeconomic imbalances, Lithuania has shown its ability to rebalance its economy and regain competitiveness by means of internal devaluation.
(+) Ongoing commitment to fiscal prudence
Given the overarching goal of euro accession in 2015, Lithuania’s political elite is strongly committed to prudent macroeconomic policies and ongoing fiscal consolidation
(-) Strong exposure to external economic shocks
Lithuania’s small and very open economy is exposed to external demand shocks, particularly from the euro area and Russia. Given persistent current account deficits, an increase in global risk aversion vis-à-vis emerging markets could cut the country off needed external financing.
(-) High external debt levels and financing needs
Lithuania’s external debt, mainly parent bank loans and foreign-held government bonds, remains at elevated levels and burdens the economy with considerable debt servicing costs. While Lithuania’s economic recovery has alleviated the situation, debt sustainability problems might emerge if economic growth were to fall or current account deficits to widen.
1. Economic recovery underway
Following its very deep recession in 2009, when GDP declined by a staggering 15%, Lithuania has embarked on a solid economic recovery made possible by a strict internal devaluation course to restore competitiveness and thereby rebalance the local economy. Even though economic growth has been slowing in recent years and real output still remains about 5% below its pre-crisis level, the country currently ranks among the EU’s fastest-growing member states. Mainly driven by net exports, which benefitted from a bumper harvest, and improving private consumption, Lithuania’s economy expanded by 3.6% last year. Economic growth this year is expected to come in at about 3%, whereby the strong positive contribution of net exports will likely decline as private consumption and private investment should increase and thereby boost imports. While the former should benefit from rising real wages, the latter should be boosted by high levels of capacity utilization and reduced political uncertainty in the aftermath of last year’s general elections.
2. Considerable rebalancing improves external resilience
After having peaked at 14.5% of GDP in 2007, Lithuania’s current account deficit continues to decline, as a combination of import contraction and rising exports on the back of regained competitiveness bears fruit. Benefitting from the export-boosting effect of last year’s record harvest, the current account deficit declined to 0.5% of GDP, while this year’s deficit is expected to widen to a still limited 1% of GDP. Even though rising domestic demand on the back of the gradual decline in unemployment levels and companies’ investments into new machinery should widen the current account deficits in the coming years, improved export competitiveness and more prudent bank lending policies should limit the size of future current account deficits. Given Lithuania’s sizeable external debt burden of about 75% of GDP, this development is certainly welcome, as smaller current account deficits reduce the pace of additional external debt accumulation, while higher export earnings boost the country’s debt repayment capacity.
3. Lithuania’s banking sector moves towards a more stable footing
Lithuania’s largely foreign-owned banking sector continues to strengthen, as credit quality gradually improves and the sector’s dependency on external parent bank funding declines amid several years of negative credit growth. After having peaked at 186% in 2008, the sector-wide loan-to-deposit ratio declined to a more manageable 120% in early 2013, while non-performing loans declined to about 12% of total loans compared to 19% in late 2009. Meanwhile, the sector’s Tier 1 capital adequacy ratio rose to a healthy 15.5%, which should provide sufficient buffers in case a stronger-than-expected fall in economic growth were to lead to rising credit losses. So far, however, a return of Lithuania’s pre-crisis credit boom seems far off, as nominal credit growth has hardly reached positive territory and banks will likely apply more prudent lending criteria going forward. The sector’s improving financial position goes hand in hand with the central bank’s efforts to clear the sector from “financial adventurers and thieves”. Following the liquidation of the domestic Bankas Snoras in 2011, it recognized the domestic Ukio Bankas as insolvent since the bank proved unable to raise additional capital and address issues regarding related-party lending. Given their small size and the fact that Ukio Bankas could be split into a ‘good’ bank (sold to Siauliu Bankas) and ‘bad’ bank, the impact on the sector and government finances was quite small.
4. A new government took office after noisy elections
Following the previous center-right government’s defeat at last October’s parliamentary elections, a new center-left coalition government under the leadership of prime minister Algirdas Butkevičius of the Social Democrat Party (LSDP) was sworn in in December. Owing to suspicions of electoral misconduct by the Labor Party, one of the coalition partners, President Dalia Grybauskaite initially refused to appoint the new cabinet. Notwithstanding its difficult start, cabinet cohesion has been strong so far, even as the several members of the Labour Party, including its controversial leader Viktor Uspakich, have been convicted. While promising a relaxation of Lithuania’s strict fiscal consolidation course and a considerable change in the country’s energy policies during the election campaign, actual policy changes have been limited. Reflecting the new cabinet’s firm commitment to euro area accession in 2015, it reneged on its earlier promises regarding looser fiscal consolidation. Given current low inflation levels and expected budget deficits of 2.9% and 2% of GDP in 2013 and 2014, respectively, Lithuania should indeed be eligible to introduce the euro in 2015. In terms of energy policy, reducing dependency on Russia remains high on the agenda.
Lithuania, the southern-most of the three Baltic countries, is a small and very open economy with a nominal GDP of USD 42bn (2012). Given a total population of 3.2m inhabitants, GDP per capita amounts to a comparatively low USD13,210 (or USD 20,074 in PPP terms), which suggests considerable catch-up potential vis-à-vis the country’s western EU peers. While agriculture still contributes about 3% of GDP, the country is fairly industrialized, whereby the PKN Orlen Lietuva refinery on the Baltic shore has a dominant position within the sector. Besides refined oil products, machinery and transport equipment, as well as chemicals constitute important export products. Reflecting the importance of the refinery, imports are dominated by mainly Russian oil imports.
In spite of Lithuania’s close economic ties with its eastern neighbor, bilateral relations between the two former Soviet republics remain relatively tense. Similar to its Baltic peers, Lithuania opted for strong Euro-Atlantic ties following its independence from the Soviet Union, which is reflected in strong commitment to NATO membership and a general political consensus on swift accession to the euro area. In spite of the very deep recession in 2009 and the ensuing strict fiscal consolidation course pursued by the previous and the current government, Lithuania’s political and social situation is quite stable. Lithuania’s population seems to have accepted the need for internal devaluation and rather opted for emigration than protests. Thanks to the successful implementation of these policies, Lithuania succeeded in reining in large current account and budget deficits and restored its export competitiveness.