Republic of Lithuania: Second Review Under the Stand-By Arrangement

Lithuania showed progress in macroeconomic stability and structural reforms, under the Stand-By Arrangement. Executive Directors welcomed this development, and endorsed the authorities' intention to switch the peg of the litas to the euro, with a view to move toward greater economic integration with the European Union area, while preserving the credibility of the currency board. They welcomed the comprehensive medium-term fiscal framework, which aimed to determine the priorities, address future expenditure pressures, and achieve the medium-term goal of a cyclically balanced budget.


Lithuania showed progress in macroeconomic stability and structural reforms, under the Stand-By Arrangement. Executive Directors welcomed this development, and endorsed the authorities' intention to switch the peg of the litas to the euro, with a view to move toward greater economic integration with the European Union area, while preserving the credibility of the currency board. They welcomed the comprehensive medium-term fiscal framework, which aimed to determine the priorities, address future expenditure pressures, and achieve the medium-term goal of a cyclically balanced budget.

I. Introduction

1. During the discussions for the first program review and the 2000Article IV Consultations on January 10, 2001, Directors commended Lithuania’s progress in restoring macroeconomic stability and advancing structural reforms. They also noted that the currency board arrangement had constituted a linchpin of stability, and expressed support for the authorities’ intention to maintain the currency board with a repegging to the euro in the coming year, with a view to achieving greater economic integration with the EU area. Given the need to preserve financial viability and the increasing expenditure commitments that Lithuania will face in the coming years, Directors welcomed the authorities’ plan to prepare a comprehensive medium-term fiscal framework, in order to determine priorities, address future expenditure pressures, and seek ways to achieve the medium-term goal of a cyclically balanced budget

2. Relations with the Fund and World Bank are summarized in Appendixes I and III, respectively. A US$98.5 million Structural Adjustment Loan (SAL) was approved by the Executive Board of the World Bank in July 2000, and the first tranche of US$50 million was disbursed in July. Technical assistance provided by the Fund is described in Appendix II. The periodicity and timeliness of the most important statistics are adequate and are presented in Appendix IV.1 Appendix V describes an illustrative medium-term fiscal framework.

II. Recent Developments and Performance Under the Program

3. The program supported by the standby arrangement remains broadly on track. The macroeconomic situation in 2000 was better than expected and growth prospects for 2001 appear somewhat stronger than envisaged under the program, although the unemployment rate has continued to rise. All performance criteria for end-December 2000 were met, except for the elimination of expenditure arrears of the central government (Tables 1-8). Moreover, significant progress has been made in negotiations for EU accession. The authorities indicated that they would move to regain momentum in the implementation of structural reforms in view of some delays experienced in late 2000-early 2001.

A. Macroeconomic Developments

4. Lithuania is slowly reemerging from the recession experienced in 1998-99, but the situation is still difficult. The economic recovery, which gained momentum in the latter part of 2000, is stronger than expected, as real growth is estimated to have reached 2.7 percent in 2000, compared with the initial program projection of 2.3 percent (Table 1 and Figure 1.). Exports continued to be the major engine of growth, while real domestic demand is estimated to have declined by 2 percent in 2000.

Figure 1.
Figure 1.

Lithuania: Selected Economic Indicators,1996-2001

Citation: IMF Staff Country Reports 2001, 063; 10.5089/9781451824032.002.A001

Sources: Lithuanian Department of Statistics; Bank of Lithuania; and Fund staff estimates.1/ Real GDP growth is estimated for the fourth quarter of 2000.

5. Inflation and wage growth remained subdued in 2000, while unemployment continued to rise. The year-on-year average CPI and PPI increased by 1.5 percent in 2000, while average wages increased by 1.2 percent in nominal terms, all in line with program projections, and no inflation was registered as measured by the CPI in the 12 months to end-February 2001. The unemployment rate reached 13.1 percent in January 2001, with employment declining despite the recovery. The continued increase in unemployment is attributable to the ongoing restructuring, and to some extent, a higher level of registration, resulting from a tapering off of informal economic activity.

6. The improvement in the external current account was faster than expected, driven mainly by strong export growth. The current account deficit is estimated to have shrunk from 11.2 percent of GDP in 1999 to 5.4 percent in 2000, compared with a program target of 6.9 percent, reflecting mainly higher exports, the delay in the recovery of domestic demand, and lower-than-expected fuel imports owing to a mild winter. Exports of goods grew by 28 percent in U.S. dollar terms, while imports grew by 13 percent (Figure 2.). The smaller current account deficit more than offset the lower-than-expected net capital inflows leading to an increase of US$114 million in official reserves (Table 3). External debt at end-2000 stood at 43.3 percent of GDP, almost 1 percent of GDP below program projections, and external vulnerability indicators continued to improve (Table 9). The real effective exchange rate, after appreciating for most of the year, started to depreciate in November 2000, reflecting the recovery of the euro vis-à-vis the U.S. dollar. For the year as a whole, the real effective rate appreciated by 6.2 percent, but competitiveness was sustained by productivity and terms of trade gains (Figure 2).

Figure 2.
Figure 2.

Lithuania: Indicators of External Competitiveness,1996-2000

Citation: IMF Staff Country Reports 2001, 063; 10.5089/9781451824032.002.A001

Sources: Lithuanian authorities; and Fund staff estimates.

7. Despite somewhat lower-than-projected revenue, the general government deficit was 2.8 percent of GDP, 0.5 percent of GDP lower than targeted. The general government cash expenditure was around 1 percent of GDP lower than expected. Compression of expenditure by the state budget, Social Insurance Fund (SoDra),2 Health Insurance Fund (HIF) and extrabudgetary funds, more than offset minor expenditure overruns by municipalities and revenue shortfalls of the order of 0.5 percent of GDP (Table 2).3

8. Expenditure arrears of the general government were cut from 1.4 percent of GDP at end-1999 to 0.5 percent at end-2000. Arrears of the central government, however, were not fully cleared, contrary to the expectations under the program. While the arrears of the Road Fund (LTL 2 million) and the state budget (LTL 16 million) resulted from technical difficulties, the arrears of the HIF (LTL 22.6 million) were incurred because insufficient resources were allocated to reimburse pharmaceuticals. Municipal arrears increased by 0.1 percent of GDP (LTL 40 million) during 2000.4

9. The currency board arrangement continued to anchor macroeconomic policies. The BoL has stated publicly its intention to switch the peg of the litas from the dollar to the euro in the next year. The amendments to the Law on the Stability of the Litas, which will allow the BoL to re-peg the currency in consultation with the government, were approved by the Seimas Finance and Budget Committee and are now being considered by Seimas. Market confidence continues to be strong, as reflected in the successful placement by the government of a €200 million Eurobond issue in February 2001, with a much lower spread (219 points) than the previous issue in August 2000 (246 points). The amendment to the BoL Law, which establishes its independence and creates a legal impediment for direct lending to the government, was approved by Seimas in March 2001.

10. All end-December monetary performance criteria were met by large margins, with official foreign reserves reaching US$1,344 million (Tables 4. and 7). In 2000, broad money grew by 16.5 percent (compared with a program target of 9.5 percent) mainly reflecting increased monetization of the economy. The reduction in the reserve requirement from 10 to 8 percent in October 20005 and increased deepening of the financial system, with a movement away from currency to other financial instruments in transactions, led to some increase in the multiplier. However, the limited resort of the budget to domestic financing and the increase in liquidity in the system did not lead to an expansion of credit to the private sector, mainly reflecting continued uncertainties in the economy and the banking system. Credit to the private sector remained below program projections (Figure 3), due both to the cautious behavior of bank managers, and the fact that the second and third largest banks were undergoing privatization, while the largest commercial bank was concluding a merger with another medium-sized bank.6 With little credit expansion, commercial banks increased their net foreign assets to US$190 million by year-end, significantly higher than expected. All banks complied with prudential ratios at end-December 2000.

Figure 3.
Figure 3.

Lithuania: Financial Indicators,1997-2001

Citation: IMF Staff Country Reports 2001, 063; 10.5089/9781451824032.002.A001

Sources: Bank of Lithuania; Bloomberg News; and National Stock Exchange of Lithuania.1/ Included are reclassification of 270 million of DMB’s claims on private sector to government lending funds, which were removed from banks’ balance sheets in July,2000.2/ Yield spread between Lithuanian Eurobond and U.S. bond; Lithuanian Eurobond maturing July 2002.3/ Calculated from all issues quoted in the current trading list, excluding treasury bills and investment companies.

B. Structural Reforms

11. Structural reforms advanced in late 2000-early 2001. However, results in the fiscal and energy areas were mixed. The completion of the treasury project was postponed until mid-2001 because of technical difficulties in implementing the software, and the draft Law on Budgetary Organizations and Appropriation Managers was somewhat delayed due to a crowded legislative agenda. The Reserve Stabilization Fund (RSF) is being set up in line with the commitments of the SMEP. Moreover, the Ministry of Labor and Social Protection is making preparations for the introduction of an ambitious pension reform (Box 1) with the legal framework to be put in place in 2001-2002, and the reform to be implemented from 2003. Finally, the debt management unit of the Ministry of Finance has been upgraded with a new software in the context of the SAL.

Pension System and Prospective Reform

The new Pension Law took effect on January 1, 1995 and it is applicable to those retiring after this date. The Law is based on the principles of a contribution-defined pay-as-you-go (PAYG) system and provides for a gradual increase in the pension age and the contribution period, as well as the elimination of the Soviet-type early retirement privileged groups. The existing pension system is highly redistributive as it puts a strict limit on the maximum pension and guarantees a basic pension to all. The benefit package combines two components. The first is a years-of-service flat benefit—the basic pension—which effects substantial redistribution. The second is an earning-related benefit—the supplementary pension—which is proportional to life-time payroll contributions.

Social security employer contributions under labor contracts are 30 percent of gross wages, and employee contributions were increased from 1 to 4 percent of gross wages on January 1, 2000. Contributions explicitly assigned to pensions amounted to 22.5 percent before January 1, 2000 and 25 percent thereafter. Self-employed, employed under licenses, and farmers (about one third of employment) are required to pay mandatory contributions for a basic pension only which is equal to one half of the basic pension per month. Maximum payroll contributions were capped until end-1999. The state budget pays contributions for noncontributory periods of some groups, i.e., soldiers and maternity leave beneficiaries.

Noncontributory pensions include social pensions paid to uninsured elderly, disabled before age 18, and some other uninsured groups, as well as state pensions. In general, social pensions are equal to the basic pension with higher amounts for higher levels of disability. State pensions are paid to former Presidents, people making substantial social contributions (mainly artists), victims of the Soviet occupation, and scientists. These pensions could be as high as 1.8 times minimum living level for each year of service. Both types of noncontributory pensions are funded by the state budget

Since the August 1998 Russian crisis the cash flow position of SoDra has deteriorated significantly. The tax base has shrunk as the number of employees under wage contracts has declined and wage growth has been weak. At the same time, the number of pension recipients has increased. As a result, the SoDra’s deficit increased to 1 percent of GDP in 1999. Despite the increase in the payroll tax, the deficit is estimated at 0.4 percent in 2000. Recognizing the problems of the existing pension system, a package of expenditure measures for SoDra was approved in the context of the 2001 budget. Pension measures included a reduction in pensions of working pensioners and further acceleration of the increase in the retirement age from 2 to 6 months per year for men and from 4 to 6 months per year for women. Both measures would strengthen the medium-term position of the pension system, which is expected to generate surpluses by 2003-4 in the absence of pension reform.

To strengthen the incentives for retirement savings and promote the development of financial markets, Seimas instructed the government to prepare a plan for pension reform in 2000. A special committee of the government has prepared a White Book outlining various reform options. The government is considering a number of reform options involving a set up of a three-pillar pension system by 2003. The legislation for the voluntary third pillar has already been passed, and the government is preparing relevant legislation to set up a mandatory privately funded pension scheme (second pillar). The current plans are to limit the diversion of the payroll tax to the second pillar to 5 to 7 percentage points while making the second pillar mandatory for only the younger cohort of the population. The reform-related deficit of SoDra, ranging from 1.0 to 1.5 percent of GDP per year at an early stage depending on options, is envisaged to be financed by privatization proceeds during the first three to four years and later on by transfers from the state budget. Privatization proceeds earmarked for pension reform would be accumulated in the Reserve Stabilization Fund, which would be set up based on an amendment to the Law on Privatization.

12. Little progress was made in the restructuring of the energy and gas sectors, owing first to the desire of the new government to review all plans and, second, to the replacement of the Minister of Economy. Nonetheless, the financial situation of energy public enterprises improved following tariff increases. The Mazeikiu Nafta oil company continues to encounter difficulties in reaching a long-term supply agreement with Russian oil companies. Without such an agreement, the company operates below capacity and cannot proceed with modernization and expansion plans, for which additional government guarantees of US$118 million may be required.

13. The government has made progress in the banking privatization program. Negotiations with Hansabank for the privatization of the Savings Bank (LTB), which ceased making losses from the second half of 2000, are close to completion. Negotiations were complicated by the announcement by Swedbank, the owner of Hansabank, of a merger plan with SEB Bank, the owner of Vilnius Bank (VB), Lithuania’s largest bank.7 Nevertheless, the authorities decided to go ahead with the sale of the Savings Bank (LTB), with the condition that, if the merger occurs, one of the two Lithuanian banks will have to be sold. A new tender for hiring advisors to privatize the Agricultural Bank was announced in February. Negotiations for the sale of the majority stake in the Lithuanian Shipping Company (LISCO) are close to completion.

14. In order to facilitate private sector activity, steps were taken to streamline procedures for the sale and purchase of land, and simplify the restitution of ownership rights. An amendment to the Constitution allowing foreigners to buy agricultural land (an EU requirement) has been submitted to Seimas. All parties in Seimas agreed to a resolution in January 2001 to support the passage of legislation needed to advance negotiations with the EU, as the authorities objective is to conclude negotiations in 2002, for accession in 2004. Reforms in the agriculture sector are broadly on track. Bankruptcy and company restructuring legislation was passed by Seimas in March. A set of amendments to the labor law to reduce restrictions on hiring and firing of labor was also passed in March.

III. Policy Discussions

A. Outlook for 2001

15. The macroeconomic outlook for 2001 has been updated, in light of recent developments. Real GDP is now expected to grow by at least 3.6 percent against the program target of 3.2 percent, reflecting continued export growth and some revival in domestic demand. End-of-year CPI inflation would be contained at 1.9 percent as initially envisaged (Table 1). The external current account deficit is projected to widen from 5.4 percent of GDP in 2000 to 6.5 percent, but still below the original program projection of 6.7 percent (Table 3). Slower economic growth in the major trading partners may well be offset by the positive impact of the recent favorable exchange rate developments8 if these were to persist. No major changes were made to the capital account projections. Foreign direct investment is projected to increase significantly in 2001, as several privatization projects are expected to be completed this year. The share of portfolio investment has been increased to reflect the issuance by the government of the Eurobond in February rather than the initial assumption of a syndicated bank loan. Gross official reserves are projected to reach US$1,668 million at end-2001, slightly below earlier projections.

16. The fiscal deficit of 1.4 percent of GDP for 2001 remains appropriate and end-March targets under the program appear to be achievable. According to the authorities, the planned revision of the budget in May would aim mainly at reallocating expenditure. In the staff’s view, modest upward revisions of revenue and expenditure should only be considered at a later stage if it becomes clear that the revenue performance during the first half of the year exceeds expectations. The authorities remain committed to the deficit target, but would want to use any additional revenue beyond program projections to revise expenditure or reduce taxes. The authorities are committed to eliminating central government expenditure arrears by end-March 2001. A lasting solution to the arrears of the HIF would require a revision of the regulations for reimbursing pharmaceuticals.

17. The authorities intend to maintain the currency board arrangement in the run-up to EU and EMU accession. Regarding the re-pegging strategy, the BoL underscored the need for providing market participants with sufficient lead time to adjust their financial portfolios. A multi-topic MAE mission visited Vilnius in March 2001 for consultations regarding the technical preparations for the switch, including legal and practical steps to be taken by the BoL and commercial banks, issues of reserve management, and the needed public information campaign. The BoL will announce the final decision on dates and exact technical modalities of the switch in the second half of 2001, in consultation with Fund staff.

18. The monetary program for 2001 was revised to reflect the impact of a substantially higher-than-expected level of monetization registered in 2000. The program for 2001 projects a further reduction in velocity consistent with the ongoing deepening of financial intermediation, resulting in broad money growth of 6.9 percent at end-2001. The combination of the higher level of monetization and unchanged assumptions on the financing of the budget would leave room for 11.3 percent growth in credit to the private sector, to support small and medium-sized business activities, fostering growth and employment creation in the medium term. However, for this credit growth to materialize, increased competition in the banking system would be desirable, with banks becoming more active in identifying good prospective borrowers. No further decreases in reserve requirements would be appropriate at this stage, given prudential considerations under the CBA and ample liquidity in the banking system.

19. The authorities intend to accelerate structural reforms in the near future, with the appointment of a new Minister of Economy in early March. The approval of the restructuring plan for the Lithuanian Power Company (LPC), scheduled for January 2001, was expected in March-April, and the announcement of the tender for the privatization of the distribution network is now slated for August 2001. The approval of the plan for the evaluation of the assets of the gas company should take place in April, while the announcement of a tender for privatization should take place by May 2001. The initiation of the privatization of the electrical utilities grid and the gas company is a condition for the disbursement of the second tranche of the World Bank’s SAL. The authorities are determined to complete the privatization of the two state-owned banks in the near future, which would promote competition and efficiency in the banking system and investment and growth in the medium term.

20. To promote private activity and streamline government operations, several specialized commissions will replace the Sunset and Sunrise commissions. The main priorities for foreign investors include measures to render labor markets more flexible, and new rules for initiating bankruptcy proceedings and satisfying creditors’ claims. In this regard, newly passed legislative acts to reform the labor market and streamline the bankruptcy procedures are expected to make Lithuania more attractive to foreign investors and to facilitate employment creation. Regarding the new bankruptcy legislation, the authorities are concerned that the easing of the stringent current requirements may increase the number of bankruptcies and layoffs in the short term, leading to a further increase in the unemployment rate. To cushion the vulnerable segments of population, the staff advised the authorities to improve the design of social safety nets. Legal steps to simplify the restitution of land ownership rights are currently under discussion within the government.

B. Medium-Term Fiscal Strategy

21. The authorities are developing a medium-term fiscal strategy that would be incorporated into the Pre-accession Economic Policy paper, which is to be submitted to the European Commission by October 1, 2001. In formulating such a strategy, the authorities’ objective is to achieve a cyclically balanced budget by 2003, while making provisions for new expenditure commitments, such as the costs of EU accession, the pension reform, social safety nets, the elimination of arrears, and environmental clean-up.9

22. The government presented in February 2001 a tax reform program aiming at simplifying the tax system and reducing the tax burden in order to stimulate investment, growth, and employment. The main elements of the original proposal included the elimination of the corporate income tax (CIT) beginning in 2002,10 a significant gradual reduction in the personal income tax beginning in 2003, and the re-alignment of indirect taxation to conform to EU requirements.11 The government expects that the tax rate cuts would have a positive effect on economic growth and tax compliance, so as to generate sufficient revenue to finance essential and new expenditure commitments. However, even after allowing for this positive impact, in the staff’s view, if all measures were to be introduced according to the proposed schedule, the fiscal deficit would likely be higher, unless expenditures are significantly cut.

23. The staff prepared with the authorities’ assistance an illustrative medium-term fiscal scenario to highlight policy tradeoffs and their macroeconomic implications. The major tax and expenditure measures contained in the government program were phased in such a way that the medium-term fiscal deficit, excluding the cost of the pension reform, would be reduced gradually from a projected 1.4 percent of GDP in 2001 to a balanced position in 2005 (Appendix V). Expenditure would be maintained at 31-32 percent of GDP. Taxes on labor were assumed to be reduced at an early stage, while the corporate income tax would be phased out in stages. New taxes were proposed by the staff to compensate for revenue losses (Appendix V). The impact of EU-related tax changes was considered to be positive over the medium term. Finally, substantial post-accession EU transfers would help finance post-accession costs. The staff emphasized that a number of different tax packages would be consistent with the expenditure and fiscal balance objectives.

24. The staff pointed out that a number of considerations should be taken into account in assessing different tax reform options. First, the speed of the tax reform should be consistent with the authorities’ objective of achieving a cyclically balanced budget by the time of EU accession to anchor expectations under the CBA. To this end, a marginal reduction of the structural budget deficit,12 excluding the cost of the pension reform, would be necessary. Second, there appears to be little scope for compressing expenditure further, given the need to cofinance EU accession costs, finance the pension reform starting in 2003, comply with the Seimas decision setting binding expenditure floors on education and defense, and ensure the delivery of basic government services. Third, in the case of Lithuania, a reduction of taxation on labor should be given priority over cuts in taxation of capital, given the high level of unemployment. Fourth, the impact of a reduction in taxes on capital on growth is likely to be small in the short term. While such a reduction could result in long-term efficiency gains, the immediate impact of lower capital taxation—without any decrease in labor taxation—could well be higher savings and capital-intensive growth, leading to a persistence of high unemployment. Finally, tax collection under the personal income tax could be adversely affected if employee compensation were to shift from wages to capital income, especially since capital gains are not taxed.

25. The authorities agreed that tax reforms should be more gradual than initially envisaged, while expressing their intention to finish the tax reform by 2004, before the next parliamentary elections. The authorities also indicated that they were working on their own macro-fiscal scenario, and a tax reform package will be presented to Seimas for discussion.13

26. The authorities are also examining options to address the problem of expenditure arrears of municipalities. The staff underscored a strategy for helping municipalities clear arrears should minimize moral hazards associated with bail-outs. Transfer schemes should be linked to concrete measures to be undertaken by the municipalities, and be part of a comprehensive overhaul of municipal finances, with a view to aligning resources and responsibilities, identifying possible new sources of revenue (e.g., real estate or enhanced property taxes) and further expenditure rationalization. In any event, municipalities should comply with the 2001 budget law and clear all arrears by end-2001 independently of the timing of additional transfers from the central government.

IV. Staff Appraisal

27. The Lithuanian authorities managed to restore macroeconomic stability in 2000 and give new impetus to structural reforms. Macroeconomic stability needs to be preserved if credibility is to be maintained, and structural reforms must be accelerated if private activity is to be promoted, leading to higher growth and employment creation. This is especially important given that Lithuania might be able to conclude accession negotiations with the EU in 2002, and to join in the first wave of enlargement.

28. The authorities should be commended for their efforts to achieve the fiscal targets. The prospect for an accelerated recovery in 2001 might result in better than expected revenue performance, thus enabling the authorities to achieve their ambitious targets while at the same time addressing critical expenditure needs. However, the staff recommends caution, and urges the authorities to proceed with supplementary spending only after additional revenue has been collected. Maintaining a prudent fiscal stance in advance of the repegging of the litas would enhance confidence in economic policies and help maintain the momentum for further reforms over the medium term.

29. The staff endorses the authorities’ intention to switch the peg of the litas to the euro, with a view to moving smoothly toward greater economic integration with the EU area, while preserving the credibility of the currency board, which has anchored macroeconomic policies and provided price stability. In order to minimize uncertainties, the staff welcomes the authorities’ plans to make the process as transparent as possible, and would also caution against any further reduction of reserve requirements in the period prior to the repegging.

30. The staff welcomes the authorities’ ongoing work on the preparation of a comprehensive medium-term fiscal framework, which will provide an opportunity to determine priorities, address future expenditure pressures, and seek ways to achieve the medium-term goal of a cyclically balanced budget. Fiscal policy should preserve the consolidation achieved in 2000, with some modest further adjustment. This would send a signal to financial markets regarding the irreversibility of fiscal adjustment in the context of the currency board arrangement. On the expenditure side, there might be little room for further cuts if essential services and social expenditures are to remain adequate; the authorities are encouraged, however, to pursue expenditure rationalization.

31. The staff welcomes the objective of simplifying and making the tax system more transparent, bringing it in line with the EU. Regarding the government’s tax reform plans, the staff believes there is limited scope for measures that would entail sudden and large losses of revenue. In the staff’s view, a gradual phasing of tax reforms over several years, would be consistent with the government’s program of easing the tax burden to promote economic growth and with the expenditure and fiscal balance objectives. Moreover, there is a need to preserve a balance between the taxation of capital and labor, if employment-creating growth is to be promoted. In this connection, the staff would caution against the immediate abolition of the CIT, and would favor some easing of the tax burden on labor, in particular by reducing the PIT.

32. A number of structural problems need to be addressed. While macroeconomic performance appears to be better than expected and progress in structural reforms was registered in several areas, the staff urges the authorities to move ahead clearly and concretely in the coming months with planned reforms in the fiscal area, banking privatization, the energy sector, and measures to facilitate private sector activity. First, in the fiscal area, the staff is concerned that the position of municipalities, the HIF and the Road Fund would deteriorate sharply in the medium term, unless steps are taken to improve their financial situation in a sustainable manner and to prevent the re-emergence of arrears. The authorities are urged to proceed with caution in providing additional transfers to the municipalities to help them clear arrears. Any transfers should be part of a comprehensive change package of measures to address financial imbalances of municipalities. The staff welcomes the progress in preparing for the pension system reform, to be implemented as of 2003, and supports the authorities’ view that it should be financed by privatization proceeds at an early stage.

33. The authorities are encouraged to complete the privatization of the two remaining state-controlled banks as soon as possible. Bank privatization and strengthened banking supervision should enhance the efficiency of financial intermediation and increase confidence in the domestic financial system.

34. The staff urges the government to proceed swiftly with the implementation of the recommendations of the sunset and sunrise commissions so as to address a wide range of structural and strategic issues. The new bankruptcy and labor legislation would stimulate further restructuring, promoting private investment and employment over the medium term. At the same time, the reforms planned in the energy and agricultural sectors should help boost efficiency and reduce the scope of government support. In this connection, the staff urges the authorities to limit the provision of new government guarantees. Deregulation is also crucial to improving Lithuania’s business environment and competitiveness. Social concerns should be addressed through improved social safety nets.

35. In the staff’s view, the program remains broadly on track, and the end-March targets can be achieved. The staff considers that the authorities’ program is strong, supports the authorities’ request for a waiver of applicability for end-March performance criteria, and recommends the completion of the second program review, taking into account that the authorities have taken the necessary steps to clear the remaining arrears of the central government.

V. Proposed Decision

The following draft decision is proposed for adoption by the Executive Board:

  • 1. The Republic of Lithuania has consulted with the Fund in accordance with paragraph 3(c) of the Stand-By Arrangement for the Republic of Lithuania (EBS/00/28,

  • Sup. 1) and paragraph 2 of the letter from the Prime Minister of the Republic of Lithuania and the Governor of the Bank of Lithuania dated February 22, 2000.

  • 2. The letter from the Prime Minister of the Republic of Lithuania and the Governor of the Bank of Lithuania dated April 2, 2001 shall be attached to the Stand-By Arrangement, and the letters dated February 22 and December 13, 2000 shall be read as supplemented by the letter dated April 2, 2001.

  • 3. The Fund decides that the second review contemplated in paragraph 3(c) of the Stand-By Arrangement is completed, and that the Republic of Lithuania may make purchases up to a cumulative amount of the equivalent of SDR 51.5 million under the arrangement through April 20, 2001, and thereafter in accordance with the provisions of the arrangement, notwithstanding the non-availability of data to assess the observance of end-March 2001 performance criteria specified in paragraph 3(a) of the Stand-By Arrangement, on condition that, with respect to the purchase subject to the performance criteria specified above, (i) the Republic of Lithuania has accurately represented that such information is unavailable, and (ii) the information provided by the Republic of Lithuania on performance under end-December 2000 performance criteria specified in paragraph 3(a) of the Stand-By Arrangement is accurate.

Table 1.

Lithuania: Selected Macroeconomic Indicators,1996-2001

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Sources: Lithuanian authorities; and Fund staff estimates and projections.

GDP for 1999 has been substantially revised by the Statistical Office since EBS/00/28 has been published.

Registered unemployment, end-of-period.

The program adjuster was 0.2 percent of GDP for 2000.

Including valuation changes. Gross official reserves reported here differ from the monetary survey because here reverse repos involving major currencies in both legs are included.

External liabilities minus equity investment in Lithuania.

CPI-based, trade-weighted real exchange rate against 21 major trading partners in 1999.

Dec. 2000 is adjusted for LTL 270 million of DMB’s reclassified loans. If included, private sector credit would fall by 6.1 percent.

Actual figure.

Table 2.

Lithuania: Summary of Consolidated General Government Operations,1998-2001

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Sources: Ministry of Finance, Ministry of Social Security; and Fund staff estimates.

Revenue and expenditure numbers reported in EBS/00/286 were adjusted to reflect the incorporation in the several goverment budget of fees paid to educational establishments and their spending (LTL 128 million)

Interest payments do not include provisioning of defaults, which are reflected under “net lending”.

Program numbers for 2000 are reported without the program adjuster to net lending and deficit for higher-than-expected project lending. The adjustor for 2000 is LTL 81 million. The budgeted amount of provisioning of defaults of LTL 102 million is included for the program numbers and estimates for 2000.

Budget GDP for 200l.

Table 3.

Lithuania: Balance of Payments,1997-2001

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Sources; Lithuanian authorities; and Fund staff estimates and projections.

Including valuation changes. Gross official reserves reported here differ from the monetary survey because reverse repos involving major currencies in both legs are included.

External liabilities minus equity investment.

Debt service comprises interest and gross repayment on external loans, and interest and net repayment on debt securities.

Table 4.

Lithuania: Summary Monetary Accounts,1998-2001

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Sources: Bank of Lithuania; and Fund staff estimates and projections.

Excludes local government deposits; includes counterpart funds.

December 2000 is adjusted for reclassification of LTL 270 million of DMB’s claims on private sector to government lending funds, which were removed from balance sheets in July,2000. If included, private sector credit would fall by 6.1 percent in 2000.

Only annual average velocity is reported at year-end.

Gross official reserves for historic data differ between Tables 1 and 3 because the exposure under reverse repos was not reflected either in foreign assets or liabilities at the time of the program design. For projections, assumption is that all reverse repo transactions are unwound.

Table 5.

Lithuania: Schedule of Available-Purchases Under the Stand-By Arrangement,2000-2001

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Source: Fund staff calculations.

In addition to other clauses in the arrangement.

Table 6.

Lithuania: Indicators of Financial Obligations to the Fund,2001-2008

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Sources: Lithuanian authorities, and Fund staff estimates and projections.

Assuming no drawings under the stand-by arrangement.

Assuming all drawings are made under the stand-by arrangement.

Table 7.

Lithuania: Performance Criteria, Benchmarks and Indicative Targets Under Stand-By Arrangement; January 2000–March 2001 1/

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Sources: Lithuanian authorities; and Fund staff estimates and projections.

Initial targets for end-March, end-June and end-September, and revised targets for end-December and end-March under items III, V, VII, VIII, IX, X and XI are performance criteria, and item VI is a benchmark.

Ceilings will be increased by the amounts that actual on-lending of already committed project loans from IFIs exceed the programmed amounts (with a maximum adjustment of LTL 193 million based on a quarterly project-by-project list for 2000).

The end-March ceilings will be increased by the amount that the actual investment projects included in the attached quarterly list exceeds the program target of LTL 27 million for end-March (with a maximum adjustment of LTL 27 million on a project-by-project basis for end-March.

Of which: not initially budgeted defaults LTL 146 million.

Applies to the central government.

The term debt has the meaning set forth in point No.9 of the Guidelines on performance criteria with Respect to Foreign Debt, adopted August 24, 2000.

Excluding import-related credits and short-term credit lines of municipalities with resident banks.

Table 8.

Lithuania: Structural Benchmarks Under Stand-By Arrangement

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Table 9.

Lithuania: Indicators of External and Financial Vulnerability,1998-2001

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Sources: Bank of Lithuania, Ministry of Finance, Department of Statistics, National Stock Exchange of Lithuania, Bloomberg, Baltic News Service, and Information Notice System.

Public and publicly guaranteed debt.

Includes reduction of claims on private sector of LTL270 million in July,2000.

Gross official reserves reported here differ from the monetary survey because here reverse repos involving major currencies in both legs are included.

On a remaining maturity basis.

Deposit money banks.

External liabilities minus equity investment in Lithuania.

CPI-based REER against the 21 major trading partners in 1999.

LITIN-G price index, calculated for all issues that have been quoted in the current trading list in the past three months, excluding treasury bills and shares of investment companies.

S&P investment grade rating.

Monthly average spread of 5-year Eurobond (US$200 million) issued in July 1997 above the rate on U.S. treasury bills maturing July 31, 2002.