Republic of Lithuania: Staff Report for the 2003 Article IV Consultation
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International Monetary Fund
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Publication Date:
11 Sep 2003
eISBN:
9781451824056
Language:
English
Keywords:
ISCR; CR; authority; EU accession; market; bank; government; first quarter; exchange rate; budget deficit; job creation; economic growth; Pensions; Europe
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Lithuania showed strong economic growth with low inflation owing to its sound economic policies. Executive Directors commended this development, and appreciated Lithuania for signing the European Union Accession Treaty. They encouraged the authorities to maintain macroeconomic stability and accelerate structural reforms. They welcomed the efforts of the Bank of Lithuania to implement Financial Sector Assessment Program recommendations. They emphasized the need for energy and transport privatization, the modernization of the agriculture sector, and streamlining of the legal framework to enhance transparency, governance, and the overall business environment.

Abstract

Lithuania showed strong economic growth with low inflation owing to its sound economic policies. Executive Directors commended this development, and appreciated Lithuania for signing the European Union Accession Treaty. They encouraged the authorities to maintain macroeconomic stability and accelerate structural reforms. They welcomed the efforts of the Bank of Lithuania to implement Financial Sector Assessment Program recommendations. They emphasized the need for energy and transport privatization, the modernization of the agriculture sector, and streamlining of the legal framework to enhance transparency, governance, and the overall business environment.

Lithuania: Basic Data

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Sources: Lithuanian authorities; and Fund staff estimates.

Data as of 2001.

Average wags deflated by consumer price index.

Figures for 2001 and 2002 reflect a downward revision of the estimated population.

Calculated on the basis of registered unemployment; period average.

Average annual interest rate on loans in domestic currency; period average.

There is a break in series beginning in 1998 when a new classification of fiscal account was implemented.

Including the discrepancy between monetary and fiscal data.

I. Introduction

1 In the space of a few years, Lithuania has transformed its economy and is poised to join the EU in May 2004, after the favorable results of the referendum last May. Lithuania’s efforts since 2000, under two successive Stand-by arrangements (SBA), have left its economy well placed to rise to the challenges of EU accession. Prudent macroeconomic policies—in particular fiscal consolidation—and a significant breakthrough in structural reforms delivered macroeconomic stabilization, high growth, and low inflation; restored external viability and credibility; and placed the country in the first wave of EU accession. The policy discipline maintained to support the currency board arrangement (CBA) has contributed to macroeconomic stability, and its continuation will be key to ensuring a smooth and fast transition to the adoption of the euro. In 2003-04, a prudent fiscal stance, consistent with EU commitments, is required to bolster the CBA’s credibility, attract FDI and reinforce sustainability. The increase in EU-related expenditures will make the maintenance of such a stance more challenging, however, and additional pressures may arise in connection with the October 2004 parliamentary elections. Structural reforms must be pursued in earnest to increase competitiveness, foster growth, and preserve social support for the reforms.

II. Recent Economic And Policy Developments

2. The Lithuanian economy is enjoying a broad-based economic expansion with very low inflation. Real GDP grew by 6.7 percent in 2002 and by 9.4 percent in the first quarter of 2003. Since the 1999 recession, economic growth has gradually become more balanced (Text Table 1, Table 1, and Figures 1-2). Supported by intense construction activity, investments continue to be a major source of growth, while consumption has gradually accelerated. This reflects higher household income following a gradual decline in unemployment and a pick-up in wage growth from close to zero in 2000-01 to about 5 percent during 2002. Exports continued to perform remarkably well in spite of the appreciation of the nominal effective exchange rate and the persistent softness of the EU economy, as the investments of recent years are loosening capacity constraints. The trade balance, however, remained broadly unchanged, as imports grew in step with exports. Inflation is virtually absent, with the CPI index falling by 0.9 percent in the 12 months to May 2003, reflecting cheaper imports and downward price pressures from increased competition and higher productivity. In these circumstances, wage growth slowed to 3.4 percent in the year to end-March 2003, and indications are that unit labor costs are falling even in the non-tradable sector. This was coupled with a further drop in the unemployment rate to a four-year low of 9.4 percent in June.

Text Table 1.

Selected Macroeconomic Indicators, 1999-2003

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

The figure for the unemployment rate refers to June 2003.

Growth rates for the first quarter of 2003 are based on a comparison with the first quarter of 2002.

Beginning in January 2003, the estimate of the labor force was revised downward causing a one-time increase in the unemployment rate of 0.8 percentage points.

After 1999, data exclude salaries of owner-operated enterprises.

In percent of annual GDP. The figures for 2003 include the early repurchase of Lithuania’s EFF by the BoL in net lending, which reduces the annual deficit by 0.3 percent of GDP.

Table 1.

Lithuania: Selected Macroeconomic Indicators, 1999-2004

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

Registered unemployment, end-of-period. The figure for 2003 Q1 refers to June.

The figures for 2003 include the early repurchase of Lithuania’s EFF by the BoL in net lending.

Gross official reserves reported here differ from Table 2 due to valuation differences.

External liabilities minus foreign equity investment in Lithuania.

CPI-based, 2000-01 trade-weighted real effective exchange rate against 21 major trading partners.

December 2000 is adjusted for reclassification of LTL 270 million of DMB’s claims on private sector, which were removed from balance sheets in July 2000. Also, December 2001 numbers have been adjusted to reflect LTL 785 million of reclassified assets in July 2001.

Figure 1:
Figure 1:

Contributions to Real GDP Growth, 1998-2002

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Figure 2.
Figure 2.

Macroeconomic Indicators, 1996-2003

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

3. Reflecting the litas’ real appreciation and faster growth than in partner countries, the external current account deficit widened somewhat in 2002, to 5.3 percent of GDP from 4.8 percent in 2001 (Table 2). This development does not raise competitiveness concerns so far, given the impressive export performance, with substantial gains in market shares (Figure 3). Also, the fast growth of imports was the result of strong private investment, with the share of capital goods in imports rising from 14 percent to 18.5 percent between 2001 and 2002. The current account deficit was easily financed by foreign direct investment (FDI). Net FDI grew by over 60 percent relative to 2001, reflecting ongoing privatization, as well as an expansion of operations by existing foreign investors and new investments induced by sound policies and the prospect of EU accession. Lithuania continued to tap international capital markets on increasingly favorable terms. Following the issue of a €400 million 10-year eurobond in May 2002, in February 2003, the government floated another €400 million 10-year eurobond at a record-low 74 basis points spread, which was trading at a spread of 45 basis points in mid-July (Figure 4).1 Against this background, gross official reserves reached $2.9 billion at end-March 2003 (covering more than 3 months of imports and just under 100 percent of short-term debt, on an original maturity basis, at end-2002). Preliminary data for the first quarter of 2003 show that the current account deficit narrowed to 3.7 percent of quarterly GDP, reflecting an improvement in the trade balance.

Table 2a.

Lithuania: Balance of Payments, 1999-2003

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Source: Data provided by the Lithuania authorities, and Fund staff estimates and projection.

“-” indicates repurchase; “+” indicates purchase.

The 2003 stocks are calculated based on end-2003 exchange rates. Gross official reserves reported here differ from the monetary summary because revenue repos involving major currencies in both legs are included.

External liabilities minus foreign equity investment.

Total external liabilities minus total external assets, excluding foreign direct investment, equity investment and reserve assets.

Total short-term liabilities minus total short-term assets, on set original maturity basis.

Debt service comprises interest and repayment on external loans, and interest and repayment on debt securities. The peak in 2001-02 reflects large-scale amortization of dollar-demonistrated debt immediately before and after the rapegging of the litas.

Table 2b.

Lithuania: Balance of Payments, 2002-2008

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Source: Data provided by the Lithuanian authorities; and Fund staff estimates and projections.

“−” indicate repurchase; “+” indicates purchase.

The stocks for 2003 and beyond are bated on end-2003 exchange rates. Gross official reserves reported here differ from the monetary survey because reverse repos involving major currencies in both legs are included.

External liabilities minus foreign equity investment.

Total external liabilities minus total external assets, excluding foreign direct investment, equity investment and reserve assets.

Debt service comprises interest and repayment an external loans, and interest and repayment on debt securities. The peak in 2001-02 reflects large-scale amortization of dollar-denominated debt immediately before and after the repegging of the litas.

Oil prices for 2003-08 based on WEO baseline projection.

Figure 3.
Figure 3.

Indicators of External Competitiveness. 1996-2003

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Figure 4.
Figure 4.

Interest Rate Spreads, 1999-2003

(Eurobond vis-à-vis German benchmark)

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

4. Monetary and credit aggregates expanded further in 2002 and the first quarter of 2003. Broad money has been expanding rapidly since 2000 due to the improved economic environment and greater confidence in the banking sector. Credit to the private sector started expanding in late 2001, reflecting improved business confidence, a decline in interest rates, and greater competition and efficiency of the newly privatized banks. Broad money grew by 18.2 percent year-on-year by end-May 2003, with monetization gradually converging toward the level of other advanced transition countries, reflecting improved economic conditions and enhanced confidence in the banking system (Table 3, Figures 5-6). Cash in circulation grew significantly, partly reflecting the conversion of dollars into litai, in response to the dollar depreciation. Credit to the private sector expanded rapidly, by 35 percent, albeit from a low base, in response to low interest rates and increased economic activity. The reserve coverage of the currency board remains high at 155 percent at end-May, and interest rates continue to be low, in line with EU rates. Significant progress was made in implementing FSAP recommendations (see Supplement 1).

Table 3.

Lithuania: Summary Monetary Accounts, 1999-2004

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

Excludes local government deposits; includes counterpart funds.

Data for 2001 onwards include Treasury accounts, which were moved from commercial banks to the BoL at end-June, 2001.

December 2000 is adjusted for LTL 270 million of DMB’s claims on private sector, which were removed from balance sheets in July 2000. Also, July 2001 numbers have been adjusted by LTL 785 million of reclassified assets.

Gross official reserves for historic data differ from the BOP table because of valuation differences.

Figure 5.
Figure 5.

Financial Indicators, 1998-2003

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Figure 6.
Figure 6.

Monetization and Private Sector Credit in the Baltics, Selected EU Accession Countries, and the Euro Area, 2002

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Sources: International Financial Statistics.1/ Includes Czech Republic. Hungary, Poland, Slovak Republic and Slovenia.2/ Private sector credit includes credit to public enterprises and to non-bank financial institutions.

5. The strong fiscal consolidation initiated in 2000 continued in 2002 and in the first quarter of 2003. The general government budget recorded a deficit of 1.2 percent of GDP in 2002 (compared with 2 percent in 2001), and a surplus of 0.8 percent of annual GDP in the first quarter of 2003 (Table 4). In the first quarter of 2003, revenues were broadly in line with the budget, as shortfalls in the corporate income tax (CIT) and other taxes were offset by higher-than-budgeted collection of personal income tax (PIT) and non-tax revenue. Expenditure was lower than budgeted by almost 0.5 percent of GDP, mainly due to savings in interest and low layouts in goods and services.

Table 4.

Lithuania: Summary of Consolidated General Government Operations, 1999-2008

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

From 2000 onward, five new extra-budgetary funds, which had not been reported before, were added.

From 2001 onward, fees paid to educational establishments and their spending (LTL 128 million) were added to general government operations.

From 2002 onward, fees paid by trucks crossing the borders of the country were added. In addition, following the new organic budget law, revenue of state institutions for provided services was included in municipal budget.

Grants from EU and related expenditures are not included prior to 2002.

For 2001, current expenditure and non-bank financing include LTL72 million of pharmaceutical arrears rescheduled in December 2001 (according to the definition in the SMEP (EBS/01/211)). The entire amount was repaid in March 2002 through a commercial bank loan contracted by the Health Insurance Fund. The latter operations are recorded in 2002Q1 as domestic bank borrowing for LTL 72 million, and amortization to the non-bank sector by the same amount. The terms of the loan include repayments in right equal tranches of LTL 9 million, starting in 2003, with the final payment due on December 31, 2006.

The early repurchase on January 2, 2003, would reduce the 2003 budgeted deficit by SDR 39.244 million, everything else being equal, as this amount, which was previously on-lent to the monetary authorities, is treated as a repayment in net leading.

6. Structural reforms continued during the past year, although with some disappointments. Tax reforms brought the tax system basically in line with EU requirements, but revenue failed to stabilize. Cost-cutting measures successfully reduced pharmaceutical expenditures of the Health Insurance Fund (HIF), and measures to improve municipal finances were implemented, but expenditure arrears persisted, and further reform steps envisaged for early 2003 were postponed in the wake of municipal elections. In 2002, the last state-owned bank was privatized, a 34 percent stake in Lithuanian Gas was sold to a German consortium, and Russia’s Yukos took a controlling stake in the Mazeikiu Nafta oil refinery, ensuring long-term supplies. In addition, bankruptcy regulations were strengthened, and a new labor code became effective at the start of 2003. Substantial progress was also made in implementing projects funded by EU pre-accession grants, particularly in agriculture, an area facing large restructuring needs. The privatization process was recently subject to delays, with protracted negotiations for the sale of another 34 percent stake in Lithuania Gas to Russia’s Gazprom, and a cancellation of the tender for Lithuanian Airlines.

III. Report on the Discussions

A. Retrospection

7. The Lithuanian authorities and civil society involved in the discussions assessed very favorably the economic performance under the recent Fund-supported programs. When Lithuania embarked on the program in March 2000, it was in the midst of both a political crisis and a recession. Three years later, Lithuania had achieved macroeconomic stabilization, high growth, and a significant breakthrough in structural reforms; restored credibility; and is in the first wave of EU accession. This turnaround happened against the background of three successive governments, a steep nominal appreciation of the litas, the lack of a long-term oil supply contract, and rising unemployment.

8. The general view was that the Fund programs had played a catalytic role in bringing about the turnaround, with financing considerations secondary.3 Fund programs helped to create consensus across a fragmented political spectrum on the economic policies needed to achieve the widely shared goals of preserving the CBA and joining the EU. Such consensus allowed strong fiscal adjustment to take place and enabled the passage of needed legislation. The programs also supported the BoL’s strategy of a preannounced repegging of the litas from the dollar to the euro at the prevailing exchange rate, emphasizing stability and transparency. This approach worked because wage flexibility and enterprise restructuring helped maintain competitiveness and successfully reorient exports to the EU. In the authorities’ view, discussions with the staff and the outreach efforts had contributed to the internal debate, leading to true domestic ownership of the final decisions. This inclusive approach permitted continuity when changes of government took place. The authorities considered that cooperation with the Fund had been very good, with an open constructive dialogue. Looking at what could have been done differently, they believed that the program targets for the general government budget deficit were initially too ambitious, but the programs had been adequately adjusted over time.

9. The staff believes that the programs were generally successful in delivering macroeconomic stabilization and restoring credibility. The commitment of the authorities was the crucial factor. Despite political upheavals, a key set of politicians and technocrats believed in the reforms and pushed for their implementation, even when politically difficult. The staff believes that a strong upfront fiscal adjustment was necessary, but some flexibility was shown in revising the program when warranted. Fund and World Bank technical assistance in key areas was used effectively. In the staff’s view, the main weaknesses in program implementation occurred in some structural areas, where the consensual approach led to political compromises; the tax reform fell short of expectations; fundamental problems in municipalities and social spending remain; meaningful pension reform was essentially postponed (Box 1); and energy privatization was subject to delays. Fund surveillance was effective in this period; the Article IV discussions identified the key challenges confronting the authorities, who were generally receptive to the recommendations.

B. Discussions with the Authorities

10. The authorities’ main macroeconomic targets are maintaining high and employment-generating growth with low inflation, and safeguarding the external position. In their view, joining the EU should help achieve these targets. Their strategy aims at keeping the CBA within ERMII until the adoption of the euro, implying that fiscal policy and structural reforms will remain the key policy instruments.

11. The discussions focused on the fallowing issues relevant to macroeconomic stability:

  • The medium-term outlook and external vulnerabilities, and the possible implications of prolonged economic weakness in Europe and an appreciating euro;

  • The exchange rate and monetary framework before and after EU accession;

  • Preserving the quality of banks’ credit portfolios in a period of rapid economic growth and credit expansion;

  • The medium-term fiscal stance and the short-term challenges of making room for EU-related costs; and

  • Structural reforms and a strengthening of the social safety net, to address high unemployment and regional inequalities.

The Pension System: Long-Term Problems and Solutions

The Lithuanian pension system is administered by the State Social Insurance Fund Board (SoDra) and operates on pay-as-you-go (PAYG) principles. The system is financed by 25 percentage points of the 34 percent social security tax, with special arrangements for farmers and the self-employed. Three types of pensions are provided—old-age, disability, and survivor—at a cost of 6.8 percent of GDP in 2002, with old-age pensions accounting for more than 70 percent of expenditure. In addition to SoDra pensions, a number of pension programs are financed by the state, which cost about 0.6 percent of GDP (see tables).

To be eligible for an old-age pension individuals must reach retirement age and contribute for at least 15 years (30 years to get full benefits). The old-age pension has two components: a flat basic pension, currently about $45 a month (19 percent of the average net wage), and an earnings-related pension of on average about the same magnitude. The basic pension is in principle indexed to inflation and earnings-related pensions to the average wage. However, during the last few years the basic pension has been increased substantially faster than inflation. Given the ceiling on the earnings-related component the system is highly redistributive. Primarily as a result of demographic developments, the PAYG pension system has recently started to generate surpluses, reflecting relatively large cohorts of workers entering the labor farce (due to a period of high fertility rates from the 1960s to the mid-1980s) and a relatively small number of new retirees (due to a low birth rate during the 1940s). This favorable situation is set to continue through about 2015 (see figure).

The pension system faces two serious problems. First, only about 60 percent of the working age population is currently making contributions, so many will not qualify for a future pension. This contrasts with the present situation where almost all those of retirement age are covered, reflecting notionally full employment in the Soviet period, and it is especially worrying given the lack of a targeted social safety net. Second, the decline in the fertility rate from above 2 in the 1980s to currently under 1.3 will over the coming decades entail a dramatic rise in the number of retirees per worker. It is projected that the population will fall by about 30 percent by year 2060, with the dependency ratio almost doubling during the 40 years from 2015. Consequently, the surplus of the PAYG pension system, which is projected to reach about 1 percent of GDP in 2015, would turn into a substantial deficit by mid-century.

To address shortcomings, a number of legal changes were instituted in recent years, including a tightening of provisions regarding fanners and the self-employed and a gradual increase in the statutory retirement age to 62.5 years for males and 60 years for females (by 2006). Also, parliament introduced in late 2002 a pension reform law, which on a purely voluntary basis and starting in 2004 will allow people to switch part of their pension contributions into authorized private pension funds, thereby establishing a funded “second pillar” of the pension system. The magnitude of the contribution, and hence the loss of revenue to SoDra, is initially set to 2.5 percentage points rising to 5.5 percent in 2007. The effect of this last reform is still highly uncertain, but it is probably minimal, as only few are expected to opt in.

Ensuring the long-term sustainability of the pension system will require additional measures. In this regard, the PAYG scheme would benefit from: (i) further increasing the retirement age to reflect greater longevity; (ii) changing eligibility requirements for old-age pensions to reward service longer than 30 years; (iii) strengthening collection of contributions to increase revenues and coverage; (iv) eliminating the ceiling on the earnings-related pension or cap contributions to reduce the level of redistribution and improve incentives; and (v) tightening eligibility requirements for disability pensions, where the number of recipients has been growing rapidly. Also, to secure participation in the second pillar and encourage the development of private pension funds it would be advisable to: (i) make participation in the second pillar mandatory for younger cohorts, as originally proposed; and (ii) strengthen the regulation of pension funds to increase transparency and install confidence in the market. Finally, it would be desirable to reduce the number of pension schemes, possibly by replacing social assistance pensions, state pensions, and the basic pension with a single scheme.

Pensions and Pensioners, 1995-2001

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Source: Department of Statistics

Cross-Country Indicators, 2000

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Main public old-age pension in 2002/03.

Ratio of population aged 60 and over to aged 20-59.

Sources: SSA, Eurostat, European Policy Committee, and national statistics.
uA01fig01

Projections for the Current Pension System

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Source: Ministry of Social Security and Labor.Note: Based on current rules and midpoint (“conservative”) assumptions regarding key variables and excluding effects of the introduction of a second pillar.

C. The Economic Strategy for the Medium Term

12. The potential for sustained economic growth is in place, but continued sound policies are needed. The stable macroeconomic environment and the restructuring undergone in the past three years have enabled businesses to achieve strong sales and profit growth (Figure 7). Investors are optimistic and are starting to look beyond export industries, which, nonetheless, would continue to be the main engine of growth. Provided prudent macroeconomic policies and structural reforms to improve the business environment are in place, the economy could continue to grow rapidly, with further advances in productivity, modest inflation, and gradually declining unemployment (Annex I). EU accession will provide additional stimulus due to the inflow of grants and opportunities created by further integration of trade and finance. In 2003, real GDP growth would decelerate to about 5.8 percent, due to the impact of slow growth in partner countries. Growth would then pick-up somewhat, to 6.2 percent in 2004-05, reflecting a projected economic recovery in the EU and increased investment associated with the availability of EU structural funds (Table 7).

Figure 7.
Figure 7.

Trade Structure, 1998-2002

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Table 5.

Lithuania: Indicators of External and Financial Vulnerability, 1999-2003

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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, excluding short-term debt of SoDra and nonguaranteed debt of municipalities.

December 2000 is adjusted for LTL 270 million of DMB’s claims on private sector, which were removed from balance sheets in July, 2000. Also, July 2001 numbers have been adjusted by LTL 785 million of reclassified assets.

Gross official reserves reported here differ from the monetary table due to valuation differences.

On a remaining maturity basis.

External liabilities minus equity investment in Lithuania.

Total external liabilities minus total external assets, excluding foreign direct investment, equity investment and reserve assets.

Total short-term liabilities minus total short-term assets, on an original maturity basis.

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

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.

Table 6.

Lithuania: Financial Sector Indicators, 1999-2003

(In percent, unless otherwise indicated)

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Sources: Bank of Lithuania and National Stock Exchange of Lithuania.

December 2000 is adjusted for LTL 270 million of DMB’s claims on private sector, which were removed from balance sheets in July, 2000. Also, July 2001 numbers have been adjusted by LTL 785 million of reclassified assets.

Prudential standards are broadly at international levels, and there is a full program of on-site and off-site supervision. Foreign bank branches are not included.

Includes loans overdue for 31 days. The classification of loans may be adjusted according to the borrower’s standing, loan restructuring and refinancing. (Resolution on the Board of the Bank of Lithuania on the Approval of the Regulations for Classification of Doubtful Assets, April 24, 1997 No. 87).

The compilation of the minimum capital adequacy ratio was aligned with the Basle methodology on January 1, 1997.

Defined as the ratio of total capital to total liabilities.

Interbank rates; basis points.

As of January 1,1999, the spread between the average overnight Vilnius Interbank Offered rate (VILIBOR) and the average overnight Vilnius Interbank Bid rate (VTLIBID) during the respective month; before January 1, 1999, the spread between the average of the highest and lowest VILBOR and the average between the highest and lowest VILIBID.

Open position includes off-balance exposure.

Maximum open position requirements have been reduced as of June 1,2000. Maximum in foreign currency and precious metals is 25 percent of a bank’s capital, while earlier it was 30 percent. Maximum in each currency is 15 percent, while earlier it was 20 percent.

Table 7.

Lithuania: Macroeconomic Framework, 1999-2008

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Sources: Lithuanian authorities; and Fund staff calculations.

Negative current account balance.

Includes discrepancy between above and below the line estimates of the financial balance and balances of budgetary organizations not recorded in the above the line number. Also includes savings restitution payments in 1998-99.

External liabilities minus equity investment in Lithuania. Includes public, publicly guaranteed and private external debt.

13. Over the medium term, Lithuania’s current account deficit as a share of GDP and the external debt ratio are expected to decline (Tables 2a and 2b). Notwithstanding robust export growth, the current account deficit would temporarily widen during 2003-04, reflecting the import content of investment and the boost to private consumption and infrastructure investment provided by EU transfers 4 The larger deficit mirrors the fiscal expansion projected for this period. After 2005, the current account deficit as a share of GDP would gradually start narrowing, mainly reflecting increasing public saving as fiscal consolidation resumes, and is projected to decline to under 5 percent of GDP by 2008. The baseline scenario makes a conservative assumption on FDI flows, to reflect the declining privatization potential over time—should FDI flows prove to be higher, the economy could sustain a somewhat wider current account deficit over the medium term. The external debt ratio is projected to decline steadily, from 45 percent in 2002 to 35 percent in 2008.

14. The authorities agreed that Lithuania’s external position remains vulnerable to a number of potential shocks, due to large gross financing needs in the medium-term. Prolonged economic weakness in Europe or a further appreciation of the euro might affect competitiveness and export growth. Higher international interest rates, and/or a decline in capital inflows to emerging markets could also adversely affect Lithuania’s external position (Annex II).

D. The CBA and Monetary and Financial Policies

15. The authorities reiterated their intention of maintaining the CBA until an early adoption of the euro. Their proposed strategy is to join the ERMII very soon after accession, maintaining the current parity and an unilateral commitment to the CBA, and adopt the euro after two years of successful membership of ERM II and continued compliance with the Maastricht criteria, subject to agreement with the relevant EU authorities. The staff recognized the benefits in terms of stability of the authorities’ strategy. A double regime shift within a short period of time could increase uncertainty and could prove very costly. In addition, an early adoption of the euro would not entail a loss in policy flexibility compared with the current monetary framework, while further bolstering confidence, reducing interest spreads, and lowering transaction costs. The staff also pointed out the risks. For this approach to succeed, domestic policies—in particular fiscal policy—must continue to be supportive and competitiveness remain appropriate (Box 2). While there is no indication of exchange rate misalignment at present, a joint assessment of competitiveness will have to be made by the authorities and the EU when entering ERM II. Moreover, with income convergence or large capital inflows the Maastricht inflation criterion might be exceeded.

16. Rigorous banking supervision is needed to protect financial sector stability at a time of rapid growth of money and credit. In 2003, broad money is projected to grow by 13.7 percent, reflecting further financial deepening and technological improvements in the banking sector (Table 3). Credit to the private sector would continue to expand by 28 percent, boosted by favorable economic conditions and low interest rates. The staff and the authorities shared the view that this credit expansion does not pose an immediate risk and remains manageable in view of the results of the FSAP follow-up, the low credit base, and the current favorable macroeconomic conditions. However, this situation will require continued close monitoring and a sound credit risk management system in order to safeguard the quality of the banks’ credit portfolio and the country’s external position.5 In this context, the staff endorsed the BoL’s intention of lowering very gradually, in three to four steps, the required reserve ratio from its current level of 6 percent toward the required ECB level of 2 percent by 2007 but recommended caution. While overheating remains unlikely in the near term, credit expansion or large capital inflows could give rise to inflationary pressures in the future and the pace of the reduction would have to be reconsidered.

Competitiveness in Lithuania: Waiting for Balassa-Samuelson

As Lithuania approaches participation in ERM II, which requires the choice of a central parity vis-à-vis the euro, evaluating the country’s competitiveness is key to assessing the sustainability of Lithuania’s exchange rate regime. Based on the results of the background paper on competitiveness in the Baltics (SM/03/118) for the period 1994-2002, Lithuania appears to have maintained its competitiveness, as suggested by a range of indicators:

Real effective exchange rate (REER) indicators (figure). REERs strongly appreciated in the mid- and late-1990s. Since early 1999, the appreciation of the dollar against the euro and later the appreciation of the euro against the dollar—following the litas repegging—led to an appreciation of Lithuania’s effective exchange rate of 16 percent in 1999-2002. This appreciation was partially offset by low inflation rates than those in the trading partners, as shown by the CPI-based REER. Since 1999, the producer price-based REER (excluding oil) appreciated by under 10 percent, less than the appreciation in the CPI-based measure. The unit labor cost (ULC)-based REER was about 20 percent lower in mid-2002 than in early 1999, due to very low wage increases and exceptionally high increases in productivity in the context of the strong recovery following the 1999 recession.

uA01fig02

Real Effective Exchange Rates, 1999-2002

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Export performance. Despite the EU slowdown, Lithuania has expanded the share of its exports in the EU market by a remarkable 50 percent since 1999. Lithuania’s export base is quite diversified, with oil, textile, machinery and equipment, all contributing significantly to export growth.

Productivity growth. Although the gap between income and productivity levels in Lithuania and in the euro area remains very large, convergence is taking place. GDP per capita and per worker growth rates averaged 6.3 percent and 6.8 percent a year, respectively, for the period 1994-2002, almost double the EU average. Estimates of total factor productivity (TFP) suggest that the rapid growth in output in Lithuania over 1995-2001 primarily reflect TFP growth, which is estimated to have contributed about 3 percentage points to annual GDP growth.

Equilibrium REER (EREER). Based on an estimation of the EREER in a theoretical framework that incorporates the Balassa-Samuelson hypothesis and the balance of payments approach, there is evidence that the EREER has appreciated significantly since 1994, although the rate of appreciation has slowed down since the beginning of 1999 (figure). At the beginning of 2002, the REER appears to be lower than the EREER, by anywhere from 2½ percent to 8¼ percent. Alternative methods that identify underlying trend movements produce similar results. The strength of the euro in the last year, however, may have removed some of this difference.

uA01fig03

Real Effective Exchange Kate end IS Equilibrium

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Balassa-Samueison. Based on this evidence, the authorities’ monetary strategy would be viable provided cautious policies are maintained. One concern is that, with a fixed exchange rate, the ability to meet the Maastricht inflation criterion will depend on the scale of the Balassa-Samuelson effect. But high productivity growth has not effected prices in Lithuania so far. The lack of evidence for the Balassa-Samuelson effect is possibly explained by the fact that productivity in non-tradables sector has also grown very fast, as large technical advances have taken place in the non-tradables sector for services such as electricity distribution, finance services, and telecommunications, thanks to restructuring and privatization. Productivity growth in the retail sector has also been very large. This development would be consistent with the findings of Harberger (“Economic Growth and the Real Exchange Rate: Revisiting the Balassa-Samuelson Effect”, paper for a conference organized by the Higher School of Economics, Moscow, 2003) for numerous high-growth countries.

17. Since the November 2001 FSAP, financial markets in Lithuania have developed while remaining stable.6 The foreign exchange market has grown considerably and is the most developed. With bank privatizations finalized, the banking system has exhibited steady strengthening and increased soundness of prudential indicators. Measures recommended by the FSAP report in the Basel Core Principles for Effective Banking Supervision have been largely implemented in the new draft Law on Banks. The draft also enhances the BoL’s ability to detect and prevent money laundering. Most issues regarding insurance supervision have been addressed by a new draft Law on Insurance, however, limits on the financial independence of the insurance supervisory agency raise concerns given its new responsibility for pension fund supervision.7 Regarding debt management, the government’s savings securities program, originally intended to attract the nonbank public to capital markets, introduced distortions instead, proving costly to the budget and posing a risk in case of a sudden encashment of the outstanding stock. Following the staff’s advice, the government suspended the issuance of new savings securities in June.

E. Fiscal Policy and Fiscal Structural Reforms

18. Looking ahead at EU membership and the obligations of the Treaty, the authorities reiterated their commitment to keeping low fiscal deficits in the short run and reaching a structurally balanced budget in the medium term. Moving towards a structurally balanced budget, a requirement under the Stability and Growth Pact, would bolster the credibility of the CBA, help maintain low interest spreads, limit the public sector’s call on national savings, and safeguard the external position. This strategy would also provide some room for maneuver if countercyclical policies were needed and would prevent an upward drift in public debt. The staff endorsed the authorities’ strategy, underscoring the challenges that they will face in the short run. In particular, prioritization of expenditure remains key to foster productive investment and promote efficient social spending Equally important is the need to increase revenue by improving tax administration, eliminating preferential treatments, and promoting good governance and transparency.

19. The authorities explained that, in 2003-04, the budget deficit is expected to increase to accommodate upfront expenditures related to EU membership, leading to a deviation from the medium-term path (Text Table 2). Given the current strong economic position, the good track record of prudent policies, and the authorities’ commitment to medium-term balance, the staff took the view that this widening of the deficit would not jeopardize macroeconomic stability, provided it remains limited and temporary, as envisaged by the authorities.

Text Table 2.

Fiscal Impact of EU Accession, 2003-06 1/

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

Assumes full absorption of available post-accession grants and topping up of direct payments to farmers up to 40 percent of EU level.

Defined as total expenditure less EU-related expenditure, benefits paid by SoDra, defense spending, and interest.

2003 discrepancy between above and below the line (-0.5 percent of GDP) assigned to expenditure.

Figures for 2004-06 are staff projections.

20. The staff underscored the importance of holding the general government fiscal deficit for 2003 at the budgeted 2.1 percent of GDP (Table 4) (1.8 percent adjusted for an EFF early repurchase).8 The authorities stated that they would cut discretionary expenditure to meet the fiscal target should revenue shortfalls materialize. A supplementary budget, approved by Seimas in July, entailed some expenditure reallocation but left the authorities’ fiscal deficit target for the year unchanged. The staff indicated, however, that the reallocations in favor of agriculture (almost 0.2 percent of GDP) set a bad precedent, and stressed the importance of resisting political pressures for additional spending or preferential treatment to some sectors of the economy. The financing of the general government deficit remains as originally budgeted.

21. The authorities noted that expenditure pressures are expected to intensify in 2004, but they would aim at keeping the budget deficit below 3 percent of GDP. The tax revenue-to-GDP ratio will decline further, reflecting the impact of the tax reforms and further changes to the tax system likely to be required by the EU (Text Table 3). EU-related expenditure will increase by 2.6 percent of GDP.9 In addition, spending pressures may mount in the run-up to parliamentary elections. Careful expenditure prioritization is therefore needed to preserve essential services and social expenditure.10 The staff emphasized that there is no room for topping up EU-related payments to farmers from national funds11 or scope for accelerating the saving and land restitution plans.12 The authorities are in the process of preparing the 2004 fiscal deficit and they indicated that they intend to keep it somewhat below 3 percent of GDP. The staff noted that, at this stage in the economic cycle, there is the need to leave some room for counter-cyclical fiscal policies in the event of a slowdown or adverse external shocks and still remain in compliance with Maastricht criteria. The staff argued that a fiscal deficit of about 2.6 percent of GDP would provide such room, accommodate EU-related expenditure, and allow non-EU related expenditure to grow in real terms, although at a slower pace than GDP (Text Table 4).13 The authorities considered the staff’s proposal useful and they will take it into account for the preparation of their budget.

Text Table 3.

Estimated Losses in 2004 Associated with Tax Concessions

(In millions of litai)

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Sources: Country authorites and Fund staff estimates.

Change imposed by Seimas to the original tax reform proposal presented by the government. This concession became effective in 2003.

Text Table 4.

Fiscal Balance of the General Government, 1999-2004

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Sources: Country authorities, and Fund staff estimates.

Staff proposal for 2004.

22. The decline in the tax revenue-to-GDP ratio raises major concerns. The tax reform failed to stabilize revenue in GDP terms, mainly owing to concessions awarded by Seimas on VAT, PIT, and excise tax, estimated at almost 0.4 percent of GDP in 2004 (Text Table 5). Further revenue losses are likely to materialize in 2004 if the elimination of the turnover tax and the excise tax on sugar are required by the EU (0.9 percent of GDP in subsequent years). The authorities and the staff shared the view that alternative sources of revenue to offset these losses are needed. These could include a tax on transportation (estimated revenue of LTL 65 million for the first year and LTL 100 million thereafter), and higher duties and excises on oil products and gas. The staff also encouraged the authorities to persevere in their efforts to improve tax administration and fight tax evasion.

Text Table 5.

Impact of Approved Legislative Changes Effective in 2004

(In millions of litai)

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Sources: Country authorities and Fund staff estimates.

Not yet approved by Seimas, but likely to be requested by the EU.

23. The staff welcomed the marked improvement in the HIF’s financial prospects, but emphasized that further efforts are needed to enhance the efficiency of the health sector. The measures implemented in 2001-02 to limit HTF’s pharmaceutical expenditures (see EBS/03/14) have started to bear fruit—the HIF’s budget was in balance at the end of 2002 and in line with the budget in early 2003, though some arrears persist. The authorities agreed that improving further the administration of the HIF and developing a long-term plan for rationalization of expenditure and infrastructure are needed to create an efficient and financially viable health care system. A first step was made in March 2003 with the publication of the criteria for restructuring hospitals.

24. The authorities noted the improvement in the overall financial situation of municipalities in 2002, but acknowledged that the underlying problems have not been resolved. Municipalities reduced substantially their arrears by end-2002 (by LTL 48 million relative to end-2001), mainly because of the favorable economic environment, but accumulated new arrears (LTL 26 million) in the first quarter of 2003. The staff recommended further expenditure rationalization, enforcing borrowing limits, and improving budgeting and planning procedures. Technical assistance in this area has been requested from FAD. In addition, the staff pointed to the need to provide municipalities with control over their tax base and expressed disappointment that the introduction of the real estate tax before the 2004 elections was unlikely.

25. The amount of EU grants will increase sharply upon accession, when Lithuania will become fully responsible for the approval and oversight of all EU-financed projects. Two departments were created at the Ministry of Finance to coordinate and monitor EU-related financial issues. Further efforts are being made to enhance administration capacity and put in place efficient control mechanisms, to ensure that grants are properly used and to prevent financial mismanagement and corruption.

F. Other Structural Reforms

26. Deeper structural reforms are needed to underpin growth and employment creation. EU funds will provide resources to help restructure an inefficient agricultural sector, which accounts for 16 percent of employment—well above the EU average (Text Table 6)—but only 8 percent of GDP.14 The legal framework should be streamlined, to increase transparency and improve the business environment (Box 3). Privatization appears to be picking up speed with a number of large sales expected in 2003, including two electricity distribution companies and four alcohol producers. The fate of the sale of a stake in Lithuania Gas remains uncertain, however. Finally, pension reform would stimulate private savings and financial market development.

Text Table 6.

Lithuania and the EU: Employment by Sector, 1990-2001

(In percent of total)

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Sources: Lithuania Statistics Department and OECD.

27. Strengthening the social safety net is crucial. While unemployment has been declining, regional disparities remain high and rural poverty is widespread, with subsistence farming representing a form of hidden unemployment. The system of social assistance needs to be overhauled and its targeting improved (Box 4). Despite increasing expenditure, the quality of services provided remains substandard in a number of areas, particularly health.

28. Lithuania maintains an open trading system with a three-tier tariff structure, with different tariffs applying to imports from countries with MFN status, to those from countries with free trade arrangements, and to those from all other countries. Tariff rates vary widely for different product groups. No changes to the trading system have been introduced since the last Article IV consultation. Looking ahead, however, Lithuania will need to harmonize its tariff system with the EU single tariff system. It is estimated that this will result in a somewhat more restrictive system, as tariffs on imports from some important non-EU trading partners will have to be raised.

Creating a Favorable Business Environment

From 1991 to 2001, the share of the private sector in GDP increased rapidly from less than 20 to more than 70 percent (Figure), but the private sector was unable to absorb all the labor shedded by the restructuring of the public sector, giving rise to high and persistent unemployment. Improving the business environment, especially for small and medium-sized enterprises (SMEs), therefore constitutes apriority for job creation.

uA01fig04

Share of the Private Sector in GDP, 1991-2001

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

Source: Department of Statistics

Factors that create favorable business conditions include a stable and enabling environment (political and macroeconomic stability, an open trade and investment regime, a sound banking system, flexible labor markets and good infrastructure) and a simple, transparent and enforced legal framework promoting competition. Lithuania has made significant progress in all those areas, but further efforts are needed. According to various surveys (by Lithuanian institutions, the World Bank, and the EBRD), businesses viewed as the main obstacles: complex and changing tax requirements, an unstable and cumbersome legal framework, low-level corruption, lack of financing, and the shortage of skilled workers. Efforts should focus on:

  • Improving tax administration, simplifying the system, eliminating exemptions and preferential treatments, and bringing out businesses from the shadow economy.

  • Simplifying administration procedures and licensing requirements. Excessive state involvement in the operations of private businesses creates opportunities for corruption.

  • Mitigating skill shortages and mismatches between the unemployed and vacancies through a well-targeted education and training system for low-skilled workers and promoting labor mobility.

  • Reducing the shortage of financial intermediaries for SMEs by promoting microfinance, especially in rural areas. These institutions would help address the issues of high collateral requirements and short repayment periods encountered by SMEs.

  • Completing the privatization of transport and utilities to improve infrastructure.

The Social Protection System: A Reform in Waiting

Lithuania’s complex social protection system established at independence consists of a state social insurance program (SSIP) and a social assistance program (SAP).

  • The SSIP, which includes pensions, unemployment benefits, and health insurance, has its own budget, administered centrally by the State Social Security Fund and the HIF. It is financed through mandatory contributions and from state and local government budgets.

  • The SAP includes a cash-transfer program and social services (long-term social care and day care). The cash transfer program provides benefits for selected groups regardless of income (family benefits and social pensions) and income-tested benefits for low-income families (social benefits and utilities compensation). The financing and administration of most cash transfers were decentralized to local governments during the 1990s, but transferred back to the central government from 2002, given poor administrative capacity al the local level.

Several issues must be addressed:

  • Total social insurance expenditure has grown rapidly in real terms and in percent of GDP (from 8 percent in 1996 to 16.7 in 2000), and now accounts for almost half of public expenditure. High payroll taxes established to finance this expenditure hamper job creation and contribute to high and persistent unemployment.

  • Pensions account for the largest share of the SSIP, although the average pension is low.

  • Although unemployment is high, and of long duration, expenditure on unemployment benefits is low, 0.4 percent of GDP (the replacement rate and duration of benefits are low relative to other EU accession countries).

  • Social assistance programs are not well targeted and do not protect the most vulnerable groups from poverty, while creating work disincentives for others. Given the multitude of programs, resources are spread without visible results.

  • Large territorial differences in the provision of social protection exist, reflecting regional disparities in economic development, wages and unemployment. The inadequate social insurance for the rural population is particularly worrisome, as many farmers are self-employed and lack insurance for old age and other critical situations.

Better targeting is needed, to create an adequate social safety net for the poorest segments of the population and the unemployed, as unemployment is likely to remain high in the near future, especially in light of forthcoming structural changes in agriculture. In addition, the problem of poor pensioners should be addressed through well-targeted social payments.

IV. Staff Appraisal

29. The Lithuanian economy continues to perform beyond expectations, and is well positioned to take on the challenges of EU accession. The authorities are to be commended for their firm implementation of sound economic policies that have led to these favorable results. These achievements should not lead, however, to complacency. Hard-won credibility would be quickly dissipated if the authorities’ commitment were to waver. Policies to maintain macroeconomic stability and ongoing structural reforms will be necessary to ensure improved competitiveness, sustained growth and further reductions in unemployment in the coming years.

30. The CBA, which has anchored macroeconomic stability, continues to serve Lithuania well. The authorities’ proposed exit strategy is appropriate, provided supportive policies are conducted and competitiveness remains adequate. The staff underscores, however, that the success of this strategy hinges on the ability of the authorities to maintain rigorous fiscal discipline.

31. In this context, the staff wishes to underscore the importance of meeting the deficit target for 2003 and limiting the 2004 deficit to about 2.6 percent of GDP. This target is ambitious but feasible, and would leave adequate room for countercyclical policies in the event of a slowdown or adverse external shocks. Careful prioritization is required to accommodate EU commitments, and the staff urges the authorities to resist spending pressures in the run-up to elections since any concessions could jeopardize the fiscal target. With declining revenue, there is no scope for payments to farmers from national funds or for accelerating the saving and land restitution plans. Any slippages that would threaten compliance with the Maastricht criteria and the commitments under the SGP would damage confidence, undermining the CBA, macroeconomic stability and the strategy for an early adoption of the euro.

32 The staff is very concerned about the decline in tax revenue-to-GDP ratio. Efforts should focus on eliminating exemptions and loopholes, promoting fairness and transparency, and improving tax administration. In the event the elimination of some taxes is deemed necessary by the EU, the authorities would have to find alternative sources of revenue to offset these losses. Raising sufficient revenue is the precondition for carrying out needed reforms. The staff thus urges the authorities to resist pressures for tax reductions or awarding preferential treatments to particular groups or sectors.

33. The staff welcomes the authorities’ efforts to strengthen administrative capacity, financial controls, and audit capabilities for the utilization of EU funds. It is essential that these transfers be used effectively and transparently, given the scope for potential mismanagement and even corruption.

34. Efforts should be made to complete the reforms of municipalities and the HIF, setting their finances on a sound footing. Further steps should include expenditure rationalization, better budgeting and planning procedures, strict borrowing limits, and concrete measures for arrears reduction. A real estate tax would help provide a stable source of own revenue, and it is regrettable that its introduction has been postponed.

35. The staff welcomes the efforts by the BoL to implement FSAP recommendations and thereby establish high-quality supervision and reinforce the stability of the banking system. The system was assessed as sound and resilient to foreseeable shocks. However, in the midst of widespread optimism, with rapid money and credit expansion, strict banking and insurance supervision and high standards in bank credit risk management are required to safeguard the soundness of the financial system. Overheating is unlikely in the near term, but inflationary pressures could emerge in the future and could be exacerbated by credit expansion or large capital inflows. In this regard, the timing of the planned reductions in the required reserve ratio would need to take into account liquidity and inflationary conditions as well as Lithuania’s external position. If developments were unfavorable, the authorities should be ready to postpone the reduction of the reserve requirement ratio or tighten the fiscal stance further.

36. There is a need to accelerate and deepen the structural reform process in order to sustain employment creation and rapid economic growth. The privatization of the energy and the transport sectors would encourage modernization in these areas. The large but relative unproductive agricultural sector also needs restructuring. In this regard, available EU funds should be used to improve the income-generating capacity of rural areas and not just for direct income support. Further removing red tape and other regulatory obstacles to private sector activity would encourage the development of small and medium-sized companies and hence job creation.

37. Measures to increase labor market flexibility and mobility would help generate jobs and even out high and increasing regional differences. The large structural component of unemployment and growing income disparities call for a reform of the social safety net, to improve efficiency and targeting towards the poorest segments of the population.

38. There is a need to adopt measures that would ensure the long-term viability of the pension system. The rapidly ageing population will entail substantial increases in public expenditures on pensions for which it is important to prepare. The authorities should expand gradually the scope of the reform by raising contribution rates and making participation mandatory for younger cohorts, fostering the development of private pension funds. Also, it is critical that the surplus projected for SoDra over the coming decade be saved for the future rather than spent on increasing benefits. Any increase in benefits should be financed through new measures, such as increasing the retirement age. Moreover, steps are needed to establish appropriate supervision for the pension funds.

39. Lithuania continues to improve its statistical base. A number of measures suggested by data ROSCs have been implemented. In the fiscal area, however, the maintenance of different budget concepts is still a problem, adversely affecting transparency. In this connection, the staff encourages the authorities to implement the fiscal ROSC recommendations.

40. There are additional risks associated to the authorities’ macroeconomic strategy. Lithuania remains vulnerable to external shocks due to large gross financing needs in the medium term. Prolonged economic weakness in Europe or further euro appreciation might affect competitiveness and export growth. Higher international interest rates, and/or a decline in capital inflows to emerging markets could also have adverse effects on Lithuania’s external position. While Lithuania has now access to international financial markets on very good terms, net external debt should be kept low, so as to guard against possible unfavorable external developments.

41. Despite these concerns, the staff considers that Lithuania’s economy is well placed to reap the benefits of EU membership. Cooperation between the authorities and the Fund is expected to continue to be close in the context of surveillance.

42. Lithuania is expected to remain on the standard 12-month consultation cycle.

APPENDIX I Lithuania: Fund Relations

(As of April 30, 2003)

I. Membership Status: Joined: 04/29/1992; Article VIII.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:

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V. Latest Financial Arrangements:

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VI. Projected Obligations to Fund: Under the Repurchase Expectations Assumptions1 (SDR Million; based on existing use of resources and present holdings of SDRs):

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VII. Implementation of HIPC Initiative:

N/A

VIII. Current Status of Safeguards Assessments:

Under the Fund’s safeguards assessment policy, BOL is subject to a full safeguards assessment with respect to the current SBA. A safeguards assessment of the BOL was completed on December 10, 2001. The assessment concluded that an on-site visit was not necessary, but identified certain weaknesses and made appropriate recommendations, as reported in EBS/01/211. BOL has implemented the vast majority of these recommendations under a timetable agreed with the Fund. Staff continues to monitor progress on the implementation of the remaining measure.

IX. Exchange Arrangements:

The currency of Lithuania is the litas. From April 1, 1994 to February 1, 2002, the litas was pegged to the U.S. dollar at LTL 4 per U.S. dollar under a currency board arrangement. Since February 2, 2002 the litas has been pegged to the euro at LTL 3.4528 per euro. Lithuania has accepted the obligations of Article VIII of the Fund’s Article of Agreement and maintains an exchange system free of restrictions on the making of payment and transfers for current international transactions.

X. Article IV Consultation:

Lithuania is on the 12-month consultation cycle.

XI. FSAP Participation and ROSCs:

FSAP work program is completed. Data and fiscal ROSC modules have been recently completed.

XII. Technical Assistance:

The following table summarizes the technical assistance missions provided by the Fund to Lithuania since February 1997.2

Lithuania: Technical Assistance from the Fund, 1997-2002

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XIII. Resident Representative:

The resident representative of the Fund in Lithuania is Ms. Zuzana Brixiova, who took up her post in November, 2002.

APPENDIX II Lithuania: World Bank Relations

Overview of the World Bank Group Involvement

1. Since 1992, the Bank has contributed to Lithuania’s transition through investment and adjustment lending, policy dialogue, and analytical advisory assistance. Bank-supported investment projects were designed to help the government implement structural reforms and build institutional and human capacity at sector and local levels. The Bank’s analytic work was oriented to analyzing the steps needed to implement Lithuania’s structural reform agenda. In addition, the government’s overall reform efforts were supported through two structural adjustment loans in 1996 and in 2000 dealing with banking, energy, agriculture, social sectors, private sector development, and budget management issues.

Partnership in Lithuania’s Development Strategy

2. Lithuania’s leading political, economic, and social objective for the coming years is integration into the European Union, and subsequent improvement in living standards and income convergence. In the pre-accession period Lithuania seeks to maintain rapid and sustainable economic growth and increase competitiveness. A long-term vision of Lithuania is a welfare state that would ensure that benefits of economic growth are spread broadly through the population by supporting knowledge economy, improving public services, and strengthening social policies.

3. A new World Bank Group Country Assistance Strategy (CAS) for the assistance in 2003-2005 is under preparation. The government has indicated its continuing interest in the Bank’s strategic advice on medium and long-term issues and its intention to shift to a non-lending relationship for this upcoming period. The government’s priority areas for the Bank’s support in the next three years are: education and knowledge economy, social and health sector reforms, public administration reform, municipal finance and capacity building, rural development.

4. To date, the Bank has approved 19 projects in the amount of US$490.8 million, of which 10 operations are completed. Of this amount, US$339.1 million has been disbursed and US$64.9 million has been repaid.

5. IFC has supported projects for US$130 million in the financial markets, electronics, chemicals, textile, wood processing, construction materials, and food processing sectors. Current IFC exposure is US$38.6 in four projects as of January, 2003. Government representatives have participated in MIGA-sponsored meetings on investment promotion, and Lithuania is an active user of MIGA’s internet-based information dissemination facilities. FIAS has produced a study on administrative barriers to investment.

Areas of the World Bank supported policy reforms and World Bank-Fund Collaboration:

6. The Fund and the World Bank maintain a collaborative relationship in promoting macroeconomic stability through support of structural reforms. The government’s reform program supported by the World Bank’s Structural Adjustment Loan (SAL) II was designed to promote a number of synergetic reforms in the areas of budget management, pensions and social assistance, private sector development, energy and agricultural sectors, which helped Lithuania to deal with the consequences of the Russian crisis. The government and the Bank consider that the development objectives of the reform program and of the SAL II were for the most part met. Major accomplishments under the reform program supported by the SAL II included, among others, privatization of two remaining state-owned banks, adoption of new bankruptcy and enterprise restructuring laws, and restructuring of Lithuanian Power company. However, a couple of the reform actions originally agreed under the loan were not fully implemented, in particular those dealing with shifting ownership and managerial control of Lithuanian Gas to a strategic investor, and maintaining restrictions on budgetary expenditures and market regulation of certain agricultural commodities. After an initial one year extension of the loan’s closing date, in May 2002 the Government requested that SAL II be closed without release of its second tranche.

7. Public expenditure management. The SAL II supported medium-term reforms of public finances and the core budget process. Specific reform areas included government accounting, budgetary support for commercial activities, debt management, control and governance of extra-budgetary arrears, and management of the budget process. Subsequent to the SAL II, technical assistance is being provided to debt management through a World Bank Institutional Development Fund (IDF) grant facility.

8. Municipal finance. The World Bank has contributed to analyzing and shaping policies in municipal finance with 1998 policy notes and a report on municipal finance in 2002. The Bank and the Fund are closely monitoring developments in municipal finance. The future agenda includes greater tax and expenditure autonomy at municipal level, improving the selection and financing of municipal capital investments, and strengthening financial reporting of municipal operations.

9. Financial sector reforms. The World Bank and the Fund worked closely together to support financial sector reforms. The Bank has maintained close dialogue with the government on banking sector restructuring and provided policy advice in 1998 policy notes and a Macro Financial Vulnerability Study of 1999. Most recently, the Bank and the Fund conducted a joint Financial Sector Assessment Program (FSAP). Post-FSAP technical assistance is being arranged to strengthen accounting and auditing and insurance supervision capacities.

10. Energy sector. Lithuanian energy sector reform was supported by SAL programs I and II, which aimed for decentralization of district heating, economic efficiency and privatization of gas and power sectors, the establishment of proper regulatory and competitive frameworks. The Fund program has emphasized restructuring and subsequent privatization of LPC, and the privatization of LG under its structural reform measures.

11. Labor markets. In July 2002, Lithuania passed a new labor market code. The law introduces new forms of flexible employment contracts, liberalizes firing conditions, and foresees the possibility of reducing minimum wages for specific sector or groups. The Bank has provided advice on labor market reform with the analysis presented in Lithuania Country Economic Memorandum (CEM) 2002.

12. Pensions and social protection. The Bank worked with the government on pension reform in the context of SAL II, which supported reform measures directed at achieving fiscal balance of the social insurance system in the short term. In 2002, the government approved a law on pension system reform which introduces a voluntary defined contribution second pillar beginning in 2004, in addition to the existing mandatory pay-as-you-go pillar. Preparation for pension reform has been financed through a PHRD grant. Social policy and community services project is helping the Government of Lithuania in providing social security to the population through the institutional development of the Ministry of Social Security and Labor and development, testing, and replication of new community-based social service models that allow feasible and cost-effective social service delivery.

13. Health sector reform. Lithuania’s health reform is aimed at improving quality and equity in health service provision, strengthening fiscal sustainability of the health system and increasing efficiency in the use of public funds. The Bank has been supporting the government reform program in the health sector through a Health project, which became effective in 2000. Implementation of the project investment component has been satisfactory, but the health policy framework, including health financing issues, has not been adequately addressed in the past. The Bank and the Fund coordinate their advice to the government on identifying measures to improve health financing and health sector management.

14. Education reform. The Bank is supporting Lithuania’s education improvement program through Education improvement project, approved in 2002. The project seeks to improve student achievement in basic education and to make a more efficient use of the financial, human and physical resources allocated to education, by supporting municipalities in their effort to optimize school network and by improving energy efficiency and space utilization in an initial group of sixty-two targeted schools.

Lithuania: Financial Relations with the World Bank Group Statement of active IBRD loans

(as of May 6, 2003, in millions of original currency)

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APPENDIX III Lithuania: Status of Statistical Database

1. Over the past several years, Lithuania has made good progress in establishing a macroeconomic database. Official data for all sectors are generally of sufficiently good quality to support economic analysis. However, frequent and large revisions of national accounts data, though necessary for improving the accuracy and reliability of the data, tend to complicate the analysis of economic developments.

2. In general, the data are available on a timely basis, and the authorities have given the staff ready access to all available data (see the attached matrix). An IFS page for Lithuania was introduced in December 1995. Lithuania meets the Special Data Dissemination Standard (SDDS) specifications for coverage, periodicity and timeliness of the data, and for the dissemination of the advance release calendars. Lithuania subscribed to the Special Data Dissemination Standard in May 1996, posted its metadata on the Fund’s Dissemination Standards Bulletin Board (DSBB) on the Internet since April 1997, and met SDDS specifications in July 1999. A significant amount of information is now available on various websites through the Internet (see section on Dissemination of Statistics, below).

National accounts

3. The national accounts are compiled by the Department of Statistics (DOS) in accordance with the guidelines of the European System of Accounts 1995 (ESA 95). Quarterly GDP estimates at current and at constant prices are compiled both from the production and expenditure approaches. GDP estimates by production are considered to be more reliable than the corresponding estimates by expenditure, but no statistical discrepancies between these two estimates are shown in the published figures. Good data sources and sound methods are used, in general, for the compilation of the national accounts, but difficulties remain in measuring the economic activity of the informal sector. These latter estimates are compiled at detailed levels of economic activity using fixed coefficients derived from a benchmark survey conducted in 1996. The base year for the fixed price series was changed to 2000 in early 2003.

Price data

4. Since December 1998, the CPI weights have been updated each year. The last update was undertaken in December 2002 and based on the Household Budget Survey (HBS) covering the period October 2001 to September 2002. The monthly CPI is available in the second week following the reference month. The producer price index is calculated according to the chain-linked Laspeyres formula with weights updated every year.

Public finance

5. Data on the central government budget execution are available quarterly, although these data are subject to frequent revisions. The ongoing treasury project is expected to improve fiscal data quality substantially. In January 1999, the Ministry of Finance began publishing data on monthly and quarterly consolidated central government operations and on annual consolidated general government operations, which include the budgetary central government, municipalities and extrabudgetary and social security funds. Further work is needed to clarify the treatment of public health care providers and of EU transactions, and the consolidation procedure for government operations. Regarding classification, amortization of foreign debt in the appropriation to line managers appears to be currently misclassified by the authorities above the line as capital expenditure and would need to be addressed in the Data ROSC update. (The staff reclassifies this item for program monitoring purposes.) Monthly and quarterly data on consolidated central government are not reconciled because they are on different recording bases. In accordance with EU requirements progress was made in adopting ESA 95 accounting standards. However, the maintenance of different budget concepts is still a problem, adversely affecting transparency.

Money and banking

6. The accounts of the BoL for the end of each month are available in the second week of the following month, while the consolidated accounts of banking institutions are available within the month following the month of reference. The scope of the analytical accounts of the banking sector does not fully conform with the recommendations of the IMF’s MFSMby not including banks in liquidation and two institutions that issue monetary liabilities, recording_securities held to maturity by credit institutions at historical values even though they are traded in the secondary market, and not including accrued interest in the valuation of loan portfolios.

External sector

7. The BoL is responsible for compiling the balance of payments, the international investment position and the international reserves statistics. The BoL compiles balance of payments statistics on a quarterly basis using the format recommended in the Balance of Payments Manual, fifth edition (BPM5). In 1999, BoL set in motion plans to develop and produce monthly balance of payments statistics to meet the requirements of the EU following Lithuania’s application for membership of the EU. Hence, in addition to quarterly balance of payments data, the BoL has started publishing monthly balance of payments statistics since January 2002. The monthly data correspond to several key balance of payments components, compiled on the basis of a sample survey covering the public sector, commercial banks, and some nonfinancial private sector institutions. The Data Template on International Reserves and Foreign Currency Liquidity is disseminated according to the operational guidelines and is hyperlinked to the Fund’s DSBB.

Dissemination of statistics

8. The Lithuanian authorities publish a range of economic statistics through a number of publications, including the DOS’s monthly publication, Economic and Social Developments, and the BoL’s monthly Bulletin. A significant amount of data are available on the Internet:

  • Lithuania’s metadata for data categories defined by the Special Data Dissemination Standard are posted on the IMF’s DSBB (http://dsbb.imf.org);

  • The BoL website (http://www.lbank.lt) provides data on monetary statistics, treasury bill auction results, balance of payments, the international investment position, and main economic indicators;

  • The DOS website (http://www.std.lt) provides quarterly information on economic and social development indicators;

  • The Ministry of Finance (http://www.finmin.lt) home page includes data on the national budget, as well as information on laws and privatization; and

  • The National Stock Exchange website (http://www.nse.lt) has information on stock trading.

Core Statistical Indicators

(As of July 2, 2003)

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Through the resident representative office.

Notes:

Frequency of data: D-daily, W-weekly, M-Monthly, Q-Quarterly.

Frequency of reporting: M-Monthly, Q-Quarterly, V-irregular in conjunction with staff visits.

Mode of reporting: C-cable or facsimile, E-electronic news reporting, V-staff visits, or O-other.

Confidentiality: (B) for use by the staff and the Executive Board, (C) for unrestricted use.

ANNEX I Medium-Term Outlook

In the process of establishing a market-based economy, Lithuania has undergone major changes since independence in 1991. The Russian crisis in 1998 and the resulting recession in 1999 accelerated the restructuring process by forcing enterprises to modernize and re-orient exports towards the EU and other accession countries. These reforms paid off in the form of high foreign direct investment, rapidly increasing exports, and accelerating economic growth. A driving force has been the eagerness of foreign investors to take advantage of Lithuania’s well-educated labor force and low-cost environment. With average monthly wages of about $350 and per capita GDP at less than 20 percent of the EU average (about 35 percent in PPP terms) there is room for a continuation of this process.

In the next few years the economy will see stimulus from further structural reforms, a likely pick-up in growth among advanced economies, and increased financial deepening. Accession to the EU, in May 2004, will also have a positive impact by furthering many of the developments that have contributed to economic growth in recent years, in particular the replacement of Soviet-era laws with more business friendly and EU-compatible versions. The full effect of these steps have not yet been seen, implying a positive impact on growth in the coming years. Grants from the EU have boosted investment in infrastructure and encouraged restructuring of the still highly inefficient agricultural sector, and more will be done on these fronts as grants increase from 0.7 percent of GDP in 2002 to a projected 3.2 percent in 2005 and remain at about 3 percent of GDP annually thereafter. Finally, EU accession will reduce barriers to trade and financial flows with current and prospective EU members, encouraging further integration.

These developments suggest that Lithuania should be able to sustain annual growth rates of about 6 percent over the medium term. This would be somewhat faster than the average growth rate of 4.9 percent since 1995 and closer to the pace of the last few years, reflecting the positive outlook and signs of an increase in growth potential and loosening capacity constraints following increased investment.1 In fact, annual growth rates of over 6 percent have now been sustained for some time without inflationary pressures. There is, however, considerable uncertainty attached to these projections, as Lithuania is subject to rapid structural change and highly exposed to developments in partner countries.

uA01fig05

Output

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

uA01fig06

Investment

(percent of GDP)

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

uA01fig07

Fiscal Balance

(percent of GDP)

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

uA01fig08

Current Account

(percent of GDP)

Citation: IMF Staff Country Reports 2003, 295; 10.5089/9781451824056.002.A001

The envisioned medium-term scenario involves a continuation of recent trends. EU-related expenditure will cause a temporary widening of the fiscal deficit in 2003-04, after which the movement towards structural balance would resume.2 Private saving would increase, as higher EU grants can be expected to be spent with some lag and to contribute positively to business profits. In addition, given weak Ricardian equivalence, pension reform and the emergence of private pension funds would boost savings, especially if additional reform steps are taken such as making participation in the second pillar mandatory for younger cohorts. The current account deficit may deteriorate slightly in the near term, due to increased imports of capital goods, but it is subsequently expected to return to near the current level, as higher domestic savings reduce the demand for foreign savings. Foreign direct investment (FDI) is projected to cover about half of the current account deficit, below recent levels. While FDI may well turn out to be higher, there is, however, a risk that the current account deficit could be wider than projected (see Annex III).

The export sector will likely continue to grow, but investors are also expected to be looking to expand the domestic service sector, which will benefit from growing income levels. Unemployment is projected to continue its gradual fall, with an ongoing migration from rural to urban areas. Due to skill mismatches, many of the workers released from the restructured agricultural sector will, however, have difficulties finding alternative employment. Consequently, structural unemployment would remain high so that, while there would be some increase in overall employment, growth would be driven largely by productivity advances. With flexible labor markets, wages are expected to reflect productivity growth—at least in the tradable sector. As a result, competitiveness would remain strong and inflation would remain low, although perhaps ½ a percent higher than in the EU, as productivity growth in the tradable sector may outstrip that in the non-tradable sector (the Balassa-Samuelson effect).

ANNEX II Debt Sustainability Analysis

Fiscal Sustainability

This section presents the staff’s baseline scenario for the Lithuania’s public debt for the period through 2008 and the results of public debt sustainability simulations based on shocks to various underlying variables (Table 8). Deviations from the baseline scenario are based on historical averages and/or shocks to these averages (plus/minus two standard deviations). No dynamic feedback effects are considered. The historical averages are based on the period 1997-2002, because the Lithuania’s economy went through significant structural changes before 1997, which could distort the analysis.1 The authorities broadly agreed with this baseline scenario; however, at the time that this scenario was produced, the authorities were still in the process of revising their medium-term projections.

Table 8.

Lithuania: Public Sector Debt Sustainability Framework, 1997-2008

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether tutor gross debt is used.

Derived as [(r - π(1 + g)- g + αε(1 + g)]/(1 + g + π + gπ) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator, g = real GDP growth rate; α = share of foreign-currency denominated debt; and g = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r-π(1 + g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r)

Defined is public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on (JDP deflator).

After a two years of economic recovery, the Lithuania’s economy suffered setbacks towards the end of 1998 and in 1999, as a result of the impact of the Russian crisis. While real GDP grew by more than 7 percent a year in 1997-98, it shrank by 1.8 percent in 1999. The primary fiscal deficit increased from 3.2 percent of GDP in 1997 to 7 percent in 1999. The ratio of debt to GDP increased from 21.1 percent in 1997 to 29 percent in 1999. Reflecting prudent macroeconomic policies, Lithuania started to recover in 2000. In 2000-2002 strong growth and remarkable fiscal consolidation reduced debt to 27 percent of GDP by the end of the period. Moreover, over this period, the authorities were able to diversify their liabilities, issuing Eurobonds in international capital markets and broadening their domestic debt instruments, and thereby diversifying risks associated with their public debt. Under these circumstances, public debt does not raise significant concern.

Under the baseline scenario, public sector debt is projected to decline gradually to about 21 percent of GDP by 2008, as fiscal consolidation continues and real growth remains strong. The weakening of the fiscal position during 2003-04 is not expected to significantly affect the debt ratio to GDP, which would remain at about 25 percent of GDP for two years before starting to decline again in 2006. Public sector debt as a ratio of revenues would decline from 89 percent in 2002 to 65 percent by the end of the period.

The results of the stress tests in Table 8 suggest that public debt sustainability is particularly sensitive to shocks to the primary fiscal deficit (stress test 4) and to a severe real depreciation (stress test 6), underscoring that fiscal prudence and maintenance of the CBA credibility are key to safeguard public debt sustainability. Of course, the results of stress tests 8-10 show that public debt is quite sensitive to shocks to revenue, suggesting that stabilizing the revenue-to-GDP ratio is critical in maintaining public debt sustainability.

External Sustainability

The external sustainability analysis framework follows broadly along the lines of the fiscal sustainability analysis discussed in the previous section. A medium-term baseline projection, incorporating the staff’s central forecasts regarding the evolution of a number of key variables, generates a path for the external debt to GDP ratio over the WEO forecast horizon (Table 9). The analysis also considers deviations from this baseline path, reflecting the impact of a number of potential adverse shocks to the historical averages of the variables that mainly drive the external debt dynamics. Once again, to provide a more realistic picture of Lithuania’s medium term prospects, these historical averages were based on the 1997-2002 period, rather than the standard 10-year historical period.

Table 9.

Lithuania, External Debt Sustainability Framework, 1997-2008

(In percent of GDP, unless otherwise indicated)

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Derived as [r- g - ρ(l + g) + εα(l + r)] / (l + g + ρ + gp) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(l + g) + εα(l + r)] / (l + g + ρ + gp) times previous period debt stock, ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium-and long-term debt, plus short-term debt at end of previous period.

The large current account imbalances in the last years of the 1990s resulted in a rapid accumulation of external debt, with this trend exacerbated by the recession that followed Russia’s default. As a result, the external debt to GDP ratio peaked at 44½ percent in 2002. On the basis of the baseline scenario (Table 9), this ratio is projected to decline steadily over the medium term, falling below 35 percent by the end of the projection period. The main factors behind this path are continued strong GDP growth, higher EU transfers, and a gradual narrowing of the current account deficit that reflects an increase in domestic savings. As expected, however, interest payments would continue to have an adverse impact on the debt dynamics, on the basis of the WEO projection of euro area interest rates from their current historically low levels.

Turning to the impact of adverse potential shocks on the debt dynamics, the stress tests of Table 9 suggest that Lithuania’s external position is somewhat more vulnerable than its fiscal position. Owing to the relatively high initial external debt ratio and the openness of the economy, Lithuania is likely to come against external constraints before fiscal constraints become binding, should such shocks materialize. Table 10 shows that in the event of slowdown in GDP growth or a failure of the current account deficit to narrow the external debt ratio is projected to exceed 70 percent on impact, and to remain above 60 percent through the end of the projection period. This highlights the need for deeper structural reform and a resumption of fiscal adjustment in 2005 to safeguard the external position. The external debt ratio is moderately sensitive to shocks to the interest rate and the exchange rate, with the stress tests pointing to a debt ratio that remains above 50 percent throughout the period under consideration. Finally, the external debt ratio turns out to be least sensitive to negative shocks to inflation, remaining roughly constant at 50 percent.
1

Standard & Poor’s upgraded its rating on long-term sovereign credit in foreign currency for Lithuania from BBB to BBB+ in February 2003.

3

The arrangements were treated as precautionary and no purchases were made.

4

The authorities classify EU structural funds as (non-debt-creating) capital rather than current transfers.

5

Credit to the private sector was 16.6 percent of GDP in 2002, compared to 36 percent in Latvia and 51.1 percent in Estonia (Figure 6). It is projected to increase to 20.6 percent in 2003.

6

See Supplement 1 for details on the FSAP follow-up and SM/03/122.

7

The agency’s salary structure and employment of staff will remain determined by the Law on Civil Servants. As a result, salaries might not be sufficient to retain the necessary highly specialized staff, such as actuaries (see Supplement 1).

8

The non-budgeted repurchase to the Fund of SDR 39 million was made in January 2003.

9

Part of these EU-related expenditures (about 0.9 percent of GDP) would overlap with expenditures that would have taken place in any case.

10

Initiatives to mandate expenditure in certain sectors could impede prioritization. In this regard, in December 2002, Seimas approved an amendment to the Health Insurance law effective on January 1, 2004, establishing the minimum amount of annual transfer from the State Budget to the HIF. The authorities are trying to postpone the implementation date of the amendment, which would imply and additional outlay of 0.5 percent of GDP in 2004.

11

Direct payments to formers at 40 percent of the current EU level with be complensated by EU funds in 2005. If Lithuania were to pay farmers 55 percent (the upper limit allowed by the EU), the additional 15 percent (0.3 percent of GDP) would have to be financed from national resources.

12

Total outstanding claims under the land and saving restitution programs amounted to about LTL 3.6 billion (6.5 percent of DGP) in June 2003.

13

The following assumptions underlie the staff’s 2004 fiscal deficit projection. On the revenue side, an overall revenue loss of 0.4 percent of GDP would be offset by the introduction of a tax on transportation and higher excises on gas and fuel (about 0.2 percent of GDP), and by the budget support funds from the EU (0.2 percent of GDP). On the expenditure side, some EU-related expenditure could be accommodated within existing budget allocations (0.9 percent of GDP). Other additional EU-related expenditure -support to farmers (almost 0.7 percent of GDP), EU-membership fee (0.9 percent of GDP) and part of post-accession programs (almost 0.2 percent of GDP)- could be virtually accommodated by savings in interest (0.1 percent of GDP) and by reducing spending in wages and salaries (by 0.2 percent of GDP), non EU-related expenditure in good and services (by 0.5 percent of GDP), and SoDra outlays (by 0.2 percent of GDP).

14

Lithuania faces a challenge similar to that of Spain when it joined the EU in 1986: 16 percent of Spanish employment was in agriculture, which accounted for only 5 percent of GDP. By 2001, the contribution of agriculture of GDP was unchanged, but its share in employment had dropped to less than 7 percent.

1

Disbursements made after November 28,2000—with the exception of disbursements of emergency assistance and loans from the Poverty Reduction and Growth Facility—are expected to be repaid on the expectations schedule. Countries may request the IMF Executive Board to make repayments according to the obligations schedule if their external payments position is not strong enough to meet the repayment expectations without undue hardship or risk. Please note: Repayments under the Supplemental Reserve Facility are scheduled to be repaid on the expectations schedule.

2

For technical assistance before 1997, see previous reports.

1

Applying a Hodrick-Prescott filter to seasonally adjusted quarterly real GDP from 1995Q1 to 2004Q4 (with projected data for the last seven quarters) shows potential output growing at an average rate of 5 percent during this period, accelerating from 4.2 percent in 1999 to 5.4 percent in 2002, and 5.8 percent in 2004. The results are heavily influenced by the 1999 recession—largely the result of a collapse in Russian import demand and thus, arguably, unrelated to Lithuania’s output potential—and are also sensitive to choice of the end-period. Excluding 1999, the average historical growth rate over the period was 6 percent.

2

Based on the above calculation of potential output and assuming that underlying general government revenue moves in line with potential rather than actual GDP, the structural fiscal deficit would be 0.2-0.3 percent of GDP larger than the actual deficit in 2003-04. Assuming that potential GDP grows by 6.1 percent during the following years implies that the projected output gap, and hence the difference between the structural and the actual deficit, would gradually decline. These results, however, should be interpreted with considerable caution due to the uncertainty associated with the estimate of the output gap, raising doubts about the applicability of the concepts of business cycles and structurally balanced budgets to a country subject to such a high degree of structural change.

1

As discussed in Annex II, the historical data are heavily influenced by major structural changes and external shocks, also for the more limited period from 1997-2002. In particular, this period was heavily impacted by the Russia crisis, which caused real GDP to decline by 1.8 percent in 1999, and no such shocks are included in the baseline scenario.

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Cover IMF Staff Country Reports
Republic of Lithuania: Staff Report for the 2003 Article IV Consultation
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 295
Publisher:
International Monetary Fund
ISBN:
9781451824056
ISSN:
1934-7685
Pages:
82
DOI:
https://doi.org/10.5089/9781451824056.002
Figure 1:

Contributions to Real GDP Growth, 1998-2002
Figure 2.

Macroeconomic Indicators, 1996-2003
Figure 3.

Indicators of External Competitiveness. 1996-2003
Figure 4.

Interest Rate Spreads, 1999-2003

(Eurobond vis-à-vis German benchmark)
Figure 5.

Financial Indicators, 1998-2003
Figure 6.

Monetization and Private Sector Credit in the Baltics, Selected EU Accession Countries, and the Euro Area, 2002

Projections for the Current Pension System
Figure 7.

Trade Structure, 1998-2002

Real Effective Exchange Rates, 1999-2002

Real Effective Exchange Kate end IS Equilibrium

Share of the Private Sector in GDP, 1991-2001

Output

Investment

(percent of GDP)

Fiscal Balance

(percent of GDP)

Current Account

(percent of GDP)