Republic of Lithuania
Selected Issues
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International Monetary Fund
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Publication Date:
22 Apr 2008
eISBN:
9781451824179
Language:
English
Keywords:
ISCR; CR; current account; Lithuania; deficit; GDP deflator; output gap; GDP growth; balance gap; GDP improvement; Productivity; equilibrium current account deficit
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This paper estimated the output gap in Lithuania using three different methodologies—an HP filter, a panel regression, and a production function. This study examines how the levels of the current account deficit and the real exchange rate in Lithuania compare with estimates of their equilibrium values. The regression-based estimates are sensitive to the regression specifications and samples that determine equilibrium values. The large current account deficit in Lithuania may well be the equilibrium outcome of rapid income catch-up driven by strong fundamentals, including EU accession.

Abstract

This paper estimated the output gap in Lithuania using three different methodologies—an HP filter, a panel regression, and a production function. This study examines how the levels of the current account deficit and the real exchange rate in Lithuania compare with estimates of their equilibrium values. The regression-based estimates are sensitive to the regression specifications and samples that determine equilibrium values. The large current account deficit in Lithuania may well be the equilibrium outcome of rapid income catch-up driven by strong fundamentals, including EU accession.

I. Methodologies for Current Account Assessment

A. Introduction

1. The current account deficit has returned to levels last seen in the late 1990s. Following the Russia crisis in 1998, investment as a share of GDP fell sharply, leading to a narrowing of the current account deficit from 11½ percent of GDP in 1998 to 4¾ percent of GDP in 2001. Since then, the investment ratio has risen, supported by EU accession, generally sound macroeconomic policies, and the inflow of EU funds. As the saving ratio has remained roughly flat, the current account deficit increased.1

uA01fig01

Current Account Deficit and Real GDP Growth

(in percent of GDP and in percent, respectively)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

uA01fig02

National Savings and Investment

(in percent of GDP)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Sources: Bank of Lithuania; Statistics Lithuania; and IMF staff estimates.
uA01fig03

Real Effective Exchange Rate

(1998=100)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Source: Eurostat.

2. Notwithstanding the appreciation of the real effective exchange rate over the past decade, export growth has been strong. While the CPI-, ULC-, and GDP deflator-based real effective exchange rates show slightly different patterns, they are all now more appreciated than a decade ago. Nonetheless, Lithuanian exporters have steadily gained market share in world markets. Exports benefited from EU accession in 2004, which facilitated a reorientation of trade from Commonwealth of Independent States (CIS) countries to EU member countries. Even excluding processed trade (mostly oil and cars) and agriculture, export growth was rapid. Oil refining contributed significantly to real export growth until production reached capacity in 2004. In 2006 and especially 2007, oil exports fell after production disruptions at the refinery due to a fire. This disruption of oil refining contributed to the widening of the current account deficit.

uA01fig04

Contribution to Real Export Growth

(In percentage points)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Source: Department of Statistics; and IMF Direction of Trade Statistics.
uA01fig05

Structure of Exports

In percent of total trade)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

uA01fig06

Share of World Exports

(In percent)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

3. This paper examines how the levels of the current account deficit and the real exchange rate in Lithuania compare with estimates of their equilibrium values. Three different approaches are discussed: the equilibrium real exchange rate approach, the macrobalance approach, and the external sustainability approach. The equilibrium real exchange rate approach directly estimates an equilibrium real exchange rate based on fundamentals that is then compared with the most recent actual real exchange rate. The macrobalance and external sustainability approaches estimate an equilibrium or benchmark current account balance that is compared with the underlying actual current account balance. The real exchange rate overvaluation is the real exchange rate change required to close the resulting gap between underlying and equilibrium balances. The three methodologies provide a wide range of estimates and each methodology suffers from important caveats.

B. The Equilibrium Real Exchange Rate Approach

4. The ERER approach directly compares the actual real exchange rate (RER) with an equilibrium real exchange rate (ERER) estimated from a cross-country analysis. The cross-country analysis is based on a panel cointegration regression of CPI-based real exchange rates on fundamental variables (IMF, 2006). The resulting exchange rate assessment is sensitive to the regression specification and the regression sample. The inclusion of a fixed effect also makes the estimates sensitive to the sample period chosen for Lithuania.

5. The following variables were found to be important determinants of the ERER:

  • Debtor countries need larger current account surpluses—and, hence, more depreciated real exchange rates—to service their debt. Hence, a 10 percentage point increase in net foreign assets (NFA) as a share of trade appreciates the ERER by ½ percentage point.

  • Balassa-Samuelson effect. A 1 percent increase in the productivity differential between tradables and nontradables appreciates the ERER by one-fifth (for a global sample of countries) to one-and-a-half (for a sample of Central and Eastern European countries).

  • Real income and wealth effects. A 10 percent increase in the commodity terms of trade appreciates the ERER by 4-5 percent.

  • Government consumption tends to fall more on nontradables than on tradables. An increase in government consumption by 1 percentage point of GDP appreciates the ERER by 2½ percent (in the global sample of countries).

  • Trade restrictions appreciate the ERER. Price liberalization, concentrated on nontradables, appreciated the ERER especially in the early years of the CEEs’ transition.

All variables are measured as deviations from partner countries except for those variables that intrinsically already measure deviation from partner countries (real effective exchange rate, NFA, terms of trade, price controls). The regression also includes country fixed effects that are estimated such that the average in-sample prediction error is zero. It uses annual data for a sample of 48 emerging and industrialized countries for 1980–2004. Lithuania is not included in the sample. The forecast error of the regression is about 12 percent (assuming a 90-percent confidence interval).

Coefficients Estimates for the Equilibrium Real Exchange Rate Approach 1/

article image
Source: IMF (2006) and subsequent refinements using CEE-specific coefficients. Note: Fixed effect regression for 48 industrialized and emerging market countries (excl. Lithuania), 1980-2004. CEE are Poland, Slovak and Czech Republics, Hungary, Slovenia.

Dependent Variable: CPI-based real exchange rate from IFS.

Calculated such that the average prediction error (i.e. the average misalignment) for 1997-2004 is zero.

Relative to a trade-weighted average of top nine trade partner countries.

6. The regression specifications allow for a stronger Balassa-Samuelson effect among the Central and Eastern European countries (CEE) than for the rest of the sample. The regression is run in two specifications: (i) constraining all countries to have the same coefficients; and (ii) allowing the CEE to have a different coefficient on relative productivity and on government consumption. Among the CEE, a 1 percent increase in the relative productivity of tradables compared with nontradables appreciates the equilibrium real effective exchange rate (ERER) by 1.4 percent. This compares with a 0.15 percent equilibrium real appreciation in the full sample. Since Lithuania’s experience is more likely to be similar to the CEE-countries than the global sample, we here choose the CEE-specific regression coefficients for the exchange rate assessment.

7. The equilibrium RER suggested by these regression coefficients has overestimated Lithuania’s actual RER since 2004.2 Since 2004, the regression has predicted a more appreciated real exchange rate than the actual real exchange rate. The reason is rapid productivity growth in the tradables sector since EU accession in 2004. In the regression using the CEE-specific coefficients, movements in the relative productivity of tradables are the main source of movements in the equilibrium real exchange rate for Lithuania.

uA01fig07

Equilibrium and Actual Real Exchange Rate

(CPI-based, logarithm of index, 2000=100)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Source: IMF staff estimates.

8. Relative to nontradables, productivity growth of Lithuanian tradables outpaced that in Lithuania’s trading partners by about 20 percentage points between 2000 and 2006. Since 2000, productivity in Lithuanian tradables has grown more than 30 percentage points more rapidly than productivity in nontradables, as labor moved out of agriculture and into services and construction. In particular, measured agricultural employment fell by almost one-third, which contributed almost 13 percentage points to the increase in the productivity differential between tradables and nontradables. Much agricultural labor has reportedly emigrated. Rapid employment growth in construction accounted for another 9 percentage points of the increase in the productivity differential.

Contribution to Relative Productivity Growth of Tradables

(In percentage points)

article image

Defined as ln(GDPT)-ln(EmploymentT)-(ln(GDPNT)-ln(EmploymentNT)), 2000-2006.

9. Using medium-term forecasts as proxies for fundamental values, the ERER coefficient estimates suggest an undervaluation of 9½ percent. In line with CGER practice, the WEO projections for 2013 are used for the terms of trade and the most recent, 2006, actual value is used for the productivity differential, trade restrictions, and the number of administered price categories defined by the EBRD. Using these values, the equilibrium RER is 9.6 percent higher than the actual RER at end-2007. This estimate is subject to two caveats. First, this assessment is sensitive to the projected constant productivity differential between tradables and nontradables in the medium-term. If a slowdown in the housing market forced a reallocation of labor back into agriculture or other tradables, the productivity differential may shrink. Secondly, the forecast error of 12 percent is large compared with the point estimate. The 90-percent confidence interval of the exchange rate assessment ranges from an undervaluation of up to 22 percent to an overvaluation of 2 percent.

C. The Current Account Gap

10. Both the macrobalances and the external sustainability approaches compare the underlying current account balance with an equilibrium or benchmark balance. The underlying current account balance is the actual current account balance stripped of temporary factors, the business cycle, and lagged effects of real exchange rate changes. The macrobalances approach defines the equilibrium current account balance based on fundamental variables. The link between fundamental macroeconomic variables and the current account balance is established in a panel regression. The external sustainability approach defines the benchmark current account balance as the one that stabilizes NFA at its most recent (end-September 2007) level.

Underlying Balance

11. The underlying balance can be estimated in a backward-looking or in a forward-looking calculation. The backward-looking calculation starts with the 2007 actual current account balance and removes temporary factors. The forward-looking calculation starts with the medium-term current account balance and removes changes in policies. As long as medium-term projections are based on the assumption of a zero output gap and a constant REER, the two calculations should yield broadly consistent results.

12. In the backward-looking calculation, the 2007 current account balance is adjusted for temporary factors, lagged effects of past real exchange rate movements, and—most importantly in Lithuania’s case—the business cycle. A large positive domestic output gap, estimated at 4½ percent of GDP in 2007, has contributed to cyclically high imports on the order of 4¾ percent of GDP. Conversely, a small positive output gap in Lithuania’s trading partners has cyclically raised exports in 2007, accounting for a cyclical improvement in the current account balance of 0.4 percent of GDP. Once the CPI-based real exchange rate appreciation of 2005–07 has fed through the system, the underlying balance will likely worsen by 1 percentage point of GDP.

Deriving the Underlying Current Account Balance

(in percent of GDP)

article image
Methodology: Isard and Faruqee (1998), OP167.

13. The estimate of the underlying balance is sensitive to the assumed export and import elasticities to the output gap and the real exchange rate. Here, the elasticities from a cross-country sample in Isard and Faruqee (1998) are used. On one hand, the Bank of Lithuania uses lower elasticities in its macro model but, overall, the Bank of Lithuania’s set of elasticities yields a similar underlying current account balance. On the other hand, especially the elasticity of imports to demand pressures may be underestimated by Isard and Faruqee (1998). As the output gap widens, further demand pressures may increasingly spill over into the current account deficit rather than into GDP growth and the elasticity of imports to the output gap may increase. If, say, the elasticity of imports to the output gap was 2 rather than the currently assumed 1.5, the underlying current account balance would be 7¼ percent.

14. Lithuania-specific factors temporarily worsened the current account deficit in 2007. First, the temporary production shortfalls of the oil refinery Mazeikiu Nafta are estimated to have worsened the trade balance by 1 percent of GDP in 2007. As a result of the fire at Mazeikiu Nafta and the pipeline shutdown in 2007, mineral exports declined by almost two-fifths in 2007 and imports by just over one-fifth. With mineral exports about 11 percent of GDP and mineral imports about 15 percent of GDP in 2006, this implied a worsening of the net oil balance of about 1 percent of GDP. Second, Lithuania’s terms of trade are expected to improve by 1.6 percent over the medium-term. By itself, this may lead to a narrowing in the trade deficit of ¼ percent of GDP. Third, current transfers, especially from the EU, are expected to decline by about ¼ percent of GDP over the medium-term. Although this in itself may worsen the current account balance, it may also reduce transfer-related imports by 0.1 percent of GDP.

Adjustment for Temporary Factors to the Current Account Balance in 2007

(in percent of GDP)

article image

15. In the forward-looking calculation, the 2013 projection of the current account balance is adjusted for expected fiscal consolidation. The cyclically-adjusted general government deficit is estimated at 3¼ percent of GDP in 2007. The fiscal responsibility law is expected to constrain the general government budget to balance in the medium term, implying a fiscal consolidation of 3¼ percent of GDP. Using the passthrough of the fiscal balance to the current account deficit from the panel regression in IMF (2006), i.e., 0.19, this fiscal consolidation is expected to improve the current account balance by just over ½ percentage point of GDP.

Forward-Looking Calculation of the Underlying Current Account Balance in 2007

(in percent of GDP)

article image

Projection needs to assume a zero output gap, no temporary effects, and a constant real exchange rate from the latest data.

Macrobalance Approach

16. Based on a cross-country regression, the macroeconomic balance approach estimates the current account balance that would be in line with fundamentals. Two such regressions have recently been used, with similar fundamental variables but different samples: the standard CGER approach (IMF, 2006) and one that puts more emphasis on the convergence process in European countries (Abiad et al., 2007).

17. The standard CGER methodology uses a consistent approach to assess the current account deficits of a wide range of countries. The pooled OLS regression uses data for 54 industrialized and emerging markets for non-overlapping four-year averages during the period 1973–2004 (IMF, 2006). The following fundamental macroeconomic variables are included.

  • Ricardian equivalence—where changes in private savings fully offset changes in public savings—is well-known not to hold. Hence, an increase in the general government deficit by 10 percentage points of GDP increases the equilibrium current account deficit by 1.9 percentage points of GDP.

  • A more economically active population increases national savings. Hence, a 1 percentage point increase in the dependency ratio raises the equilibrium current account deficit by one-tenth percentage point of GDP. An increase in population growth by 1 percentage point raises the current account deficit by 1 percentage point of GDP.

Macrobalance Approach using CGER Coefficients

article image
Source: IMF (2006).

Relative to weighted average of trading partners.

Relative to US.

  • The oil balance captures country-specific effects of oil price fluctuations. A 1 percentage point of GDP improvement in the oil balance reduces the current account deficit by one-fifth percentage point of GDP.

  • Economic growth and the stage of economic development capture intertemporal considerations, such as investment catchup. A 1 percentage point increase in real GDP growth per capita raises the current account deficit by one-fifth percentage point of GDP. A 10 percentage point increase in income relative to the U.S. reduces the current account deficit by one-fifth percentage point of GDP.

  • The lagged current account deficit proxies stock variables, such as NFA, and captures strong persistence in the current account.

Again, all variables are calculated as deviations from trading partner averages with the exception of those variables that already intrinsically capture deviations from trading partners (current account balance, NFA and oil balance). The regressions’ forecast error is 2–3½ percentage points of GDP (based on the 90 percent confidence level).

18. Historically, the level of the equilibrium current account balance mostly reflects the lagged current account deficit. In addition, the equilibrium current account balance improved with the fiscal balance until 2003 and then began to deteriorate as the general government deficit (including restitution payments) widened. Since EU accession, rapid real GDP growth and a slowing decline in population growth compared with Lithuania’s trading partners added to the widening equilibrium current account balance.

uA01fig08

Predicted Current Account Balance

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Source: IMF staff estimates.

19. The regression coefficients suggest an equilibrium current account deficit of 2½ percent of GDP based on medium-term projections. Again, the 2013 WEO projections, supplemented with medium-term UN population projections, are used as medium-term equilibrium values for the fundamental macroeconomic variables. The projected narrowing of the current account deficit between 2007 and 2013 is what primarily drives the decline from the predicted current account deficit of 4 percent of GDP in 2007 to the medium-term equilibrium level of 2½ percent of GDP. Given the forecast errors for the 90 percent confidence level, the equilibrium current account balance can range between a deficit of 5½ percent of GDP to a surplus of 1½ percent of GDP.

20. Abiad and others (2007) attempt to capture the financial deepening that has been especially important in the EU. Over the past 30 years, European countries have rapidly expanded their trade and financial links. Rapid financial deepening has provided financing for wide current account deficits in the convergence process. In addition to a financial deepening variable, Abiad and others (2007) include the standard variables, such as per capita GDP, real GDP growth, the fiscal balance, dependency ratios, and trade openness. In a broad sample of countries, they find that the usual variables have broadly the expected signs and that financial integration is insignificant. Once they restrict the sample to EU countries, however, their results differ sharply. The standard variables become mostly insignificant while financial integration becomes the main determinant of the current account balance. In the broader sample, income convergence widens current account deficits in a general way. In the EU sample, however, income convergence widens the current account deficit through the channel of financial integration. Controlling for financial deepening, rapid GDP growth tends to narrow the current account deficit. This suggests that financial integration is capturing the effect of domestic demand-driven growth on the current account, while the coefficient on GDP growth itself reflects the effect of export-led growth on the current account deficit. Given Lithuania’s financial integration with the rest of Europe, a 10 percent increase in Lithuania’s GDP per capita reduces the current account deficit by ¾ percent of GDP. These estimates may better reflect the convergence process in Lithuania than the estimates based on IMF (2006).

Macrobalance Approach using Coefficients from Abiad et al (2007)

(in percent of GDP)

article image
Source: Abiad, Mody, and Leigh (2007).

Calculated such that average prediction error over all 23 EU countries in the sample in 2013 is zero.

21. The regression coefficients by Abiad and others (2007) imply an equilibrium current account deficit of 4¾ percent of GDP.3 Again, the 2013 WEO projections are used as medium-term values. By far the most important determinant of the equilibrium balance is Lithuania’s financial integration (including the interaction with GDP per capita). The process of financial deepening alone accounts for 5¼ percent of GDP of the equilibrium current account balance.

Equilibrium Current Account Balance in Macrobalance Macrobalance Approach using Coefficients from Abiad et al (2007)

(in percent of GDP)

article image
Source: Abiad, Mody, and Leigh (2007).

Calculated such that average prediction error over all 23 EU countries in the sample in 2013 is zero.

External Sustainability Approach

22. The external sustainability approach determines the current account balance that would be consistent with an unchanged stock of net foreign assets. The following relationship defines the NFA-stabilizing current account balance:

C ⁢ A ⁢ B = g + π ( 1 + π ) ⁢ ( 1 + g ) ⁢ N ⁢ F ⁢ A ,

where CAB = NFA-stabilizing current account balance

g = real GDP growth rate

π= inflation rate

23. The standard CGER approach is to use the most recently available net IIP position (i.e., at end-September 2007). The growth rate is evaluated at potential output growth in the medium-term (5¾ percent) and inflation at U.S. inflation in the medium term (2¼ percent). A refinement of this approach allows for different interest rates on assets and liabilities (Appendix). This is especially relevant for Lithuania with a substantial stock of foreign assets (43 percent of GDP).

24. Lithuania’s net international investment position is broadly in line with other Central and Eastern European countries. Lithuania’s net international liabilities at end-September 2007 were 53¾ percent of GDP, with international assets of about 41½ percent of GDP (Table 1). About two-thirds of international liabilities and nine-tenths of international assets were held in debt. Two-fifths of international liabilities were either FDI or equity.

Table 1.

Lithuania: Net International Investment Position, 2002-07

(in percent of GDP)

article image
Sources: Bank of Lithuania, and IMF staff estimates.

All reserves attributed to monetary authorities.

uA01fig09

Net International Investment Position, 2006

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 140; 10.5089/9781451824179.002.A001

Source: IMF, International Financial Statistics.

25. The current account balance that stabilizes NFA at its end-September 2007 level is 4 percent of GDP. Rapid nominal GDP growth allows Lithuania to “outgrow” its net international liabilities of about half of GDP. On this account, Lithuania could be running a trade deficit of about 4 percent of GDP.

NFA-Stabilizing Current Account Balance in External Sustainability Approach

article image
Source: Milesi Feretti (2006) and IMF (2006).

Real Exchange Rate Assessment Based on the Current Account Gap

26. The gap between underlying and equilibrium or benchmark current account balances is partly closed by factors that are insensitive to real exchange rate movements. Larger current account deficits can be sustained in the medium-term if they are financed by capital transfers, for example due to EU funds or migrants’ transfers. In Lithuania’s case, medium-term capital transfers amount to about 1½ percent of GDP.

27. The remaining gap may eventually have to be closed by real exchange rate movements. To obtain the required real depreciation, we use elasticities of imports and exports to the real exchange rate from a cross country study (IMF, 1998), 0.92 and -0.71, respectively. Applying these elasticities, the real exchange rate would need to depreciate by 7–9 percent to close the current account gaps.

Current Account Balance Gap and Real Exchange Rate Overvaluation in Macrobalances and External Sustainability Approaches

(in percent of GDP, unless otherwise specified)

article image

Elasticities based on Isard and Faruqee (1998).

D. Conclusions

28. Estimates of real exchange rate overvaluation and current account gaps vary widely and are subject to large uncertainties. The regression-based estimates (ERER and macrobalance approaches) are sensitive to the regression specifications and samples that determine equilibrium values. The forecast errors of the regressions are large compared to the point estimates for Lithuania. For example, the actual real exchange rate is within one standard deviation of its equilibrium value. The two current account gap-based approaches (macrobalance and external sustainability approaches) require in addition the estimation of an underlying current account balance that depends on the estimated size of the output gap, which itself is subject to much uncertainty, and on uncertain and probably state-dependent import and export elasticities to real exchange rate movements and the business cycle.

29. However, a large current account deficit—even if not far from its equilibrium value—still poses risks. The large current account deficit in Lithuania may well be the equilibrium outcome of rapid income catch-up driven by strong fundamentals, including EU accession. But the need to finance such a large current account deficit also increases vulnerability to contagion from global financial markets.

Appendix I. External Sustainability Approach Allowing for Interest Payments

By focusing on the trade balance, the financing cost—varying for assets and liabilities—can be taken into account in calculating the NFA-stabilizing balance. The following relationship defines the NFA-stabilizing trade balance4:

T ⁢ B = − ( i E ⁢ A − n ) ( 1 + n ) ⁢ A E − ( i D ⁢ A − n ) ( 1 + n ) ⁢ A D + ( i E ⁢ L − n ) ( 1 + n ) ⁢ L E + ( i D ⁢ L − n ) ( 1 + n ) ⁢ L D ,

where TB = NFA-stabilizing trade balance

n = nominal GDP growth

iEA = interest on equity assets

iDA = interest on debt assets

iEL = interest on equity liabilities

iDL = interest on debt liabilities

AE = stock of equity assets (in percent of GDP)

AD = stock of debt assets (in percent of GDP)

LE = stock of equity liabilities (in percent of GDP)

LD = stock of debt liabilities (in percent of GDP)

The interest rate on debt is assumed to be 6 percent, with a spread of 100 basis points for liabilities. The interest rate on equity is assumed to be real GDP growth (Lithuanian for Lithuanian assets and world growth for foreign assets) plus medium-term US inflation plus an spread of 100 basis points on liabilities. Nominal GDP growth is chosen at its projected medium-term, 2013, value.

The trade deficit that stabilizes NFA at its end-2006 level is about ¾ percent of GDP. This is the result of three offsetting factors.

  • First, rapid nominal GDP growth of about 10¼ percent allows Lithuania to “outgrow” its net international liabilities of about half of GDP. On this account alone, Lithuania could be running a trade deficit of about 5½ percent of GDP.

  • Second, interest due on Lithuania’s net international liabilities, at a rate of 7¾ percent on average, needs to be financed. This by itself should require trade surpluses of 4 percent of GDP.

  • Third, Lithuania makes a net interest loss of about 1½ percent on its international assets compared to its international liabilities. With international assets amounting to almost half of GDP, by itself this net interest loss would have to be financed by a trade surplus of about ¾ percent of GDP.

Equilibrium Trade Balance in External Sustainability Approach

article image
Source: Milesi Feretti (2006) and IMF (2006).

Net, these three factors yield an NFA- Source: Milesi Feretti (2006) and IMF (2006). stabilizing trade deficit of ¾ percent of GDP.

This equilibrium trade balance, after adjustments, is about 3¾ percent of GDP narrower than the actual trade balance in 2007. The underlying trade balance is obtained with the same adjustments as the underlying current account balance. The trade balance for 2007 was about 11½ percent of GDP, implying an underlying trade balance of about 7¼ percent of GDP. The gap between the equilibrium and the underlying trade balance is, hence, 6½ percent of GDP. Again, this gap can partly be financed by medium-term capital transfers of 1½ percent of GDP. In addition, larger trade deficits can be sustained without a real exchange rate depreciation if they are financed by long-term current transfers (about 2¾ percent of GDP in 2013) or by long-term worker remittances reflected in the income balance (about ½ percent of GDP in 2013). The resulting gap, net of mitigating factors is therefore just under 2 percent of GDP, implying a real exchange rate overvaluation of 5½ percent.

References

  • IMF, 2006, “Methodology for CGER Exchange Rate Assessments”, available at http://www.imf.org/external/np/pp/eng/2006/110806.pdf.

  • Isard, Peter, and Hamid Faruqee, 1998, “Exchange Rate Assessment—Extensions of the Macroeconomic Balance Approach”, IMF Occasional Paper No. 167.

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  • Abiad, Abdul, Daniel Leigh, and Ashoka Mody, 2007, “International Finance and Income Convergence: Europe is Different,” IMF Working Paper No. 07/64.

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1

The narrowing of the current account deficit in 2005 reflected a surge in current transfers due to EU funds. The trade balance worsened in 2005 by ¼ percentage point of GDP.

2

Our calculation uses Lithuania’s top nine trading partners (Euro area, Russia, Poland, Latvia, Estonia, Sweden, Denmark, UK, and US). The weights are the same as those used by the EER facility for calculating the CPI-based real effective exchange rate. The nine country groups accounted for 82 percent of Lithuania’s trade in 2006.

3

For consistency with IMF (2006), the contributions are shown in deviations from the mean.

4

The relevant “trade balance” is the part of the current account balance that is not related to income payments on external assets and liabilities and that is not financed by capital transfers. Hence, it includes the conventional trade balance, the labor income balance, the current transfer balance, and the capital account balance. IMF (2006), p. 19, calls it the “trade balance inclusive of services and transfers”.

References

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  • World Bank, 1993, “The East Asian Miracle: Economic Growth and Public Policy,” Oxford University Press

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Cover IMF Staff Country Reports
Republic of Lithuania: Selected Issues
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 140
Publisher:
International Monetary Fund
ISBN:
9781451824179
ISSN:
1934-7685
Pages:
39
DOI:
https://doi.org/10.5089/9781451824179.002

Current Account Deficit and Real GDP Growth

(in percent of GDP and in percent, respectively)

National Savings and Investment

(in percent of GDP)

Real Effective Exchange Rate

(1998=100)

Contribution to Real Export Growth

(In percentage points)

Structure of Exports

In percent of total trade)

Share of World Exports

(In percent)

Equilibrium and Actual Real Exchange Rate

(CPI-based, logarithm of index, 2000=100)

Predicted Current Account Balance

Net International Investment Position, 2006

(In percent of GDP)