Republic of Lithuania
2010 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Lithuania
Author: International Monetary Fund
Publication Date:
09 Jul 2010
eISBN:
9781455203796
Language:
English
Keywords:
ISCR; CR; authority; capital; deficit; banking system; exchange rate; real GDP; private sector; market share; Global
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Lithuania experienced a severe output decline. A large consolidation contained the deterioration in the fiscal deficit and safeguarded market financing. Further fiscal consolidation is needed to place deficits and debt on a sustainable path. Tackling the deficit in the social security system and expanding the revenue base will achieve adjustment in a sustainable, pro-growth, and equitable manner. A sustained recovery also hinges on the ability of the economy to rebalance toward tradables. The rising level of unemployment makes it imperative to advance with structural reforms.

Abstract

Lithuania experienced a severe output decline. A large consolidation contained the deterioration in the fiscal deficit and safeguarded market financing. Further fiscal consolidation is needed to place deficits and debt on a sustainable path. Tackling the deficit in the social security system and expanding the revenue base will achieve adjustment in a sustainable, pro-growth, and equitable manner. A sustained recovery also hinges on the ability of the economy to rebalance toward tradables. The rising level of unemployment makes it imperative to advance with structural reforms.

I. Context: Lithuania’S Ongoing Response to the Global Crisis

A. Recent Economic and Policy Developments

1. Lithuania experienced a severe output decline in 2009. The economy started contracting in the third quarter of 2008 as a reversal in capital flows led to a collapse of domestic demand and the global recession caused exports to fall. Output dropped by 14.8 percent in 2009 and by 20 percent from peak to trough.

uA01fig01

The 10 Largest Output Declines in the World, 2008–09

(2008-09 cumulative percent changes)

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: April 2010 WEO.

2 The economy is beginning to recover aided by exports and now inventories as well (Figure 1) Exports—led by capital and transport goods, pharmaceuticals, and oil derived products—rebounded strongly and real GDP showed signs of stabilizing during the second half of 2009. In the first quarter of 2010, real GDP contracted by a smaller than expected -2¾ percent y/y. Two factors explain the better than expected outcome: (i) the closure in January 2010 of the Ignalina nuclear power plant that generated about 70 percent of Lithuani’s power was a less severe shock than anticipated, and (ii) a rebuilding of inventories that contributed 11.7 percentage points to growth, as stocks had fallen sharply in 2009. The export led recovery is filtering to business and consumer confidence, with retail sales growing modestly from early 2010. Housing prices are also showing tentative signs of bottoming out, while the stock market is up 100 percent from its March 2009 trough.

Figure 1.
Figure 1.

Lithuania: Real Sector Developments

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Haver; Eurostat; and IMF staff calculations.1/ Unemployment rate is estimated as a percentage of the working age population.2/ Percent balance equals percent of respondents reporting an increase minus the percent of respondents reporting a decrease.
uA01fig02

Contributions to GDP Growth by Components

(YoY, percent)

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Haver.

3. A rapid internal adjustment played a crucial role in stabilizing the economy, but unemployment has risen sharply (Tables 1–3):

  • The current account adjusted rapidly. It moved by around 19 percentage points of GDP to a surplus of nearly 4 percent of GDP end-2009 as the collapse in domestic demand caused imports to contract more than exports. This alleviated external financing needs and helped maintain reserves amid net capital outflows that amounted to 7.2 percent of GDP (Figure 2). Despite deleveraging in the private sector, the external debt-to-GDP ratio rose to 87 percent of GDP. Strong export trends continued in the first months of 2010, with imports showing signs of recovery (partly due to energy imports after the closure of Ignalina). Government debt issuance has partly compensated the continuing repayment of banks’ foreign liabilities

  • Inflation quickly ebbed and core inflation is now negative. Headline inflation has fallen to 0.2 percent in April 2010 despite a 33 percent increase in electricity prices after Ignalina’s closure and a VAT rate increase in fall 2009. Core prices have been falling for over a year.

  • Wages have fallen fast. Average gross earnings have fallen by 12.4 percent from pre-crisis peaks, but in sectors such as construction and real estate services, labor costs are down 20–25 percent. Unemployment had reached 18.1 percent by end Q1 2010, with high levels of youth and long-term unemployment an increasing concern.

Table 1.

Lithuania: Selected Economic and Social Indicators, 2007–15

Population (2009): 3.32 million

GDP per capita, at purchasing power parity (2009): USD 15,803

Life expectancy at birth (2008): 77.6 years (women), 66.3 years (men)

At-risk-of-poverty, share of population (2008): 20 percent

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Sources: Lithuanian authorities; World Bank; Eurostat; and IMF staff estimates and projections.

More than half of the decline in the investment/GDP ratio in 2009 is accounted for by the large (in absolute terms) decline in inventories. As such, the decline in the ratio overstates the decline in gross fixed capital formation.

Including unidentified measures quantified below.

The decline post-2012 is due to the growth in nominal GDP.

Excluding guarantees.

FDI in 2009–11 includes funds for recapitalization of foreign banks’ subsidiaries.

Includes loans guaranteed by the government.

CPI-based, 2000 trade-weighted real effective exchange rate against 17 major trading partners. For 2010, average January-April.

Table 2.

Lithuania: Balance of Payments, 2007–15

(In billions of euros, unless otherwise indicated)

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Sources: Data provided by the Lithuanian authorities; IMF International Financial and Trade Statistics; and Fund staff estimates and projections.

The 2010 projections assume average rollover rates of 90 percent for foreign banks, 74 percent for domestic banks, and 80 percent for corporates; 5 percent deposit outflows for nonresidents; and FDI (excluding bank recapitalizations) declining 50 percent. The overall FDI figures includes some further recapitalization of subsidiaries by parent banks in 2010.

Short-term debt at remaining maturity.

Table 3.

Lithuania: Summary of Monetary Accounts, 2007–11

(In billions of litai; unless otherwise specified)

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

Excludes local government deposits; includes counterpart funds.

BOP basis. Differs from gross foreign assets as shown in the monetary authority’s balance sheet because of valuation effects (BOP-basis official reserves include accrued interest on deposits and securities but exclude investments in shares and other equity).

Bank of Lithuania’s gross foreign assets less reserve money, in percent of banking system deposits. Excess reserves for lending to commercial banks are determined based on net foreign reserves, and represent the equivalent of 4 percent of bank deposits.

Figure 2.
Figure 2.

Lithuania: External Sector Developments

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Bank of Lithuania and staff calculations.1/ Reserves minus base money to deposits.
uA01fig03

Inflation By Components, YoY

(Percent)

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Haver.
uA01fig04

Hourly Labor Cost

(Peak=100) 1/

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Eurostat.1/ EU27 has not peaked, so we use the same peak as Lithuania.
uA01fig05

Unemployment Rates, Under 25 Years Old

(Percent)

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Haver.

4. A large consolidation contained the deterioration in the fiscal deficit and safeguarded market financing (Tables 4 and 5). The authorities implemented measures worth about 10 percent of GDP (staff’s estimates of meaures’ yields) in the 2009–10 budgets that were appropriately expenditure-led given the legacy of spending increases in the boom.1 The initial focus on broad-based cuts gave way to more targeted and progressive reductions in wage, pension and benefit levels that were agreed with social partners. About 40 percent of the consolidation in the 2009 and 2010 budgets is temporary (wage cuts are set to expire at the end of 2010 and pension cuts in 2011), and the April 2010 constitutional court decision on pensions could unwind 0.6 percent of GDP in the adjustment.2 Steps to increase VAT and excise rates and broaden their base played a complementary role in the adjustment. Overall, by end-2009, the fiscal deficit was contained to 8.9 percent of GDP (ESA 95 basis) with the early adjustment rewarded with access to international bond markets at declining cost. While still low by emerging market standards, the public debt burden—at 33 percent of GDP end-March 2010—is more than double its 2008 level. The improvement in the deficit continued in the first months of 2010, amid better revenues and containment of expenditure (Figure 3).

Table 4:

Lithuania: General Government Operations, 2007-15

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

Including payments not transfered by SODRA to private pension accounts.

Table 5.

Lithuania: Fiscal Impulse and Cyclically-Adjusted Balance, 2007–15

(in percent of GDP)

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Sources: Statistics Lithuania; Ministry of Finance; and Fund staff estimates.

Based on disaggregated elasticities for different revenue and expenditure components.

Including social contributions retransferred from private pension accounts to PAYG pillar in 2009 and 2010.

Based on the European Commission’s aggregated approach and a budget sensitivity parameter of 0.27, estimated by the EC (2009).

Based on the European Commission’s aggregated approach and a budget sensitivity parameter of 0.33, estimated by the Bank of Lithuania (2009).

Figure 3.
Figure 3.

Lithuania: Fiscal Developments

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Haver; Eurostat; Sodra and IMF staff calculations.
uA01fig06

Large Scale Fiscal Adjustments

(Change in the Primary Banance, percent of GDP) 1/

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Sources: Fiscal Adjustment Database, Fiscal Affairs Department, IMF.1/ For the Baltics in 2009, adjustment is measured relative to un changed policies and, net of the impact of rate reductions in PIT and CIT or of spending increases.
uA01fig07

Fiscal Adjustment in the Baltics, 2009–10

(Percent of GDP) 1/

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: IMF staff estimates.1/ Measures implemented net of the impact of rate reductions in PIT and CIT or of spending increases. Gross adjustment was larger. For Estonia and Latvia, measured on a cash-basis; for Lithuania, on a ESA 95 basis.

5. The financial sector weathered the crisis but faces sizeable non-performing loans (NPLs). To preserve financial stability, reserve requirements were lowered, the deposit insurance coverage raised, liquidity support procedures streamlined, and the 2009 Financial Stability Law was adopted. Banks improved their liquidity positions, with subsidiaries of international banks benefiting from parent support at the height of the global turmoil. Asset quality has suffered, with the level of non-performing loans (defined as past due more than 60 days plus impaired loans) rising almost four-fold from end-2008 to March 2010 and banks making large losses in 2009 (Figure 4). However, capital and liquidity indicators improved to 15 percent and 45 percent, respectively by end-March 2010 (Table 6). Provisions increased to cover 7½ percent of gross loans but the ratio of provisions to NPLs at almost 40 percent of NPLs, is still lower than most international comparators. Credit to the private sector is down 9.7 percent from its peak while parent bank funding (net of capital injections) fell by an estimated 8.5 percent in 2009, reflecting in part lower loan demand (Box 1). The loan-to-deposit ratio has fallen to below 150 percent while interbank rates have returned to pre-crisis levels, although as before, transactions at longer maturities are limited.

Figure 4.
Figure 4.

Lithuania: Financial Sector Developments

Citation: IMF Staff Country Reports 2010, 201; 10.5089/9781455203796.002.A001

Source: Bank of Lithuania and Global Financial Stability Report, 2010.
Table 6:

Financial Soundness Indicators, 2004–10, Banking System Data

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Source: Bank of Lithuania.

Without foreign bank branches.

Total profits (losses) after tax. Interim quarterly results are annualised.

From end-2005 to Q1-2008, NPLs are loans with payments on which are overdue more than 60 days. Until 2004 NPLs are loans in Substandard, Doubtful and Loss loans categories.

Non-performing loans are defined as the sum of the impaired loans and those non-impaired loans that are overdue more than 60 days. New series not comparable to the previous ones.

Data as of the end of period.

Information is based on interbank deals of all maturities (mostly overnights) made between resident banks in Litai within the last quarter of the period.

Specific provisions include provisions against general portfolio risk until end-2004. From end-2005, due to the change in definition of NPLs, specific provisions are not directly attributable to the NPLs. Therefore, the ratio may turn negative.

Specific provisions include allowances for both individually and collectively assessed loans.