Selected Issues

Abstract

Selected Issues

Fiscal Challenges in Lithuania1

Lithuania’s fiscal position has strengthened in recent years. However, medium term challenges are significant given the severe demographic pressures from population aging and net emigration. Against this background, this paper analyzes three important fiscal issues for Lithuania: The first assesses the fiscal position by constructing the balance sheet of the public sector; the second discusses the fiscal and social sustainability of the pension system; and the third discusses Lithuania’s constitutional fiscal rule. The main findings are:

  • Lithuania’s net financial worth of the general government is relatively strong compared to other countries in the region although contingent liabilities from the pension system are sizable.

  • The recent reform of the pension system will help make the system more fiscally sustainable. Upcoming reforms should be carefully designed, considering their trade-offs, to ensure social sustainability; reduce old-age poverty; and limit adverse impact on labor supply and informality.

  • The current fiscal rule has strengthened the ability to implement counter-cyclical policies. However, there are many escape clauses which make the rule unnecessarily complex. The authorities may consider a simpler rule, in the context of an EU-wide reform, to enhance its signaling effect.

A. Lithuania’s Public-Sector Balance Sheet

1. The public-sector balance sheet (PSBS) analysis of fiscal policy goes beyond the traditional debt and deficit based analysis. Focusing on central or general government debt and deficits ignores the asset side as well as other entities in the public sector that can carry fiscal risks such as state-owned enterprises (SOEs) or public banks. A government can also hold substantial non-financial assets or reserves of natural resources that can be monetized in the future. The PSBS provides a framework to analyze long-term policies, fiscal risks, and the resilience of fiscal policy in a comprehensive way. The importance of the balance sheet analysis was highlighted during the Asian Crisis, when inflated private sector balance sheets shifted to the public sector, or more recently during the global financial crisis and its aftermath when financial sector balance sheets blew up and largely shifted to the public sector.

2. Lithuania’s public sector includes the general government and public corporations. The general government consists of the central government, local governments, and the social security fund. Public corporations include the non-financial (the Bank of Lithuania, and state-owned enterprises) and some small financial corporations such as state social insurance funds. The balance sheet covers financial and non-financial assets and liabilities by instruments as defined in the Government Finance Statistics Manual 2014.

3. Lithuania’s net financial position is relatively strong but contingent liabilities from the pension system are sizable. The net worth (the difference between total assets and liabilities) of the general government in 2015 was slightly positive, at 35 percent of GDP (see Figure 1 and Table 1). The net financial worth (the difference between financial assets and liabilities) on the other hand, while negative at around 28 percent of GDP, was stronger than many other EU countries (see Figure 2). Moving beyond the General Government, SOEs have an overall positive net position, due to large non-financial assets (particularly those related to railways, electricity grid etc.). The central bank’s balance sheet includes government deposits in treasury account and holdings of government securities, which need consolidating out when constructing the overall PSBS. Contingent pension liabilities coming from the pay-as-you-go system, or Pillar I, are the biggest component in Lithuania’s PSBS (see Figure 3).2 They capture accrued liabilities up until December 31st of that year ignoring future contributions. At the end of 2015, pension liabilities made up around 206 percent of GDP, resulting in a negative net worth for the public sector of 144 percent of GDP.

Figure 1.
Figure 1.

Lithuania: Static Public-Sector Net Worth, 2015

(In percent of 2015 GDP)

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

Sources: NFA: non-financial assets, FA: financial assets, FL: financial liabilities. The authorities, the Governance Coordination Center Reports, the Bank of Lithuania, and IMF staff calculations.
Table 1.

Lithuania: Static Public-Sector Balance Sheet as of 2015-End

(In percent of GDP)

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Pension liabilities under General Government covers only pension for public servants and NPV of budgetary cost for Pillar II.

Accrued social security scheme entitlements up until December 31st, 2015

Cross-holdings between government entities are not consolidated for each of the instruments. However, the total net worth and net financial worth are not affected.

Source: The authorities, the Governance Coordination Center Reports, the Bank of Lithuania, and staff calculations.
Figure 2.
Figure 2.

Lithuania: Net Financial Worth of the General Government

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

Figure 3.
Figure 3.

Lithuania: Pension Liabilities Account for Large Portion of Public-Sector Balance Sheet

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

4. While the recovery in the fiscal position since the crisis has been remarkable in Lithuania, balance sheet vulnerabilities remain. Lithuania faced the global financial crisis with a robust positive net financial worth position for the general government of around 10 percent of GDP (see Figure 2). This allowed a countercyclical response that helped ameliorate the impact of the crisis on the private sector, at the cost of deteriorating the net worth position of the general government by almost 40 percent of GDP by 2012. While the recovery, including a sizeable structural fiscal adjustment that has translated into fiscal surpluses since 2016, has helped improve the net position of the general government, the deterioration due to the 2008–09 financial crisis has proven to be rather persistent. Going forward, improving the net worth position of the public sector in Lithuania will increase resilience to future shocks.

5. The recent reform of the pension system extending the retirement age and changing the indexation formula, effective in 2018, has made the system more fiscally sustainable. Total pension entitlements in Lithuania amounted to 256 percent of GDP in early 2015 and declined to 205 percent by years-end after the approval of the reform (see Figure 3). Thus, it reduced accrued liabilities of the system by 51 percent of GDP.3 Since contingent liabilities of Pillar I pensions capture all acquired liabilities while ignoring future contributions, the net worth of any pay-as-you-go pension scheme will always be negative. The level in Lithuania, around 200 percent of GDP, is well below several other EU countries. To get a full assessment of the financial sustainability of the system we would need to look at the net present value of all current and future liabilities as well as all current and future contributions. With estimated deficits peaking at 2 percent of GDP around 2030s before moderating by 2040, the pay-as-you-go system is financially sound.

B. Pension System in Lithuania

6. Lithuania’s pension system kept evolving over the last 20 years. The system was established in 1995 with just one pillar, the classic pay-as-you-go system. In 2000, the government adopted a new pension system, aiming to increase income for pensioners and reduce redistribution effects.4 Therefore, in 2004, a quasi-mandatory pillar II and a voluntary pillar III were introduced. Both pillars later became voluntary. Contributions to Pillar II have fluctuated partly due to the 2008–09 financial crisis.

7. Currently, the system consists of three pillars that serve complimentary purposes. While the design of the first pillar is rather standard, the second and third pillars in Lithuania differ slightly from other European countries.

Table 2.

Lithuania: Contribution to Pillar II

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Not part of social security contributions, the amount is based on individual salary

Based on the average annual economy-wide gross salary of t-2

  • Pillar I is a classic pay-as-you-go system, administered by the State social insurance fund board (Sodra). It currently comprises of: a base part with a fixed benefit paid to any individual with at least 30 years of contribution (the required length expected to increase to 35 years by 2027); a supplementary part linked to income and length of service; and the additional benefit for contributions beyond 30 years. Because it exhibits a relatively weak link between contributions and benefits, pillar I is more redistributive, although it does not fully address old age poverty.

  • Pillar II is a defined-contribution pension system based on personal accounts. Other countries, including CEE countries, often establish Pillar II as a mandatory defined-contribution scheme to complement the defined-benefit scheme of Pillar I. In the 2013 reform, while all new participants have a “2+2+2” contribution formula,5 pre-existing participants could choose to have only 2 percentage points of their social security contributions diverted to Pillar II. This latter group represents 61 percent of all participants as of 2017. By 2020, an additional 1.5 percent of an individual’s social security contributions would be transferred from Pillar I to Pillar II. At the time of retirement, individuals can choose to convert pension entitlements into annuities or a lump sum. Those with accumulated returns lower than a certain threshold would only receive lump sum amounts. Having Pillar II allows for diversification of the pension system. The only redistributive element of Pillar II is the matching contribution from the government that comes from the general revenues. Otherwise, entitlements depend solely on voluntary contributions that are proportional to individual wages.

  • Pillar III is a voluntary supplementary pension accumulation system. Contributions to this are paid by an individual or an employer with accompanying tax benefits. Individuals can cash out from Pillar III prior to retirement providing that the tax benefits be returned.

8. Recent changes to Pillar I have largely achieved fiscal sustainability. Starting from 2018, pension benefits are indexed to the overall wage bill and the retirement age will gradually increase to 65 by 2026 for both men and women. This will result in a reduction of 51 percent of GDP in the net present value of pension entitlements (see Section A). However, with low and decreasing replacement rates, these reforms have not addressed the issue of social sustainability carrying fiscal risks going forward.

9. Unfavorable demographic projections for Lithuania are worse than the rest of Europe. Compared to the other Baltic economies, Lithuania has lower fertility rates. After the financial crisis, the share of families with children dropped further and is now below the share of households without children6. Meanwhile, life expectancies have increased steadily over the past five years and the gap of longevity between men and women is expected to narrow to six years by 2070 from 11 years in 2015.7 The combined effects of these factors make Lithuania’s old age dependency ratio among the highest in Europe.

10. Lithuania has one of the highest old-age poverty risk in the EU.8 Older workers with outdated skills face increasing challenges in the labor market. Once laid off, they remain unemployed for a longer period. They also tend to be concentrated in declining sectors.9 On the other hand, more older workers participate in the labor force in Lithuania compared to other EU countries, partly due to the modest level of pension benefits.

Figure 4.
Figure 4.

Lithuania: Average Replacement Ratios

(In percent of gross incomes prior to retirement)

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

1/ Assumptions fcgm EC-EPC AWG Projections 2018Sources: Ministry of Social Security and Labor of the Republic Of Lithuania.

11. Therefore, the current pay-as-you-go pension system does not ensure socially sustainable level of benefits. The current replacement rate at 35 percent is already lower than the ILO recommended minimum of 40 percent. Based on the UN median population projection and the baseline assumptions, the replacement ratios for workers opting out of Pillar II would decline to slightly above 20 percent by 2050. To deliver a socially acceptable replacement rate, social contributions, which are already high at 30.7 percent of gross wages, would have to increase to more than 40 percent by 2050. The existence of a large informal sector poses an additional challenge to any increase in contribution rates.

12. Pillar I expenditures would need to increase significantly to deliver socially sustainable benefits. With the current population trends, contribution rates, and retirement ages, pillar I results in a small deficit by 2020. This deficit widens to 2 percent of GDP before closing towards the end of the projection horizon in 2070. The accrued pension liabilities by the end of 2015 amounted to around 206 percent of GDP, lower than other EU countries. However, to raise the replacement rate to 40 percent (as recommended by the ILO), pension expenditure would have to increase by more than 3 percent of GDP reaching 9–10 percent of GDP over the medium term (see Figure 5). Such an increase throughout 2070 would raise accrued pension liabilities by up to 66 percent of GDP.

Figure 5.
Figure 5.

Lithuania: Impact of Pension Reforms on the PAYG System

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

13. There are additional issues arising during the transition into a mature system. Pension reforms have been frequent, which can undermine the credibility of the system. Due to the changes in the formula of Pillar II contributions, some previous participants have not moved to the new formula of “2+2+2.” Their returns on Pillar II at retirement will likely be small, leaving them vulnerable to the declining replacement ratios of Pillar I. The constantly changing formula for pillar II has undoubtedly dampened the incentive to participate.

14. The trade-offs to each policy proposal should be transparently examined and communicated. There are inevitable trade-offs between reigning fiscal costs and reducing old-age poverty, and between increasing redistribution and ensuring participation and compliance. For example, strengthening the links between contributions and benefits in Pillar I will reduce its redistributive component and potentially affect old-age poverty. On the other hand, a more generous basic pension could reduce labor supply and induce underreporting of income. Increasing pension benefits could be achieved by raising the retirement age; financing Sodra’s deficit by higher tax revenues; increasing social security contributions, and increasing the scale and returns of Pillar II. While increasing the retirement age can deliver significant resources, replacement ratios high enough to reduce old-age poverty would likely result in further costs. Since social security contributions are already high, higher budgetary transfers appear inevitable to increase replacement ratios going forward.

  • Reform Pillar I to increase social sustainability while preserving fiscal soundness. Increasing the retirement age further by linking it to life expectancies at birth can provide significant resources. Lithuania’s statutory retirement age was increased to 65 by 2026. Everything else held constant and for illustrative purposes, increasing the retirement age for both men and women gradually to 75 by 2070 could increase replacement ratio to 40 percent in a budget-neutral way.

  • Further incentivise delayed retirement while supporting those at risk of poverty and long-term unemployment. Given the shrinking labor force in Lithuania, it is doubly beneficial to increase labor force participation among older workers who are eligible for pensions. Currently, early retirement results in a significant penalty and, as a consequence, lower benefits. On the other hand, defering retirement for five years could raise benefits by almost 8 percent per year. Yet, the effective retirement age is lower than the statutory age largely driven by older workers facing no futher unemployment benefits after being unemployed for long. Consideration could be given to partial or full pension eligibility for retirees who take on new part-time or full-time work.

  • Make Pillar II mandatory and more efficient. The budget incentivizes participation in Pillar II by pledging matching contributions, currently at 2 percent of the natinonal average wage. These permanent matching contributions could alternatively be used in raising the replacement rate for pillar I with larger redistributive impact. However, any changes in this area should weigh too the benefits of increasing incentives to achieve high participation in Pillar II (crucial for the success of the system). Fees are also an important factor in Pillar II. Despite the initial cap of one percent for managemet fees, the last few years have seen the doubling of management fees for most pension funds. The returns on pillar II have been volatile, highly correlated with domestic market, reducing the benefit of risk diversification for participants (see Figure 6). These issues are largely transitional while Pillar II funds become big enough to exploit economies of scale. However, in the meantime, they reduce incentives to participate.

  • Raise gross pension benefits subjecting to income tax. Pensions are currently exempt from personal income tax in Lithuania. By taxing pensions under the standard personal income tax system and use the proceeds to increase lower pensions, Pillar I would have a stronger and better targeted redistributed impact without budgetary cost. However, this should be done minimizing labor supply disincentives. The “implicit tax” or the change in net pension wealth from continuing to work has been found to significantly reduce the effective retirement age.10

  • Reduce the uncertainty around pension entitlements and seek broad consensus in any future reform. Regulatory or parametric changes to the pension system are costly to its stability and credibility as they can be viewed as partial default over previous commitments. Any future pension reform, should be preceded by broad discussion involving all social agents and political parties and should seek broad consensus to ensure a smooth implementation.

Figure 6.
Figure 6.

Lithuania: Returns on Private Pension Funds

(In percent)

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

Sources: Bank of Lithuania

C. Fiscal Rule in Lithuania

Considerations for Assessing Fiscal Rules11

15. The main objective of fiscal rules is to prevent the deficit bias that results from unconstrained policy discretion. The incentives of governments to inflate away its nominal liabilities and renegade on its promises lead to a time inconsistency problem for optimal policy. This could be particularly costly given the costs of restoring sustainability after a period where the intertemporal budget constraint was ignored ex ante. Fiscal rules promote fiscal discipline and limit the deficit bias when they effectively act as commitment devices tying the hands of the government and limiting the use of fiscal discretion; they provide a signaling effect in a context of imperfect information by increasing transparency and predictability of fiscal policy; and serve a political function by imposing numerical limits.

16. The design of fiscal rules should be guided by three criteria, difficult to fulfill simultaneously: simplicity, flexibility, and enforceability. The period after the global financial crisis has seen a surge in the adoption of a new generation of fiscal rules originating in Europe. These rules attempt to increase resilience in the face of shocks by increasing flexibility. Thus, while earlier rules tried to combine simplicity and enforceability, newer rules have significantly expanded existing flexibility provisions. Rules have become increasingly complicated at the cost of simplicity. To strengthen enforcement, monitoring procedures have also been enhanced through, for example, independent fiscal councils. Early evidence suggests that formal compliance with fiscal rules remains disappointing: while countries tend to develop budgetary plans in accordance with the rules, they deviate during the fiscal year as forecasts prove overoptimistic or budget plans are poorly executed.

17. Empirical evidence suggests that rule design matters for its effectiveness. There are five key features that tend to characterize effective fiscal rules:

  • Broad institutional and economic coverage.

  • Countercyclical behavior i.e. builds buffers during upturns and allows for adequate fiscal support during downturns.

  • Sensible calibration of thresholds and/or targets.

  • Well-designed escape clauses.

  • Supportive institutions or corrective mechanisms to foster compliance

18. Three elements have been identified for effective fiscal frameworks: anchoring, parsimony and consistency. In other words, the system of rules should be anchored by a debt objective to preserve fiscal sustainability; fiscal frameworks should rely on a limited number of rules and remain as simple as possible; and individual rules should not conflict with each other.

19. Recent work suggests that for the euro area, consideration could be given to updating the framework with a single anchor together with an expenditure growth operational rule.12

  • Single anchor. Since the main objective is to ensure fiscal sustainability, public debt-to-GDP ratio should be the natural anchor.

  • Operational rule. A good rule should support counter-cyclical policies (economic stabilization) and provide a strong link to the fiscal anchor (long-term debt sustainability). Based on model simulations, an expenditure growth rule as the single operational target, possibly including an explicit debt correction mechanism, appears to be the best option.

Three Main Types of Rules

Nominal budget balance rules: constrain the overall deficit and is, thus, directly link to fiscal sustainability. Easy to communicate and largely under the control of policymakers. They lack economic stabilization features potentially leading to pro-cyclical fiscal policies.

Structural balance rules: Similar to nominal budget balance rules but take into account economic shocks explicitly allowing automatic stabilizers to operate. Can be complemented with a debt break to correct for past deviations from the target and ensure fiscal sustainability. Estimating the output gap is difficult and subject to measurement errors. Thus, the rule is difficult to operate, communicate and monitor.

Expenditure rules: They typically impose limits on (total, primary or current) spending in absolute terms, real growth rates or in percent of GDP. They allow for automatic stabilizers to work fully on the revenue side and could allow for further support of macroeconomic stabilization on the spending side depending on the specification of the rule. They are transparent and easy to communicate. Since they are not directly linked to fiscal sustainability, a debt break mechanism may be added.

Assessment of Lithuania’s Fiscal Rule and Possible Avenues for Reform

20. Lithuania’s Fiscal Rule has proven effective in consolidating fiscal discipline. Lithuania’s fiscal policy track record has been strong, particularly after the crisis. In the run up to the global financial crisis, with low deficits and debt levels, fiscal policy was too accommodative, as suggested by strong expenditure growth and an associated deterioration in the structural deficit until 2007. This happened at a time when the output gap was positive and increasing. However, during and after the crisis Lithuania has had a strong track record of countercyclical policy. Initially allowing the large deterioration of the fiscal position during 2008–09 to help absorb the large collapse of potential output. This was followed by a remarkable structural consolidation over 2009–17, from a structural deficit of −9.7 percent of GDP to a surplus of 0.8 percent at a time when the output gap was improving (see Figure 7). Current expenditure played a significant role in the consolidation effort as, contrary to the pre-crisis period, current expenditure growth has closely tracked but remained below potential growth since 2012.

Figure 7.
Figure 7.

Lithuania: Fiscal Performance since 2005

Citation: IMF Staff Country Reports 2018, 186; 10.5089/9781484363546.002.A001

21. Fiscal rules in Lithuania are described in the Constitutional Law on the Implementation of the Fiscal Treaty (CLIFT) of 2014, and the Republic of Lithuania Law on Fiscal Discipline (LFD) of 2007. The CLIFT adapted the fiscal framework to the European Fiscal Compact ahead of Lithuania’s euro area accession. In case of conflict, the CLIFT has prominence over the LFD.

22. Although the CLIFT is difficult to categorize, it is best described as a form of structural balance rule with a debt anchor in the form of an expenditure correction mechanism. Its main provisions can be summarized as follows:

  • Two anchors: debt (below 60 percent of GDP) and a (structural) balance target in the form of the Medium-Term Objective (MTO).

  • Operational Target. Each year, except in exceptional circumstances,13 at least one of the following conditions must be met:

    • The structural balance of the general government is in surplus.

    • If not in surplus (and below the MTO), it should be improving except when the output gap is negative.

    • When the output gap is negative, the structural deficit can deteriorate, but not exceed the MTO.14

    • If structural balance is worse than the MTO, the targeted improvement, consistent with the EU compact framework, should be met.15

  • Expenditure growth limit. This is an additional provision that must be assessed in parallel to the operational rule. If the average general government balance in the previous 5 years is negative, budget appropriations for the general government should grow by less than half of the average growth of potential GDP during the same period. The Law specifies five ‘escape clauses’ under which this expenditure rule would not apply:

    1. Weaker economy relative to the EU. Lithuania’s nominal GDP growth is less than the average 5-year GDP growth in the EU plus 2 percentage points.

    2. Strong fiscal adjustment underway of at least 1 percent of GDP.

    3. Strong fiscal position. The average general government balance during the last 4 years and the projection for the current year is in surplus of at least 0.1 percent of GDP.

    4. No deterioration relative to the original budget. In case of budget revisions, the balance of the revised budgets is not worse than the original one.

    5. Weak economy. The projected output gap for the budget year is negative.

  • Rules for other parts of the general government. All general government budgets except Sodra (and smaller units) must be planned, approved, amended, and implemented targeting a structural balance (on accrual basis) or surplus. Sodra’s structural deficit can deteriorate only when the projected output gap is negative. For smaller general government units (below 0.3 percent of GDP), expenditures can only exceed revenues (by no more than 1.5 percent) when the output gap is projected to be negative.

23. The main features of Lithuania’s fiscal rule can be summarized as follows:

  • Countercyclical. Using the information that was available in early 2008 (i.e. before major down revisions of potential output and structural fiscal balance), one can assess what may have been the impact of the rule had it been in place in 2003. The rule would have forced a significant adjustment during the boom years of 2004–06 (1.7 percent structural adjustment in 2004, followed by a 1.4 percent adjustment in each of the two subsequent years). Alternatively, under the second escape clause, the authorities may have chosen to implement a more moderate structural adjustment of 1 percent per year.16

  • Size of adjustment. A key public concern is the perceived severity and speed of the expenditure adjustment under the correction mechanism if the general government balance is improving but the five-year average remains negative. While still imposing a relatively large adjustment, this concern is lessened somewhat by the many difficult-to-understand ‘escape clauses.’

  • Overly complex. There is a significant degree of overlap between the CLIFT and the FLD, which could create confusion as they mix structural and nominal targets. There are too many escape clauses from the expenditure growth limit, some of which could be better defined and others have no clear objective or do not even appear to be properly defined escape clauses.17 Lithuania’s fiscal rule is intended to be counter-cyclical and strict, particularly through the expenditure correction mechanism. In practice however, while it is counter-cyclical, the rule is not as stringent as it appears given the many escape clauses.

  • Enforceability. The monitoring of compliance with the rules envisaged by the CLIFT and implementation of any required adjustment is performed by the State Audit Office. It is unclear however how the rule is enforced ex post in case of deviations.

  • Coverage is adequate. The budgets of Sodra and municipalities are included in targets for the General Government. The SOE sector, not covered by the rule, is undergoing active reform particularly focused on governance and transparency, reducing risks to the budget.

Table 3.

Lithuania: Simulation of Adjustment Had the Fiscal Rule Been in Place in 2003

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1/ Assumes adjustment by expenditures and revenue increase as under the baseline
Table 4.

Lithuania: Main Type of Rules vs. Lithuania’s Fiscal Rule

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24. Implementation of the rule suggests that while the rule imposes a welcome counter-cyclical fiscal stance, there is room for improvement.

  • First, under current conditions, the MTO is not economically binding and does not provide guidance for fiscal policy. Over time, it could be made more realistic in line with the fiscal rule becoming more effective as a fiscal policy anchor.

  • Second, ex post deviations from the rule have limited consequences. For example, the fiscal adjustment in 2017 projected to be 1 percent under one of the escape clauses, is expected to be much more modest than planned.18 There is no provision in the CLIFT outlining the practical consequences in such a case.

  • Furthermore, because of the complexity of the rule and the lack of clarity in the definition of some ‘escape clauses’ (which appear not to be escape clauses at all), it is difficult to determine what part of the rule determines future fiscal policy, reducing predictability. In fact, the expenditure correction mechanism could be simplified significantly by loosening it somewhat and eliminating most of the ‘escape clauses’. In practice, the implied fiscal policy stance could be kept unchanged under these modifications that would, however, bring much needed clarity and simplicity.

  • Finally, as any structural balance rule, the fiscal rule in Lithuania is subject to unavoidable measurement errors. If more profound changes to the rule were to be considered, likely in the context of potential future revisions to the European framework, consideration should be given to a debt target complemented by an expenditure rule.

1

Prepared by Vina Nguyen and Jean Guillaume Poulain (all EUR).

2

PSBS pension liabilities exclude defined-contribution schemes, i.e. Pillar II, which are outside the public sector. However, defined-benefit schemes for government employees are classified in the liabilities of the general government.

3

Note that estimates of pension liabilities are sensitive to policy changes and the assumed discount rates. For example, a one percentage point change in the discount rate can increase or decrease contingent liabilities by around 20 percent.

4

Bitinas, Audrius, 2011. “Modern Pension System Reforms in Lithuania: Impact of Crisis and Ageing.”

5

2 percent of the employee’s salary previously contributed to Pillar I is now transferred to Pillar II. The employer contributes 2 percent to match the employee’s and the budget contributes 2 percent of the nationwide average wages.

6

See further discussions in Selected Issues Paper “Social Inequality in Lithuania after the Global Financial Crisis: Evidence from Household Survey Data,” 2018.

7

The 2018 Ageing Report: Underlying Assumptions and Projection Methodologies, the European Commission.

8

OECD Data on Inequality, 2015.

9

Ageing and Labor Market Implications for Lithuania, ILO Research, 2015.

10

Bassanini and Duval, 2006. “Employment Patterns in OECD Countries: Reassessing the Role of Policies and Institutions,” OECD Economics Department Working Paper No.486.

11

This section summarizes key findings from IMF Staff Discussion Note SDN/18/04 “Second-Generation Fiscal Rules: Balancing Simplicity, Flexibility, and Enforceability”, April 2018.

12

See IMF Staff Discussion Note SDN/15/09 “Reforming fiscal governance in the European Union”, May 2015.

13

Exceptional circumstances refer to an event outside the control of the authorities or a severe economic downturn.

14

The MTO is established by the Seimas by March 15 of the current year for a three-year period. The MTO for Lithuania is a structural government deficit of 1 percent of GDP if debt to GDP ratio is less than 60 percent and risks to debt sustainability are low (as it is the case currently), and not higher than 0.5 percent of GDP otherwise.

15

A structural adjustment target is to be set if: (i) the deficit (actual or planned) reaches 3 percent of GDP; (ii) the structural deficit is worse than the MTO [by more than 2 percentage points]. The adjustment target is set so that the MTO is reached within four years or less.

16

As the focus is on the stance of policy (i.e. counter- or pro-cyclical) rather than its actual magnitude, these partial- equilibrium simulations assume unchanged revenues abstracting from the growth impact of consolidation.

17

Escape clauses must be selective, well-defined and subject to independent scrutiny and should have a limited and clearly defined set of triggers. In this regard only the first and last appear to be legitimate escape clauses.

18

In the autumn of 2017, when preparing the 2018 budget, the expenditure limit was not applied because of the escape clause “strong fiscal adjustment of 1 percent underway.” At that time, the authorities were forecasting a fiscal balance of—0.4 percent of GDP in 2017 and a surplus of 0.6 percent in 2018. Eventually, a surplus of 0.5 percent was recorded in 2017 while the current forecast for 2018 remains unchanged.

Republic of Lithuania: Selected Issues
Author: International Monetary Fund. European Dept.
  • View in gallery

    Lithuania: Static Public-Sector Net Worth, 2015

    (In percent of 2015 GDP)

  • View in gallery

    Lithuania: Net Financial Worth of the General Government

  • View in gallery

    Lithuania: Pension Liabilities Account for Large Portion of Public-Sector Balance Sheet

  • View in gallery

    Lithuania: Average Replacement Ratios

    (In percent of gross incomes prior to retirement)

  • View in gallery

    Lithuania: Impact of Pension Reforms on the PAYG System

  • View in gallery

    Lithuania: Returns on Private Pension Funds

    (In percent)

  • View in gallery

    Lithuania: Fiscal Performance since 2005