Press Release No. 19/427

IMF Staff Concludes Visit to the Republic of Lithuania

November 21, 2019

An International Monetary Fund (IMF) mission visited Vilnius during November 15–21, 2019, to discuss recent economic developments and policy priorities with the Lithuanian authorities. At the conclusion of the visit, Mr. Borja Gracia, IMF mission chief for the Republic of Lithuania, made the following statement:

“Growth in Lithuania in 2019 remains strong and balanced in the face of a global slowdown. The tight labor market and strong wage growth have supported private consumption while a better utilization of EU funds has helped accelerate investment, particularly in construction and transportation. The current account surplus strengthened further, supported by increases in export of services related to transport, which almost doubled over the last four years. Credit has continued to grow, yet at a moderately slower pace than in 2018, due to a decline in credit to non-financial corporations that are increasingly using alternative funding sources such as issuing bonds. The banking sector remains well-capitalized, liquid, and profitable.

“There is no evidence so far of high wage growth affecting the economy’s competitiveness. Despite continued strong wage growth, recently led by the public sector amidst moderating private sector wage developments, inflation has declined. The less productive non-tradable service sectors have experienced higher inflation as firms passed higher labor costs to prices to preserve profitability. By contrast, price increases in exporting companies are lower as external competitiveness and profitability are supported by higher productivity. While this trend has so far not dented the competitiveness of the economy, raising productivity via structural reforms is crucial to sustain high wage growth going forward. However, the authorities’ reform agenda has so far failed to deliver in key areas. In health and education, the upfront wage increases have not been complemented by other critical, but socially sensitive, reform areas. The systems remain oversized at the cost of lower quality, hindering the efforts to boost productivity and competitiveness.

“On the 2019 budget, fiscal risks to revenue and expenditure have materialized and will have a lasting impact. The small surplus projected for 2019 will fall short of the budget due to revenues that have not kept up with output growth and a higher wage bill and social spending, especially poorly targeted child benefits. With growth exceeding expectations and higher than last year, fiscal policy in 2019 is unnecessarily pro-cyclical.

“The initial 2020 budget proposal sets adequate fiscal targets but relies on optimistic revenue projections. An overall balance of 0.2 percent of GDP, if achieved, will translate into a broadly neutral fiscal stance, which is adequate given the cyclical position of the Lithuanian economy. However, overly optimistic improvements in tax administration, unrelated to changes in tax policy, would be required to achieve such goals. Similar projected improvements did not materialize in 2019 and are unlikely to do so next year. Furthermore, proposals for new and modest real estate and environmentally related revenue measures, in line with past IMF recommendations, have proved politically challenging and are unlikely to be approved.

“Lithuania struggles to find the right balance between increasing demands for better public services and a competitive tax environment to attract investment. This has resulted in budget rigidities that have become apparent this year and will remain going forward. In this environment, further efforts should be made to increase the efficiency of the tax system as well as its expansion through environmental and real estate taxes. At the same time, it is critical to enhance the efficiency of public spending, particularly in education and healthcare, with the focus on raising long-term growth. This will also require better targeted social spending. Pension increases should preserve the financial sustainability of the system as guaranteed by the existing indexation formula while addressing pressing demands to ensure its social sustainability.

“Economic growth is expected to moderate in 2020 towards more sustainable levels. Domestic demand is expected to reduce its contribution to growth with slower growth in employment and wages as well as slower investment growth due to a slowdown in the absorption of EU funds, which is particularly high this year. Meanwhile, slower export growth due to weaker external demand is also expected to weigh on growth.

“Risks remain tilted to the downside. Domestic risks are related to political uncertainty around the budget, upcoming parliamentary elections next year, and the lack of progress in structural reforms. External risks are related to uncertainty surrounding trade tensions, Brexit, and the European Commission’s Mobility Package, with the latter having a potentially large impact on the recently booming transportation sector. “