IMF Executive Board Concludes 2010 Article IV Consultation with the Republic of Lithuania

Public Information Notice (PIN) No. 10/80
July 8, 2010

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

 

On July, 06, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Lithuania.1

Background

A determined policy response helped Lithuania weather the crisis. The country experienced a severe output decline in 2009 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. The adjustment of the economy has been large and swift. The current account swung from a sizeable double-digit deficit to a surplus of nearly 4 percent of GDP in 2009. Inflation quickly ebbed, with core prices now falling for over a year. Wages have also declined sharply and unemployment rose to very high levels.

A large fiscal consolidation with measures worth about 10 percent of GDP in the 2009–10 budgets contained the fiscal deficit to 8.9 percent of GDP in 2009. The early and sizeable fiscal adjustment was rewarded with access to international bond markets at declining cost. Still, the public debt burden has doubled, reaching 33 percent of GDP at end-March 2010. In the financial sector, capital and liquidity indicators have improved aided by new capital injections. However, asset quality has suffered. The non-performing loan ratio rose almost four-fold from end-2008 to 19.2 percent by end-March 2010. Provisions in the system increased to about 40 percent of the non-performing loan stock but banks are making large losses and credit is contracting.

Lithuania is now benefitting from the global recovery. Recent data are encouraging, with signs that an economic recovery is starting to take hold. In 2010, real GDP is expected to grow by 2 percent on the back of an export-led recovery. Deflation in core CPI is expected to persist, although higher energy and food prices will leave headline inflation close to zero. Over the medium term, domestic demand is likely to remain subdued amid high unemployment, falling incomes, and weak credit prospects. As such, a return to pre-crisis growth rates is unlikely and real GDP is only expected to recover its pre-crisis levels in 2014/15.

Executive Board Assessment

Executive Directors commended the authorities for their decisive fiscal and financial sector policies during the crisis, which helped stabilize the economy and generate a recovery. Notwithstanding encouraging signs, the Lithuanian economy faces important challenges of high fiscal deficits and rapidly growing public debt as well as a high stock of non-performing bank loans. In addition, growth needs to rebalance towards exports. Addressing these challenges will sustain the recovery and facilitate euro adoption.

Directors commended the large fiscal consolidation implemented in the 2009 and 2010 budgets. Nevertheless, further consolidation is critical to maintain confidence, reduce borrowing needs, and place debt on a sustainable path. Directors recommended a timely announcement of a package of specific expenditure and revenue measures so as to underpin the credibility of the consolidation path and ensure that it is achieved in a sustainable, growth-friendly, and equitable manner.

Directors emphasized that far-reaching reform of the social insurance system will be necessary to tackle its large deficit. They saw scope to reduce generous social benefits and restore the viability of the pension system by increasing the retirement age and gradually moving towards a mandatory funded system, while ensuring adequate funding for the minimum basic pension. Expenditure adjustment will need to be complemented with revenue enhancing measures as part of a broad-based package. In particular, it will be important to exploit new, less distortive revenue sources, such as wealth taxes and to strengthen tax compliance.

Directors noted that, overall the financial sector had weathered the crisis well, with both liquidity and capital indicators improving despite rising levels of non-performing loans. They cautioned however that some banks are not as well provisioned and capitalized, and also face pressure on interest rate margins. Directors considered it important that banks be subjected to forward-looking stress tests to ensure their viability. They commended the ongoing efforts to fine-tune the legal framework to facilitate voluntary debt restructuring and cautioned against mandatory moratoriums on debt payments that risk increasing the level of non-performing loans in the banking system.

Directors emphasized that export performance would be key to future growth. They noted that Lithuania’s success in preserving cost competitiveness during the boom was supported also by adjustment and on-going decline in wages. This has contributed to the credibility of the currency board arrangement as an anchor for macroeconomic policy. Directors nevertheless emphasized that continued progress in structural reforms was needed to reorient the economy towards tradeables as a source of growth.

Directors stressed that high and rising levels of unemployment call for decisive action. They supported the plans to enhance labor market flexibility and proposals in parliament to expand fixed-term contracts, ease dismissal requirements, and allow greater flexibility in overtime. Effective use of European Union funds to support job creation will be crucial. Directors also welcomed initiatives to improve the business climate and attract foreign direct investment. These initiatives, coupled with ongoing structural reforms, would enhance medium-term growth prospects.


Republic of Lithuania: Selected Economic Indicators

 

 

 

 

 

 

  2007 2008 2009 2010
   

 

  Projections
 
         

Real Economy

   
         

Real GDP growth

9.8 2.8 -14.8 2.1

CPI inflation, end of period

8.2 8.5 1.2 -0.1

Unemployment rate (year average, in percent of labor force)

4.0 5.9 13.7 18.0
         

Public Finance

(In percent of GDP)
         

General government balance

-1.0 -3.3 -8.9 -7.8

General government gross debt

16.9 15.6 29.5 39.1

Foreign currency-denominated public debt

14.1 12.9 27.0 35.2
         

Balance of Payments

(In percent of GDP, unless otherwise specified)
         

Trade balance for goods

-15.0 -12.1 -2.9 -1.7

Current account balance

-14.5 -11.9 3.8 0.6

Gross official reserves (in billions of euros)

5.2 4.4 4.6 5.2
         

Exchange Rates

(Litai per U.S. dollar, unless otherwise specified)
         

Exchange rate (end of period)

2.36 2.45 2.37

Exchange rate (period average)

2.52 2.36 2.48

Real effective exchange rate (2000=100, increase=appreciation)

107.1 114.9 122.8
         

Money and Credit

(Year-on-year percent change)
         

Reserve money

21.1 -1.4 -17.2 5.7

Broad money

21.7 -0.4 0.3 9.4

Private sector credit

45.3 17.8 -6.9 -6.4

 

 

 

 

 

         
 

Sources: Lithuanian authorities; and IMF staff estimates.

       

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.



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