## 1ltuea2023002 ## Source details **Canonical URL:** [1ltuea2023002](https://www.imf.org/-/media/files/publications/cr/2023/english/1ltuea2023002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1ltuea2023002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1ltuea2023002.pdf.json) --- ### Drivers of Export Success: Price Competitiveness and Growing Sophistication - Lithuania’s exports’ market share rose by about 60 percent since 2008. - Per capita income reached 92 percent of the EU average. - Sustained productivity growth in the tradeable sector kept unit labor costs competitive despite significant real wage increases. - Economic complexity: - Lithuania’s ranking in the economic complexity index increased by ten points in the decade to 2020. - Structural drivers: growing human capital; technological progress; growing networks and international interconnectedness. - Transport sector (driver of services trade surpluses): - Net exports increased by one percentage point of GDP in 2022. - Lithuanian road transportation companies’ revenues: 90 percent of overall business with most activity in the EU and the UK. - Competitive features: lowest taxes and charges on road transportation in the EU; modest labor unionization. - Low-margin transport firms benefited when fuel prices rose across the EU. ### Recent Macroeconomic Developments and External Linkages - Activity and growth: - Economy resilient until Q4 2022; weakened in Q4 2022 and Q1 2023 amid high inflation, uncertainty, weak external demand, and tightening financial conditions. - Refugee labor supply: - Influx of refugees from Ukraine: 80,000 refugees; around 20,000 have found a job out of 1.4 million total employment. - Exports to Russia/Ukraine/Belarus: - Share of exports to Russia, Ukraine, and Belarus: 18 percent as of end-2021 (down from 29 percent in 2014); declined to 12 percent in 2022. - Re-exports account for around 90 percent of exports to Russia. - Terms-of-trade and trade balances: - Lithuania experienced a 20 percent decline in the terms-of-trade relative to countries outside the EU last year. - Energy trade balance deteriorated by 7.6 percentage points of GDP (from -5.5 percent of GDP in 2021). - Non-energy trade balance improved by 1.4 percentage points of GDP. - Trade balance with other EU countries improved by 2.2 percentage points of GDP. ### Inflation Dynamics and Energy Policy - Inflation levels: - Annual average inflation in 2022: 19 percent. - Inflation in May (recent figure in text): 11 percent, down from a peak of 23 percent in September last year; remains 5 percentage points above the eurozone average. - Core inflation (excluding energy and unprocessed food) is equally high. - Drivers and dynamics: - Post-pandemic demand and war-related supply shocks; energy prices declined substantially since last August but second-round effects and tight labor markets sustained cost-push pressures. - ECB-determined monetary conditions tightened but “remain looser than warranted by domestic conditions,” placing onus on fiscal policy to contain inflationary risks. - Energy subsidies and fiscal cost: - Energy-related subsidies: around 1.3 percent of GDP in 2022 and 0.3 percent of GDP in Q1 2023. - Some gas subsidies to households remain until end of year at a fiscal cost of 0.07 percent of GDP. - With electricity prices decreasing and below subsidized levels since January this year, in the absence of shocks, there will be no further electricity subsidies. ### External Position, Outlook, and Baseline Projections - Current account: - Turned into a deficit of 5.1 percent in 2022, driven by massive increase in net energy imports. - Expected to converge over time toward its norm as energy price shock is largely temporary. - Outlook and timing: - Economy expected to experience a recession in 2023 given weak momentum from late-2022 and early-2023; activity expected to strengthen in second half of year. - Baseline assumes no further escalation of the war and a gradual decline in commodity prices remaining above pre-war levels. - Disinflation expected to be gradual toward an equilibrium moderately above the euro area average. - Recovery later this year and next supported by high public investment financed by EU funds. - Main macro variables under baseline, 2022–2028 (in percent): - Real GDP growth: 1.9 -1.4 2.9 2.7 2.5 2.2 2.1 - Output gap: 1.9 -1.1 -0.7 -0.3 0.0 0.0 0.0 - Inflation (HICP, period average): 18.9 9.6 4.0 3.0 2.6 2.5 2.4 - Core Inflation: 13.6 10.8 4.7 3.2 2.6 2.5 2.4 - Unemployment Rate: 5.9 7.8 6.7 6.2 6.0 6.0 6.0 - Wage Growth: 11.3 11.9 8.5 6.2 5.0 5.1 5.1 - Pre-war real GDP growth projections: 3.9 3.1 2.6 2.4 2.3 2.3 ### Fiscal Position, Revenues, and Policy Recommendations - Fiscal outcomes and debt: - Budget deficit narrowed to 0.6 percent of GDP in 2022 (projected originally at 3.3 percent of GDP). - Budget deficits: 1.2 percent in 2021 and 6.5 percent in 2020. - Windfall revenues from high inflation estimated at about 0.5 percent of GDP. - Public debt: below 40 percent of GDP in 2022 (from 46.3 percent in 2020). - Fiscal policy role and recommendations: - Fiscal policy should take a disinflationary stance notwithstanding a weaker economy; small fiscal contraction this year would actively contribute to lower inflation and would have required an improvement of 0.5 percent of GDP in the structural fiscal balance. - Any revenue overperformance and unnecessary spending on energy subsidies should be saved in line with the Stability Program. - Set moderate minimum and public sector wages to mitigate risks of higher wage growth; unions’ proposal to increase minimum wage by 10 percent next year stays below current rate of inflation but future increases need to be prudent. - Going forward, and consistent with Lithuania’s fiscal rule, a tightening of at least 0.5 percent of GDP per year over the next few years will support disinflation. - Energy subsidies and budget appropriations: - From a budget appropriation of 1.3 percent of GDP, subsidies will be less than 0.4 percent of GDP this year. - Recommendation: import prices should be fully passed through to consumers and no new subsidies provided. ### Tax Reform and Climate Policy Measures - Tax reform scope and revenue potential: - Authorities’ recent tax reform proposals would generate a modest 0.35 percent of GDP in additional net revenues. - Scope to remove inefficient tax concessions and exemptions amounting to about 4.2 percent of GDP as of 2022 (half on income tax and a sixth on VAT). - Carbon tax proposal: - Introduce economy-wide carbon tax set to gradually increase to USD50 (or about EUR60) per metric ton of CO2 emissions on all types of fossil fuel by 2030. - Government plans: ambitious offshore wind and solar aiming to reach 9GW of capacity by 2030, matching domestic demand. - Selected tax reform measures and 2026 fiscal impacts (in EUR million and other entries as provided): - “Green package” changes in excise duty taxation — 172.90.26 - “Green package”: introduction of the CO2 component — 1200.18 - Review of taxation of revenue from self-employement — 840.13 - Review of application of progressive PIT rates — 640.10 - Changes in property taxation — from 17 to 115 from 0.03 to 0.17 - Increase of the VAT registration threshold — -7.4-0.01 - Automatization of PIT tax refund requests — -57-0.09 - Total — 252.5 to 350.50.38 to 0.52 ### Financial Sector Strength, Fintech, and Macroprudential Measures - Banking sector indicators: - Capital adequacy: 19 percent CAR (text reference); regulatory capital to risk-weighted assets: Dec-22 20.4 percent; Regulatory Tier 1 capital: Dec-22 20.2 percent. - Liquidity coverage ratio: 390 percent. - Bank deposits excluding non-residents: rose from 54 percent of GDP at end-2019 to 62 percent of GDP by end-2022. - Nonperforming loans: Dec-22 0.6 percent (down from higher earlier). - RoE (Total profits after tax): Dec-22 10.6. - Loan to deposit ratio: Dec-22 55.9. - Fintech specifics and risks: - Revolut: third biggest bank in Lithuania with 18 percent of system-wide assets; relies on non-resident EU depositors (98 percent of total deposits). - Revolut deposits: 12 percent of GDP at end-2022; liquidity held at the BoL increased by 10 percent of GDP; lending portfolio increase: 0.3 percent of GDP. - Number of fintechs: 265 in 2021 to 263 in 2022 (no growth after exponential expansion since 2014). - Macroprudential actions: - Countercyclical Capital Buffer (CCyB) increased from 0 to 1 percent in September 2022, effective October 2023. - Sectoral systemic risk buffer: 2 percent applicable to housing loan portfolio since July 2022. - Affordability and borrower-based measures since 2015: Down payment: 15 percent first loan; 30 percent subsequent loans (introduced in 2022). DTI: 40 percent; 50 percent under 5 percent interest rate scenario. Maturity: Maximum 30 years. - Systemically Important Institution buffer: Swedbank 2 percent; SEB 2 percent; Šiaulių and Revolut (since mid-2023) 1 percent. - Bank windfall levy: - Temporary levy applied this year and next to all credit institutions and existing loans—new loans excluded—to limit increase in net interest income to, at most, 15 percent above last year’s level. - “Solidarity contribution” of 60 percent applied on net interest income that exceeds the average of the previous four years by more than 50 percent. - Proceeds expected to be around EUR400 million to finance military spending. - Recommendation: the levy should remain temporary. ### Real Estate Market and Housing Risks - Price dynamics: - From 2010 to end-2022, house prices increased more than 140 percent—the third highest rate in the EU. - Pace of nominal property price increase slowed to 14 percent as of April 2023 from an average of 21 percent in 2022. - Prices are converging to, but remain above, levels consistent with fundamentals. - Mortgage and housing market structure: - Low stock of mortgages: around 20 percent of GDP. - Large share of transactions in cash: 60 percent by value. - Relatively low average loan-to-value ratio (text reference). - Housing bubble detection (Annex VIII): - Evidence of explosive behavior in real housing prices across five cities and national level during January 1994–September 2022. - House price-to-rent ratio shows no significant bubble in recent years except in one city. - Policy stance if sharp downturn: - If a sharp downturn causes credit supply disruptions or a disorderly correction of real estate prices, “a relaxation of capital- and borrower-based macroprudential measures should be considered.” ### Risk Assessment (Annex I) — External and Domestic Risks - External risks (selected): - Intensification of regional conflict(s) — Likelihood: High (Short-term). Response: use fiscal space for targeted relief and let automatic stabilizers work if inflation and growth are negatively affected. - Abrupt global slowdown or recession — Likelihood: High (Short-term). Response: allow automatic stabilizers and provide targeted support to vulnerable if needed. - Deepening geo-economic fragmentation — Likelihood: High (Long-term). Response: continue EU trade integration; pursue education and healthcare reform. - Commodity price volatility — Likelihood: Medium (Short-term). Response: allow price signals and provide targeted support to vulnerable groups. - Domestic risks (selected): - Failure to implement structural reforms — Likelihood: High (Medium-term). Staff assessment: High. Response: accelerate implementation of structural reforms and elaborate medium-term fiscal plan. - Risks to competitiveness — Likelihood: Low/Medium (Long-term). Response: proactively use fiscal policy to reduce inflationary pressures and avoid large minimum wage increases. - Staff recommended responses emphasize targeted, timebound support; preserving price signals; and use of fiscal policy to curb inflationary pressures. ### Debt Sustainability and Public Debt Projections (DSA summary) - Overall risk of sovereign stress: Low. - Public debt path (percent of GDP): - 2022: 38.1; 2023: 36.7; 2024: 35.0; 2025: 33.5; 2026: 32.4; 2027: 31.5; 2028: 30.8 (and stable at 30.8 through 2032 in projections). - Change in public debt (percent of GDP): - 2022: -5.6; 2023: -1.4; 2024: -1.8; 2025: -1.5; 2026: -1.1; 2027: -0.9; 2028: -0.8. - Gross financing needs (percent of GDP): - 2022: 4.6; 2023: 5.5; 2024: 6.6; 2025: 8.2; 2026: 10.6; 2027: 12.2; 2028: 13.9. - Memo macro variables (selected): - Real GDP growth (percent): 2022: 1.9; 2023: -1.4; 2024: 2.9; 2025: 2.7; 2026: 2.5; 2027: 2.2; 2028: 2.1. - Inflation (GDP deflator; percent): 2022: 16.7; 2023: 9.4; 2024: 5.0; 2025: 3.8; 2026: 2.9; 2027: 2.5; 2028: 2.4. - Nominal GDP growth (percent): 2022: 18.9; 2023: 7.9; 2024: 8.0; 2025: 6.6; 2026: 5.5; 2027: 4.8; 2028: 4.6. - External sector (Annex III): - NIIP 2022: -6.7 percent of GDP. - Gross Assets 2022: 101.9 percent of GDP. - Gross Liab. 2022: 108.6 percent of GDP. - EBA-lite CA model: CA gap -4.5 percent of GDP in 2022; cyclically adjusted CA -3.9 percent; CA norm 0.7 percent. - REER model suggests an REER gap of -1.3 percent while CA model suggests REER gap of 8.4 percent. ### Structural Reforms, Labor Market, Education, Health, and Green Transition - Structural reform priorities: - Labor market: maintain structural flexibility; targeted minimum wage increases; strengthen ALMPs, life-long learning, apprenticeships; consider differentiated regional approaches. - Education: PISA scores “significantly below the OECD average”; spending on primary and secondary education is the lowest of the OECD with large inefficiencies; tertiary outcomes misaligned with labor market leading to skills mismatch (third largest in the EU). - Healthcare: share of out-of-pocket spending is 15 percentage points higher; lowest life expectancy in the EU; recommendations to reorganize hospital sector and expand primary care. - Green transition: - Current renewable share planned to increase “from the current 30 percent to 50 percent by 2030.” - Staff recommendation: introduce economy-wide carbon tax (gradually to EUR50 per metric ton of CO2 by 2030) and other measures including “feebates.” - Government plans: offshore wind and solar to reach 9GW by 2030. - Caution: transition should be carefully calibrated to avoid hampering long-term growth. ### Staff Appraisal: Outlook, Risks, and Policy Priorities - Major near-term risk: persistent high inflation relative to the euro area. - Policy mix: - Fiscal policy should support disinflation; fiscal contraction would actively reduce inflationary pressures. - Financial policies: use macroprudential measures proactively to preserve stability. - Over medium-term, advance structural reforms to support productivity and income convergence. - Financial sector view: - Risks from higher interest rates and weaker activity are manageable given high liquidity, capitalization, and profitability; close monitoring is required. - BoL should consider relaxing capital- and borrower-based macroprudential measures in a sharp downturn scenario. - AML/CFT: - Progress made (VASPs, CENTROLink) but further work needed: expand National Risk Assessment to non-resident activity; strengthen BoL AML/CFT resources; increase controls for access to CENTROlink. *Source: 1ltuea2023002 - Selected excerpts from IMF PDF chapter/annexes as provided.* ### 1. Drivers of Export Success: Price Competitiveness and Growing Sophistication _________________ 5 ### 1. Drivers of Export Success: Price Competitiveness and Growing Sophistication ### Convergence and Competitiveness - Lithuania experienced a successful income convergence particularly after the global financial crisis (GFC), with exports’ market share rising by about 60 percent since 2008. - Sustained productivity growth, particularly in the tradeable sector, kept unit labor costs competitive despite significant real wage increases. - Lithuania’s per capita income has reached 92 percent of the EU average. ### Role of Policy and Buffers in Shocks - Ample policy buffers and European institutional safety nets (notably after eurozone entry) provided stability and predictability during the pandemic and Russia’s war in Ukraine. - Private sector buffers at shock onset: - Nonfinancial corporates: low leverage and high profit margins. - Household resilience supported by a strong labor market and fiscal transfers during the pandemic and energy subsidies last year. ### Inflation and Monetary-Fiscal Interaction - High inflation is a risk to competitiveness: inflation was 50 percent above the eurozone average (textual statement). - Post-pandemic demand and war-related supply shocks contributed to inflation; energy prices declined substantially since last August but second-round effects and tight labor markets sustained cost-push pressures. - Monetary conditions are largely determined by the European Central Bank (ECB) and have tightened but “remain looser than warranted by domestic conditions,” placing the onus on fiscal policy to contain inflationary risks. ### Box — Drivers of Export Success (Highlights) - Beyond price advantages, Lithuania’s exports increased in complexity: the country’s ranking in the economic complexity index increased by ten points in the decade to 2020. - Structural drivers of export sophistication: - Growing human capital. - Technological progress. - Growing networks and international interconnectedness. - Transport sector performance: - Transportation sector made significant external market gains since 2014 and was a main driver of increasing services trade surpluses. - Net exports increased by one percentage point of GDP in 2022. - Lithuanian road transportation companies’ revenues stand at 90 percent of their overall business with most activity conducted in the EU and the UK. - Competitive advantages include the lowest taxes and charges on road transportation in the EU, modest labor unionization, and competitive tax levels. - Low-margin Lithuanian transport firms benefited when skyrocketing fuel prices increased costs across the EU. ### Recent Macroeconomic Developments - Growth and activity: - Economy remained resilient until Q4 2022; weakened in Q4 2022 and Q1 2023 amid high inflation, uncertainty, weak external demand, and tightening financial conditions that impacted private consumption and investment. - Refugee labor supply: - Influx of refugees from Ukraine: 80,000 refugees; around 20,000 have found a job out of 1.4 million total employment. - External linkages with Russia/Belarus/Ukraine: - Share of exports to Russia, Ukraine, and Belarus: 18 percent as of end-2021 (down from 29 percent in 2014); declined to 12 percent in 2022. - Re-exports account for around 90 percent of exports to Russia. ### Inflation Dynamics and Energy Policy - Inflation: - Annual average inflation in 2022: 19 percent. - Inflation in May (recent figure in text): 11 percent, down from a peak of 23 percent in September last year; remains 5 percentage points above the eurozone average. - Core inflation (excluding energy and unprocessed food) is equally high, indicating broad-based pressures. - Energy subsidies and fiscal cost: - Energy-related subsidies: around 1.3 percent of GDP in 2022 and 0.3 percent of GDP in the first quarter of 2023. - Some gas subsidies to households remain until the end of the year at a fiscal cost of 0.07 percent of GDP. - With electricity prices decreasing and below subsidized levels since January this year, in the absence of shocks, there will be no further electricity subsidies. ### Fiscal Position - Fiscal outcomes: - Budget deficit narrowed to 0.6 percent of GDP in 2022 (originally projected at 3.3 percent of GDP). - Budget deficit history cited: 1.2 percent in 2021 and 6.5 percent in 2020. - Windfall revenues from high inflation estimated at about 0.5 percent of GDP. - Public debt: - Public debt below 40 percent of GDP in 2022 (from 46.3 percent in 2020), leaving substantial fiscal space and low medium-term sovereign stress risk. ### Financial Sector and Macroprudential Measures - Banking sector strength: - Capital adequacy: 19 percent CAR (capital ratios well above regulatory requirements). - Liquidity coverage ratio: 390 percent. - Deposit accumulation: bank deposits excluding non-residents rose from 54 percent of GDP at end-2019 to 62 percent of GDP by end-2022. - Low and declining NPL ratios. - Macroprudential tightening: - Countercyclical Capital Buffer (CCyB) increased from 0 to 1 percent in September 2022, effective October 2023. - Fintech and structural change: - Revolut became the third biggest bank in Lithuania with 18 percent of system-wide assets; relies on non-resident EU depositors (98 percent of total deposits). - Revolut’s rapid deposit increase: 12 percent of GDP at end-2022; liquidity held at the BoL increased by 10 percent of GDP. - Lending portfolio increase much smaller: 0.3 percent of GDP. - After exponential expansion since 2014, the Fintech sector showed no growth in the number of companies from 2021 to 2022, around 260 firms. ### Real Estate Market - Real estate price dynamics: - From 2010 to end-2022, house prices increased more than 140 percent—the third highest rate in the EU. - Pace of nominal property price increase slowed to 14 percent as of April 2023 from an average of 21 percent in 2022. - Prices are converging to, but remain above, levels consistent with fundamentals (Annex VIII). - Mortgage and household indicators: - Low stock of mortgages (around 20 percent of GDP). - Large share of transactions in cash (60 percent by value). - Relatively low average loan-to-value ratio (text reference). ### Trade, Terms-of-Trade, and Competitiveness - Terms-of-trade shock and trade balances: - Lithuania experienced a 20 percent decline in the terms-of-trade relative to countries outside the EU last year. - Energy trade balance deteriorated by 7.6 percentage points of GDP, from -5.5 percent of GDP in 2021. - Non-energy trade balance improved by 1.4 percentage points of GDP. - Trade balance with other EU countries improved by 2.2 percentage points (suggesting underlying competitive strength has not deteriorated to date). - Sectoral impact: - Some sectors (e.g., furniture industry with reliance on low-cost lumber from Belarus) were affected more permanently and need to adjust. *Source: 1ltuea2023002 - 1. Drivers of Export Success: Price Competitiveness and Growing Sophistication (IMF PDF content provided).* ### 14. Lithuania’s external position was substantially weaker than fundamentals in 2022 ### 14. Lithuania’s external position was substantially weaker than fundamentals in 2022 ### External position and outlook - The current account balance deteriorated strongly turning into a deficit of 5.1 percent in 2022. - Deterioration driven by a massive increase in net energy imports. - Since most of the deterioration of the terms-of-trade is largely temporary, the current account is expected to converge over time to its norm under the current baseline. - Outlook: - The economy is expected to experience a recession in 2023 given the weak momentum from late-2022 and early-2023 but with activity strengthening in the second half of the year. - Baseline projections assume no further escalation of the war and a gradual decline in commodity prices that remain above pre-war levels. - Inflation will remain elevated for longer: despite lower global energy and food prices and the recent slowdown, a weakening but still tight labor market and second round effects will result in more persistent inflation throughout this year and next. - Disinflation—driven by falling energy prices and weakening activity—is expected to be gradual towards the equilibrium level moderately above the euro area average given the convergence process. - Activity will be weak in the first half of the year with softening domestic and external demand, and a weaker labor market; recovery is expected later this year and next supported by high public investment financed by EU funds. - Potential output should be only marginally affected from the recent shocks if inflationary risks do not materialize. ### Risks and scenarios - Baseline is highly uncertain with risks—mostly external—tilted to the downside: - Low growth-low inflation risks: - Financial stability risks from uncertain and volatile financial markets that could trigger a disorderly correction of the real estate market. - Policy recommendation: let automatic stabilizers operate and, if needed, provide targeted and timebound support. - Low growth-high inflation risks: - Domestic: persistently higher inflation than the euro area; deviations of wages from productivity can be accommodated if transitory, but prolonged high inflation could raise inflation expectations and erode competitiveness. - External: escalation of the war could trigger higher energy and food prices, leading to higher inflation. - Policy recommendation: do not interfere with price signals; provide targeted support to the most vulnerable. - Other external risks: high volatility of commodity prices, financial sector instability and geo-economic fragmentation. - Upside scenario: stronger-than-projected resilience due to strong private sector balance sheets, strong fundamentals and quicker-than-expected external demand recovery. ### Authorities’ views - Authorities broadly agree with staff’s assessment of the outlook and risks and highlight the resilience of the labor market. - They expect low or negative export growth this year and somewhat faster convergence of inflation to its target. - They see lower inflation and high wage growth supporting consumption and emphasize that high public investment this year will support activity. - On trade sanctions against Russia, authorities note higher input costs for some sectors but express confidence that Lithuanian companies can absorb the shock and maintain competitiveness. ### Main Macroeconomic Variables Under Baseline, 2022-2028 (in percent) - Real GDP growth1.9-1.42.92.72.52.22.1 - Output gap1.9-1.1-0.7-0.30.00.00.0 - Inflation18.99.64.03.02.62.52.4 - Core Inflation13.610.84.73.22.62.52.4 - Unemployment Rate5.97.86.76.26.06.06.0 - Wage Growth11.311.98.56.25.05.15.1 - Pre-war real GDP growth projections3.93.12.62.42.32.3 ### Policy discussions: fighting inflation and preserving stability - Persistent high inflation is the biggest risk; fiscal policy should support disinflation and financial policies should be used proactively to preserve stability. - Over the medium-term, structural reforms are the only way to support further productivity gains. - Short-term challenges should not be addressed by introducing long-term distortions that reduce structural flexibility. A. An Appropriate Policy Mix to Reduce Inflationary Risks and Preserve Macroeconomic Stability Fiscal policy - Fiscal policy has an important role in containing high and persistent inflation; ECB monetary tightening came late and monetary conditions remain loose relative to local economic conditions, so fiscal policy is the main macro-stabilization tool. - Energy subsidies and budget: - From a budget appropriation of 1.3 percent of GDP, subsidies will be less than 0.4 percent of GDP this year. - Going forward, import prices should be fully passed through to consumers and no new subsidies should be provided. - Latest Stability Program projects a fiscal relaxation this year adding to inflationary pressures: - Projected loosening of the structural balance by 0.3 percent of potential GDP—0.9 percent of GDP under the Stability Program. - Policy recommendations: - Fiscal policy should take a disinflationary stance notwithstanding a weaker economy; a small fiscal contraction this year would actively contribute to lower inflation and would have required an improvement of 0.5 percent of GDP in the structural fiscal balance. - Any revenue overperformance and unnecessary spending on energy subsidies should be saved in line with the Stability Program. - Set moderate minimum and public sector wages to mitigate risks of higher wage growth and help anchor inflation expectations. The proposal by unions and businesses to increase the minimum wage by 10 percent next year stays below the current rate of inflation, but future increases need to be prudent. - Going forward and consistent with Lithuania’s fiscal rule, a tightening of at least 0.5 percent of GDP per year over the next few years will support disinflation. - Spending pressures and revenues: - Spending pressures: negative demographics; pension system projecting declining replacement ratios; permanently higher military spending; moderately increasing interest payments on debt. - The 2021 EU’s ageing report projects age-related spending to increase by almost 2 percent of GDP up to 2070 and replacement ratios falling from 23 percent to 13 percent in 2070. - With social protection spending below the EU average and discretionary spending low, accommodating additional expenditures will require revenue-generating tax reforms and/or a moderate relaxation of fiscal targets. - The structural fiscal position has remained strong given the transitory and targeted nature of most support measures since 2020. Tax reform and climate policies - Rebalancing the tax system from labor towards wealth, capital, and environmental taxes can generate more revenue and improve efficiency. - Authorities’ recent tax reform proposals are a step in the right direction but will only generate a modest 0.35 percent of GDP in additional net revenues. - Scope to remove inefficient tax concessions and exemptions amounting to about 4.2 percent of GDP as of 2022 (half on the income tax and a sixth on the VAT). - Climate policy: - Introduction of an economy-wide carbon tax—set to gradually increase to USD50 (or about EUR60) per metric ton of CO2 emissions on all types of fossil fuel by 2030—could help lower labor taxes and increase public investment. - The EU plans to extend the Emissions Trading System (ETS) but an economy-wide carbon tax is necessary to achieve Lithuania’s target by 2030. - Government plans include ambitious offshore wind and solar aiming to reach 9GW of capacity by 2030, matching domestic demand. B. Financial policies and financial sector stability - Banking sector profitability: - Higher interest margins and cost-efficient business models have boosted profitability. - Depositors’ behavior (forced and precautionary savings, lack of domestic investment opportunities other than real estate) shows little sensitivity to deposit rates; deposit rates have adjusted slower than lending rates, boosting interest margins. - Temporary windfall levy on banks: - Introduced because profitability will reach unprecedented levels in the current environment. - Levy applied this year and next to all credit institutions and existing loans—new loans are excluded—to limit the increase in net interest income to, at most, 15 percent above last year’s level. - The “solidarity contribution” of 60 percent is applied on the net interest income that exceeds the average of the previous four years by more than 50 percent. - Proceeds expected to be around EUR400 million to finance military spending. - A prior temporary increase in the corporate tax rate for big banks from 15 to 20 percent (introduced in 2019 and made permanent last year) affects mostly foreign banks; it is important the levy remain temporary to avoid being perceived as a tax on foreign investment. - Risks from higher interest rates: - Higher interest rates bring significant—if manageable—non-systemic risks, notably through the real estate market. - Macroprudential measures and buffers: - Affordability requirements to higher interest rates for new mortgages since 2015. - Down payment: 15 percent first loan; 30 percent subsequent loans (introduced in 2022). - DTI: 40 percent; 50 percent under 5 percent interest rate scenario since 2015. - Maturity: Maximum 30 years. - Systemically Important Institution buffer: Swedbank 2 percent; SEB 2 percent; Šiaulių and Revolut (since mid-2023) 1 percent. - Counter-cyclical capital buffer: 1 percent effective October 2023. - Capital conservation buffer (in place). - Balance sheet resilience: - Securities held to maturity represent 5 percent of total assets or 60 percent of equity, making potential unrealized losses manageable. - Under BoL’s severe downside scenario with cumulative GDP losses of around 10 percent in three years, banks’ capital would still exceed minimum requirements with all banks meeting regulatory requirements. - Regarding liquidity, banks are currently able to cover a 40 percent decrease in deposits. - Banks are building resilience by not fully distributing 2022 profits to strengthen capital. *Source: 1ltuea2023002 - 14. Lithuania’s external position was substantially weaker than fundamentals in 2022 (IMF).* ### 2.5 percent ### 2.5 percent ### Sectoral systemic risk buffer and housing market - Sectoral systemic risk buffer: "2 percent applicable to housing loan portfolio since July 2022". - The correction in property prices is bringing valuations closer to fundamentals in an orderly fashion so far. - Risks from the real estate market are receding with the gradual decrease of housing price overvaluation. - If a sharp downturn causes credit supply disruptions or a disorderly correction of real estate prices, "a relaxation of capital- and borrower-based macroprudential measures should be considered." ### AML/CFT risks, fintech, and cross-border activity - The value and volume of cross border financial flows have remained elevated since 2020, including with higher risk jurisdictions, driven in part by the BoL’s enabling foreign EMI and PI to use its payment system for SEPA payments directly, "heightening the ML/TF risk." - Number of fintechs: "265 in 2021 to 263 in 2022" after seven years of significant growth. - Progress reported: increased ML/TF supervisory resources; risk assessment of new and existing clients of BoL’s payments system (CENTROLink); upgraded regulatory framework and sectoral risk assessment for VASPs. - Remaining priorities and selected AML/CFT recommendations (from 2022 Article IV consultation and ongoing regional Nordic-Baltic technical assistance): - Expand the National Risk Assessment to cover Analysis of ML/TF Risks from non-resident activity and cross-border payments and reflect the evolution of the financial sector. - Develop and operationalize understanding of ML/TF higher-risk countries based on Lithuania-specific risk factors in coordination with all relevant AML/CFT agencies. - Monitor the rapid and sizable increase in the value and volume of correspondent banking transactions from an ML/TF perspective. - Broaden the AML/CFT supervisory coverage of the financial sector with a focus on risk-sensitive supervisory presence in the sector and a more detailed strategy for the risk-based supervision of banks. - Strengthen BOL's AML/CFT resources and capacity. - Increase AML/CFT controls to access the BoL payment system (CENTROlink), including formalizing risk rating methodology to inform CENTROlink onboarding decisions. - Strengthen ongoing monitoring of PSP activity in CENTROlink and fine-tune BoL's due diligence questionnaire to reflect Lithuania-specific ML/TF risks. ### Impact of higher interest rates on deposit and lending rates - Charts provided in the source compare interest rates differentials on new household loans, new NFC loans by loan size, and interest rates on new household and NFC deposits relative to the Euro Area (3-month moving average differentials). (Data sources: European Central Bank; Haver Analytics; and IMF staff calculations.) ### Authorities’ views (fiscal, banking, fintech, green transition) - Fiscal policy: - Authorities emphasize fiscal policy should contribute to macroeconomic stabilization and that price stability is not its only objective. - Committed to save any revenue overperformance and savings from lower-than-budgeted energy subsidies in 2023. - Consider the broadly neutral fiscal stance this year and gradual fiscal adjustment going forward as balancing disinflation and supporting economic activity. - Reiterate commitment to prudent fiscal policy as reflected in the domestic fiscal rule "that is set to become operational again next year." - Highlight proposed tax reform to make the system more fair and efficient and approved changes in excises, including increased rates on fossil fuels and introduction of a carbon component, which "will support the green transition." - Banking and fintech: - Emphasize ample buffers in the banking sector provide stability. - Stress macroprudential actions have increased buffers. - Note decisive actions to increase supervisory resources and strengthen the regulatory framework including for virtual asset service providers (VASPs). - Plan to continue enhancing the domestic AML/CFT framework. - Green transition: - Authorities highlighted the approval of civil sector reform and reiterated that the green transition and energy independence remain top priorities with "the ambitious goal of renewables generating 100 percent of electricity demand by 2030." ### Structural reforms: unlocking growth potential - Lithuania has outperformed peers since the GFC; structural reforms are critical to mitigate scarring and accelerate income convergence. - Labor market: - Structural flexibility, particularly of the labor market, remains key to absorb shocks. - The 2017 labor code reform increased flexibility and enhanced the social safety net. - Moderate increases in the minimum wage can contribute to fight inflation; targeted range cited as "45-50 percent of average wages" disproportionately affects low-skilled and young workers in rural areas. - Education and health: - Healthcare: expenditure broadly in line with peers but "the share of out-of-pocket spending is 15 percentage points higher," and Lithuania faces the lowest life expectancy in the EU. - Education: PISA scores are "significantly below the OECD average." Spending on primary and secondary education is the lowest of the OECD with large inefficiencies. - Tertiary education outcomes do not align well with labor market needs; some graduates require vocational training and Lithuania has the "third largest level of skills mismatch in the EU." - Energy and climate: - Current renewable share: "from the current 30 percent to 50 percent by 2030" is planned. - The pace of emissions reduction is "not consistent" with pledges for climate change mitigation. - Policy tools recommended: introduce an economy-wide carbon tax and other measures including "feebates" on fossil-fuel consumption to incentivize conservation, renewable investment, and raise fiscal revenues. - Staff warn the new energy matrix and transition "should be carefully calibrated to avoid hampering long-term growth." ### Staff appraisal: outlook, risks, and policy recommendations - Economic resilience and outlook: - The Lithuanian economy remained resilient until the end of last year; high inflation and rising interest rates weakened disposable income and, combined with weak external demand, resulted in an economic contraction. - Lower energy prices are helping decrease inflation, which "remains significantly above the eurozone average." - "A recovery is expected later this year." - Risks are tilted to the downside with "persistently higher inflation than the euro area" as the biggest risk. - Fiscal policy assessment: - Fiscal policy is "projected to become moderately expansionary this year adding to inflationary pressures." - To mitigate persistent inflation risk, "a fiscal contraction would actively contribute to lower inflation." - Reactivation of the domestic fiscal rule will lead to a contractionary fiscal stance that "will help contain inflation risks." - Accommodating new and pre-existing spending pressures will likely require new revenues under the existing fiscal targets. - Rebalancing taxation from labor towards wealth, capital, and environmental taxes can generate additional revenue and improve efficiency; recent excise reforms do not go far enough. - Financial sector assessment: - A weakening economy and higher interest rates bring risks to the banking sector but "should remain manageable given high liquidity, capitalization, and profitability." - Vulnerabilities require close monitoring, especially if additional shocks lead to even higher interest rates and weaker activity. - In a sharp downturn scenario, the BoL should consider relaxing capital-based macroprudential and potentially borrower-based measures. - The levy on banks "should remain temporary" to avoid perceptions of taxing foreign investment and to minimize negative impacts on efficiency; permanent sector-specific taxes on excess profits are distortionary over time. - AML/CFT assessment: - Progress has been made, particularly in the VASP sector and CENTROLink risk assessment, but further progress is needed on mitigating remaining risks in the VASP sector and on regulation and supervision of designated non-financial businesses and professions via draft amendments to the AML/CFT law. - External position and reforms: - Lithuania’s external position was "substantially weaker than fundamentals in 2022"; deterioration of the current account is largely temporary and expected to converge over time under the current baseline. - Preserving flexibility and advancing structural reforms—especially in education and healthcare—are necessary to support productivity and living standards. - Developing renewables and improving energy efficiency are necessary for climate mitigation and energy security; meeting pledges will require a carbon tax in sectors not covered by the ETS and other measures including "feebates." *Source: 1ltuea2023002 - 2.5 percent.* ### 47. The next Article IV Consultation is expected to be completed on the standard 12- ### 1ltuea2023002 - 47. The next Article IV Consultation is expected to be completed on the standard 12-month cycle. ### Inflation Developments - Monetary conditions have tightened but remain looser than warranted. - Inflation expectations increased with the burst of inflation in 2022 but are not de-anchored. - Euro area inflation decline in energy; current euro area inflation mainly reflects food and services prices. - Lithuania’s inflation remains more broad-based than the euro area. - Spending on energy and food is higher in Lithuania than in the euro area, reinforcing the impact on low-income households who spend more on energy and food. - Survey and index observations (as presented): - Financial Conditions Index (Index) plotted for Lithuania/Estonia/Latvia across 2005Q1–2022Q3 showing tightening. - Survey Based Inflation Expectations (Percent): expectations for same year's and next year's average inflation plotted Jan-20 to Jan-23. - Euro Area: Inflation Decomposition (Percentage points) and Lithuania: Inflation Decomposition (Percentage points) plotted May-21 to May-23 showing contributions from Food, Energy, Services, Nonenergy Goods, HICP inflation, Core Inflation. - Inflation gap relative to 5th quintile (Percentage points) and contributions of consumption categories to inflation inequality plotted May-16 to May-23. ### Macroeconomic Developments - Lithuania was on a strong recovery path but started to show signs of weakening in the last two quarters. - Lithuania still outpaced most euro area peers on quarterly real GDP (Index; 2019 Q4=100). - Activity started to weaken in the second half of 2022, but tradable services remain resilient. - Trade surplus declined, related to weakening external demand. - Industrial production started to decrease since the second half of 2022; retail sales and industrial production plotted Jan-17 to May-23. - Inflation slows but remains higher than the euro area average (HICP Inflation, Year-on-year percent change). - Key series and components (as presented): - Real GDP growth and components (Year-on-year percent change) plotted Mar-17 to Mar-23 with contributions from private consumption, government consumption, gross fixed capital formation, inventories, net exports. - Quarterly Real GDP Index (2019Q4=100) for Lithuania, Latvia, Estonia, Euro area through 2023Q1. - Contributions to GDP Growth by Industry (Year-on-year percent change): contact-intensive services, tradable services, manufacturing & mining, other. - Current Account Balance (Percent of GDP), Industrial Production and Retail Sales (Year-on-year percent change). ### Labor Market Developments - Unemployment remained on a downward path with sustained growth until the last quarter of 2022. - Employment growth accelerated prior to the recent weakening. - Wage growth has been strong for a few years, but real wages have been negative due to high inflation. - A high minimum wage disproportionately affects rural areas and the young. - Key indicators (as presented): - Unemployment Rate (Percent, NSA, Labor Force Survey) plotted Mar-05 to Mar-23 for Lithuania, Latvia, Estonia, Euro Area. - Employment Growth (Year-on-year percent change) by Total/Male/Female plotted Mar-05 to Mar-23. - Nominal and Real Wage Growth (Year-on-year percent change) plotted Mar-05 to Mar-23. - Minimum Wage/Average Wage and Unemployment Rate by Region (2022) and by Age Group (Minimum Wage and Unemployment Rate by Age Group). ### Banking Sector Developments - Credit growth, especially for corporates, has decelerated with tightening monetary conditions. - Deposits stabilized after large increases during 2020 and 2021. - Low NPLs supported by resilient economy and strong household and corporate balance sheets. - Banks’ holdings of securities are low. - Banks continue to have significant capital buffers, largely in the form of Tier 1 Capital. - Key indicators and data points include: - Credit to Corporate and Households (Year-on-year percent change) and Corporate and Households Deposits (Year-on-year percent change) through Mar-23. - Non-Performing Loans (Percent of outstanding loans): Lithuania and peers through 2022Q3. - Bank Holdings of Debt Securities (Percent of total bank assets) and Capital Adequacy metrics: Capital to risk-weighted assets, Pillar 1 Capital Requirement, Capital Conservation Buffer, Countercyclical Capital Buffer (CCyB). - Regulatory Tier 1 Capital to Risk-Weighted Assets (Percent) for Lithuania/Estonia/Latvia/Euro Area as of 2018–2022. ### Fiscal Developments - Strong revenue growth and lower pandemic-related spending narrowed the budget deficit. - Better fiscal performance and higher nominal GDP growth lowered the debt-to-GDP ratio. - Lithuania’s government debt is among the lowest in the region. - Interest bill projected to remain low, helped by decline in government debt and improving credit quality as measured by bond spreads. - Public sector wage growth is key to inflation and competitiveness; the public sector will play a critical role. - Illustrative indicators presented: - General Government Total Revenue and Expenditure (Percent of GDP) and Overall Balance across 2006–2022. - General Government Debt (Percent of GDP) decomposition into external and domestic. - Debt and Interest Expenditure (Percent of GDP) projections 2008–2028. - 1-year and 10-year Spread over Germany (Percent) plotted 2007–2023. - Nominal Wage Growth vs. Wage Bill (Percent and % of GDP) 2005–2022. ### Energy Imports and Diversification - Diversification away from Russian gas began after Russia’s annexation of Crimea, replacing it with liquified gas from Norway and the United States. - Diversification of crude oil and solid fuels has been more limited because they are global markets. - Electricity imports from Russia and Belarus remained large, but access to the European network has allowed for a prompt decline in dependency. - Time series presented 1991–2021 for: - Imports of Natural Gas (Million cubic metres) by partner (Russia, Norway, USA, Nigeria, Trinidad and Tobago, Egypt). - Imports of LNG (Million cubic meters) by partner. - Imports of Crude Oil (Thousand tonnes) by partner. - Imports of Solid Fuels (Thousand tonnes) by partner. - Imports of Electricity (Gigawatt-hours) by partner (Latvia, Poland, Sweden, Belarus, Russia). ### Evolving ML/FT Threats (Fintech and Cross-Border Flows) - Success in attracting Fintech led to a significant increase in non-resident cross-border activity and a large rise in cross-border flows in recent years. - A large share of gross flows go to financial centers. - Outliers among outflows have intensified exponentially and account for a large share of the increase in outflows. - CENTROlink fostered these flows; its controls are key to safeguard the European payment system integrity. - Observations and series presented: - Fintechs in Lithuania and Revenues (Mil. EUR, RHS) for 2017–2022. - Gross Cross-Border Flows (Index, 2015=100) Jan-15 to Dec-22. - Gross Flows to Financial Centers (Flows index, 2015=100; share in percent). - Outflows Outliers (Index, 2015=100) number and value of outlier flows. - Outflows Outliers vs Non-Outliers (Outflows index, 2015=100). - E-money and Payment Institutions Transactions through CENTROlink: Value of transactions (Bil. EUR) and No of transactions (Millions) for 2017–2022. ### Key Projections and Selected Indicators (high-level from tables) - Table 1: Selected Economic Indicators, 2018–28 — headline projections (annual percent changes and levels): - Real GDP growth: 2018 4.0; 2019 4.6; 2020 0.0; 2021 6.0; 2022 1.9; 2023 -1.4; 2024 2.9; 2025 2.7; 2026 2.5; 2027 2.2; 2028 2.1. - HICP, period average: 2018 2.5; 2019 2.2; 2020 1.1; 2021 4.6; 2022 18.9; 2023 9.6; 2024 4.0; 2025 3.0; 2026 2.6; 2027 2.5; 2028 2.4. - General government gross debt (percent of GDP): 2018 33.7; 2019 35.8; 2020 46.3; 2021 43.7; 2022 38.1; 2023 36.7; 2024 35.0; 2025 33.5; 2026 32.4; 2027 31.5; 2028 30.8. - Current account balance (percent of GDP): 2018 0.3; 2019 3.5; 2020 7.3; 2021 1.1; 2022 -5.1; 2023 -2.2; 2024 -1.5; 2025 -1.1; 2026 -0.6; 2027 -0.2; 2028 0.8. - Nominal GDP (in billions of euro): 2018 45.5; 2019 48.9; 2020 49.8; 2021 56.2; 2022 66.8; 2023 72.1; 2024 77.9; 2025 83.0; 2026 87.6; 2027 91.8; 2028 96.0. - Table 2: General Government Operations, 2018–28 (percent of GDP) — selected lines: - Revenue: 2018 34.5; 2019 35.2; 2020 36.1; 2021 36.4; 2022 35.8; 2023 38.1; 2024 36.7; 2025 36.1; 2026 35.5; 2027 35.6; 2028 35.5. - Expenditure: 2018 34.0; 2019 34.7; 2020 42.6; 2021 37.5; 2022 36.5; 2023 40.1; 2024 38.2; 2025 37.3; 2026 36.7; 2027 36.6; 2028 36.5. - Overall Budget Balance: 2018 0.5; 2019 0.5; 2020 -6.5; 2021 -1.2; 2022 -0.6; 2023 -2.0; 2024 -1.5; 2025 -1.2; 2026 -1.1; 2027 -1.0; 2028 -1.0. - Table 3: Balance of Payments, 2018–28 (Billions of Euros) — selected lines: - Current Account Balance: 2018 0.1; 2019 1.7; 2020 3.6; 2021 0.6; 2022 -3.4; 2023 -1.6; 2024 -1.1; 2025 -0.9; 2026 -0.5; 2027 -0.2; 2028 0.7. - Exports (f.o.b.): 2018 24.6; 2019 26.0; 2020 25.5; 2021 31.6; 2022 41.1; 2023 37.5; 2024 39.8; 2025 42.1; 2026 44.6; 2027 47.3; 2028 50.3. - Imports (f.o.b.): 2018 27.4; 2019 28.3; 2020 25.9; 2021 34.5; 2022 48.4; 2023 43.1; 2024 45.3; 2025 47.6; 2026 50.1; 2027 53.0; 2028 56.0. - Gross External Debt (percent): 2018 78.3; 2019 66.5; 2020 80.5; 2021 79.3; 2022 68.1; 2023 66.5; 2024 64.9; 2025 63.2; 2026 61.6; 2027 60.1; 2028 58.5. - Table 4: Summary of Monetary Accounts, 2012–22 (Billions of Euros) — selected lines: - Reserve money: 2012 4.7; 2013 4.9; 2014 5.9; 2015 9.1; 2016 12.6; 2017 15.7; 2018 18.8; 2019 15.5; 2020 20.6; 2021 24.8; 2022 20.9. - Broad Money: 2012 15.7; 2013 16.4; 2014 16.6; 2015 22.0; 2016 23.6; 2017 25.0; 2018 27.8; 2019 30.7; 2020 40.6; 2021 46.1; 2022 50.2. - Table 5: Financial Soundness Indicators, Banking Systems Data, 2013–22 (In percent) — selected lines: - Regulatory capital to risk-weighted assets: Dec-13 17.6; Dec-14 21.3; Dec-15 24.9; Dec-16 19.4; Dec-17 19.1; Dec-18 18.6; Dec-19 23.7; Dec-20 24.0; Dec-21 23.5; Dec-22 20.4. - Regulatory Tier 1 capital to risk-weighted assets: Dec-13 17.1; Dec-14 20.9; Dec-15 24.3; Dec-16 19.1; Dec-17 18.8; Dec-18 18.5; Dec-19 23.3; Dec-20 23.6; Dec-21 23.2; Dec-22 20.2. - Nonperforming loans to total (non-interbank) loans: Dec-13 1.6; Dec-14 7.0; Dec-15 5.7; Dec-16 4.1; Dec-17 3.1; Dec-18 2.5; Dec-19 1.5; Dec-20 1.4; Dec-21 0.7; Dec-22 0.6. - RoE (Total profits after tax): Dec-13 9.8; Dec-14 8.9; Dec-15 8.2; Dec-16 9.0; Dec-17 14.0; Dec-18 12.5; Dec-19 12.7; Dec-20 12.3; Dec-21 10.7; Dec-22 10.6. - Loan to deposit ratio in the banking sector: Dec-13 121.5; Dec-14 101.6; Dec-15 98.6; Dec-16 99.0; Dec-17 94.6; Dec-18 89.3; Dec-19 81.9; Dec-20 61.4; Dec-21 64.0; Dec-22 55.9. *Source: Provided IMF content for the Republic of Lithuania (content unit 1ltuea2023002).* ### Annex I. Risk Assessment Matrix ### Annex I. Risk Assessment Matrix ### External Risks — Major findings and policy responses - Intensification of regional conflict(s) — Likelihood: High (Short-term) - Impact on Lithuania: "The direct trade impact with Russia, Ukraine and Belarus will be small. The main impact will come through rising commodity prices and from a weaker global outlook and confidence effects." - Recommended policy response: "Use fiscal space to provide targeted relief to firms and households and let automatic stabilizers work fully provided that both inflation and growth are negatively affected." - Social discontent — Likelihood: High (Short-term) - Drivers: "Supply shocks, high inflation, real wage drops, and spillovers from crises in other countries worsen inequality, trigger social unrest, and give rise to financing pressures and damaging populist policies..." - Staff assessment: Low — "The economy has shown resilience to pandemic related shocks... price increases and shortages link to the War in Ukraine are unlikely to result in social discontent given broad consensus on support for Ukraine." - Recommended policy response: "Provide targeted support to ameliorate the impact of higher food/energy prices on vulnerable households." - Commodity price volatility — Likelihood: Medium (Short-term) - Staff assessment: High/Medium — "Further increases in energy and food prices will put additional pressure on consumers and firms. However, their balance sheets are strong, and the government has fiscal space to provide support." - Recommended policy response: "Allow price signals to work and provided targeted support to vulnerable groups and those most affected." - Abrupt global slowdown or recession — Likelihood: High (Short-term) - Impact: "A marked slowdown in the global economy will impact Lithuania through its impact on the global economy, and to key EU trading partners." - Recommended policy response: "Allow automatic stabilizers to work and depending on the magnitude of the slowdown and given weak social safety net, provide targeted support to the most vulnerable." - Monetary policy miscalibration — Likelihood: Medium (Short-term) - Staff assessment: Medium — "A premature loosening of the monetary stance will not help reduce high inflation and would increase the risk of persistently high inflation with a negative impact on competitiveness." - Recommended policy response: "Fiscal policy will have to more proactively reduce inflationary pressures by adopting a tighter stance." - Systemic financial instability — Likelihood: Medium (Short-term) - Staff assessment: Medium — "Banks have enough capital and liquidity buffers to absorb shocks, but there are potential pockets of vulnerability and the risk of a disorderly correction of the real estate market." - Recommended policy response: "Risks and potential vulnerabilities require close monitoring. If there are credit supply disruptions or a disorderly correction of the real estate market, macroprudential policies will have to be relaxed." - Deepening geo-economic fragmentation — Likelihood: High (Long-term) - Staff assessment: Medium — "The slowdown in global growth and trade will affect Lithuania’s overall trade prospects weakening the labor market." - Recommended policy response: - "Continue EU trade integration to secure access to a large market." - "Pursue education and healthcare reform to shift the labor force to higher value-added sectors with fast growing labor demand." - Cyberthreats — Likelihood: Medium (Short-term) - Staff assessment: Medium — "Credit growth and investment could be impaired, though high liquidity in the economy could limit the impact." - Recommended policy response: "Step up collaboration with home country supervisors and strengthen crisis preparedness." - Extreme climate events — Likelihood: Medium (Long-term) - Staff assessment: Medium — "While Lithuania could benefit from higher temperatures, associated increased volatility entails risks to biodiversity, food production, infrastructure, and weather sensitive activities." - Recommended policy response: "Continue to strengthen climate-related policies along with energy security, including increasing the share of renewables." ### Domestic Risks — Major findings and policy responses - Risks to competitiveness — Likelihood: Low/Medium (Long-term) - Staff assessment: Medium — "Competitiveness and growth potential would suffer. However, real wages and productivity have traditionally been closely linked and temporary deviations have been self-correcting." - Recommended policy response: - "Proactively use fiscal policy to reduce inflationary pressures." - "Redouble efforts to implement structural reform programs. Avoid large minimum wage increases." - Failure to implement structural reforms — Likelihood: High (Medium-term) - Staff assessment: High — "Lithuania would be vulnerable to a middle-income trap and face continued social demands without commensurate growth and revenue." - Recommended policy response: "Accelerate the implementation of elusive structural reforms and elaborate a medium-term fiscal plan that raises potential and meets social needs." --- ### Annex II. Implementation of Past IMF Recommendations ### Education - Issues identified: - "Oversized system does not reflect demographics resulting in high spending and poor outcomes." - "System leads to mismatch of education and occupational choices." - Recommendations: - "Address overcapacities (reduce number of teachers and consolidate school and university infrastructure). Review nexus between universities, financial incentives, and quality standards." - Authorities’ actions: - "Parliament approved a decision on the amendments to the rules in 2021 that is broadly in line with recommendations and the new requirements entered into force in 2022 for general education schools and higher education. But implementation was largely decentralized, especially for the reforms in higher education. The pandemic and war have further delayed reform efforts." ### Healthcare - Issues identified: - "The system remains hospital-care centered while out-patient and long-term care for elderly lag." - Recommendations: - "Continue reorganizing and rationalizing the hospital sector, improve out-patient and long-term care, and expand role of primary care. Develop a copayments system to incentivize cost efficiency. Strengthen accountability, particularly at municipal level." - Authorities’ actions: - "The authorities diverted more financial resources to the health sector during covid and renewed implementation efforts, including introduction of legal changes to allow for joint ownership of hospitals with municipalities. The government approved two programs for 2022-2030 to improve the quality and efficiency of the health care system in the country." ### Tax Policy - Issues identified: - "Low overall tax collection with high labor tax wedge and low wealth and environmental-related taxes. Tax system has limited redistributive impact." - Recommendations: - "Reduce social security contributions for low wage earners. Rebalance tax system from indirect and labor taxes towards wealth, capital and environmental taxes. Reduce tax exemptions and privileged regimes." - Authorities’ actions: - "The authorities recently proposed tax reform is in the right direction, but the revenue gains would be low and not strong enough to achieve climate goals." ### Labor Market - Issues identified: - "Flexible labor market with high skill-mismatches and labor shortages mostly in high-skill industries. High minimum wage introduces distortions in regional areas with low wages." - Recommendations: - "Reduce the tax wedge. Strengthen ALMPs, including life-long learning and apprenticeships, and increase its funding. Reduce barriers to non-EU migration and increase retirement age. Pause minimum wage increase and consider having differentiated minimum wage across regions." - Authorities’ actions: - "Enhanced ALMPs (introduced internships, mobility support, recognition of self-education). Increased minimum wage by 15 percent in 2022 to 50 percent of average wage. Restrictions on immigration were eased and migration from Ukraine has been facilitated." ### Pensions - Issues identified: - "Low and falling replacement ratios for a rapidly aging population. Highly redistributive—currently the most effective redistributive policy tool—but not targeted at the poor." - Recommendations: - "Link retirement age to life expectancy and tighten early retirement. Raise gross pensions (to at least preserve replacement ratios) and subject them to progressive PIT. Strengthen multi-pillar system by funding non-contributory basic pensions through general revenues and by making payments to second pillar compulsory. Scale back incidence of disability pensions." - Authorities’ actions: - "Multi-pillar system was strengthened as basic pension and commensurate social contributions were transferred to the state budget. Participation in Pillar II became mandatory with limited opting-out. A ceiling on social contributions was established and a new PIT bracket was introduced. A ceiling on private pension fund fees was introduced and the minimum amount to purchase an annuity reduced. The retirement age has not been increased. One-off increases in pension benefits outside of the indexation formula are commonly introduced with possibility to undermine the system’s financial sustainability. In 2021, two third pillar pension funds were established with environmental sustainability goals." ### Green Transformation - Issues identified: - "Lithuania is increasingly vulnerable to climate change, while geopolitical tensions have brought energy security to the fore." - Recommendations: - "A comprehensive carbon tax is necessary to achieve the authorities’ emission Reduction objectives for 2030 and reduce energy imports by (i) reducing fossil fuels, (ii) investing in low-emission transportation, and (iii) raising energy efficiency. The introduction of an economy-wide carbon tax—set to gradually increase to EUR50 per metric ton of CO2 emissions by 2030—would help achieve these goals." - Authorities’ actions: - "The authorities have proposed new environmental taxes, but these are not ambitious enough to deliver the climate objectives and still being discussed in parliament." --- ### Annex III. External Sector Assessment ### Overall assessment and medium-term outlook - Overall Assessment: "The external position of Lithuania in 2022 was substantially weaker than the level implied by fundamentals and desirable policies. This was driven by the large energy price hike which has already subsided." - Medium-term projection: "Over the medium-term and under the policies expected under the baseline scenario and as energy prices decline, Lithuania’s current account balance is expected to remain in the vicinity of the norm. Therefore, there is no concern about long-term misalignments." - Policy response: "The energy transition strategy by the government is essential to reduce fuel energy imports which could remain permanently elevated should fuel prices not return to pre-crisis levels." ### Foreign assets and liabilities — position and trajectory - Background: "Between 2009 and 2021, the NIIP has strengthened almost every year by a total of more than 50 percentage points of GDP, reaching a low of -7.2 percent of GDP in 2021. In 2022, the NIIP deteriorated slightly in absolute terms, driven by the current account deficit. However, strong nominal GDP growth resulted in a further improvement of the NIIP relative to GDP. Gross assets declined to 101.9 percent of GDP, while liabilities fell to 108.6 percent." - Assessment: "The current NIIP and its projected path do not imply risks to external sustainability." - 2022 (% GDP) key figures: - NIIP: -6.7 - Gross Assets: 101.9 - Debt Assets: 15.9 - Gross Liab.: 108.6 - Debt Liab.: 25.7 ### Current account — background, assessment, model estimates - Background: - "The 2022 current account turned into a deficit of 5.1 percent of GDP, much smaller than the surplus of 1.4 percent in 2021 and of 7.3 percent in 2020. Most of the deterioration is explained by the energy trade balance, which declined by 7 percent of GDP in 2022 with net non-oil goods and services exports providing a partial offset." - Assessment (EBA-lite results): - "The EBA-lite CA model estimates that the current account gap is -4.5 percent of GDP in 2022 and a cyclically adjusted CA of -3.9 percent while the norm envisages a surplus of 0.7 percent of GDP. The gap is largely driven by the energy price hike with policies providing a sizable offset of +3.3 percent of GDP, with public health expenditures and the cyclically adjusted fiscal balance being the main contributors." - Table 1: Model estimates for 2022 (in percent of GDP) - CA-Actual: -5.1 - Cyclical contributions (from model) (-): -0.7 - COVID-19 adjustor (-): 0.0 - Additional temporary/statistical factors (-): 0.0 - Natural disasters and conflicts (-): -0.5 - Adjusted CA: -3.9 - CA Norm (from model): 0.7 - Adjustments to the norm (+): 0.0 - Adjusted CA Norm: 0.7 - CA Gap: -4.5 0.7 - o/w Relative policy gap: 3.3 - Elasticity: -0.5 - REER Gap (in percent): 8.4 -1.3 - Notes: "1/ Based on the EBA-lite 3.0 methodology. 2/ Cyclically adjusted, including multilateral consistency adjustments." ### Real effective exchange rate (REER) - Background: "The real effective exchange rate appreciated almost 6 percent in 2022, and about 12 percent during the last three years. As of March, it has appreciated by 5.6 percent relative to the 2022 average level." - Assessment: - "While the current account model suggests an REER gap of 8.4 percent, the expectedly temporary nature of the current account suggests that a potentially large part of this overvaluation may be temporary as well. The REER model, in contrast and less plausibly, estimates an REER gap of -1.3 percent, consistent with a CA gap of 0.7 percent." ### Capital and financial accounts; FX intervention and reserves - Capital and financial accounts: - Background: "Lithuania experienced strong capital inflows during 2022 reflecting financing needs related to elevated energy prices. The inflows largely occurred through accelerated FDI and portfolio investments, reversing the outflows in 2021." - Assessment: "Gross debt has declined by 10 percentage points of GDP, a large part of it held by the public sector. Risks are further ameliorated by the holding of significant assets including sizable reserve holdings by the central bank." - FX intervention and reserves level: - Background: "The euro has the status of a global reserve currency." - Assessment: "Reserves in the euro area tend to be low relative to standard metrics, but the currency is free floating." --- ### Annex IV. Debt Sustainability Analysis — Summary ### DSA summary assessment and commentary - Headline: "Overall...Low" (risk of sovereign stress) - Commentary: - "Lithuania is at a low overall risk of sovereign stress and debt is sustainable. Most indicators have started to normalize as the recovery from the COVID-19 pandemic has proceeded and the economy has suffered a transitory contraction in activity due to the terms-of-trade shock caused by Russia's invasion of Ukraine. Accordingly, public debt is expected to remain firmly on a downward path over the medium term, with no difficulty in financing. Over the longer run, Lithuania should continue with structural reforms to tackle risks arising from population aging. However, even in that case, the debt-to-GDP ratio is comfortably below the EU debt threshold of 60 percent." - Mechanical signal and final assessment highlights: - "Medium-term risks are assessed as low in line with a mechanical low signal on the basis of the strength of institutions and prudent policies, the low level of public debt as a share of GDP, the access to wider pool of investors in Europe, and the ECB’s stabilizing role." - "The projected debt path is expected to stabilize and GFNs will remain at manageable levels, with the reinstatement of the domestic fiscal rule in 2024 and beyond. Therefore debt is assessed as sustainable." - "The overall risk of sovereign stress is low, with low levels of vulnerability in the near- and medium-term and moderate in the long-term." - "Long-term risks are moderate as aging-related expenditures on health and social security will eventually feed into debt dynamics." *Source: Annex I–IV, "1ltuea2023002 - Annex I. Risk Assessment Matrix"* ### 1. Debt coverage in the DSA: 1/CGGGNFPSCPSOther ### 1. Debt coverage in the DSA: 1/CGGGNFPSCPSOther ### Coverage and subsectors included - Chosen coverage: Budgetary central government: Yes - Extra budgetary funds (EBFs): No - Social security funds (SSFs): Yes - State governments: No - Local governments: Yes - Public nonfinancial corporations: Yes - Central bank: Yes - Other public financial corporations: Yes - Note: 1/ CG=Central government; GG=General government; NFPS=Nonfinancial public sector; PS=Public sector. ### Debt consolidation, accounting, and recording - Reporting on intra-government debt holdings: table entries indicate consolidation status across holders and issuers (values shown as zero in provided matrix). - Basis of recording indicated options (not applicable in provided text for this unit): Non-cash basis 4/, Cash basis, Nominal value 5/, Face value 6/, Market value 7/. - Valuation notes: - Nominal value: reflects value at creation and subsequent economic flows other than market price changes. - Face value: undiscounted principal to be paid at (or before) maturity. - Market value: value as if acquired in market transactions on the balance sheet reference date; only traded debt securities have observed market values. - Footnotes highlight: - 2/ Stock of arrears could be used as proxy in absence of accrual data on other accounts payable. - 3/ IPSGSs: Insurance, Pension, and Standardized Guarantee Schemes, typically including government employee pension liabilities. - 4/ Includes accrual recording, commitment basis, due for payment, etc. ### Public debt structure indicators (selected figures and notes) - Perimeter shown: general government. - Debt by instrument and holder presented as percent of GDP across time (figures referenced but only summary metrics listed elsewhere). ### Baseline scenario: public debt and contributors (Figure 4, percent of GDP unless indicated otherwise) - Public debt series (Actual and projections): - 2022: 38.1 - 2023: 36.7 - 2024: 35.0 - 2025: 33.5 - 2026: 32.4 - 2027: 31.5 - 2028: 30.8 - 2029: 30.8 - 2030: 30.8 - 2031: 30.8 - 2032: 30.8 - Change in public debt: - 2022: -5.6 - 2023: -1.4 - 2024: -1.8 - 2025: -1.5 - 2026: -1.1 - 2027: -0.9 - 2028: -0.8 - 2029: 0.0 - 2030: 0.0 - 2031: 0.0 - 2032: 0.0 - Contribution of identified flows: - 2022: -4.6 - 2023: -0.1 - 2024: -0.9 - 2025: -0.7 - 2026: -0.2 - 2027: 0.0 - 2028: 0.2 - 2029: 0.4 - 2030: 0.4 - 2031: 0.3 - 2032: 0.2 - Primary deficit (percent of GDP): - 2022: 0.4 - 2023: 1.6 - 2024: 1.0 - 2025: 0.5 - 2026: 0.4 - 2027: 0.3 - 2028: 0.4 - 2029: 0.3 - 2030: 0.3 - 2031: 0.3 - 2032: 0.3 - Noninterest revenues (percent of GDP): - 2022: 35.8 - 2023: 38.1 - 2024: 36.6 - 2025: 36.1 - 2026: 35.5 - 2027: 35.5 - 2028: 35.4 - 2029: 35.4 - 2030: 35.4 - 2031: 35.4 - 2032: 35.4 - Noninterest expenditures (percent of GDP): - 2022: 36.1 - 2023: 39.6 - 2024: 37.6 - 2025: 36.5 - 2026: 35.9 - 2027: 35.8 - 2028: 35.7 - 2029: 35.7 - 2030: 35.7 - 2031: 35.7 - 2032: 35.7 - Automatic debt dynamics (percent of GDP): - 2022: -4.8 - 2023: -1.6 - 2024: -1.8 - 2025: -1.1 - 2026: -0.6 - 2027: -0.2 - 2028: 0.0 - 2029: 0.1 - 2030: 0.1 - 2031: 0.1 - 2032: 0.0 - Real interest rate and relative inflation (percent): - Series provided, including Real interest rate: - 2022: -5.8 - 2023: -2.9 - 2024: -1.0 - 2025: -0.3 - 2026: 0.2 - 2027: 0.4 - 2028: 0.6 - 2029: 0.7 - 2030: 0.7 - 2031: 0.7 - 2032: 0.6 - Relative inflation: - 2022: 1.4 - 2023: 0.7 - 2024: 0.3 - 2025: 0.1 - 2026: 0.1 - 2027: 0.1 - 2028: 0.0 - 2029: 0.0 - 2030: 0.0 - 2031: 0.0 - 2032: 0.0 - Real growth rate (percent): - 2022: -0.8 - 2023: 0.5 - 2024: -1.0 - 2025: -0.9 - 2026: -0.8 - 2027: -0.7 - 2028: -0.7 - 2029: -0.6 - 2030: -0.6 - 2031: -0.6 - 2032: -0.6 - Other identified flows (percent of GDP): consistently -0.1 from 2022 through 2032. - Contingent liabilities (percent of GDP): 0.0 across 2022–2032. - Contribution of residual (percent of GDP): - 2022: -1.0 - 2023: -1.2 - 2024: -0.8 - 2025: -0.8 - 2026: -0.8 - 2027: -0.9 - 2028: -1.0 - 2029: -0.4 - 2030: -0.4 - 2031: -0.3 - 2032: -0.2 - Gross financing needs: - 2022: 4.6 - 2023: 5.5 - 2024: 6.6 - 2025: 8.2 - 2026: 10.6 - 2027: 12.2 - 2028: 13.9 - 2029: 13.0 - 2030: 13.6 - 2031: 14.0 - 2032: 13.9 - Of which: debt service: - 2022: 4.3 - 2023: 4.0 - 2024: 5.8 - 2025: 7.8 - 2026: 10.3 - 2027: 11.9 - 2028: 13.6 - 2029: 12.7 - 2030: 13.3 - 2031: 13.7 - 2032: 13.6 - Local currency vs foreign currency composition of GFN: - Local currency: - 2022: 3.1 - 2023: 2.7 - 2024: 3.9 - 2025: 5.4 - 2026: 7.1 - 2027: 8.2 - 2028: 9.4 - 2029: 8.7 - 2030: 9.1 - 2031: 9.3 - 2032: 9.2 - Foreign currency: - 2022: 1.2 - 2023: 1.3 - 2024: 1.8 - 2025: 2.5 - 2026: 3.2 - 2027: 3.7 - 2028: 4.2 - 2029: 4.0 - 2030: 4.3 - 2031: 4.4 - 2032: 4.4 - Memo key macro variables: - Real GDP growth (percent): - 2022: 1.9 - 2023: -1.4 - 2024: 2.9 - 2025: 2.7 - 2026: 2.5 - 2027: 2.2 - 2028: 2.1 - 2029: 2.1 - 2030: 2.1 - 2031: 2.1 - Inflation (GDP deflator; percent): - 2022: 16.7 - 2023: 9.4 - 2024: 5.0 - 2025: 3.8 - 2026: 2.9 - 2027: 2.5 - 2028: 2.4 - 2029: 2.4 - 2030: 2.4 - 2031: 2.4 - Nominal GDP growth (percent): - 2022: 18.9 - 2023: 7.9 - 2024: 8.0 - 2025: 6.6 - 2026: 5.5 - 2027: 4.8 - 2028: 4.6 - 2029: 4.6 - 2030: 4.6 - 2031: 4.6 - Effective interest rate (percent): - 2022: 1.0 - 2023: 1.4 - 2024: 2.0 - 2025: 2.9 - 2026: 3.5 - 2027: 3.9 - 2028: 4.3 - 2029: 4.7 - 2030: 4.7 - 2031: 4.7 - 2032: 4.3 - Staff commentary: "Public debt is projected to decline over the medium term as well as during the extended projection period, reflecting expectations of a narrowing of primary deficits and stable economic conditions." ### Realism and risk assessment (Figures 5–6 and accompanying notes) - Realism analysis: "Realism analysis does not point to major concerns." - Debt fanchart and risk metrics (Figure 6): - Fanchart width (percent of GDP): 47.3 0.7 (values presented together as shown) - Probability of debt non-stabilization (percent): 55.3 - Terminal debt-to-GDP x9.9 0.2 (values presented together as shown) - Debt fanchart index (DFI): 1.4 - Risk signal: Moderate (per note 3/ thresholds) - Gross Financing Needs (GFN) Module: - Average baseline GFN (percent of GDP): 9.5 3.2 (values presented together) - Banks' claims on the gen. govt (pct bank assets): 3.7 1.2 - Change in banks' claims in stress (pct bank assets): 8.6 2.9 - GFN financeability index (GFI): 7.3 - Risk signal: Low (per note 4/ thresholds) - Medium-term index and final assessment: - Medium-term index: normalized components shown (Debt fanchart index (normalized) 1.37; GFN financeability index (normalized) 7.32) - Final assessment: Prob. of missed crisis, 2023-2028, if stress not predicted: 9.1 pct. - Prob. of false alarms, 2023-2028, if stress predicted: 48.9 pct. - Comparator group: advanced economies, non-commodity exporter, surveillance. ### External Debt Sustainability Framework (Table 1, percent of GDP unless otherwise specified) - Baseline: External debt series: - 2018: 75.4 - 2019: 66.1 - 2020: 81.2 - 2021: 75.6 - 2022: 68.5 - 2023: 66.3 - 2024: 64.9 - 2025: 63.2 - 2026: 61.6 - 2027: 60.1 - 2028: 58.5 - Debt-stabilizing non-interest current account: -3.5 - Change in external debt: - 2018: -12.6 - 2019: -9.4 - 2020: 15.1 - 2021: -5.6 - 2022: -7.1 - 2023: -2.1 - 2024: -1.5 - 2025: -1.6 - 2026: -1.6 - 2027: -1.5 - 2028: -1.6 - Identified external debt-creating flows (4+8+9): - 2018: -12.4 - 2019: -7.0 - 2020: -12.3 - 2021: -14.5 - 2022: -0.9 - 2023: 1.0 - 2024: -2.3 - 2025: -2.5 - 2026: -2.9 - 2027: -3.1 - 2028: -4.0 - Current account deficit, excluding interest payments: - 2018: -1.4 - 2019: -4.8 - 2020: -8.3 - 2021: -1.8 - 2022: 4.5 - 2023: 1.5 - 2024: 0.3 - 2025: -0.1 - 2026: -0.7 - 2027: -1.0 - 2028: -1.9 - Exports (percent of GDP) series: - 2018: 75.2 - 2019: 77.3 - 2020: 73.2 - 2021: 80.5 - 2022: 87.6 - 2023: 74.1 - 2024: 72.7 - 2025: 72.0 - 2026: 72.0 - 2027: 72.6 - 2028: 74.1 - Imports (percent of GDP) series: - 2018: 73.4 - 2019: 72.0 - 2020: 63.9 - 2021: 76.0 - 2022: 89.5 - 2023: 73.9 - 2024: 71.9 - 2025: 70.8 - 2026: 70.7 - 2027: 71.3 - 2028: 72.1 - Net non-debt creating capital inflows (negative): - 2018: -2.2 - 2019: -2.1 - 2020: -2.5 - 2021: -1.7 - 2022: -1.8 - 2023: -2.0 - 2024: -2.0 - 2025: -2.0 - 2026: -2.0 - 2027: -2.0 - 2028: -2.1 - Automatic debt dynamics 1/: - 2018: -8.7 - 2019: -0.2 - 2020: -1.4 - 2021: -11.1 - 2022: -3.6 - 2023: 1.6 - 2024: -0.6 - 2025: -0.4 - 2026: -0.3 - 2027: -0.1 - 2028: 0.0 - Contribution from nominal interest rate (percent): - 2018: 1.1 - 2019: 1.2 - 2020: 1.0 - 2021: 0.6 - 2022: 0.6 - 2023: 0.7 - 2024: 1.2 - 2025: 1.2 - 2026: 1.2 - 2027: 1.2 - 2028: 1.2 - Contribution from real GDP growth (percent): - 2018: -3.1 - 2019: -3.4 - 2020: 0.0 - 2021: -4.2 - 2022: -1.3 - 2023: 0.8 - 2024: -1.8 - 2025: -1.7 - 2026: -1.5 - 2027: -1.3 - 2028: -1.2 - Contribution from price and exchange rate changes 2/: 2018: -6.8; 2019: 2.1; 2020: -2.5; 2021: -7.6; 2022: -2.9; subsequent periods shown with ellipses in source. - Residual, incl. change in gross foreign assets (2-3) 3/: - 2018: -0.2 - 2019: -2.4 - 2020: 27.4 - 2021: 8.9 - 2022: -6.2 - 2023: -3.1 - 2024: 0.8 - 2025: 0.9 - 2026: 1.3 - 2027: 1.6 - 2028: 2.5 - External debt-to-exports ratio (in percent) series (selected): - 2018: 100.3 - 2019: 85.4 - 2020: 110.9 - 2021: 93.9 - 2022: 78.2 - 2023: 89.6 - 2024: 89.2 - 2025: 87.8 - 2026: 85.6 - 2027: 82.7 - 2028: 79.0 - Gross external financing need (in billions of US dollars): - 2018: 24.5 - 2019: 21.9 - 2020: 12.8 - 2021: 21.0 - 2022: 28.7 - 2023: 29.9 - 2024: 22.3 - 2025: 24.2 - 2026: 35.2 - 2027: 36.4 - 2028: 36.3 - Gross external financing need (in percent of GDP) noted in table with series and long-run benchmarks (values presented in source). - Scenario with key variables at their historical averages: 66.3 63.4 60.1 56.9 53.8 51.5 -3.9 (values presented together as in source). - Key macro assumptions underlying baseline (selected): - Real GDP growth (in percent) historical and projections include: 4.0 4.6 0.0 6.0 1.9 3.2 1.7 -1.4 2.9 2.7 2.5 2.2 2.1 - GDP deflator in US dollars (change in percent) series: 8.3 -2.7 3.9 10.3 4.0 2.0 7.5 12.4 4.4 3.8 3.0 2.6 2.4 - Nominal external interest rate (in percent): 1.5 1.6 1.6 0.9 0.8 1.9 0.7 1.2 1.9 2.0 2.1 2.1 2.1 - Growth of exports (US dollar terms, in percent): 15.1 4.7 -1.7 28.6 15.2 7.1 13.7 -6.2 5.5 5.5 5.6 5.9 6.7 - Growth of imports (US dollar terms, in percent): 16.0 -0.1 -7.9 39.1 24.8 7.7 16.7 -8.5 4.6 5.1 5.4 5.8 5.9 - Current account balance, excluding interest payments: 1.4 4.8 8.3 1.8 -4.5 2.3 3.6 -1.5 -0.3 0.1 0.7 1.0 1.9 - Net non-debt creating capital inflows: 2.2 2.1 2.5 1.7 1.8 2.2 0.3 2.0 2.0 2.0 2.0 2.0 2.1 - Notes define computations: - 1/ Derived formula for automatic dynamics with r, g, e, a explained in footnotes. - 2/ Contribution from price and exchange rate changes defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock; r increases with appreciating domestic currency (e > 0) and rising inflation. - 4/ Gross external financing need defined as current account deficit plus amortization on medium- and long-term debt plus short-term debt at end of previous period. - 5/ Key variables for historical-average scenario: real GDP growth; nominal interest rate; dollar deflator growth; non-interest current account and non-debt inflows as percent of GDP. - 6/ Long-run constant balance that stabilizes the debt ratio assuming key variables remain at levels of last projection year. ### Annex V (High Inflation in the Baltics): inflation dynamics and policy implications (selected findings) - Recent inflation dynamics: - After low and stable inflation in the post-GFC and pre-pandemic period, the Baltics experienced a surge in inflation, which remains twice as high as in the rest of the eurozone. - Inflation exceeded 20 percent in 2022 and is projected to remain elevated relative to the euro area for the foreseeable future. - Drivers and quantitative impacts (structural VAR results and related findings): - About 37 percent of the variance of inflation in the Baltics is explained by global factors (demand and supply). - A 5 percentage point increase in oil prices: - Increases inflation in the Baltics by around 0.3-0.4 percentage points (0.1 percentage points in the euro area). - Leads to a 0.7-0.8 percentage point contraction in output in the Baltics (0.5 percentage points in the euro area). - Impact on wage growth: not statistically significant in Estonia and Latvia; in Lithuania the oil price shock leads to a 1 percentage point decline in wage growth after the third quarter. - Domestic factors (demand and supply) explain about 25 percent of the variance of inflation but have a significant impact. - A one standard deviation shock to domestic real GDP (~0.7-0.8 percentage points of growth in the Baltics; 0.6 percentage points in the euro area) increases inflation by around 0.3-0.4 percentage points in the Baltics (0.1 percentage points in the euro area). - Domestic demand shocks impact wage growth in Estonia (1 percentage point) and the euro area (0.4 percentage points). - Global demand shocks have a significant positive impact on wage growth in the Baltics (1 percentage point) and the euro area (0.5 percentage points). - Policy implications: - Monetary conditions tightened recently in response to rising inflation, but fiscal policy—the only macroeconomic stabilization tool available in the Baltics—has not done enough. - ECB monetary policy cannot fully respond to country-specific Baltic conditions due to the small share of the Baltic economies in euro area GDP; monetary tightening came late from the Baltic perspective. - Over the last few years fiscal stance was largely countercyclical before and throughout the pandemic, but more recently it has not done enough to contain inflation, particularly in Estonia and Lithuania where the fiscal stance is expected to loosen this year. *Source: Republic of Lithuania chapter, IMF staff estimates and projections, as contained in the provided PDF content unit.* ### Annex V. Figure 1: Baltics: Monetary and Fiscal Policy Stance ### Annex V. Figure 1: Baltics: Monetary and Fiscal Policy Stance ### A. Fiscal policy impact on inflation - Using an augmented Phillips curve with fiscal variables, an increase of one percentage point of (potential) GDP in the cyclically adjusted primary balance is associated with an increase in inflation of around 0.3-0.4 percentage points in the Baltics. - A VAR framework delivers a 0.3-0.75 percentage points increase in inflation from the same fiscal shock; the VAR result is not statistically significant for Lithuania. - These findings are compared with Chapter 2 of the IMF Fiscal Monitor, April 2023: a Bayesian panel VAR of 17 advanced economies (1985-2019) found a one percent of GDP increase in fiscal spending leads to a 0.5 percentage point increase in inflation, with the effect dissipating over 3 to 4 years. ### B. Inflation, wages, and competitiveness — key findings - Persistently higher inflation than in the euro area above what would be justified by productivity gains could: - Adjust inflation expectations upward, - Perpetuate large increases in price and wages, - Erode competitiveness and slow income convergence. - A loose policy mix (particularly in Estonia and Lithuania) and tight labor markets have exacerbated these risks. - Long-run wage-productivity co-movement: - Estimated long-run association of labor productivity to real wages: about 0.8 percent in Lithuania, 0.9 percent in Estonia, and 1.3 percent in Latvia for a one percent increase in labor productivity. - Short-term deviations and speed of adjustment: - Short-term deviations self-correct in Estonia and Lithuania. - Estimated speed of reversion: about 3 quarters for Estonia and 6 quarters for Lithuania. - No significant evidence of short-term self-correction in Latvia. - Sample period and robustness: - Co-integration and long-run relationships assessed over the sample period 2000-2022. - The strengthened relationship post-GFC in Lithuania is robust over the full sample for Estonia. ### C. Labor market structure and implications - Labor market flexibility: - Estonia: most flexible in the Baltics (proxied by employment protection legislations, EPL), reforms in 2009-2010. - Lithuania: improvements with an important labor code reform in 2017-18. - Latvia: least flexible, with EPLs among the most stringent in Europe and no recent reform efforts. - Wage-setting features: - Flexible labor markets lead to wages largely determined at the firm-level rather than the industry-level. - Small share of workers covered by collective bargaining across the region. - Cyclical flexibility: - Employers’ perceived labor market shortages tend to be lower than the EU average during downturns and higher during expansions. ### D. Firm-level evidence on inflation, profitability, and investment - Firm-level panel (unbalanced) of more than one hundred thousand firms from the Baltics, sample 1997-2021: - Temporary inflation shocks (likely linked to demand increases) had a small, transitory positive impact on profitability and investment—driven by tradable sector firms; non-tradable firms’ responses statistically insignificant. - During expansionary periods: positive but transitory impact on profitability and a longer-lasting increase in investment. - During contractionary periods: inflation shocks decrease profitability and, over time, negatively impact investment. - Context on shock size: - One standard deviation inflation shock during the sample period equaled 2.5 percent. - By contrast, inflation reached as much as 25 percent in 2022—illustrating that the analyzed shocks are moderate compared to recent volatility. ### E. Policy considerations and recommendations - Primary concern: - High and persistent inflation is identified as the biggest risk facing the Baltic economies. - Fiscal policy recommendation: - A tighter fiscal stance would actively contribute to lower inflation in the current context, given fiscal policy’s impact on domestic demand. - Wage policy and structural measures: - Structural policies such as setting moderate minimum and public sector wages can help mitigate the risk of higher wage growth and make inflation expectations less backward-looking. - Country-specific risk assessment: - Short-term deviations of wages from productivity can be absorbed in Estonia and Lithuania if temporary; risks are higher in Latvia where wage growth already exceeds productivity growth in equilibrium and short-term deviations do not self-correct. - The role of fiscal policy in containing inflationary risks is reinforced, especially for Latvia. - Resilience considerations: - The lack of macroeconomic imbalances, flexible labor markets (except Latvia), and strong competitive positions provide some comfort that these economies can absorb the current shock—contrasting with the 2008 situation. ### F. Banking sector concentration and profitability (Lithuania) - System structure and concentration: - At end 2022 there were 13 banks and 6 foreign branches operating in Lithuania (up from 7 and 9 in 2018). - The three largest banks accounted for 70 percent of system assets (down from 84 percent in 2018). - Profitability metrics (averages 2012-2021): - Return on assets: 0.95. - Return on equity: around 10. - Comparators for Europe: average return on assets 0.57 and return on equity 5.9 percent. - Nonperforming loans and balance-sheet repair: - NPLs fell from over 20 percent in 2010 to 7 percent in 2015 and below 1 percent in 2022. - Drivers of profitability: - Profitability largely driven by efficiency—cost-to-income ratios among the most efficient in Europe. - Net interest margins below the European average. - Low cost measured in percent of total assets driven by low personnel and non-personnel expenses (e.g., one of the lowest numbers of branches per capita in Europe). - Large decline of parent funding (mainly wholesale) since the GFC. - Competition dynamics: - Number of participants increasing, though new banks are small and often target nonresident European clients—limited immediate impact on lending competition. - Increasing competition on payments from fintech participants. - In times of heightened uncertainty, established banks benefit from perceptions of safety—evidenced by large increases in deposits during covid and after the war in Ukraine. ### G. Government’s new tax reform proposal — key elements - Real estate taxes: - Reform applies tax on properties valued above 1.5 times the median in each municipality, exempting more than the bottom half of residential real estate. - Annual tax rate: 0.06 percent on properties worth between one and a half and two times the median value; 0.1 percent on properties above that threshold. - Retired and socially vulnerable people could apply to defer the tax until their property is sold or otherwise passed on to new owners. - Property tax revenues would be channeled directly to municipalities. - Self-employed taxation: two alternative regimes proposed - (i) Business certificate regime (intended for short-term work): - Cap on annual income at €20,000 (currently €45,000). - Tax rate of 15 percent (minus deductions) rather than paying a fixed amount of tax. - Currently about 84 percent of self-employed using business certificates earn less than €20,000 per year. - (ii) Individual activity regime (covering mostly high-earners such as lawyers): - Income tax rate would increase from 15 percent to 17 percent in 2025 and to 20 percent in 2026. - Currently, employment income is subject to a tax rate of 20 percent, with the higher marginal rate of 32 percent applied to earnings above €101,100 per year; passive income (i.e., interest earnings and rental income) are taxed at 15 percent. - Proposed reform would tax all types of income at 20 percent by 2026 and apply an additional marginal tax of 5 percent on earnings above €101,100 and 7 percent on earnings in excess of €303,300 euros per year. - About 16,500 taxpayers would be subject to the higher income tax rates (up from around 8,000), or 0.8 percent of all taxpayers in the country. - Social insurance on self-employed: - All self-employed workers would be required to pay social insurance contributions as other workers—calculated on 90 percent of taxable income instead of the existing range of 50 to 100 percent. - The maximum amount on which contributions are paid would increase from €64,700 to €101,000 per annum. *Source: European Central Bank; Haver Analytics; and IMF staff calculations (text extracted from Annex V and subsequent annexes).* ### 3. The tax reform package also includes, among others, (i) increasing annual income ### 3. The tax reform package also includes, among others, (i) increasing annual income ### Tax reform package — main measures - Increasing annual income threshold for businesses to register as VAT payers from €45,000 to €55,000 in 2024. - Reducing the corporate income tax rate to 5 percent for small businesses with annual income up to €300,000 and no more than 10 employees. - Raising the annual turnover threshold for companies to qualify for faster depreciation of fixed assets from €150,000 to €300,000 and removing the requirement on the number of employees. ### Fiscal impact: Fiscal Impact of the Initial Tax Review Package Proposal, 2026 (in EUR million) - "Green package": changes in excise duty taxation — 172.90.26 - "Green package": introduction of the CO2 component — 1200.18 - Review of taxation of revenue from self-employement — 840.13 - Review of application of progressive PIT rates — 640.10 - Changes in taxation of business certificates — 30.70.05 - Review of CIT exemptions (measures which have a positive effect on State budget revenue) — 18.70.03 - Changes in property taxation (varies depending on the rates set by municipalities, lower bound estimate is included in the overall estimate) — from 17 to 115 from 0.03 to 0.17 - Unification of taxable base for different types of self-employed — 6.50.01 - Introduction of unemployment insurance contributions for the self-employed — 9.80.01 - Increase of the VAT registration threshold — -7.4-0.01 - Automatization of PIT tax refund requests — -57-0.09 - Discarding of the criteria of number of employees in the definition of small companies for CIT purposes, where a reduced 5% CIT rate and other incentives are applied (keeping just the revenue criteria) — -1.40.00 - CIT incentive aimed at increasing reinvestment of profits (allowing instant deduction of selected asset categories, fiscal impact in the long-term is neutral) — -85.3-0.13 - Extension of the CIT tax incentive for investment projects — -106-0.16 - Extension of the CIT tax incentive for the film production — -14-0.02 - Total — 252.5 to 350.50.38 to 0.52 *Source: Ministry of Finance* --- ### Annex VIII. Housing Price Bubbles in Lithuania ### Key findings and methodology - Dataset: monthly observations of city-level housing prices in Lithuania during the period 1994–2022 using the Ober-Haus apartment price index for 5 cities (Kaunas, Klaipėda, Panevėžys, Šiauliai and Vilnius) and the national average on a monthly basis from January 1994 to September 2022. - The city-specific consumer price index (CPI) and its housing component are drawn from Statistics Lithuania to calculate the house price-to-rent ratio at the city level. - Bubble detection method: recursive unit root test with an augmented Phillips-Wu-Yu (2011) test using a double-recursive algorithm and a recursive flexible window approach to identify multiple bubble episodes and estimate origination and termination dates while allowing for multipole structural breaks. ### Empirical results - Test statistics are significantly greater than the 1 percent critical value; the null hypothesis of no-bubble is rejected. - Evidence of explosive behavior in real housing prices across five cities as well as at the national level in Lithuania during the period from January 1994 to September 2022. - Similar results obtained for the house price-to-rent ratio, though this alternative measure shows greater variation in the extent of explosive behavior across cities. - Overall, long and multiple periods of explosive behavior in real house prices—beyond the level justified by fundamentals—are found in all major cities during 1994–2022. - The house price-to-rent ratio measure shows no significant bubble in recent years except in the case of one city. - After remaining stable for an extended period after the GFC, house price growth accelerated significantly during the pandemic. - Conclusion: while the size of bubbles varies across cities, especially when using the house price-to-rent ratio, there is a similar boom-bust pattern throughout the country. *This annex is based on S. Cevik and S. Naik, “Bubble Detective: City-Level Analysis of House Price Cycles,” IMF Working Paper No. 23/33.* ### Annex VIII. Figure 1: Explosive Behavior of Real House Prices: Generalized Supremum ### Annex VIII. Figure 1: Explosive Behavior of Real House Prices: Generalized Supremum ### Test and Data Presented - Test: Augmented Dickey-Fuller Test (Generalized Supremum). - Time coverage shown on the figure: 1997, 1999, 2002, 2004, 2007, 2009, 2012, 2014, 2017, 2019, 2022. - Series plotted: Generalized Supremum Augmented Dickey-Fuller Test Statistic for each panel. - Panels shown: Klaipėda, Šiauliai, Vilnius, National, Kaunas, Panevėžys. - Critical values shown: Right-tail CV (95%) and Right-tail CV (90%). - Vertical axis ticks explicitly depicted: -4, -3, -2, -1, 0, 1, 2, 3, 4, 5. ### Key Visual Elements (as presented) - For each panel, the Generalized Supremum ADF test statistic is plotted across the years listed above (1997–2022). - Two right-tail critical value reference lines are displayed in each panel: one labeled Right-tail CV (95%), and one labeled Right-tail CV (90%). - Axis range for test statistic spans at least from -4 to 5 as indicated by the tick labels. ### Notes and Source - Note: CV indicates critical values. - Source: IMF staff calculations. *Annex VIII. Figure 1: Explosive Behavior of Real House Prices: Generalized Supremum (Augmented Dickey-Fuller Test) — Source: IMF staff calculations.* ### introduction of a carbon component, will support the green transition. Consolidation of national ### 1ltuea2023002 - introduction of a carbon component, will support the green transition. Consolidation of national ### Green transition and institutional consolidation - Introduction of a carbon component will support the green transition. - Consolidation of national promotional institutions will increase the public sector's capacities to efficiently channel investment into priority areas, such as the green and digital transitions. - Expected outcome: boosting the resilience and growth potential of the Lithuanian economy. ### Final remarks — multilateral engagement and support for Ukraine - The authorities emphasize their commitment to multilateralism, including through participation in the Fund’s financial initiatives. - Lithuania has joined: - the FTP, - the BBAs, - the VTAs. - Lithuania responded to the calls to contribute to the RST and the PRGT with full requested amounts. - Lithuania is actively participating in the coalition of international partners that continue to support Ukraine. - Lithuania has joined the G7 and other countries in providing financial assurances, which enabled the IMF’s EFF program for Ukraine. - The humanitarian, financial, and military aid allocated by Lithuania to support Ukraine already amounts to more than 1.4 percent of GDP. *Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1ltuea2023002.pdf* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1ltuea2023002.pdf_