## 1. External Stability Assessment

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### Context
- Authorities remain on track with public finance repair and meeting conditions for euro adoption.
- Political setting:
  - Four-party coalition led by the Social Democrats since late 2012 limits scope for bold reforms.
  - Two key projects advancing: (i) Prime Minister Butkevicius has staked his political survival on successfully adopting the euro next year, (ii) fiscal consolidation is moving further ahead, with the public debt ratio now on the verge of starting to decline.
  - Presidential and European elections are due in May. Incumbent President Grybauskaite is running as an independent and is leading opinion polls by a large margin.
- Income convergence and labor market:
  - Lithuania’s per capita GDP has advanced to only one-third of Western Europe’s.
  - Unemployment is 11.4 percent.
  - Demographic headwinds and diminishing dividends from macro adjustment place emphasis on structural reforms and consistently high investment.

### Recent developments and outlook
- Growth and demand:
  - Real GDP expanded by 3.3 percent in 2013, driven largely by domestic demand.
  - Output is set to surpass its 2008 peak for the first time this year.
  - Investment rebounded on the back of high capacity utilization, more public investment, and a recovery in construction.
  - Export growth slowed in H2 2013 due to softer trading partner demand and weaker agricultural exports after the 2012 bumper harvest.
  - Unemployment continued to fall, including for youth and the longer-term unemployed.
- Inflation:
  - Average inflation moderated from 3.2 percent in 2012 to 1.2 percent in 2013.
  - Average core inflation ran at 1.4 percent in 2013.
  - Minimum wage increases: cumulative 25 percent from July 2012 and January 2013 one-off increases contributed to wage dynamics.
- External sector and reserves:
  - Current account in slight surplus in 2013.
  - International reserves stood at €6 billion at end-2013; adequacy metric €8.9 billion.
  - Reserves metrics: 17 percent of GDP; 2½ months of imports.
  - Note: euro adoption would remove remaining reserve-related vulnerability.
- Outlook:
  - Growth expected to pick up from 3.3 percent in 2013 to 3¾ percent in the medium term.
  - Output gap expected to close in 2014; potential growth projected to rise to some 3¾ percent over time.
  - Staff projects the current account to swing into a deficit on the order of 1½–2 percent of GDP over the medium term; it would be more than fully covered by FDI.
- Risks (tilted to the downside, mainly external):
  - Protracted low growth in advanced and emerging economies; increasing geopolitical tensions surrounding Ukraine; tighter global financial conditions.
  - Domestic risk: protracted lack of credit growth could curtail investment.
  - Selected entries from Risk Assessment Matrix:
    - Side-effects from global financial conditions: Relative Likelihood = High; Impact = Low.
    - Protracted period of slower growth in advanced and emerging economies: Relative Likelihood = High (in Europe); Impact = Medium. (Exports account for some 80 percent of GDP.)
    - Increasing geopolitical tensions surrounding Ukraine: Relative Likelihood = Medium; Impact = High.
    - Protracted period of unduly low credit growth: Relative Likelihood = Medium; Impact = Medium/High.

### External stability and external sector indicators
- Real effective exchange rate:
  - Assessment approaches: Macro balance (gap) = -4.8; Equilibrium real ER approach = 2.2; External sustain. approach = -4.8.
  - Estimates indicate the real effective exchange rate is broadly in line with fundamentals.
- External debt and IIP:
  - Gross external debt stood at 65 percent of GDP.
  - The international investment position stands at negative 46 percent of GDP, explained by excess inward over outward FDI and net parent bank funding.
  - A significant share of external debt is owed to foreign parent companies and foreign banks.
  - Private external debt relative to GDP and gross external debt relative to exports remain below customary vulnerability thresholds.
- Reserves adequacy:
  - International reserves: €6 billion at end-2013 vs. adequacy metric €8.9 billion.
  - Reserves: 17 percent of GDP; 2½ months of imports.
- External debt dynamics and projected path (selected baseline figures):
  - Gross external debt: 2013 = "64.5" percent of GDP; 2014 = "62.1"; 2015 = "59.6"; 2016 = "57.0"; 2017 = "54.3"; 2018 = "51.6"; 2019 = "49.0".
  - Gross external financing need (percent of GDP): 2013 = "60.7"; 2014 = "57.6"; 2015 = "55.1"; 2016 = "51.4"; 2017 = "48.7"; 2018 = "45.8"; 2019 = "43.3".
  - Debt-stabilizing non-interest current account: "-3.1".

### Fiscal developments and constitutional court rulings
- Fiscal outcomes:
  - 2013 fiscal deficit likely overperformed its 2½ percent of GDP target; estimated 2.1 percent of GDP deficit in 2013.
  - EC’s Excessive Deficit Procedure abrogated in June 2013 based on the 3.2-percent-of-GDP deficit in 2012.
  - 2014 budget targets a deficit of 1.9 percent of GDP for the general government.
  - 2014 budget foregoes generalized pension and wage increases; other expenditure allowed to grow roughly in line with nominal GDP; no significant tax policy changes envisaged.
- Constitutional Court rulings and budgetary implications:
  - Pension restoration: LTL 34 million in 2013 and additional LTL 211 million in 2014 (0.19 ppt of GDP in total) — restored in Oct 2013 (July 2013 CCR).
  - Pension compensation: 0.2-0.6 ppt of GDP (April 2010 CCR; postponed compensation not unconstitutional; no concrete timetable specified).
  - Wage restoration: LTL 500 million (or 0.5 ppt of GDP) — restored in 2012 (April 2010 CCR reiterated in Feb 2012).
  - Wage compensation: 0.6-0.9 ppt of GDP — compensation envisaged to begin in late 2014.
  - Once compensation payments are approved by Parliament, their full amount will be immediately recognized as public expenditure, increasing the accrual fiscal deficit as calculated by Eurostat; as a one-off, it would not affect the structural fiscal balance and may be excluded or discounted when assessing compliance with SGP deficit limits.

### Financial sector — structure, soundness, and credit conditions
- System structure and soundness:
  - Over 90 percent of the banking system is owned by Nordic cross-border banking groups.
  - Capital adequacy rose to 17½ percent at end-2013 (Regulatory capital to risk-weighted assets: decadal series ends at "17.6").
  - Liquidity indicators are well ahead of regulatory minima (liquidity ratio at 41.2 percent, above required 30 percent).
  - Some smaller banks would benefit from larger capital buffers; credit unions need reform but are small and not material risk to overall stability.
- Credit conditions:
  - Despite progress in reducing non-performing loans (NPLs reduced from peak of 20 percent to 11 percent), private sector credit has yet to return decisively to positive growth.
  - Loan-to-deposit ratios fell to 107 percent.
  - Causes of weak credit: post-crisis risk aversion by borrowers and banks, household debt overhang; banks focus on large, successful firms, leaving SMEs and new companies underserved.
- Banking system selected indicators (Dec-07 to Dec-13):
  - Regulatory capital to risk-weighted assets: "... 17.6"
  - Regulatory Tier 1 capital to risk-weighted assets: "... 17.1"
  - Capital to assets: "... 11.5"
  - Nonperforming loans to total (non-interbank) loans: "... 11.0"
  - RoE: "... 8.9"
  - RoA: "... 1.0"
  - Customer deposits to total non-interbank loans: "... 93.3"
- Authorities’ actions and preparations:
  - Authorities intervened and closed the two largest domestic banks, removing risks to financial stability.
  - Authorities intend to participate in the Asset Quality Review ahead of planned euro adoption.
  - Process of broadening BoL’s mandate to include macro-prudential policy nearly complete; amendments to the Law of the Bank of Lithuania expected to be adopted during the Spring parliamentary session ending in June 2014.
  - Countercyclical capital buffer application expected to become fully operational in end-2014; interim decision to apply 2.5 percent capital conservation buffer starting in 2015.

### Euro adoption readiness and recommended policy framework strengthening
- Euro adoption and convergence assessment:
  - Lithuania appears on track to meet the entry criteria for euro adoption.
  - Fiscal deficit and public debt are well below Maastricht thresholds.
  - Exchange rate has long been fixed under the currency board arrangement.
  - Inflation and interest rates run at less than the reference values.
  - European institutions will take a final decision on Lithuania’s euro adoption application in July, based on EC and ECB convergence reports to be published in June.
- Benefits of euro adoption:
  - Replace relatively low reserve cover with access to ECB liquidity, enhancing financial stability and putting downward pressure on risk premiums.
  - Closer integration with the euro area could help foster trade, global value chain involvement, and FDI.
- Recommended strengthening of policy frameworks:
  - Fiscal framework: Strengthen Fiscal Compact implementation and supplement with a countercyclical fiscal rule; integrate with the compact’s correction mechanism; expedite establishment of a fiscal council in the National Audit Office.
  - Financial framework: Establish macro-prudential powers for the Bank of Lithuania (legislation before Parliament); preserve Nordic-Baltic cooperation forums and adapt to the European banking union; ensure close home-host cooperation for cross-border banks.
  - Restructuring and insolvency: Speedier and more widespread use of the household insolvency law (came into effect in early 2013); address limited effectiveness for going-concern corporate restructurings.
  - Labor market: Safeguard and build on labor market flexibility; address skill mismatches, overly restrictive labor code provisions, and high tax wedge contributing to high structural unemployment.

### Boxes and specific thematic findings
- Box 4 — Sustainability of Low Inflation:
  - Lithuania’s annual average inflation differential to the euro area (EA) since 1999: 0.8 percentage points.
  - Balassa-Samuelson (BS) effect:
    - Simple accounting: BS effect about 0.7 percentage points (73 percent of observed inflation differential with the EA since 2000).
    - Econometric estimates: long-run BS effect of some 1.1 percentage points annually.
  - Short-run shock impacts on inflation differential (one-std deviation shock):
    - Commodity prices: 0.2 percentage points.
    - Output gap: 0.4 percentage points.
    - Real wages: 0.5 percentage points.
  - Econometric evidence suggests annual inflation differential about 0.7 percentage points vis-à-vis the EA over next five years, conditional on policy discipline and supporting frameworks.
  - Potential one-off inflationary impact from switch to the euro: 0.2 to 0.4 percentage points.
- Box 5 — Fiscal Sustainability:
  - Public debt before the 2008/09 crisis: 15 percent of GDP.
  - Deficit in 2009 recession: 9.4 percent of GDP.
  - Exit from EDP: spring 2013; deficit near 2 percent of GDP for 2013.
  - Public debt stabilized at some 40 percent of GDP and would gently decline even in a passive scenario with no further consolidation beyond the 2014 budget.
  - Government loans to the deposit insurance fund related to Snoras and Ukio likely to be repaid and are around 2 percent of GDP.
  - Court-mandated compensation for past pension and wage cuts would be a one-off expense of 0.8–1.5 percent of GDP.
  - Long-run demographic ageing could add 5–6 percent of GDP to public spending by 2060 absent pension reform.
  - Lithuania’s tax-to-GDP ratio: around 26 percent of GDP.
  - Estimated share of the shadow economy: 28.5 percent of GDP.

### Policy priorities and recommendations
- Fiscal policy:
  - Continue disciplined consolidation and raise quality of public spending.
  - If 2013 fiscal overperformance confirmed, a further moderate deficit reduction of ½ percent of GDP in structural terms in 2014 would suffice to ensure steady progress toward the MTO.
  - 2014 budget targets a deficit of 1.9 percent of GDP; 2013 deficit estimated in the range 2 to 2½ percent of GDP, with 2.1 percent of GDP staff’s best point estimate.
  - Recommended medium-run strategy: temporarily drive consolidation beyond the MTO; remaining consolidation should preferably come from the revenue side and by reviewing spending quality.
  - Suggested revenue measures: recurrent wealth and capital taxation; conduct a public expenditure review; pension reform and tax administration improvements to address demographic aging costs.
  - Spread compensation schemes for past pension and wage cuts over time to avoid spikes in borrowing.
  - Strengthen local government fiscal controls: hard budget constraints on local debt and borrowing limits; independent scrutiny of local finances.
- Financial sector:
  - Ensure sufficient credit to fund productive investment while preserving financial stability.
  - Continue close monitoring of credit developments; further improve insolvency frameworks; foster alternative financing sources such as capital market development and leasing.
  - Complete reforms for credit unions; participate in AQR; prepare for SSM/SRM participation and transposition of CRD IV.
- Structural reforms:
  - Raise economic efficiency and support income convergence: preserve cost competitiveness gains; address direct obstacles to global value chain involvement; improve business climate; reform labor code and social security taxation; foster return of emigrants and ease labor market access for non-EU citizens.
  - Upgrade energy and transportation infrastructure in a regional strategic plan to share costs and exploit synergies.
  - Advance governance reform of state-owned and municipally-owned enterprises to improve board independence and return-on-equity targets.

### Implementation of past Fund advice and authorities’ stance
- Implementation highlights:
  - Authorities advanced fiscal consolidation and appear to have met euro entry fiscal deficit criterion with a good safety margin.
  - Consolidation remains biased to the expenditure side; suggestions for higher recurrent taxation of wealth and property remain under discussion.
  - Authorities intervened and closed two largest domestic banks; attention turned to small credit union sector reform with MCM technical assistance.
  - Steps taken to improve business climate, including simplification of territorial planning rules; migration policies under consideration.
- Authorities’ stance:
  - Authorities broadly shared staff’s outlook and risks; Ministry of Finance projects medium-term growth some ½ percent higher than staff and sees slightly lower inflation.
  - Authorities feel ready and are firmly committed to euro adoption; Bank of Lithuania emphasizes importance of forthcoming macroprudential policy tools.
  - Ministry of Finance committed to full alignment of fiscal framework with EU and euro area requirements; work on an explicit countercyclical fiscal rule appears planned for later.

*Source: IMF staff report — Republic of Lithuania: 1. External Stability Assessment.*

### 1. External Stability Assessment ____________________________________________________________________6

### 1. External Stability Assessment

### Context
- The authorities remain on track with public finance repair and meeting conditions for euro adoption.
- Political context:
  - Four-party coalition led by the Social Democrats since late 2012 limits scope for bold reforms.
  - Two key projects advancing: (i) Prime Minister Butkevicius has staked his political survival on successfully adopting the euro next year, (ii) fiscal consolidation is moving further ahead, with the public debt ratio now on the verge of starting to decline.
  - Presidential and European elections are due in May. Incumbent President Grybauskaite is running as an independent and is leading opinion polls by a large margin.
- Income convergence and labor market:
  - Lithuania’s per capita GDP has advanced to only one-third of Western Europe’s.
  - Unemployment is 11.4 percent.
  - Demographic headwinds and diminishing dividends from macro adjustment place emphasis on structural reforms and consistently high investment.

### Recent Developments
- Growth and demand:
  - Real GDP expanded by 3.3 percent in 2013, driven largely by domestic demand.
  - Output is set to surpass its 2008 peak for the first time this year.
  - Investment rebounded on the back of high capacity utilization, more public investment, and a recovery in construction.
  - Export growth slowed in the second half of 2013 due to softer trading partner demand and weaker agricultural exports after the 2012 bumper harvest.
  - Unemployment continued to fall, including for youth and the longer-term unemployed.
- Inflation:
  - Average inflation moderated from 3.2 percent in 2012 to 1.2 percent in 2013.
  - Average core inflation ran at 1.4 percent in 2013.
  - Minimum wage increases: cumulative 25 percent from July 2012 and January 2013 one-off increases contributed to wage dynamics.
- External sector and EU funds:
  - Current account in slight surplus in 2013.
  - Lithuania contracted 99 percent of EU funds from the 2007–13 framework and 75 percent paid as of end-2013.
  - International reserve coverage appears relatively low at some 70 percent of the Fund’s reserve metric.

### External Stability Assessment (Box 1)
- Real effective exchange rate:
  - Estimates indicate the real effective exchange rate is broadly in line with fundamentals.
  - Results of assessment approaches: Macro balance (gap) = -4.8; Equilibrium real ER approach = 2.2; External sustain. approach = -4.8. (Table: Over (+)/under(-)valuation)
- Current account and projections:
  - The current account is broadly balanced.
  - Staff projects the current account to swing into a deficit on the order of 1½–2 percent of GDP over the medium term as income levels converge with Western Europe. It would be more than fully covered by FDI.
- External debt and IIP:
  - Gross external debt stood at 65 percent of GDP.
  - Private external debt relative to GDP and gross external debt relative to exports remain below customary vulnerability thresholds.
  - A significant share of external debt is owed to foreign parent companies and foreign banks.
  - The international investment position stands at negative 46 percent of GDP, explained by excess inward over outward FDI and net parent bank funding.
- Reserves adequacy:
  - International reserves stood at €6 billion at end-2013, compared to an adequacy metric of €8.9 billion.
  - Reserves related metrics: 17 percent of GDP; 2½ months of imports.
  - Note: euro adoption would remove remaining reserve-related vulnerability.

### Fiscal Developments and Constitutional Court Rulings
- Fiscal outcomes:
  - The 2013 fiscal deficit likely overperformed its 2½ percent of GDP target; estimated 2.1 percent of GDP deficit in 2013.
  - The EC’s Excessive Deficit Procedure was abrogated in June 2013 based on the 3.2-percent-of-GDP deficit in 2012.
  - The 2014 budget targets a deficit of 1.9 percent of GDP for the general government.
  - The 2014 budget foregoes generalized pension and wage increases; other expenditure allowed to grow roughly in line with nominal GDP; no significant tax policy changes envisaged.
- Constitutional Court rulings (Box 2):
  - Background: 2008/09 crisis cuts to government wages and pensions were larger and disproportionate for higher-wage and higher-pension earners.
  - Decisions: Two rulings established the disproportionality was unconstitutional and mandated reversal and compensation for disproportionate cuts. Modalities and timing not precisely specified.
  - Status and budgetary implications:
    - Pension restoration: LTL 34 million in 2013 and additional LTL 211 million in 2014 (0.19 ppt of GDP in total) — restored in Oct 2013 (July 2013 CCR).
    - Pension compensation: 0.2-0.6 ppt of GDP (April 2010 CCR; postponed compensation not unconstitutional; no concrete timetable specified).
    - Wage restoration: LTL 500 million (or 0.5 ppt of GDP) — restored in 2012 (April 2010 CCR reiterated in Feb 2012).
    - Wage compensation: 0.6-0.9 ppt of GDP — compensation envisaged to begin in late 2014.
  - Once compensation payments are approved by Parliament, their full amount will be immediately recognized as public expenditure, increasing the accrual fiscal deficit as calculated by Eurostat. As a one-off, it would not affect the structural fiscal balance and may be excluded or discounted when assessing compliance with SGP deficit limits.

### Financial Sector
- System structure and soundness:
  - Over 90 percent of the banking system is owned by Nordic cross-border banking groups.
  - Capital adequacy rose to 17½ percent at end-2013.
  - Liquidity indicators are well ahead of regulatory minima.
  - Some smaller banks would benefit from larger capital buffers; credit unions need reform but are small and not material risk to overall stability.
- Credit conditions:
  - Despite progress in reducing non-performing loans, private sector credit has yet to return decisively to positive growth.
  - Constraints include post-crisis risk aversion by borrowers and banks, and household debt overhang.

### Outlook and Risks
- Growth outlook:
  - Growth is expected to pick up from 3.3 percent in 2013 to 3¾ percent in the medium term and to remain balanced.
  - Output gap expected to close in 2014; potential growth projected to rise to some 3¾ percent over time.
  - Staff projects a small medium-term current account deficit as income converges; slight pickup in inflation from current historical lows.
- Risks (tilted to the downside, mainly external):
  - Primary external risks: protracted low growth in advanced and emerging economies; increasing geopolitical tensions surrounding Ukraine; tighter global financial conditions.
  - Domestic risk: protracted lack of credit growth could curtail investment.
  - Exchange of views: authorities broadly shared staff’s outlook and risks; ministry of finance projects medium-term growth some ½ percent higher than staff and sees slightly lower inflation.
- Risk Assessment Matrix (selected entries):
  - Side-effects from global financial conditions: Relative Likelihood = High; Impact = Low. (UMP exit may lead to economic and fiscal stress; borrowing costs could rise; parent bank funding and credit could tighten.)
  - Protracted period of slower growth in advanced and emerging economies: Relative Likelihood = High (in Europe); Impact = Medium. (Trade channel significant; exports account for some 80 percent of GDP.)
  - Financial stress in the Euro area re-emerges: Relative Likelihood = Medium; Impact = Low/Medium.
  - Increasing geopolitical tensions surrounding Ukraine: Relative Likelihood = Medium; Impact = High. (Russia is an important export market and the only natural gas supplier.)
  - Protracted period of unduly low credit growth: Relative Likelihood = Medium; Impact = Medium/High.

### Policy Discussions and Implementation of Past Fund Advice
- Key policy priorities discussed:
  - Planned euro adoption and strengthening of policy frameworks.
  - Fiscal policy: continue disciplined consolidation and raise quality of public spending.
  - Financial sector: ensure sufficient credit to fund productive investment given financial stability.
  - Structural reforms to raise economic efficiency and support income convergence.
- Implementation of past Fund advice (Box 3):
  - Fiscal policy:
    - Authorities advanced fiscal consolidation and appear to have met the euro entry fiscal deficit criterion with a good safety margin.
    - Consolidation remains biased to the expenditure side.
    - Suggestions for higher recurrent taxation of wealth and property remain under discussion.
  - Financial sector policy:
    - Authorities intervened and closed the two largest domestic banks, removing risks to financial stability.
    - Attention has turned to small credit union sector reform; MCM provided technical assistance.
  - Structural policy:
    - Authorities aim to preserve price competitiveness gains from post-crisis adjustment.
    - Steps taken to improve the business climate, including simplification of territorial planning rules.
    - Migration policies to address demographic aging are under consideration.
    - Some progress with improving frameworks to work out debt.

*Source: IMF staff report — Republic of Lithuania: 1. External Stability Assessment.*

### 13.      Lithuania appears on track to meet the

### _cr14113 - 13.      Lithuania appears on track to meet the

### Euro adoption and convergence assessment
- Lithuania appears on track to meet the entry criteria for euro adoption.
- Fiscal deficit and public debt are well below Maastricht thresholds.
- The exchange rate has long been fixed under the currency board arrangement.
- Inflation and interest rates run at less than the reference values—the average of the three “best-performing” EU economies plus a margin of 1.5 and 2 percentage points, respectively.
- European institutions will take a final decision on Lithuania’s euro adoption application in July, based on the convergence reports of the EC and the ECB, to be published in June.

### Readiness and recommended strengthening of policy frameworks
- After two decades of a currency board arrangement, the economy is well prepared for EMU, but supporting policy frameworks would benefit from further strengthening.
- Lithuania demonstrated flexibility during shocks (2008/09 crisis, Russia crisis of 1998, re-peg in 2002) but experienced a large boom-bust cycle during 2003–10.
- Key recommended reforms:
  - Fiscal framework: Strengthen Fiscal Compact implementation and supplement with a countercyclical fiscal rule to build buffers in good times and allow stabilizers to operate in downturns; integrate the rule with the compact’s correction mechanism to avoid inconsistencies; expedite establishment of a fiscal council in the National Audit Office.
  - Financial framework: Establish macro-prudential powers for the Bank of Lithuania (legislation currently before Parliament) to lean against financial cycles; preserve and build Nordic-Baltic cooperation forums and adapt them to the emerging European banking union; ensure close home-host cooperation for cross-border banks.
  - Restructuring and insolvency: Implement tangible reforms already underway; speedier and more widespread use of the household insolvency law (came into effect in early 2013) is desirable; recent corporate insolvency changes help but limited effectiveness for going-concern restructurings remains to be addressed.
  - Labor market: Safeguard and build on labor market flexibility; address skill mismatches, overly restrictive labor code provisions, and high tax wedge that contribute to high structural unemployment.

### Benefits of euro adoption
- Euro adoption would replace a relatively low reserve cover with access to ECB liquidity, enhancing financial stability and putting downward pressure on risk premiums.
- Closer integration with the euro area could help foster trade, involvement in global value chains, and foreign direct investment, supporting a vibrant export sector.

### Authorities’ stance
- Authorities feel ready and are firmly committed to euro adoption; they see no tangible risk of undue relaxation of policies.
- Bank of Lithuania emphasizes importance of forthcoming macroprudential policy tools; effectiveness will be enhanced by improved home-host cooperation under the European banking union.
- Ministry of Finance committed to full alignment of fiscal framework with EU and euro area requirements; work on an explicit countercyclical fiscal rule appears planned for later.

### Box 4 — Sustainability of Low Inflation (key findings and projections)
- Lithuania’s annual average inflation differential to the euro area (EA) since 1999: 0.8 percentage points.
- This differential is one-third that of Latvia and less than half that of Estonia.
- Since mid-2013, inflation converged to EA levels and the differential turned negative in mid-2013.
- Balassa-Samuelson (BS) effect estimates:
  - Simple accounting places BS effect at about 0.7 percentage points (73 percent of the observed inflation differential with the EA since 2000).
  - Econometric estimates suggest a long-run BS effect of some 1.1 percentage points annually.
- Short-run shock impacts on Lithuania’s inflation differential with the EA (short-run impact of a one-std deviation shock):
  - Commodity prices: 0.2 percentage points.
  - Output gap: 0.4 percentage points.
  - Real wages: 0.5 percentage points.
- Econometric evidence suggests an annual inflation differential of about 0.7 percentage points vis-à-vis the EA over the next five years, contingent on maintaining policy discipline and supporting frameworks.
- A potential one-off inflationary impact from the switch to the euro: 0.2 to 0.4 percentage points.

### Box 5 — Fiscal Sustainability (key findings and risks)
- Public debt before the 2008/09 crisis: 15 percent of GDP.
- Deficit in 2009 recession: 9.4 percent of GDP.
- Exit from EDP: spring 2013; deficit near 2 percent of GDP for 2013.
- Public debt stabilized at some 40 percent of GDP and would gently decline even in a passive scenario with no further consolidation beyond the 2014 budget.
- Government loans to the deposit insurance fund related to two bank interventions (Snoras and Ukio) are likely to be repaid and are relatively modest at around 2 percent of GDP.
- Court-mandated compensation for past pension and wage cuts would be a one-off expense of 0.8–1.5 percent of GDP.
- Long-run demographic ageing could add 5–6 percent of GDP to public spending by 2060 in the absence of pension reform.
- Lithuania’s tax-to-GDP ratio: around 26 percent of GDP (the lowest in the EU).
  - This is some 13, 6, and 4 percentage points of GDP lower than the EU, CEE, and other Baltics averages, respectively.
- Estimated share of the shadow economy: 28.5 percent of GDP.

### Completing public finance repair and policy guidance
- If fiscal overperformance in 2013 is confirmed, a further moderate deficit reduction of ½ percent of GDP in structural terms in 2014 would be sufficient to ensure steady progress toward the medium-term objective (MTO).
- The 2014 budget targets a deficit of 1.9 percent of GDP; the 2013 deficit is estimated in the range 2 to 2½ percent of GDP, with 2.1 percent of GDP being staff’s best point estimate.
- Recommendation for the medium run: temporarily drive consolidation beyond the MTO (authorities’ 2013 convergence report sets a structural deficit of 1 percent of GDP).
- Remaining consolidation should preferably come from the revenue side and by reviewing spending quality.
  - Suggested revenue measures include recurrent wealth and capital taxation.
  - Conduct a public expenditure review to identify areas where cuts went too far and where slack remains.
  - Pension reform and tax administration improvements are key to address demographic aging costs.
- Compensation schemes for past pension and wage cuts should be spread over time to avoid spikes in borrowing.
- Local government finances:
  - Local governments account for 9 percent of public spending (2.7 percent of GDP) and 4.1 percent of public debt (1.6 percent of GDP).
  - Stock of local government arrears: 1 percent of GDP.
  - Debt and borrowing limits for local governments are soft and frequently adjusted; breaches remain essentially unsanctioned.
  - Recommendations: hard budget constraints on local debt and borrowing limits, and independent scrutiny of local finances.

### Financial system repair and credit conditions
- Non-performing loan ratios reduced from a peak of 20 percent to 11 percent.
- One major bank reported it will essentially be done addressing the aftermath of the crisis in the course of 2014.
- Loan-to-deposit ratios fell to 107 percent.
- Small credit union sector: 2 percent of financial sector assets; governance and competency issues are being tackled.
- Private sector credit shows only tepid signs of recovery; real private sector credit growth has not turned positive yet.
- Causes of weak credit: both demand and supply factors, strong risk aversion among borrowers and banks; banks focus on large, successful firms, leaving SMEs and new companies underserved.
- Policy suggestions: continue close monitoring of credit developments; further improve insolvency frameworks; foster alternative financing sources such as capital market development and leasing.

*International Monetary Fund — Republic of Lithuania mission text*

### 25.      The authorities broadly agreed with staff’s assessment of the financial sector. They felt

### _cr14113 - 25.      The authorities broadly agreed with staff’s assessment of the financial sector. They felt

### Financial sector assessment
- Authorities broadly agreed with staff that the financial sector is characterized by a high degree of stability, following the successful intervention of two domestic banks in 2011 and 2013.
- Remaining areas of softness:
  - Credit union sector: a consultation paper on fundamental credit union reform had been issued; the four most problematic credit unions (out of a total of some 80 credit unions) have been closed in the past two years.
- Authorities intend to participate in the Asset Quality Review ahead of planned euro adoption.
- Observations on credit, capital markets:
  - Progress in reducing NPLs and loan-to-deposit ratios improved prospects for a resumption of credit growth, but investment could be hampered if credit growth failed to materialize in the not-too-distant future.
  - Capital markets play only a marginal financing role, in part due to shallow domestic markets failing to attract investor interest.
  - Efforts to complete regional integration of Baltic exchanges are underway.

### Advancing structural reform to further income convergence — role of exports
- Exports were a key driver of the post-2009 recovery and correction of large current account deficits.
- Lithuania has been gaining global market share, upgrading product quality, and reorienting away from traditional CIS markets.
- Constraints on future export-led growth:
  - Success relied to a large extent on labor intensive exports.
  - Involvement in global value chains has been more limited.
  - Demographic aging is becoming more acute.
- Policy priorities to sustain export competitiveness:
  - Preserve cost competitiveness gains instrumental for the post-crisis surge in exports.
  - Address direct obstacles to global value chain involvement.
  - Implement more general structural reforms to: make the most of labor resources, upgrade key infrastructure, further advance the business climate, and tap synergies from regional cooperation.

### Labor market and human capital
- Current unemployment and structural issues:
  - Current unemployment rate is 11.4 percent and is assessed as essentially entirely structural.
  - Strong wage pressures emerge at materially lower unemployment rates.
- Education and skills:
  - Lithuania features one of the highest tertiary education rates in the EU, but many graduates work in fields other than those of their study, emigrate, or take up work below their qualifications.
- Social benefits, taxation, and labor code:
  - Unemployment benefits are moderate by OECD standards, but uncontrolled tapping of multiple benefit programs and relatively high labor taxation could create unemployment traps.
  - Labor code constraints include forbidding more than 8 hours of overtime per week and 120 hours per year, stipulating rather generous severance pay, and unduly restricting temporary work arrangements.
  - Recommendations: comprehensive tax and pension reform to embed reductions in social security taxes as fiscally neutral; reform the labor code; improve management of out-of-work benefits.
- Labor supply augmentation:
  - Foster return of emigrants and ease labor market access for non-EU citizens.
- Institutional actions underway:
  - A working group for a revamp of the labor code has been formed.
  - Government recently adopted broad guidelines for migration policies.
  - Comprehensive reform of social security taxation to be considered only after completion of euro adoption.

### Infrastructure and energy
- Priority to upgrade energy and transportation infrastructure.
- Projects underway in gas, electricity, and rail sectors.
- Energy context:
  - Russia is currently the sole supplier of natural gas, and also an important provider of oil and electricity.
  - Energy prices are high and scope for effective downstream competition is limited.
  - Key projects such as the LNG terminal will become operational by year end.
- Rail context:
  - Railroad infrastructure is well suited for trade with the CIS, but there are few north-south lines and tracks with Western European gauge.
- Recommendation: carry out projects in the context of a regional strategic plan to share costs, exploit synergies, reduce user costs, and increase economic efficiency.

### State-owned and municipally-owned enterprises
- Governance reform of state-owned enterprises has been initiated.
- Policy actions recommended:
  - Push governance reform forward to achieve more independent directors on enterprise boards and faster progress toward return-on-equity targets.
  - Broaden reform to cover municipally-owned enterprises, given their role in infrastructure projects.

### Staff appraisal — macroeconomic trajectory and euro adoption
- Growth and convergence:
  - The economy has entered a broadly favorable trajectory of healthy and balanced growth.
  - Output expanding at 3–3½ percent; peak income levels of 2008 are set to be surpassed this year.
  - Large income gap with Western Europe remains; structural reforms are needed to modernize the economy.
- Euro adoption:
  - Euro adoption in 2015 would be the next logical step on Lithuania’s European integration path.
  - Benefits of euro adoption: remove vulnerability of low international reserve coverage, reduce risk premiums by strengthening financial stability, and bring integration gains from fostering trade, FDI, and global-value-chain involvement.
  - Lithuania seems ready for euro adoption in terms of meeting entry criteria, sustainability of low inflation and public finances, and external stability.
- Policy framework gaps and improvements:
  - Two decades under a currency board show Lithuania’s ability to adjust without independent monetary policy, but business-cycle control was poor.
  - Address gaps with strengthening macroprudential policy tools and transposition of the fiscal compact.
  - A mechanism to reliably build fiscal buffers in economic upswings is still missing.

### Fiscal stance and public finances
- Progress and remaining tasks:
  - Much progress made in restoring healthy public finances; fiscal deficit comfortably below Maastricht limits and public debt ratio stabilizing.
  - Medium-term objective of a broadly balanced budget not yet reached; ability to materially reduce the debt ratio remains to be demonstrated.
- Policy recommendations:
  - Continue consolidation, preferably from the revenue side with more reliance on underdeveloped recurrent taxation of wealth and capital.
  - Conduct a public expenditure review to ensure the tight spending envelope is efficiently used and sustainable.

### Financial stability, credit recovery, and structural reforms for investment
- Financial stability:
  - Strengthened further with rising bank capitalization and the intervention of two insolvent banks in 2011 and 2013.
  - Remaining weaknesses, such as in the small credit union sector, are being addressed.
- Credit recovery risks:
  - Delays in the recovery of credit are a potential area of concern requiring close monitoring.
  - Progress with reducing non-performing loans and well contained loan-to-deposit ratios should help, but credit recovery has yet to materialize and is delayed by historical standards.
  - If credit recovery remains elusive for much longer, investment critical for modernization could be constrained.
- Recommended actions:
  - Further strengthen insolvency and restructuring regimes.
  - Foster capital market development.

*Source: IMF staff report content provided in the input.*

### 39.      It is recommended that the next Article IV Consultation be held on the twelve-month

### _cr14113 - 39.      It is recommended that the next Article IV Consultation be held on the twelve-month

### Recommendation
- It is recommended that the next Article IV Consultation be held on the twelve-month cycle.

### Real Sector Developments
- GDP growth remained robust despite slowing export growth, as domestic consumption remained strong and industrial production recovered after a slowdown in mid-year.
- Contributions to GDP growth (YoY, percent) depicted components: Private consumption, Government consumption, Gross fixed capital formation, Changes in inventory, Net exports, GDP.
- Trade of goods excluding mineral products (YoY percent change) shows exports and imports series (monthly observations from Jan-12 to Jan-14).
- Retail sales excluding autos and motorcycles (YoY percentage change) series (Feb-12 to Feb-14) with smoothing: Retail sales, SA YoY (3-month smoothed).
- Industrial production excluding refined petroleum products (YoY percent change) series with manufacturing excluding refined petroleum products and IP manufacturing SA YoY (3-month smoothed).
- Investment is rebounding and production expectations are improving; Production Expectations (YoY percent change, 3MMA) series ranges from Feb-10 to Feb-14.
- Real growth in gross fixed capital formation components (YoY percent change): Gross fixed capital formation, Dwellings, Other buildings and structures, Other machinery and equipment (Mar-12 to Dec-13).

### Labor Market and Competitiveness Developments
- Unemployment continues to fall but remains high, especially for youth.
- Unemployment rate by sex and duration (percent, NSA, Labor Force Survey): series for Male, Female, Long-term (>1y), Youth (below 25) (Mar-10 to Dec-13).
- Employment and unemployment rate (percent, NSA, Labor Force Survey): unemployment rate and employment rate (RHS) series (Sep-08 to Sep-13).
- Average monthly gross earnings (2008Q1=100, SA) shown for Public sector and Private sector (Mar-10 to Dec-13).
- Average monthly gross real earnings growth rate (YoY, SA, percent) shows Public sector and Private sector (Sep-10 to Dec-13); nominal wages increasing especially in private sector and real wage growth turned positive.
- Real Effective Exchange Rate (REER) (ULC and HCPI based, Q1 2004=100) series for Economy-wide (ULC), Manufacturing (ULC), Economy-wide (HCPI) (Jun-06 to Jun-13): ULC-based REER increased somewhat but remains well below peak levels.
- REER in Selected Countries (ULC manufacturing based, Q1 2004 = 100) series includes Lithuania, Estonia, Latvia, Germany (Jun-06 to Jun-13).

### Banking Sector Developments
- External funding reductions have been small since mid-2012; deposits have continued to increase moderately.
- Credit may be staging a tepid recovery.
- Rising interest rates on new lending are supporting interest margins and profitability.
- Non-performing loans (NPLs) continue to decline.
- Banks' external liabilities (Billions of Euro) series (Feb-10 to Feb-14).
- Deposits of corporations and households (Billions of Euro): Litas Deposits and FX Deposits (Feb-10 to Feb-14).
- Credit stock (YoY percent change) series shows private sector credit to corporations and to households (Feb-10 to Feb-14); note: effect of Snoras bank crupcy.
- Interest Margins (Percent) and Interest rates: new loans (RHS) series (Mar-10 to Dec-13).
- Return on Assets (Percent) series (2006–2013) and Non-performing Loans (Percent of corresponding portfolio) series for Total loans, Business loans, Consumer loans (non-housing) (Mar-10 to Dec-13).
- Selected numeric indicators from Table 5 (banking system, Dec-07 to Dec-13):
  - Regulatory capital to risk-weighted assets: 9/10.9 11.6 12.9 14.8 14.2 15.7 17.6
  - Regulatory Tier 1 capital to risk-weighted assets: 9/7.7 9.1 9.3 10.8 12.0 14.6 17.1
  - Capital to assets: 7.9 8.9 9.4 10.9 10.2 11.4 11.5
  - Nonperforming loans to total (non-interbank) loans: .. 4.7 19.7 19.9 16.6 13.6 11.0
  - RoE: 25.9 11.8 -50.8 -3.9 15.8 7.7 8.9
  - RoA: 1.7 0.8 -3.8 -0.3 1.4 0.9 1.0
  - Customer deposits to total non-interbank loans: 66.4 56.8 68.6 82.2 80.6 85.8 93.3

### Fiscal Sector Developments
- Central government cumulative cash deficit continued to improve in 2013, reflecting strict expenditure restraint and revenue overperformance, especially after tax collection improved from May.
- The Social Security (Sodra) deficit overperformed due to favorable revenue developments.
- Cumulative central government balance (Percent of Annual GDP) series for 2011, 2012, 2013, 2014 shown monthly.
- Cumulative Sodra Deficit (Percent of annual GDP) series for 2011–2014 shown monthly.
- Revenues (Billions of Litas) and Taxes (Billions of Litas) series for 2011–2014 shown monthly; Total Primary Expenditures (Billions of Litas) series for 2011–2014.
- Table 2: General Government Operations (ESA 95 aggregates, in percent of GDP), selected lines (2011–2019 projections):
  - Revenue: 33.2 32.7 33.0 33.0 33.0 32.6 32.5 32.5 32.6
  - Revenue excluding EU grants: 30.0 29.9 30.3 30.3 30.4 30.5 30.5 30.5 30.6
  - Tax revenue: 15.9 16.0 16.0 16.0 16.0 16.1 16.2 16.3 16.4
    - Personal income tax: 3.5 3.5 3.6 3.6 3.6 3.6 3.6 3.6 3.6
    - Corporate income tax: 0.8 1.3 1.4 1.4 1.4 1.4 1.4 1.4 1.4
    - VAT: 7.8 7.5 7.5 7.5 7.4 7.5 7.5 7.6 7.7
  - Social contributions: 11.6 11.3 11.8 11.8 11.8 11.8 11.7 11.6 11.6
  - Grants: 3.2 2.8 2.7 2.7 2.6 2.1 2.0 2.0 2.0
  - Total expenditure: 38.7 35.9 35.2 34.9 34.8 34.4 34.2 34.1 34.1
  - Net lending (+) / borrowing (-): -5.5 -3.2 -2.1 -1.9 -1.8 -1.8 -1.7 -1.6 -1.5
  - General government debt (Maastricht def.): 39.2 41.0 39.3 39.5 39.1 38.6 37.8 37.0 36.0

### Summary Economic Indicators and Projections (Table 1 highlights)
- Output:
  - Real GDP growth (annual percentage change): 6.0 3.7 3.3 3.3 3.5 3.6 3.7 3.8 3.8
  - Domestic demand growth (YoY, percent): 6.4 -0.9 3.4 3.9 4.2 4.2 4.1 4.2 4.2
  - Private consumption growth (YoY, percent): 4.8 3.9 4.8 3.2 3.2 3.4 3.4 3.4 3.4
  - Domestic fixed investment growth (YoY, percent): 20.7 -3.6 12.8 7.0 6.3 6.4 5.5 5.4 5.3
  - Nominal GDP (in billions of litai): 106.9 113.7 119.5 124.9 132.3 140.7 150.3 160.9 172.1
  - GDP (in billions of euros): 31.0 32.9 34.6 36.2 38.3 40.8 43.5 46.6 49.9
- Prices:
  - CPI, end of period (YoY % change): 3.5 2.9 0.5 1.7 1.8 2.1 2.2 2.2 2.2
  - GDP deflator (YoY % change): 5.4 2.6 1.7 1.2 2.4 2.7 3.0 3.1 3.1
- Employment:
  - Unemployment rate (year average, percent): 15.4 13.4 11.8 10.8 10.5 10.5 10.5 10.5 10.5
  - Average monthly gross earnings (annual % change): 2.2 2.6 5.0 3.8 5.3 5.7 5.8 6.1 6.6
- External sector:
  - Current account balance (percent of GDP): -3.7 -0.2 1.5 0.6 0.2 -0.5 -0.8 -1.2 -1.6
  - Current account balance (billions of euros): -1.2 -0.1 0.5 0.2 0.1 -0.2 -0.4 -0.6 -0.8
  - Exports of goods and services (volume change, percent): 14.1 11.8 9.5 5.7 6.1 6.1 6.2 6.4 6.4
  - Imports of goods and services (volume change, percent): 13.7 6.1 9.8 6.6 7.1 6.9 6.8 7.0 6.9
  - Gross official reserves (in billions of euros): 6.4 6.5 6.0 6.4 6.8 7.0 7.2 7.3 7.2
  - Gross external debt: 76.9 70.9 64.5 62.1 59.6 57.0 54.3 51.6 49.0
- Public finances:
  - Revenue (percent of GDP): 33.2 32.7 33.0 33.0 33.0 32.6 32.5 32.5 32.6
  - Expenditure (percent of GDP): 38.7 35.9 35.2 34.9 34.8 34.4 34.2 34.1 34.1
  - Fiscal balance (percent of GDP): -5.5 -3.2 -2.1 -1.9 -1.8 -1.8 -1.7 -1.6 -1.5
  - General government gross debt (percent of GDP): 39.2 41.0 39.3 39.5 39.1 38.6 37.8 37.0 36.0

### Balance of Payments (Table 3 highlights, Billions of Euro)
- Current account balance: -1.2 -0.1 0.5 0.2 0.1 -0.2 -0.4 -0.6 -0.8 (2011–2019)
- Exports (f.o.b.): 20.2 23.0 24.7 25.1 25.6 26.4 27.3 28.2 29.3
- Imports (f.o.b.): -22.0 -24.0 -25.9 -26.6 -27.2 -28.2 -29.1 -30.2 -31.2
- Capital and financial account balance: 2.5 0.2 -1.0 0.2 0.3 0.4 0.5 0.7 0.7
- Foreign direct investment balance: 1.0 0.2 0.3 0.4 0.6 0.7 0.8 1.0 1.1
- Gross international reserves (GIR, billions of Euros): 6.4 6.5 6.0 6.4 6.8 7.0 7.2 7.3 7.2
- Net international investment position: -52.3 -52.8 -45.8 -41.5 -37.6 -34.6 -32.1 -30.1 -28.7

*Source: REPUBLIC OF LITHUANIA — INTERNATIONAL MONETARY FUND, _cr14113 (figures, tables, and text excerpts contained in the provided content).*

### Annex Figure 1A. Lithuania: External Debt Sustainability Analysis: Bound Tests 1/2/

### Annex Figure 1A. Lithuania: External Debt Sustainability Analysis: Bound Tests 1/2/

### Bound tests and shock scenarios
- Interest rate shock panel: labels and values appearing in figure: "i-rate", "51", "Basel in e", "49".
- Historical, Baseline and Scenario panels show series labels and year axis: "2009 2011 2013 2015 2017 2019".
- Individual scenario markers and boxed averages from figure:
  - Historical: "68"
  - Baseline: "49"
  - Combined shock: "65"
  - Combined shock with 30% depreciation: "71"
  - CA shock: "68"
  - Growth shock: "61"
- Baseline gross financing need under baseline shown on right scale (label present).
- Growth shock units: "Growth shock (in percent per year)".
- Non-interest current account shock units: "Non-interest current account shock (in percent of GDP)".
- Baseline / Scenario / Historical numeric labels reported in figure text:
  - Baseline: "2.9", Scenario: "3.4", Historical: "4.3"
  - Baseline: "3.6", Scenario: "-0.1", Historical: "4.2"
  - Baseline: "1.0", Scenario: "-2.2", Historical: "-3.4"

### Key notes on methodology (figure footnotes)
- Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.
- For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.
- Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.
- One-time real depreciation of 30 percent occurs in 2014.

### Annex Table 1A — External Debt Sustainability Framework, 2008–19 (selected rows, in percent of GDP unless otherwise indicated)
- Debt-stabilizing non-interest current account: "-3.1"
- Baseline: External debt:
  - 2008: "71.0"
  - 2009: "84.2"
  - 2010: "81.6"
  - 2011: "76.9"
  - 2012: "70.9"
  - 2013: "64.5"
  - 2014: "62.1"
  - 2015: "59.6"
  - 2016: "57.0"
  - 2017: "54.3"
  - 2018: "51.6"
  - 2019: "49.0"
- Change in external debt:
  - 2008: "-0.5"
  - 2009: "13.2"
  - 2010: "-2.5"
  - 2011: "-4.7"
  - 2012: "-6.0"
  - 2013: "-6.5"
  - 2014: "-2.3"
  - 2015: "-2.5"
  - 2016: "-2.6"
  - 2017: "-2.7"
  - 2018: "-2.7"
  - 2019: "-2.7"
- Identified external debt-creating flows (4+8+9):
  - 2008: "3.4"
  - 2009: "11.5"
  - 2010: "-3.0"
  - 2011: "-7.2"
  - 2012: "-4.0"
  - 2013: "-4.1"
  - 2014: "-3.3"
  - 2015: "-3.1"
  - 2016: "-2.6"
  - 2017: "-2.4"
  - 2018: "-2.1"
  - 2019: "-1.8"
- Current account deficit, excluding interest payments:
  - 2008: "9.6"
  - 2009: "-9.8"
  - 2010: "-2.8"
  - 2011: "1.0"
  - 2012: "-2.5"
  - 2013: "-3.8"
  - 2014: "-2.4"
  - 2015: "-1.6"
  - 2016: "-1.0"
  - 2017: "-0.7"
  - 2018: "-0.4"
  - 2019: "-0.1"
- Deficit in balance of goods and services (selected years):
  - 2008: "11.7"
  - 2009: "1.7"
  - 2010: "1.9"
  - 2011: "2.6"
  - 2012: "-1.0"
  - 2013: "-1.1"
  - 2014: "-0.3"
  - 2015: "-0.1"
  - 2016: "0.1"
  - 2017: "0.2"
  - 2018: "0.2"
  - 2019: "0.2"
- Exports (percent of GDP):
  - 2008: "59.6"
  - 2009: "54.1"
  - 2010: "67.6"
  - 2011: "77.2"
  - 2012: "83.9"
  - 2013: "86.9"
  - 2014: "84.5"
  - 2015: "81.4"
  - 2016: "79.0"
  - 2017: "76.3"
  - 2018: "73.8"
  - 2019: "71.3"
- Imports (percent of GDP):
  - 2008: "71.3"
  - 2009: "55.8"
  - 2010: "69.5"
  - 2011: "79.8"
  - 2012: "82.9"
  - 2013: "85.8"
  - 2014: "84.2"
  - 2015: "81.3"
  - 2016: "79.1"
  - 2017: "76.5"
  - 2018: "74.0"
  - 2019: "71.5"
- Net non-debt creating capital inflows (negative):
  - 2008: "-1.4"
  - 2009: "-0.1"
  - 2010: "0.3"
  - 2011: "-2.4"
  - 2012: "0.4"
  - 2013: "-0.4"
  - 2014: "-0.7"
  - 2015: "-0.9"
  - 2016: "-1.1"
  - 2017: "-1.2"
  - 2018: "-1.4"
  - 2019: "-1.5"
- Net foreign direct investment, equity (selected inline values as presented): "1.31.00.82.90.2 0.71.01.21.41.51.71.8"
- Net portfolio investment, equity (selected years):
  - 2008: "0.1"
  - 2009: "-1.0"
  - 2010: "-1.1"
  - 2011: "-0.5"
  - 2012: "-0.6"
  - 2013: "-0.3"
  - 2014: "-0.3"
  - 2015: "-0.3"
  - 2016: "-0.3"
  - 2017: "-0.3"
  - 2018: "-0.3"
  - 2019: "-0.3"
- Automatic debt dynamics (contribution) 1/:
  - 2008: "-4.8"
  - 2009: "21.4"
  - 2010: "-0.5"
  - 2011: "-5.9"
  - 2012: "-1.9"
  - 2013: "0.1"
  - 2014: "-0.2"
  - 2015: "-0.6"
  - 2016: "-0.5"
  - 2017: "-0.4"
  - 2018: "-0.3"
  - 2019: "-0.1"
- Contribution from nominal interest rate:
  - 2008: "3.3"
  - 2009: "6.0"
  - 2010: "2.7"
  - 2011: "2.7"
  - 2012: "2.7"
  - 2013: "2.3"
  - 2014: "1.8"
  - 2015: "1.4"
  - 2016: "1.5"
  - 2017: "1.5"
  - 2018: "1.6"
  - 2019: "1.7"
- Contribution from real GDP growth:
  - 2008: "-1.8"
  - 2009: "12.8"
  - 2010: "-1.3"
  - 2011: "-4.4"
  - 2012: "-2.6"
  - 2013: "-2.2"
  - 2014: "-2.0"
  - 2015: "-2.0"
  - 2016: "-2.0"
  - 2017: "-2.0"
  - 2018: "-1.9"
  - 2019: "-1.8"
- Residual, incl. change in gross foreign assets (2-3):
  - 2008: "-4.0"
  - 2009: "1.7"
  - 2010: "0.4"
  - 2011: "2.5"
  - 2012: "-2.0"
  - 2013: "-2.3"
  - 2014: "0.9"
  - 2015: "0.6"
  - 2016: "0.0"
  - 2017: "-0.3"
  - 2018: "-0.6"
  - 2019: "-0.9"
- External debt-to-exports ratio (in percent):
  - 2008: "119.1"
  - 2009: "155.6"
  - 2010: "120.7"
  - 2011: "99.7"
  - 2012: "84.5"
  - 2013: "74.1"
  - 2014: "73.5"
  - 2015: "73.3"
  - 2016: "72.2"
  - 2017: "71.2"
  - 2018: "70.0"
  - 2019: "68.7"
- Gross external financing need (in billions of Euro) 4/:
  - 2008: "25.0"
  - 2009: "18.7"
  - 2010: "20.3"
  - 2011: "22.0"
  - 2012: "22.6"
  - 2013: "21.0"
  - 2014: "20.8"
  - 2015: "21.1"
  - 2016: "21.0"
  - 2017: "21.2"
  - 2018: "21.4"
  - 2019: "21.6"
- Gross external financing need (in percent of GDP):
  - 2008: "77.1"
  - 2009: "70.1"
  - 2010: "73.4"
  - 2011: "71.0"
  - 2012: "68.6"
  - 2013: "60.7"
  - 2014: "57.6"
  - 2015: "55.1"
  - 2016: "51.4"
  - 2017: "48.7"
  - 2018: "45.8"
  - 2019: "43.3"
- Scenario with key variables at their historical averages 5/ (selected values as printed):
  - "64.5", "65.5", "66.8", "67.7", "68.2", "68.5", "68.4", "-4.1"

### Key macroeconomic assumptions underlying baseline (selected series)
- Real GDP growth (in percent):
  - "2.9", "-14.8", "1.6", "6.0", "3.7", "3.3", "3.3", "3.5", "3.6", "3.7", "3.8", "3.8"
- GDP deflator in Euro (change in percent):
  - "9.6", "-3.4", "2.3", "5.4", "2.6", "1.7", "1.2", "2.4", "2.7", "3.0", "3.1", "3.1"
- Nominal external interest rate (in percent): "5.27.03.43.73.8 3.42.92.42.72.83.23.5"
- Growth of exports (Euro terms, in percent):
  - "25.1", "-25.3", "29.9", "27.5", "15.7", "8.8", "1.6", "2.0", "3.3", "3.2", "3.4", "3.4"
- Growth of imports (Euro terms, in percent):
  - "20.0", "-35.6", "29.5", "28.2", "10.6", "8.7", "2.6", "2.2", "3.6", "3.2", "3.5", "3.5"
- Current account balance, excluding interest payments:
  - "-9.6", "9.8", "2.8", "-1.0", "2.5", "3.8", "2.4", "1.6", "1.0", "0.7", "0.4", "0.1"
- Net non-debt creating capital inflows:
  - "1.4", "0.1", "-0.3", "2.4", "-0.4", "0.4", "0.7", "0.9", "1.1", "1.2", "1.4", "1.5"

### Methodological footnotes (preserved expressions)
- 1/ Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.
- 2/ The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).
- 3/ For projection, line includes the impact of price and exchange rate changes.
- 4/ Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.
- 5/ The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.
- 6/ Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

*Source: International Monetary Fund, Lithuanian authorities, and staff estimates.*

### 2002. Data provision to the Fund for surveillance purposes is considered adequate.

### 2002. Data provision to the Fund for surveillance purposes is considered adequate.

### National Accounts
- Compiled by Statistics Lithuania (SL) in accordance with the European System of Accounts 1995 (ESA 95).
- Quarterly GDP estimates at current and at constant prices are compiled using both the production and expenditure approaches.
- GDP estimates by production are considered more reliable than expenditure estimates; statistical discrepancies are included in estimates of changes in inventories (not shown separately).
- Annual and quarterly national accounts are compiled at previous year prices and chain-linked to 2000.
- Good data sources and sound methods are used, but:
  - Measuring activity during the volatile environment of the 2008/09 crisis proved challenging.
  - Difficulties remain in measuring economic activity of the informal sector.
- Informal sector measurement:
  - Estimates compiled at detailed levels of economic activity using fixed coefficients derived from benchmark surveys conducted in 1996 and 2003, and updated in 2006, and in 2011.
  - According to the most recent updates, the informal sector was estimated to be 13 percent of GDP in 2008.

### Price Statistics
- Since December 1998, CPI weights have been updated annually.
- The monthly CPI is available in the second week following the reference month.
- The producer price index is calculated according to the chain-linked Laspeyres formula with weights updated every year.

### Government Finance Statistics
- Central government budget execution data available monthly and quarterly, but subject to frequent revisions.
- An ongoing treasury project is expected to improve fiscal data quality substantially.
- Further work needed to clarify:
  - Treatment of public health care providers.
  - Treatment of EU transactions.
  - Consolidation procedure for government operations.
- A new classification incorporating the GFSM2001 was approved in mid-2003.
- Since then, the MoF has reported to STA general government’s annual data on an accrual and cash basis (except local governments, which are still on a cash basis) for publication in the Government Finance Statistics Yearbook (GFSY).
- MoF also reports quarterly and monthly data in the GFSM 2001 format for publication in the IFS.

### Monetary Statistics
- The Bank of Lithuania (BoL) reports monetary and financial statistics (MFS) to STA on a timely and regular basis.
- Scope, concepts and definitions of the MFS are broadly in line with the Monetary and Financial Statistics Manual (MFSM).
- Following EU accession, the BoL implemented the ECB framework reflecting ECB regulations and ESA 95 on sectorization, valuation and classification of financial instruments.

### Balance of Payments, IIP, External Debt, and Reserves
- BoL compiles balance of payments, international investment position (IIP), external debt and international reserves statistics.
- BoL reports quarterly data on balance of payments and IIP, and monthly international reserves to STA on a timely and regular basis.
- Balance of payments data are compiled using BPM5 format (monthly and quarterly).
- Monthly data correspond to key BOP components compiled from a sample survey covering the public sector, commercial banks, and some nonfinancial private sector institutions.
- The Data Template on International Reserves and Foreign Currency Liquidity is disseminated monthly according to operational guidelines and is hyperlinked to the Fund’s DSBB.
- Since late 2004, the BoL disseminates quarterly external debt data in the World Bank’s Quarterly External Debt Statistics (QEDS) database.

### Data Standards and Quality; Dissemination
- Authorities publish economic statistics through multiple publications, including:
  - SL's monthly publication, Economic and Social Developments.
  - BoL's monthly Bulletin.
- Significant amount of data available on the Internet:
  - Metadata for SDDS data categories posted on the IMF’s DSBB (http://dsbb.imf.org).
  - BoL website (http://www.lb.lt/statistical_data_tree) provides monetary statistics, treasury bill auction results, balance of payments, IIP, external debt and other main economic indicators.
  - SL website (http://www.stat.gov.lt/lt/) provides monthly and quarterly information on economic and social development indicators.
  - MoF (http://www.finmin.lt) provides data on the national budget, laws, privatization; and government finance statistics (deficit, debt).
  - NASDAQ OMX Baltic website (http://www.nasdaqomxbaltic.com/market/?lang=en) includes information on stock trading at NASDAQ OMX Baltic stock Exchange in Vilnius.

### IMF Article IV Consultation — Executive Board Summary (May 5, 2014)
- Macroeconomic outlook and growth:
  - Growth above three percent in each of the past three years; similar prospects.
  - Real GDP is set to surpass the peak level of 2008 for the first time in 2014, free of external and internal imbalances.
  - Per capita income remains considerably below Western European levels; structural unemployment remains high.
- Euro adoption:
  - Lithuania targets to adopt the euro next year (prospective reference to January 2015).
  - Inflation at historical lows and public finances repaired since 2008/09 crisis; meeting entry criteria seems on track.
  - Economic and Financial Affairs Council of the European Union to take final decision about EMU membership in July (based on convergence reports).
- Public finances and debt:
  - Multi-year consolidation reduced fiscal deficit to close to 2 percent of GDP in 2013.
  - Public debt around 40 percent of GDP.
- Financial stability:
  - Capital adequacy ratio exceeded 17 percent in 2013.
  - Steady progress in reducing non-performing loans.
  - Main challenge: resuscitating sluggish private sector credit growth to support investment and recovery.

### Executive Directors' Recommendations and Observations
- Consolidate macroeconomic gains and deepen structural reforms to support job-creating growth and income convergence.
- Fiscal policy:
  - Commended fiscal strengthening but noted limits of expenditure compression.
  - Recommended well-calibrated fiscal consolidation through enhanced revenue mobilization to achieve structural budget balance in medium term and reduce public debt-to-GDP ratio.
  - Suggested improvements: recurrent taxation of wealth and capital, broaden tax base, strengthen tax administration.
  - Recommended a public expenditure review to promote efficiency and sustainability.
- Euro adoption preparedness:
  - Lithuania is well prepared; recommended strong supporting policy frameworks and macro policy tools.
  - Advised strengthening countercyclical tools to rebuild buffers in good times.
  - Welcomed strengthening of macroprudential powers of the Bank of Lithuania and planned transposition of the Fiscal Compact.
  - Advised improving accountability and control for local government finances and noted need for pension reform to enhance fiscal sustainability.
- Financial sector:
  - Decisive action and effective supervision improved stability; work remains in small credit union sector.
  - Advised sustaining efforts and reviewing banks’ asset quality.
  - Called for revival of credit growth via improved insolvency and restructuring frameworks and fostering non-bank finance.
- Structural reforms:
  - Continue reforms to improve competitiveness, business climate, and reduce structural unemployment.
  - Wage increases should be aligned with productivity growth.
  - Strengthen management of out-of-work benefits and other labor code aspects.
  - Reducing relatively high social security taxes in a fiscally-neutral manner recommended.
  - Address skill mismatches through education reform.
- Infrastructure and SOEs:
  - Emphasis on upgrading energy and transportation infrastructure welcomed.
  - Advised embedding projects in a regional strategy to reduce user costs.
  - Supported reform of state- and municipally-owned enterprises, many tasked with implementing key infrastructure projects.

### Selected Economic Indicators, 2010–14 (Republic of Lithuania)
- Real Economy (Percent)
  - Real GDP growth: 2010: 1.6; 2011: 6.0; 2012: 3.7; 2013: 3.3; 2014 (Proj.): 3.3
  - CPI, period average (annual percentage change): 2010: 1.2; 2011: 4.1; 2012: 3.2; 2013: 1.2; 2014 (Proj.): 1.0
  - CPI inflation, end of period: 2010: 3.6; 2011: 3.5; 2012: 2.9; 2013: 0.5; 2014 (Proj.): 1.7
  - Unemployment rate (year average, in percent of labor force): 2010: 17.8; 2011: 15.4; 2012: 13.4; 2013: 11.8; 2014 (Proj.): 10.8
- Public Finance (Percent of GDP)
  - General government balance: 2010: -7.2; 2011: -5.5; 2012: -3.2; 2013: -2.1; 2014 (Proj.): -1.9
  - General government gross debt: 2010: 38.3; 2011: 39.2; 2012: 41.0; 2013: 39.3; 2014 (Proj.): 39.5
  - Foreign currency-denominated public debt: 2010: 31.9; 2011: 31.7; 2012: 32.1; 2013: 27.4; 2014 (Proj.): 26.6
- Balance of Payments (Percent of GDP, unless otherwise specified)
  - Current account balance: 2010: 0.1; 2011: -3.7; 2012: -0.2; 2013: 1.5; 2014 (Proj.): 0.6
  - Gross official reserves (in billions of euros): 2010: 5.0; 2011: 6.4; 2012: 6.5; 2013: 6.0; 2014 (Proj.): 6.4
- Exchange Rates (Litai per U.S. dollar, unless otherwise specified)
  - Exchange rate (end of period): 2010: 2.61; 2011: 2.67; 2012: 2.61; 2013: 2.43; 2014: ..
  - Exchange rate (period average): 2010: 2.61; 2011: 2.48; 2012: 2.69; 2013: 2.51; 2014: ..
  - Real effective exchange rate (2005=100, increase=appreciation): 2010: 117.4; 2011: 118.9; 2012: 117.5; 2013: 119.1; 2014: ..
- Money and Credit (Year-on-year percent change)
  - Reserve money: 2010: 19.4; 2011: 37.5; 2012: -6.4; 2013: 4.9; 2014 (Proj.): 5.8
  - Broad money: 2010: 8.9; 2011: 5.0; 2012: 7.2; 2013: 4.5; 2014 (Proj.): 11.1
  - Private sector credit: 2010: -7.6; 2011: -5.7; 2012: 0.3; 2013: -3.0; 2014 (Proj.): 2.5

### Statement by Mr. Audun Groenn (Executive Director) and Ms. Ramune Arust (Advisor) — May 5, 2014
- Authorities broadly share staff analysis and outlook; thank the staff for a well-balanced Article IV Report.
- Strong GDP growth continues on a healthy and balanced path:
  - Since 2011, Lithuania has been one of the fastest growing EU economies.
  - At end-2013 GDP was 2 percent below pre-crisis level; expected to reach that pre-crisis level in 2014.
  - Growth has become more balanced and sustainable; tradable sector weight in activity has increased.
  - Private consumption was main driver of growth in 2013; investments set to increase given record high capacity utilization.
  - Risks: moderate growth of trading partners and fluid geopolitical situation affecting exports.
- Euro adoption prospects and policy measures:
  - Aim to adopt the euro on January 1, 2015; goal based on legal obligation, policy consistency, economic flexibility, and integration.
  - Fiscal policy on sustainable path; macro-policy tools strengthened.
  - Fiscal Discipline Law enacted.
  - Macro-prudential instruments introduced by BoL: 85 percent loan-to-value ratio (LTV) and 40 percent debt service-to-income ratio (DSTI).
  - Authorities stress policy prudence, especially fiscal, as key for successful euro area functioning.
- Expected benefits:
  - Euro adoption expected to significantly enhance economic integration and boost real GDP in the medium term.

*Source: _cr14113 - 2002. Data provision to the Fund for surveillance purposes is considered adequate.*

### 1.8 percent.

### _cr14113 - 1.8 percent.

### Fiscal position and policy framework
- A prudent fiscal policy underpinned by the law on Fiscal Discipline and the Stability and Growth pact is central to Lithuania’s macroeconomic framework.
- Lithuania is transposing the Treaty on Stability, Coordination and Governance in EMU (“Fiscal Compact”) into national law, including a constitutional law on the implementation of the fiscal treaty committing to sustainability of general government finances.
- Recent outturns and targets:
  - Last year the fiscal budget deficit turned out to be 2.2 percent instead of the planned 2.5 percent of GDP.
  - The ratio of public debt to GDP has stabilized just below 40 percent of GDP and is expected to start decreasing after 2014.
  - Authorities aim to reach a structural budget surplus of 0.9 percent of GDP in 2017.
- Revenue-side initiatives:
  - Improvement in fiscal position was driven by accelerating revenues from corporate and household income taxes.
  - Planned measures include strengthening tax administration, initiatives to support economic growth and create new jobs, and actions to tackle the shadow economy.
  - Proposed amendments to laws regulating tax administration and value added tax (VAT); application of the consolidated view and measures to ensure VAT and excise duty compliance and strengthen collection of personal income taxes.
  - Ongoing discussions on a comprehensive review of the tax system, with particular emphasis on taxation on labor and the application of reduced VAT rates.
- Expenditure-side priorities:
  - Emphasis on efficient use of resources and prioritization.
  - No cuts are foreseen to productive, job-creating expenditures, such as investment and expenditures on research and development.
- Local government finances:
  - Authorities share staff’s concerns about deficiencies in the control framework of local government finances and are ready to address them.
  - Government is considering asking the Fund for technical assistance to improve accountability and control framework of local government finances; initial talks with the Fund have started.

### Financial sector stability and supervision
- Overall assessment:
  - Lithuania’s financial system remains stable and resilient.
  - Banking sector is well capitalized and liquid.
- Key metrics (2013):
  - Capital adequacy ratio improved by 2 percentage points and reached 17.6 percent.
  - Liquidity ratio at 41.2 percent, above the required level of 30 percent.
  - Nonperforming loans (NPLs) decreased to 11 percent.
- Credit flows:
  - Stock of outstanding credit has not been increasing, but credit flows continue at a steady pace.
  - In 2013, new loans to non-financial corporations and households amounted to 15.9 billion litas (16.0 billion litas in 2012) or 13.3 percent of GDP; 70 percent of these loans was lent to non-financial corporations.
  - Commercial banks expect a 2–3 percent growth in their loan portfolio this year.
- Supervisory reforms and measures:
  - Bank of Lithuania (BoL) has shifted to a risk-based supervisory process, concentrating on systemically important and high risk financial market participants.
  - Government and BoL are strengthening and reforming credit union regulation to make the sector strong, sustainable, and complementary to the banking sector; an inter-institutional working group prepared draft laws submitted to parliament.
  - BoL prepared a public discussion document on credit union reform focusing on eliminating moral hazard and aligning shareholders’ incentives with prudent risk taking; proposals draw on domestic experience and international best practice and incorporate Fund technical assistance recommendations.
  - Authorities are working on implementation of CRD IV into national laws; preliminary assessment indicates implementation would contribute to increasing the capital adequacy ratio due to:
    - High quality of Tier I capital of banks
    - Reduced capital requirements for FX positions (if the euro is adopted)
    - Decreasing of risk weights for small and medium enterprises exposures
    - Introduction of releasing regime for exposures secured by mortgages on residential property
  - Preparations for prospective euro area membership include adjustments for the asset quality review (AQR) and legal acts; in December 2013 the BoL Board approved the BoL position on participation in the Banking Union.
  - Base case scenario: Lithuania joins the Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM) in 2015, together with euro area accession; after joining the SSM, the ECB is expected to take supervision of the 3 largest banks (71 percent of the market share), while other banks would remain under direct BoL supervision.
- Macroprudential mandate and buffers:
  - Process of broadening the BoL’s mandate to include macro-prudential policy is nearly complete; relevant amendments to the Law of the Bank of Lithuania are expected to be adopted during the Spring parliamentary session ending in June 2014.
  - Currently BoL indirectly pursues macro-prudential policy via the Responsible Lending Regulations approved in 2011 (including LTV and DSTI).
  - A wide macroprudential toolkit specified in EU-level legislation is envisaged once CRD IV is transposed.
  - Countercyclical capital buffer application is expected to become fully operational in the end of 2014.
  - An interim decision has been made to apply a 2.5 percent capital conservation buffer starting in 2015.

### Structural reforms and labor market
- Policy focus:
  - Government continues pro-growth structural policies to improve the business environment and reduce high unemployment, especially among youth and the long-term unemployed.
  - Measures target both labor demand and supply.
- Labor demand measures:
  - Support for investment projects expected to raise supply-side potential.
  - Housing renovation project advanced considerably since 2012.
  - Energy sector reforms prioritized; the Liquid Gas Terminal (LNG) in Klaipėda is expected to be completed by the end of this year.
- Labor supply measures:
  - Active labor market policies, training, and dialogue with educational institutions enhanced to realign worker skills with employer needs.
  - Amendments to the Labor Code submitted to parliament to reduce administrative burden; a working group established for a comprehensive review of the Labor Code.
- Business environment outcomes:
  - Lithuania moved to the 17th position among all countries and the 6th position among EU countries in the World Bank “Ease of doing business report 2014”.
  - Contributing factors include adopted new territorial planning laws, labor market flexibility, technological innovations, and high participation of women in the workforce.

*Source: _cr14113 - 1.8 percent.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14113.pdf_