Republic of Lithuania: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, June 25, 2019
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- Published: June 25, 2019
Macroeconomic and fiscal performance
- The Lithuanian economy has continued to enjoy a strong macroeconomic and fiscal performance.
- The recovery has avoided the large imbalances of the past and places Lithuania in a better position to face future economic downturns.
- Prudent fiscal policy, a flexible labor market, and proactive macroprudential policies have been critical to preserve stability and should be maintained.
- Lithuania still confronts severe demographic pressures, high social disparities, and external uncertainty.
- Effective implementation of the authorities’ comprehensive reform agenda, particularly in education and healthcare, along with a continued strong fiscal position, is key to increase productivity and support higher wages.
Boost productivity to sustain high wage growth and reduce social disparities
- Education and healthcare reforms have so far failed to deliver in key areas; maintaining large and inefficient networks comes at the cost of lower quality and opportunities.
- Only comprehensive reform in education and healthcare will allow Lithuania to produce the competitive and well-paid workforce needed to tackle income and social disparities.
- Lack of buy-in from municipalities has hindered implementation of the reform agenda.
- Recommendation: Make planned wage increases in education and healthcare conditional on progress in network optimization.
- Active labor market policies should be strengthened to effectively address skill mismatches and increase labor force participation.
- Current funding is low and relies excessively on EU funds and its composition inadequately reflects the needs of the labor market.
- Recommendation: Decrease reliance on employment subsidies (focus them on the most disadvantaged groups) and shift emphasis to well-designed training curricula to upskill the labor force.
- Tradeoff: Maintaining a low and competitive tax system versus strengthening the social safety net.
- Discretionary spending is already low; further increases in social spending will likely require increases in revenues.
- Recommendation: Use targeted social spending as the main tool to reduce poverty and inequality to ensure efficient use of limited resources.
- Child benefits design and generosity should balance their positive impact on reducing child poverty against potential disincentives to work, particularly for women.
Fintech: opportunities and challenges
- Fintech provides big opportunities to improve financial services and produce high-skill jobs, but it also brings challenges, particularly related to anti-money laundering.
- Lithuania is positioning itself as an attractive host of fintech platforms and a gateway to Europe for non-European financial companies; authorities’ efforts are already delivering results.
- In a highly concentrated banking sector, strong profitability largely reflects high operational efficiency.
- The exit of one bank and ongoing restructuring of another has lowered the intensity of competition, at least temporarily.
- Fintech companies will introduce competition, initially in the payment services segment.
- A larger focus on cross-border transactions could represent a shift in the business model of Lithuania’s financial system and bring new challenges for supervision, including on AML/CFT.
- Authorities are stepping up inter-agency coordination and efforts to implement the 2018 MONEYVAL recommendations.
- Success will require adequate resources across all agencies involved.
Preserve macroeconomic and financial stability
- Fiscal stance and outlook
- The fiscal surplus in 2019 will fall to 0.3 percent of GDP reflecting a moderate loosening of fiscal policy.
- Continued strong economic performance suggests that a neutral stance along the lines of the last few years would have been preferable.
- Heightened risks to fiscal revenues and increased spending pressures are expected going forward.
- The budget relies on uncertain gains from combating informality.
- Recent revenue gains have a significant cyclical component reflecting low unemployment and high wage growth.
- The negative revenue impact of recent tax and pension reforms is uncertain.
- Projected fiscal revenues over the next few years are subject to increased uncertainty.
- Spending pressures are intensifying: the large increase in social spending and public sector wages in 2018 are expected to continue this year and next.
- Since revenues are not increasing at the same rate, these spending pressures are being accommodated at the expense of other more flexible components of public spending.
- Recommendation: Any additional spending will require an increase in revenues.
- Tax and pension reform assessment
- Tax reform could have been more ambitious in shifting taxes away from labor into capital, wealth, real estate, and environmental taxes.
- Reduction of tax exemptions and privileged regimes is needed.
- Pension reform has ensured financial, but not social, sustainability of the system.
- Complementing pay-as-you-go SODRA pensions with a capitalized pillar is necessary given Lithuania’s negative demographic dynamics, projected as among the most severe in Europe.
- Low and declining pensions will increase pressures to boost basic pensions, which have been transferred to the budget this year; this represents a fiscal risk over the medium-term.
- Macroprudential policy and banking sector
- Macroprudential policy is being used proactively to prevent systemic risks.
- Lithuania’s cyclical position is more advanced than the euro area, making the ECB’s monetary policy stance looser than would be warranted for Lithuania alone.
- The banking system remains sound, with strong capitalization and high asset quality, liquidity, and profitability.
- Signs that moderate cyclical systemic risks are emerging: the pace of growth in credit and house prices remained relatively high.
- The Bank of Lithuania raised the countercyclical buffer to one percent in mid-2018.
- Most banks were already above the new capital requirement and have large and rising liquidity buffers given faster deposit growth than credit growth.
- Though the pace of corporate loans moderated, the growth of mortgages remains relatively high.
Economic developments and risks
- Recent performance
- Strong real growth in 2018, at 3.5 percent, continued into the first quarter of 2019, reaching 4 percent.
- Supported by resilient export growth, the current account surplus reached its highest level in four years.
- Strong domestic demand has been supported by high wage and better-than-expected employment growth.
- Inflation stood at 2.5 percent in 2018.
- Medium-term outlook and risks
- Growth is expected to moderate to a more sustainable path in the next few years.
- Over the medium-term, potential growth is projected to come down to 2-2.5 percent reflecting negative demographics.
- Domestic demand will continue to be the main engine of growth, but a moderating labor market will ease consumption growth.
- Investment in the short-term will be affected by increased external uncertainty and over the medium-term will depend on the effectiveness of reforms to translate into increased productivity.
- Low productivity growth is the key risk going forward.
- Short-term risks relate to a weakening external environment reflecting increased uncertainty.
- As a small open economy, Lithuania is particularly sensitive to external shocks.
- The current environment of low debt, high liquidity, and strong fiscal and current account positions will mitigate the impact of any negative shocks.
- In the longer-term, without progress on the reform agenda—notably in education, healthcare, and innovation—productivity growth may remain insufficient to support competitiveness and to compensate for a declining population due to ageing and emigration.
IMF Communications Department — June 25, 2019