Republic of Lithuania - Staff Concluding Statement of the 2021 Virtual Article IV Mission
IMF News, June 14, 2021
Source details
- Canonical URL
- Republic of Lithuania - Staff Concluding Statement of the 2021 Virtual Article IV Mission
Other formats
Bibliographic details
- Published: June 14, 2021
Overview and key takeaways
- Lithuanian economy entered the COVID-19 crisis on a solid footing with strong growth and ample buffers, improved private sector financial positions, and a well-capitalized, profitable banking system.
- The government’s decisive policy response and the benefits of euro area membership helped make the Lithuanian economy one of the best performers in Europe in 2020 and set the stage for a strong recovery.
- Policy priority: quality over quantity — transition from broad-based emergency support to more targeted support for the most affected sectors and pockets of vulnerability.
- Long-standing challenges to address: high social disparities and demographic pressures; decisive implementation of structural reforms is needed to achieve sustained productivity improvements and high wage growth.
Economic developments and risks
- 2020 performance:
- GDP fell by just 0.8 percent versus a euro area average of 6.7 percent; Lithuania experienced the mildest contraction in Europe in 2020.
- Early 2021 developments:
- Growth momentum picked up in the first quarter of 2021 despite lockdown restrictions; output exceeded pre-pandemic levels in Q1 2021.
- Recovery led by domestic demand and solid external demand; exports recovered quickly in H2 2020 with a strong recovery in manufacturing, services harder hit.
- Temporarily higher energy prices and rebound in demand will result in higher inflation in 2021.
- External position:
- Strong, partly due to temporary factors (low consumption and investment during lockdowns) and competitiveness gains since the GFC that led to the strongest increase in exports in the Baltics.
- Next Generation EU funds:
- RRF and related funds will support medium-term growth and help ameliorate demographic pressures if efficiently used, by supporting private and public investment and productivity growth.
- Risks:
- Short-term risks broadly balanced.
- Significant upside growth potential over the next few years if recovery accelerates and lockdowns are avoided.
- Upside scenario could lead to higher inflationary pressures and potential erosion of competitiveness if unchecked.
- Downside risks include weaker than expected external demand and geopolitical risks.
Fiscal and macroeconomic policy guidance
- Fiscal stance:
- The pace of withdrawal of fiscal support should be dictated by the strength of the recovery; government has built significant buffers in the amended 2021 budget for shocks or weaker recovery.
- Under the most likely macroeconomic scenario, a large share of 2021 buffers will not need to be used; fiscal position is expected to improve in 2021 and 2022, putting debt back on a declining path.
- As recovery becomes firmly entrenched, fiscal buffers should gradually be rebuilt; rebuild faster if growth is stronger than expected and inflationary pressures intensify.
- Targeting support:
- With minimal permanent aggregate economic losses expected, support should narrow to specific pockets of vulnerability to facilitate market-led resource reallocation.
- Some viable firms in hardest-hit sectors may need longer support; measures should become increasingly targeted.
- The proposed temporary reduction of the VAT rate for catering services, cultural, and recreation sectors is judged not well targeted and may complicate tax collection; political pressures to make temporary tax cuts permanent should be resisted as their sunset approaches.
- Macroprudential and monetary context:
- As a euro area member, Lithuania benefits from ECB accommodative policies; however, ECB stance may be looser than warranted for Lithuania alone given stronger projected recovery.
- Available fiscal and macroprudential tools should be used proactively to manage risks.
Financial sector and Fintech
- Banking sector:
- Banks remain well capitalized, liquid, and more profitable than euro area peers.
- Release of the countercyclical capital buffer (CCyB) and two private moratoria supported lending and provided relief to hard-hit borrowers.
- Banking sector has ample liquidity and capital buffers to support recovery.
- Residential real estate developments so far are estimated to be in line with fundamentals; targeted macroprudential tools or reactivation of the CCyB may be necessary if elevated sectoral risks or overheating emerge.
- Fintech and AML/CFT:
- Fintech sector is maturing rapidly; focus should be on enhancing supervisory capacity and the AML/CFT framework to contain risks.
- Authorities have been proactive (Centre of Excellence in AML, implementation of MONEYVAL 2018 recommendations); further progress will require close multi-agency coordination and more resources.
- Current efforts to develop a five-year plan should reflect supervisory challenges and authorities’ plans to address them.
Structural reforms and fiscal strategy
- Reform priorities:
- Urgent reforms needed in education and health care to improve outcomes, reduce inefficiencies, and address poor service quality; lack of municipal buy-in has hindered past efforts.
- Additional RRF funds could provide impetus for implementing challenging reforms.
- Social spending and taxation:
- Rising budget rigidities and age-related spending pressures mean further increases in social spending cannot be financed without higher revenues.
- Reducing regional disparities and high poverty rates (particularly among pensioners) requires larger and more effective social programs.
- Establishment of a working group to analyze tax policy is welcome; work should focus on:
- Eliminating inefficient loopholes and exemptions.
- Taxing environmental or other externalities.
- Shifting taxes away from labor towards capital, wealth, and environmental taxes.
- These tax-policy efforts should be part of a comprehensive fiscal strategy that complements structural reforms and raises growth potential.
- Opportunity:
- Combination of strong recovery, new EU funds, and low funding costs presents a unique opportunity to build consensus around politically difficult reforms and to undertake high upfront investment without jeopardizing fiscal position.
- Public investment should strengthen physical and human capital and support social cohesion.
- Recovery and Resilience Plan reforms rightly focus on digitalization and climate; ambitious implementation plans are being developed.
- Realizing full benefits requires progress in all main areas simultaneously, especially education and healthcare, due to complementarities.
Lithuania macroeconomic outlook (IMF staff projections starting 2021)
- GDP growth:
- 2019: 4.3
- 2020: -0.8
- 2021: 4.4
- 2022: 4.1
- 2023: 3.1
- Inflation:
- 2019: 2.2
- 2020: 1.1
- 2021: 3.2
- 2022: 2.8
- 2023: 2.7
- Core inflation:
- 2019: 2.3
- 2020: 2.6
- 2021: 3.0
- Output gap (percent of potential GDP):
- 2019: 0.8
- 2020: -0.9
- 2021: 0.3
- 2022: 0.9
- 2023: 0.6
- Overall fiscal balance (percent of GDP):
- 2019: 0.5
- 2020: -7.4
- 2021: -5.5
- 2022: -2.9
- 2023: -1.5
- Structural balance (percent of potential GDP):
- 2019: -6.3
- 2020: -5.0
- 2021: -2.8
- 2022: -1.4
- Public gross debt (percent of GDP):
- 2019: 35.9
- 2020: 47.1
- 2021: 47.8
- 2022: 45.9
- 2023: 44.3
- Nominal GDP (billions of euros):
- 2019: 48.8
- 2020: 48.9
- 2021: 52.4
- 2022: 56.0
- 2023: 59.2
Republic of Lithuania - Staff Concluding Statement of the 2021 Virtual Article IV Mission (June 14, 2021), IMF Communications Department.