IMF Staff Concludes Visit to Lithuania

IMF News, February 6, 2024

Source details

IMF mission led by Borja Gracia visited Vilnius from January 29–February 2 to meet with the Lithuanian authorities.
The team met with the Ministry of Finance, the Ministry of Economy, the Bank of Lithuania, other government agencies, representatives from the private sector, banks, and other stakeholders.
End-of-Mission press release: Press Release No. 24/37. This mission will not result in a Board discussion.

Recent shock and impact:
- Negative terms-of-trade shock caused by Russia’s invasion of Ukraine resulted in high inflation and increasing interest rates, weighing on households’ purchasing power and firms’ investment appetite.
- Weak external demand resulted in a mild contraction of the economy last year.
Near-term outlook:
- External demand is expected to recover this year while the labor market remains strong with robust wage growth above inflation since last summer.
- Looking forward, economic growth is expected to accelerate during 2024 and beyond.
Inflation dynamics:
- Inflation continued to decline rapidly to 1.6 percent at the end of last year, after peaking at 22.5 percent in mid-2022.
- Decline driven largely by the correction in energy and food prices, as well as ECB’s monetary policy tightening.
- Correction in inflation dynamics expected to continue in the earlier part of this year, supporting recovery in disposable income and domestic demand.
- Core inflation remains at an elevated level compared to the pre-crisis period but is showing significant signs of disinflation across the economy.
- Lithuania’s inflation differential vis-à-vis the rest of the eurozone is now consistent with historical averages, but relatively higher inflation and wage growth than some trading partners over the last two years has left price and wage levels elevated, which may erode competitiveness and slowdown convergence going forward.

Spending pressures identified:
- Permanently higher defense spending.
- Negative demographics.
- A pension system that, while fiscally sustainable, is not socially sustainable as it projects declining replacement ratios from already current low levels.
- Moderately increasing interest payments on debt over the next few years.
- High poverty rates and social disparities, especially at the regional level, requiring more and better social programs.
Fiscal space and implications:
- Lithuania continues to enjoy a comfortable fiscal space and low debt.
- Accommodating new and pre-existing spending pressures will require additional revenues under the existing fiscal targets.
Policy recommendations / options:
- Revenue-generating tax reforms.
- Improved expenditure efficiency.
- A moderate relaxation of fiscal targets.

Profitability and efficiency:
- Lithuania’s banking system described as one of the most cost-efficient in Europe and enjoys an unprecedented surge in profitability due to mostly variable rate mortgages and deposits that are not very interest sensitive.
- This profitability surge is despite the temporary levy on banks introduced last year.
Policy guidance on the levy:
- The levy should remain temporary to avoid being perceived as a tax on foreign investment and minimize the potential negative impact on efficiency.
Risk assessment:
- Balance sheet risks from higher interest rates and weaker activity are contained with large capital buffers and high profitability able to absorb potential losses.
- The real estate market has undergone a gradual, orderly correction and prices are now at a level broadly consistent with fundamentals.

Press Release No. 24/37 — February 6, 2024. IMF staff statement.