IMF Executive Board Concludes 2024 Article IV Consultation with the Republic of Lithuania
IMF News, July 24, 2024
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- Published: July 24, 2024
Executive Board assessment — key messages
- The Executive Board endorsed staff’s appraisal on a lapse-of-time basis.
- The Lithuanian economy is recovering from a shallow recession and high inflation.
- Risks to the outlook have become more balanced.
Economic developments and outlook
- After a short and shallow recession, the economy has started to recover supported by strong disinflation.
- Inflation trajectory:
- Inflation was around 20 percent in 2022.
- Inflation more than halved in 2023 and is now below the euro area average.
- Headline inflation is expected to remain close to 1 percent this year before converging to above 2 percent.
- Core inflation remains elevated and will experience larger persistence due to the tight labor market and strong real wage growth.
- Drivers of disinflation: lower commodity prices, tighter monetary conditions, and a contractionary fiscal stance.
- Labor market: remained tight with declining labor productivity as firms held on to workers during the downturn.
- Banking and real estate: banking system remains well capitalized and highly profitable; real estate market has partially corrected post-COVID/pre-war imbalances.
- Medium-term constraints: global fragmentation, long-term spending pressures, eroded corporate profitability, and structural challenges in education, healthcare and the labor market weigh on productivity and growth.
Fiscal position and recommendations
- Fiscal stance:
- After a strong performance last year, the fiscal position is expected to become moderately expansionary this year but less than the budget would imply.
- The structural fiscal position has barely deteriorated compared to the pre-pandemic period.
- Given a small and decreasing output gap, a broadly neutral fiscal stance is appropriate.
- Recommendation on buffers:
- Any unused spending buffers or revenue overperformance should be saved, particularly if the economy surprises to the upside.
- Long-term spending pressures:
- Defense and higher borrowing costs, aging and climate pressures could add between 5 and 10 percent of GDP to spending.
- Comprehensive strategy elements to address pressures:
- (i) pension reform;
- (ii) education and healthcare reforms;
- (iii) revenue mobilization;
- (iv) resetting the fiscal targets around current levels preserving a strong fiscal position.
Financial sector stability and macroprudential policy
- Banks:
- Despite declining interest margins, banks’ profitability will remain elevated.
- Net interest income is easing from very high levels as deposit rates gradually increase and policy rates are expected to continue decreasing.
- The banking system remains liquid and well capitalized, providing large buffers.
- Macroprudential stance:
- No new systemic risks have emerged; the financial cycle is undergoing a soft-landing.
- Authorities have adopted an appropriate neutral macroprudential stance.
- If risks materialize: relaxation of capital-based measures would be appropriate in response to credit supply disruptions; targeted adjustments to borrower-based measures can address disorderly real estate corrections.
- INVEGA (public investment agency):
- Will play an important role intermediating RRF loans.
- Should keep its mandate explicit and narrow, ensure effective monitoring and transparency, and avoid crowding out private bank lending or political interference.
- Bank levy:
- The levy on banks has had little disincentive effects given its careful design.
- The IMF recommends the levy should be phased out and not replaced to avoid perceptions of a tax on foreign investment and to minimize negative efficiency impacts.
AML/CFT supervision
- Significant progress achieved; further work needed to reduce heightened ML/TF risks.
- Implemented measures include:
- (i) deepening understanding of non-resident ML/TF risks;
- (ii) increasing Bank of Lithuania’s (BoL) AML/CFT supervisory resources;
- (iii) updating ML/FT risk assessment methodology;
- (iv) strengthening VASPs market entry controls;
- (v) strengthening AML/CFT controls to access CENTROlink.
- Next steps:
- BoL should continue mitigation efforts, including preparations to begin supervising VASPs as of the end of 2024 and developing further CENTROlink AML/CFT assessment guidelines.
External position and competitiveness
- Lithuania’s external position was broadly in line with fundamentals in 2023.
- The country entered the 2021 shock with an undervalued REER, helping absorb permanently higher input costs.
- Recent loss in goods market shares largely driven by sanctions on Russia and Belarus; exports of services have continued to grow strongly.
- With negative inflation differentials with trading partners and expected labor productivity recovery, no further losses of competitiveness are expected in the near-term.
- Long-term concerns: spending pressures and structural challenges will weigh on productivity amid domestic and global headwinds.
Structural challenges and policy priorities
- Labor market:
- Persistent structural inefficiencies require more responsive active labor market policies.
- Employment subsidies should concentrate on the most disadvantaged.
- Education:
- Reforms needed to foster vocational training.
- Current funding is locked in a large tertiary education system that does not produce demanded labor-market skills.
- Healthcare and pensions:
- Politically difficult but needed reforms in pensions, education, and healthcare are critical for growth and fiscal sustainability.
Climate policy and green transition
- Lithuania is susceptible to climate-change risks and needs to accelerate the green transition, particularly adaptation.
- Policy recommendation:
- Introduce an economy-wide carbon tax on fossil fuels, alongside the EU’s emission trading system, to:
- facilitate faster decarbonization;
- incentivize renewable investments;
- provide resources to protect vulnerable households and strengthen physical infrastructure against climate change.
Key statistics and projections (selected figures from Table 1)
- Real GDP growth (annual percentage change):
- 2020: 0.1
- 2021: 6.2
- 2022: 2.4
- 2023: -0.3
- 2024: 2.6
- 2025: 2.2
- Domestic fixed investment growth (year-on-year, in percent):
- 2020: -0.5
- 2021: 9.4
- 2022: 3.6
- 2023: 10.6
- 2024: 1.9
- 2025: 4.3
- 2026: 3.5
- 2027: 5.4
- Nominal GDP (in billions of euro):
- 2020: 49.8
- 2021: 56.5
- 2022: 67.5
- 2023: 72.0
- 2024: 75.9
- 2025: 80.3
- 2026: 84.5
- 2027: 88.5
- 2028: 92.7
- 2029: 97.0
- Output gap (percent of potential GDP):
- 2020: 1.6
- 2021: 1.8
- 2022: -0.7
- 2023: -0.2
- Unemployment rate (year average, in percent of labor force):
- 2020: 8.5
- 2021: 7.1
- 2022: 6.0
- 2023: 6.9
- 2024: 6.5
- 2025: 6.1
- Average monthly gross earnings (annual percentage change):
- 2020: 10.1
- 2021: 10.5
- 2022: 13.3
- 2023: 12.2
- 2024: 8.4
- 2025: 5.1
- 2026: 5.0
- Average monthly gross earnings, real (CPI-deflated, annual percentage change):
- 2020: 9.0
- 2021: 5.6
- 2022: -4.6
- 2023: 7.2
- 2024: 2.7
- Labor productivity (annual percentage change):
- 2020: -1.3
- 2021: -1.7
- 2022: 1.4
- 2023: 2.9
- 2024: 3.2
- HICP, period average (annual percentage change):
- 2020: 1.1
- 2021: 4.6
- 2022: 18.9
- 2023: 8.7
- HICP, end of period (year-on-year percentage change):
- 2022: 20.0
- 2023: 0.6
- Fiscal balance (percent of GDP):
- 2020: -6.5
- 2021: -1.1
- 2022: -0.8
- 2023: -1.5
- 2024: -1.4
- Revenue (percent of GDP):
- 2020: 36.3
- 2021: 35.7
- 2022: 37.4
- 2023: 39.2
- 2024: 39.1
- 2025: 38.4
- 2026: 37.3
- 2027: 37.2
- 2028: 37.1
- Expenditure (percent of GDP):
- 2020: 42.8
- 2021: 38.2
- 2022: 40.7
- 2023: 39.8
- 2024: 38.8
- 2025: 38.6
- 2026: 38.3
- General government gross debt (percent of GDP):
- 2020: 46.3
- 2021: 43.4
- 2022: 38.0
- 2023: 38.1
- 2024: 37.8
- Current account balance (percent of GDP):
- 2020: -5.5
- Current account balance (billions of euros):
- 2020: -3.7
Source: IMF Executive Board press release, "IMF Executive Board Concludes 2024 Article IV Consultation with the Republic of Lithuania" (Press Release No. 24/284).