June 6, 2025
PRESS OFFICER: Boris Balabanov
Phone: +1 202 623-7100Email: MEDIA@IMF.org
Washington, DC – June 6, 2025: Lithuania has proved resilient to multiple shocks in recent years. However, new challenges are emerging—including further increases in defense expenditure adding to the existing long-term spending pressures—while long-standing structural issues still require attention. Lithuania needs to reignite its reform momentum to boost productivity while addressing these challenges. A comprehensive strategy is needed to preserve fiscal space through revenue mobilization, enhanced spending efficiency, and limiting further spending pressures by strengthening the multi-pillar pension system. Structural reforms should focus on facilitating investments and accelerating the adoption of new technologies to boost productivity growth, supplemented by labor market policies, including reducing skills mismatches. Financial sector policies should continue to safeguard financial stability and integrity.
Recent Developments, Outlook, and Risks
The economy grew strongly in 2024. Growth accelerated to 2.7 percent—well above peers—driven by private consumption supported by significant real income gains. The recovery was broad-based across sectors, including manufacturing and high value-added services, despite sluggish productivity growth. While inflation remained low for the most part of the year, it has risen since late 2024, driven by higher energy prices and excise duties.
While fiscal performance exceeded expectations, the deficit widened, and the debt ratio is increasing. The deficit almost doubled from 0.7 percent of GDP in 2023 to 1.3 percent of GDP in 2024, reflecting increased public wages and pensions. Higher revenues supported by robust aggregate wage growth and lower-than-anticipated expenditure, mainly from the accrual correction in defense spending, prevented the deficit from increasing further. However, pre-payments for additional orders of defense equipment and the continued buildup of the general government cash buffer contributed to an increase in the debt-to-GDP ratio from 37.3 percent in 2023 to 38.2 percent in 2024, for the first time since 2020.
The banking sector remains financially sound, with high capitalization, ample liquidity buffers, and low non-performing loan (NPL) ratios. Banks continue to be highly profitable, although profitability eased in 2024 compared to the record high levels seen in the previous year, against lower interest rates driven by ECB monetary policy easing.
There are signs of gradual financial expansion. Reflecting decreasing lending rates and recovering credit demand, loan growth to both non-financial corporations and households recovered in 2024 and early 2025, and credit-to-GDP ratios have increased moderately. House price growth stabilized in 2024, down from the 2022 peak. Nevertheless, house prices are likely not significantly above levels justified by fundamentals, given the recent robust demand while housing supply is increasing, and affordability has improved.
The economy is expected to grow at 2.8 percent in 2025 while inflation will increase to 3.1 percent. Growth will be supported by private consumption and rising investment related to EU funds. External demand will remain subdued reflecting uncertainty regarding trade policies, despite the positive outlook of information and communication technologies (ICT) and professional activities. Increased excise duties and persistently high wage growth will keep headline and core inflation above pre-pandemic averages in the coming years. The labor market will tighten reflecting negative labor force dynamics affected by the normalization of migration flows.
Risks to the outlook are tilted to the downside. As a small open economy, Lithuania is exposed to high uncertainty around trade policies and geopolitical risks. A severe downturn in its main trade partners would worsen the external performance and domestic activity. In the medium term, weaker demographics pose risks to labor supply which could add pressures on wages and competitiveness if productivity growth fails to accelerate. In the absence of sufficient measures, the fiscal position is subject to considerable medium-term risk with higher defense spending needs adding to the already high existing long-term pressures.
Fiscal Policy
A moderately less expansionary fiscal stance than currently expected would be helpful in 2025, and the strategy should shift to preserving fiscal space. The deficit is projected to rise to 2.8 percent of GDP in 2025, due to significant increases in pension spending and higher public sector wages. However, with a small and decreasing negative output gap under staff projections and considering mounting spending pressures in the medium term, going forward, a moderately tighter fiscal stance to reduce deficits and stabilize the debt-to-GDP ratio would be appropriate. With a view to safeguarding fiscal buffers and minimize the need for larger adjustments in later years, any unused spending or revenue overperformance this year should be saved to limit the deficit increase.
A stronger fiscal adjustment will be required if defense spending rises notably from current levels. The envisaged increase in defense spending to 5-6 percent of GDP in 2026-30 from the current level of 3 percent would raise financing needs significantly. In the absence of additional fiscal measures, debt could reach 60 percent of GDP by 2030. The proposed tax policy changes to accommodate these spending needs are welcome, but the revenue yield is estimated to be modest. Greater efforts will therefore be needed to maintain debt dynamics on a sustainable path in the medium term to preserve fiscal space to absorb possible future shocks. An average annual adjustment of about 0.5 percentage points of GDP in the general government balance over 2026-30, with the majority of additional defense spending financed by front-loaded increases in tax revenues, would help stabilize debt at around 50 percent of GDP by 2030.
Financing options for additional defense spending should be anchored by revenue mobilization. While temporary measures and productivity-enhancing capital expenditure could be deficit-financed, a sizable part of the additional defense spending is likely to be permanent, warranting higher revenues or lower spending in other areas. The tax policy change proposal appropriately targets a mix of taxes, but there is further scope to raise additional revenues while improving the system, including increasing progressivity and efficiency. This could include raising revenues through making the personal income tax (PIT) system more progressive and streamlining the tax schedules to prevent higher marginal tax rates for lower income earners, limiting exemptions in corporate income taxes (CIT) and property taxes, and reducing the value added tax (VAT) compliance gap while improving VAT efficiency.
Revenue mobilization should be complemented by spending measures. Fiscal savings could be generated by improving spending efficiency, including in healthcare and education. Hospital network rationalization could enhance the quality of service while reducing costs. The teacher-student ratio is relatively high for secondary education and there is room to rationalize the school network while improving quality.
Strengthening the multi-pillar pension system will limit some of the additional spending pressures in the medium-term. The current pension system implies significant increases in public pension expenditure over the next two decades, driven by adverse demographics, while replacement ratios will remain low. The Pillar II reform proposal under discussion, entailing participation to become voluntary and increased options to opt out and suspend participation, is likely to further reduce the replacement rate. These changes could have a material impact on the entire pension system and the public finances. Staff urges the authorities to allow sufficient time to carefully consider all potential ramifications, including through further thorough analysis of the social and fiscal sustainability of the broader pension system.
Financial Sector Policies
Financial sector policies should continue to focus on safeguarding financial stability. Bank profitability is expected to moderate further but to remain high in 2025. Financial conditions are likely to ease in 2025 due to declining ECB policy rates and increased competition in financial sector, such as from the increasing footprint of fintech companies. Solvency and liquidity stress tests conducted by the Bank of Lithuania suggest that banks can withstand adverse macroeconomic scenarios and unexpected liquidity shocks. While some smaller banks require enhancing capitalization and closer oversight, all in all, financial stability risks arising from the banking system are broadly contained. With an increased frequency of cyberattacks on banks in recent years, cyber resilience should continue to be strengthened, including the full implementation of the Digital Operational Resilience Act (DORA) regulation.
The current macroprudential stance is broadly appropriate, but continued vigilance is warranted. Financial cycles including residential real estate and private sector credit so far have exhibited no major signs of overheating, but the sustained pace of expansion requires close monitoring and readiness to act in case early signs of an excessive financial expansion emerge. Despite the low exposure of banks, the commercial real estate market continues to require attention as risks of price corrections remain due to the persistent imbalance between supply and demand. In the event of a significant adverse financial shock with the potential to trigger widespread losses in the banking sector, the relaxation of capital-based measures would be appropriate to minimize credit supply disruptions and support lending to the economy.
The AML/CFT framework has been strengthened significantly, but continued effective implementation is essential. The third national risk assessment identified virtual asset service providers (VASPs), and electronic money institutions (EMI), and payment institutions (PI) as posing significant ML/TF risks. The authorities should continue AML/CFT efforts to mitigate cross-border risks, including Bank of Lithuania’s oversight and market controls for newly licensed VASPs under MiCAR regime, supervision of payment service institutions, and AML/CFT measures for CENTROlink members.
Structural Reforms
Lithuania faces structural headwinds limiting productivity and long-term growth. The recent recovery has been largely driven by higher labor accumulation enabled by temporary net migration, while the contributions from capital and total factor productivity (TFP) growth remained smaller than those observed during earlier periods of faster income convergence. Given expected population declines in the coming years, structural reforms to facilitate greater capital deepening and higher productivity growth are essential.
Higher investment is needed to support potential growth. Low capital intensity remains a key barrier to productivity growth and the transition towards a higher value-added oriented economy. Development of risk capital, co-financing and mechanisms for risk sharing tailored to enhance the flow of credit to small and medium sized enterprises (SMEs), targeted credit guarantee schemes and integrating digital solutions can help alleviate constraints related to the lack of access to finance experienced by some firms. In this context, the expanded role of the state-owned institution ILTE—previously INVEGA—can play a role, complementing the private banking sector in supporting investment in areas such as high value-added sectors, innovation, energy efficiency, and strategic infrastructures. To consolidate the institution's role as a national development bank, it is essential to ensure effective monitoring and transparency of ILTE operations. More fundamentally, deepening the EU’s single market—combined with stronger incentives to develop domestic capital markets—would help support access to finance of corporates and further productive investments in the country.
Inefficiencies in the education system contribute significantly to the persistent skills mismatches in Lithuania's labor market. As one of the countries with the highest skills mismatches in Europe, Lithuania faces ongoing challenges despite measures including the government’ active labor market policies and their evaluation and the smart specialization multi-year program aimed at enhancing workforce skills. Critical shortages persist in essential sectors, including nursing, engineering, and scientific fields, highlighting the urgent need for strategic reforms in education and training to better align with market demands.
Ensuring effective integration of migrants into the labor market is crucial to sustain the labor force. Recent immigrants have been successfully absorbed into the Lithuanian labor market and legislative amendments have enabled easier migration for high-skilled workers despite the reduction of the non-EU workers quota in 2025. Policies should focus on integrating migrants in the most productivity-enhancing way possible while facilitating the participation of foreign professionals in those sectors with the largest shortages.
Further investment in digitalization and AI preparedness has the potential to boost productivity growth. Lithuania has invested significantly in digitalizing its economy in recent years, becoming one of the main fintech hubs in Europe. However, despite progress in digitalization and in AI preparedness, its digital infrastructure remains close to the EU average. To unlock possibly substantial productivity gains, policies should aim to facilitate technological diffusion, job transition and AI adoption among firms, while introducing measures to mitigate associated risks in terms of possible job replacements and inequality deepening. In this respect, the recent initiatives included in the START plan aimed at promoting digitalization and the deployment of AI both in the private sector and in public administration will support these efforts.
Energy security has been reinforced in the last years. The Baltic countries joined the European electricity grid in 2025, completely disconnecting from the Russian electricity system. Moreover, Lithuania has diversified its energy sources and import dependency has been lowered through the intensification of domestic electricity production from renewable sources in the recent years. Still, being susceptible to risks associated with climate change, Lithuania needs to accelerate the green transition, particularly for adaptation. In this respect, future investment in new technologies and defense initiatives should not thwart efforts to reduce economy-wide emissions, such as the recently adopted policies in the context of the updated National Energy and Climate Action Plan (NECP) for the period 2021–2030.
The IMF team is grateful for the warm hospitality of the Lithuanian authorities and would like to thank all its interlocutors in government, the Bank of Lithuania, the European Central Bank, the private sector, unions, and business associations for constructive and fruitful discussions.
