Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with the Republic of Lithuania
IMF News, May 4, 2006
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- Published: May 4, 2006
Background: recent developments and emerging imbalances
- Growth and resource use
- GDP grew 7.5 percent in 2005.
- Most indicators suggest tightening of resource use: a declining unemployment rate, high capacity utilization, and buoyant asset prices.
- Inflation and euro adoption risk
- Inflation has been on the rise through external price shocks, adjustment of administered prices, and domestic demand pressures, creating the risk that the Maastricht inflation reference rate will be exceeded and euro adoption delayed beyond the targeted January 1, 2007.
- Fiscal stance and pressures
- The economy received stimulus from fiscal and European Union (EU) expenditures in 2005; one-off revenue gains (notably VAT and profit tax) and tax administration reorganization in late 2004 yielded revenue gains.
- Fiscal pressures expected to rise due to aging, public sector wage increases to discourage emigration, and the elimination of the social tax reducing revenues from 2008.
- To offset pressures, widening the tax base and expenditure rationalization will be needed.
- External position and financing
- The current account deficit remained sizable and relied significantly on bank and market-based financing.
- External indebtedness is among the lowest in the new Central and Eastern European members of the EU (the CEE-8).
- Accumulating short-term debt is composed of trade credits and lending by parent banks to Lithuanian subsidiaries; reserve cover of short-term debt is lower than conventionally accepted threshold values but rollover risk is mitigated by reputable foreign banks and long-term relationships.
- Financial sector and credit growth
- Rapid credit growth supported mortgages and demands in non-traded sectors.
- Financial sector earnings and liquidity ratios held steady, but asset quality and capital adequacy indicators deteriorated somewhat in 2005.
- Competition among banks has led to more aggressive lending: narrow interest margins and increasing loan-to-value and debt-to-income ratios of new loans.
- EU funds and competitiveness
- Increased use of EU funds highlights the need to harness them carefully to improve competitiveness.
- The real exchange rate appears fairly valued and export growth has been sound; capacity constraints in the oil refining industry and increased international competition in labor-intensive goods pose new challenges.
- Lithuania is to receive substantial EU funds in per capita terms; absorption is expected to rise steeply and effective use for public goods, without distorting competition, will help maintain competitiveness.
Executive Board assessment: policy messages and recommendations
- Overall evaluation
- Directors welcomed continued rapid growth with low inflation and noted Lithuania’s strong performance over the past five years among EU members.
- Strong macroeconomic policies, the currency board arrangement, wide-ranging structural reforms, and EU integration were credited for performance.
- Imbalances and vulnerabilities
- Directors cautioned that imbalances are emerging: rapid consumption and investment in property and construction contribute to inflation and new financial vulnerabilities.
- Longer-term challenges include international tax competition, demand for public goods, emigration, and pressures on international competitiveness.
- Inflation and euro adoption
- Most Directors noted inflation picked up in 2005 and rose above the Maastricht reference value; some Directors noted relative price changes related to EU integration.
- It remains a close call whether inflation will fall below the Maastricht reference value in time for euro adoption on January 1, 2007; a number of Directors considered the rise in inflation may delay euro adoption.
- Directors agreed that a year's delay is unlikely to concern financial markets given the currency board, fiscal policy, and integration with Europe.
- Directors encouraged authorities to ensure policies are in place to achieve early euro adoption.
- Fiscal policy
- Most Directors stressed a more ambitious fiscal goal would help contain the rise in the price level.
- The fiscal stance envisaged for 2006 was described as procyclical; Directors suggested reducing the projected 2006 budget deficit.
- Directors called for measures to address growing medium-term fiscal pressures, noting planned personal income tax cuts will weaken the revenue base from 2008 onward and could put at risk the medium-term target of a structural deficit of 1 percent of GDP.
- Revenue measures suggested:
- Eliminate exemptions related to mortgages.
- Introduce a more far-reaching property tax and a vehicle tax.
- Strengthen tax administration.
- Financial sector oversight and macroprudential stance
- Directors welcomed steps taken to contain vulnerabilities from aggressive lending: Bank of Lithuania increased coordination with foreign supervisors, published a financial stability report, and provided guidance to banks on prudential lending.
- Implementation of 2001 FSAP recommendations has been helpful; a planned FSAP update was welcomed to strengthen financial sector surveillance.
- At this point, Directors did not see the need for administrative measures to slow credit growth; they encouraged forward-looking supervision and ensuring banks' risk management keeps pace with market developments.
- Additional recommendations:
- Take measures to cool down the property market.
- Encourage disclosure of bank fees and disseminate borrowing guidelines.
- Continue to report and regulate on the basis of the nonperforming loan ratio.
- Emphasize a regional perspective and cooperation.
- External short-term debt monitoring
- Directors suggested risks from accumulating external short-term debt need close monitoring but noted mitigating factors: short-term debt mainly comprises trade credits and lending from reputable foreign banks to their Lithuanian subsidiaries.
- Expenditure efficiency and social sector reforms
- Directors encouraged greater expenditure efficiency, including in the social sector.
- Health sector recommendations:
- Introduce co-payments to formalize existing informal payments and strengthen patient responsibility.
- Increase competition to contain cost and improve quality.
- Social assistance recommendations:
- Consolidate and improve targeting of the fragmented system to reduce incentives for long-term unemployment.
- Institutional fiscal framework:
- Embed measures in a medium-term expenditure framework (MTEF).
- Apply stricter scrutiny of expenditures by line ministries and municipalities.
- Integrate the MTEF into a Fiscal Responsibility Act to help fiscal discipline.
- Management of EU funds and competitiveness
- Directors stressed EU funds could enhance competitiveness and should be harnessed carefully.
- Recommendations:
- Maintain centralized management of EU funds in the Ministry of Finance.
- Ensure transparency of contract awards.
- Integrate allocation of EU funds with structural reforms, for example in the social sector.
Selected economic indicators (as presented)
Real Economy (In percent)
- Real GDP growth: 2001: 6.4; 2002: 6.8; 2003: 10.5; 2004: 7.0; 2005: 7.5
- CPI inflation (end of period): 2001: 2.0; 2002: -1.0; 2003: -1.3; 2004: 2.9; 2005: 3.0
- Unemployment rate (end of year): 2001: 17.4; 2002: 13.8; 2003: 12.4; 2004: 11.3; 2005: 8.3
Public Finance (In percent of GDP)
- General government overall balance: 2001: -2.1; 2002: -1.4; 2003: -1.7; 2004: -2.5; 2005:
- Total general government debt: 2001: 22.9; 2002: 22.3; 2003: 21.2; 2004: 19.5; 2005: 18.6
- External general government debt: 2001: 16.9; 2002: 14.9; 2003: 13.7; 2004: 12.9; 2005:
Money and Credit (Year-on-year percent change)
- Reserve money: 2001: 20.8; 2002: 26.6; 2003: 7.1; 2004: 27.6; 2005:
- Broad money: 2001: 21.4; 2002: 18.2; 2003: 24.1; 2004: 32.9; 2005:
- Private sector credit: 2001: 6.3; 2002: 30.4; 2003: 58.8; 2004: 39.8; 2005: 54.8
Balance of Payments (In percent of GDP; unless otherwise specified)
- Trade balance: 2001: -5.4; 2002: -5.6; 2003: -5.9; 2004: -7.0; 2005: -7.3
- Current account balance: 2001: -4.7; 2002: -5.2; 2003: -6.9; 2004: -7.7; 2005: -7.2
- Gross international reserves (in millions of U.S. dollars): 2001: 1,669; 2002: 2,413; 2003: 3,450; 2004: 3,594; 2005: 3,816
Exchange Rates (Litai per U.S. dollar)
- Exchange rate (period average): 2001: 4.0; 2002: 3.7; 2003: 3.1; 2004: 2.8; 2005:
- Exchange rate (end of period): 2001: 3.3; 2002: 2.5; 2003:
Public Information Notice No. 06/51 — IMF Executive Board conclusion on the 2006 Article IV consultation with the Republic of Lithuania (May 4, 2006).