IMF Staff Concludes Visit to the Republic of Lithuania

IMF News, November 21, 2019

Source details

Press Release No. 19/427
Mission dates: November 15–21, 2019
Statement by: Mr. Borja Gracia, IMF mission chief for the Republic of Lithuania
Note: "End-of-Mission press releases include statements of IMF staff teams that convey preliminary findings after a visit to a country. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. This mission will not result in a Board discussion."

"Growth in Lithuania in 2019 remains strong and balanced in the face of a global slowdown."
Tight labor market and strong wage growth have supported private consumption.
Better utilization of EU funds has helped accelerate investment, particularly in construction and transportation.
Current account: surplus strengthened further, supported by increases in export of services related to transport, "which almost doubled over the last four years."
Credit developments:
- Credit continued to grow, yet at a moderately slower pace than in 2018.
- Decline in credit to non-financial corporations attributed to increased use of alternative funding sources such as issuing bonds.
Banking sector: "remains well-capitalized, liquid, and profitable."

"There is no evidence so far of high wage growth affecting the economy’s competitiveness."
Inflation trends:
- Overall inflation has declined despite continued strong wage growth.
- Non-tradable service sectors experienced higher inflation as firms passed higher labor costs to prices to preserve profitability.
- Price increases in exporting companies are lower, supported by higher productivity, which helps external competitiveness and profitability.
Policy implication: "raising productivity via structural reforms is crucial to sustain high wage growth going forward."
Concern: authorities’ reform agenda "has so far failed to deliver in key areas." In health and education, upfront wage increases were not complemented by other critical reforms; systems "remain oversized at the cost of lower quality, hindering the efforts to boost productivity and competitiveness."

2019 fiscal outcome:
- "The small surplus projected for 2019 will fall short of the budget due to revenues that have not kept up with output growth and a higher wage bill and social spending, especially poorly targeted child benefits."
- With growth exceeding expectations and higher than last year, fiscal policy in 2019 is described as "unnecessarily pro-cyclical."
2020 budget assessment:
- "The initial 2020 budget proposal sets adequate fiscal targets but relies on optimistic revenue projections."
- Target: overall balance of 0.2 percent of GDP; if achieved, "will translate into a broadly neutral fiscal stance, which is adequate given the cyclical position of the Lithuanian economy."
- Concern: achieving the 0.2 percent of GDP balance would require "overly optimistic improvements in tax administration, unrelated to changes in tax policy." Similar projected improvements did not materialize in 2019 and are "unlikely to do so next year."
- Political feasibility: proposals for new and modest real estate and environmentally related revenue measures "have proved politically challenging and are unlikely to be approved."

Fiscal trade-off: Lithuania "struggles to find the right balance between increasing demands for better public services and a competitive tax environment to attract investment," resulting in budget rigidities.
Recommendations:
- Increase the efficiency of the tax system and its expansion through environmental and real estate taxes.
- Enhance the efficiency of public spending, particularly in education and healthcare, with the focus on raising long-term growth.
- Better target social spending.
- Pension increases should preserve financial sustainability "as guaranteed by the existing indexation formula" while addressing social sustainability concerns.

Growth projection for 2020: "expected to moderate in 2020 towards more sustainable levels."
- Drivers: domestic demand expected to reduce its contribution to growth with slower growth in employment and wages, and slower investment growth due to a slowdown in the absorption of EU funds (absorption "is particularly high this year").
- Exports: slower export growth due to weaker external demand expected to weigh on growth.
Risks: "Risks remain tilted to the downside."
- Domestic risks: political uncertainty around the budget, upcoming parliamentary elections next year, and lack of progress in structural reforms.
- External risks: uncertainty surrounding trade tensions, Brexit, and the European Commission’s Mobility Package, "with the latter having a potentially large impact on the recently booming transportation sector."

Source: IMF Press Release No. 19/427, November 21, 2019.