11 February 2013

IMF: Republic of Lithuania—Concluding Statement for the 2013 Article IV Consultation

Lithuania faces three key challenges to ensure that the recovery continues: continuing the fiscal adjustment over the medium term; further strengthening the resilience of the banking system; and maintaining competitiveness so that growth and job creation are robust over the medium term.

The recovery is expected to continue in 2013, but at a somewhat slower pace. Growth is projected at about 3 per cent this year—down from 3.6 per cent in 2012 but still higher than in much of advanced and emerging Europe. Investment growth will likely be spurred by current high levels of capacity utilisation, easing financing conditions, and dissipating uncertainty about the external environment. Exports would contribute less to growth in 2013 than in 2012, as the effects of last year’s very good harvest unwind. Inflation is projected to continue to decline, reaching 2.1 per cent in 2013, reflecting the lagged impact of lower global commodity prices. Looking farther ahead, growth should gradually rise toward its potential of around 3¾ per cent, but this requires that investment continues to recover in the coming years. Risks around this outlook have moderated but remain tilted to the downside. Financial conditions have improved markedly in the past six months, but risks continue to emanate from both external and domestic sources. Renewed financial stress or weak growth in Europe would adversely affect Lithuania through trade and financial channels.

Completing the fiscal adjustment is important to rebuild Lithuania’s fiscal buffers. In light of the limited macro-economic policy tools available under the currency board arrangement and Lithuania’s vulnerability to external shocks given its size and openness, it is important that the structural fiscal deficit and public debt ratio continue to be reduced. This would bolster fiscal buffers and create space to allow automatic stabilisers to operate during future periods of weak growth. For this reason, achieving a small structural surplus remains appropriate over the medium term. The 2013 budget appropriately targets a further reduction in the deficit to 2½ per cent of GDP, but a focus on high quality measures is needed. This deficit target balances the need for further consolidation with supporting the recovery amid slowing growth. Overall, the IMF projects a fiscal deficit of 2.6 per cent of GDP in 2013. At the same time, the quality of fiscal measures has weakened over time and the consolidation now relies mainly on one-off measures or extensions of temporary measures.

Overall, the banking system is profitable, liquid, and well-capitalised, but continued vigilance is needed. The system-wide capital adequacy ratio is nearly 15 per cent and liquid assets are about 25 per cent of total assets. However, non-performing loans (NPLs)—while declining—remain high and profitability is falling. The intervention of Snoras bank removed a major threat to financial stability, and the recent steps to rapidly address problems in two troubled credit unions underscore the importance of effective financial sector supervision. In this context, the Bank of Lithuania’s (BoL) stepped-up onsite inspections, strict stress testing, and careful monitoring of banks’ loan loss provisions are essential for the continued health of the banking system. The BoL should continue to safeguard financial stability, including by requiring banks to raise capital as needed. On-going efforts to strengthen the supervision of credit institutions are welcome.

The financial sector has an essential role to play in supporting a robust and sustainable recovery. While Lithuania has so far been able to continue its economic recovery despite negative private sector credit growth for nearly four years, it is important that credit is not unduly constrained going forward. The weak economic environment and uncertainty about growth prospects both in Lithuania and abroad have no doubt hampered demand for credit by firms and households. At the same time, lending standards have been tight, partly reflecting continued risk aversion of the part of banks, lingering NPLs, and scarcer parent bank funding. NPLs appear to take a longer time to work out in Lithuania than in some regional peers, and a review of obstacles to timely NPL resolution should be considered. In this regard, the new household insolvency regime and recent proposals to modify the corporate insolvency regime are welcome.

Full press release

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