Lithuania strategy overview

Full strategy  (0.5Mb) Approved 22  Sep 2009

The Republic of Lithuania continues to meet the conditions specified in Article 1 of the Agreement Establishing the Bank. Since 1991 Lithuania has made substantial progress in transition and structural reforms. Some 75 per cent of economic activity is in the private sector and price and trade liberalisation, enterprise restructuring and effective financial sector reforms have taken place. There is an open foreign trade regime and no major constraints to foreign investment.

Economy

Economic activity in Lithuania has slowed drastically over the past year. Driven by strong domestic demand and substantial capital inflows, real GDP rose by an annual average of 7.5 per cent per year since 2000, before moderating to 3 per cent in 2008. As other Baltic countries, Lithuania has been increasingly affected by the deceleration in credit growth and falling asset prices. In addition, the global financial crisis, the difficulties in the whole Baltic region, and falling external demand as of mid-2008 led to a further slowdown, with the Lithuanian economy falling into recession in the second half of 2008. Both domestic and external imbalances have been high in recent years, leaving Lithuania vulnerable to the global financial turmoil. In particular external financing conditions and global growth prospects have deteriorated significantly over the past year. Current indications suggest a substantial reduction in the availability of finance in the coming years for households, corporates, municipalities and larger infrastructure projects. In 2009, the economy is likely to contract by some 18 per cent. As a consequence, unemployment and regional disparities are expected to rise further. So far, the banking system has mainly been affected by rising money market interest rates and decelerating credit growth while the share of non-performing loans is rising substantially, forcing banks to increase credit loss provisions. However, the main foreign (Scandinavian) parent banks remain committed to staying in the region.

The government has taken sizeable and timely steps to ensure financial stability and prudent fiscal policies. However, with a challenging external environment in the coming years, further bold policy action will be required in order to safeguard competitiveness and progress with reform made to date. Over the previous strategy period, the government made only limited progress with the remaining elements on the reform agenda. While the business environment is among the best in the region, challenges remain with regard to combating corruption, reforming the judicial system, and modernising education and health care. Privatisation moved a step closer to completion with the sale of the government’s stake in the AB Mazeikiu Nafta oil refinery at the end of 2006. At the same time, the government has strengthened its involvement in the energy sector through the establishment of a majority owned holding company (LEO LT), mainly due to the large investment needs in this sector over the coming years. The closing of Ignalina nuclear power station by the end of 2009 constitutes a particular challenge, which could lead to significantly higher energy costs in 2010 and beyond. While the impact of the crisis is severe, the government remains committed to achieving the Maastricht criteria as soon as possible, with the main challenge being the budget deficit in the coming years.

Objectives and challenges

In the current environment the main objectives of the government are to secure financial and macroeconomic stability while keeping structural reform on the agenda. Investor confidence will be crucially influenced by the speed of adjustment of external and domestic imbalances as well as the ability to improve price competitiveness and to control the deterioration in public finances. In the medium-term, re-focusing the economy towards the tradable sectors and developing key sectors for future growth will be equally important. Against this background, the key transition challenges for Lithuania include:

• Further strengthening the stability of the financial system, supporting the smooth functioning of markets and further development of financial intermediation, mainly for SMEs through equity and mezzanine capital, and improving financial supervision, corporate governance and business practices.
  
• Strengthening measures to counteract the effects of the crisis on the real sector by further improvements in the business environment to retain investor confidence, including more extensive and consistent enforcement of laws and improved transparency in public procurement.
  
• Ensuring security of energy supply after the anticipated closure of Ignalina Nuclear Power Plant in 2009 remains a key challenge. This requires major decisions as regards to alternative sources of energy, including the development of new power links to the EU energy markets, reduce energy intensity and meet environmental targets and develop renewable energy.
  
• Improving long-term competitiveness. Further ‘market-sustaining’ reforms in the areas of governance and enterprise restructuring, education, competition policy and infrastructure reform will be necessary to ensure competitive advantages attracting foreign investment.
  
• Modernising municipal and environmental infrastructure with the assistance of EU structural and cohesion funds, private sector involvement and commercial co-financing from local sources. There is limited private sector participation in municipal sectors including water and sewage, urban transport and in the development of state transport infrastructure.
  

Since the last country strategy was approved, the Bank’s activities in Lithuania have remained very limited as a result of significant progress in transition and reflecting the further development of a very competitive banking sector dominated by Nordic banks. The Bank has signed 11 projects for an amount of €49 million in 2006 – 2008.

Until a new medium term strategy is adopted by the Board of Governors, the Bank’s operational objectives in Lithuania will remain in accordance with the strategic outline for the years 2006 – 2010 agreed upon in Capital Resources Review 3, while also addressing the crisis needs in Lithuania and across the region, without questioning graduation. The Bank will work closely with the commercial banks and other IFIs to support the financial system and mobilise financing for nationally important projects in infrastructure and energy sectors as well as facilitate lending to SMEs and financing of energy efficiency projects. The Bank will also look for other opportunities to address the enhanced needs in Lithuania due to the ongoing financial crisis.

In light of the crisis and the external environment outlined above, the Bank’s activities in Lithuania will be based on the following operational objectives:

• Foster commercial banks’ continued lending to the corporate sector, particularly to SMEs, by providing long term debt and equity to financial institutions and invest in mezzanine and equity funds to ensure availability of financing.
  
• Promote investments in renewable energy and to improve energy efficiency as well as energy security also through supporting the development of power links.
  
• Provide higher-risk products such as equity for local corporations to fund their growth and improvements in competitiveness as well as to strengthen their corporate governance. Particular attention will be paid to local companies’ investments in the context of cross-border expansion.
  
• Where appropriate support municipalities through public-private partnerships and through financial institutions to ensure commercial co-financing for EU funded projects.
  
• Proactive review and management of the Bank’s portfolio to maintain its high quality.

The Bank will continue to ensure that all EBRD operations in Lithuania meet sound banking principles, have transition impact, are additional and are subject to the Bank’s Environmental and Social Policy and incorporate, where appropriate, Environmental and Social Action Plans.