lithuania economic overview

Macroeconomic performance

Economic activity in Lithuania has slowed drastically over the past year. Driven by strong domestic demand and substantial capital inflows, real GDP had risen at an annual average rate of 7.5 per cent since 2000, before moderating to 3 per cent in 2008 and falling by a dramatic 20.2 per cent year on year in the second quarter of 2009. The slow-down was triggered by the rapid retrenchment in bank credit, falling asset prices and weakening external demand for exports. Unemployment has been rising rapidly, reaching 13.6 per cent in the second quarter, and the rate of inflation has been declining in line with the falling domestic demand, to 2.6 per cent in August 2009. The rate of decline in industrial production reached over 25 per cent year on year in April 2009 but has been slowing down since then, to 13.2 per cent in August 2009.

In reaction to the drastic fall in domestic demand, imports have been falling much faster than exports, with the year-on-year rate of decline reaching 44 per cent for imports and 31 per cent for exports in the first half of 2009. As a result of the faster than expected external adjustment, the current account moved into surplus in February 2009.

The fiscal deficit has widened due to the rapid fall in fiscal revenues and was 3.2 per cent of GDP in 2008. These trends continued into 2009 when the deficit is projected to reach 9 per cent of GDP for the year as a whole. As a consequence of the fiscal imbalance the European Union initiated the Excessive Deficit Procedure in June 2009 which means that Lithuania must reduce its fiscal deficit to below 3 per cent of GDP by 2011. In July 2009 the authorities adopted a number of measures to contain the deficit, including a VAT increase from 19 to 21 per cent and further salary cuts in the public sector. As a result of the fiscal tightening and fast external balance adjustment, Lithuania has been able to avoid speculative attacks on its currency board regime, which still enjoys broad political support within the country.

Outlook and risks

The economy will likely continue to shrink well into 2010. Subsequent growth is expected to be held back by constrained availability of credit and sluggish export demand. Containing the large fiscal deficit will continue to be a crucial policy goal for Lithuania. A tight fiscal policy is also necessary for the planned adoption of the euro and for increasing the attractiveness of the country for foreign capital needed for the resumption of economic growth. Over the medium term, a return to growth will depend on banks’ ability to restart lending, especially to small and medium-sized enterprises, and on a recovery of external demand. Significant risks still remain in the financial sector which is highly dependent on external sources of funding.