OREANDA-NEWS. October 16, 2009. The Lithuanian economy continues to be severely impacted by the global economic and financial crisis. The latest World Economic Outlook projection forecasts real GDP to decline by 18? percent this year and by 4 percent in 2010. At this juncture, the unwinding of the imbalances triggered by the sharp reversal in capital inflows, outweighs the effects of the expected gradual recovery in trading partners.

2. Against this backdrop, the fiscal situation is challenging. Tax revenues have declined sharply with the economic contraction. To contain the impact on the deficit, a sizeable fiscal consolidation of 7 percent of GDP was approved this year. Nonetheless, reflecting the legacy of generous wage and benefit increases in the boom, government spending continued to grow, rising by almost 8 percent year-on year through end-August and pushing the central government deficit to almost 6? percent of full-year GDP. Without additional consolidation, the deficit would widen further as revenue continues to suffer and additional spending needs arise, notably from growing unemployment and debt service.

3. The authorities are strongly committed to returning fiscal policy to a sustainable path in 2010. The continued focus on an ambitious consolidation is necessary, even though it comes at a difficult economic time. Without it, the government risks rising deficits and debt and a less rapid exit from the EC excessive deficit procedure.

4. The government and social partners are formulating far-reaching reforms. The envisaged measures appropriately focus on benefits where spending has increased sharply and are generous by international standards. The progressive nature of the cuts and the better targeting of social assistance through stricter eligibility requirements will help protect the most vulnerable from the brunt of the adjustment. The proposed increase in social security contribution rates will strengthen the link with accrued benefits. These reforms, combined with the planned reduction in non-wage related current outlays will generate savings of about 3? percent of GDP in 2010. These gains, however, will be partly eroded by the cyclical decline in revenue as the downturn continues and by the additional spending needs.

5. To secure a substantive decline in the fiscal deficit in 2010 and beyond, as the government intends, the adjustment will need to be deeper and broader, with savings made permanent. An option, given its weight in total spending, is a further reduction in the wage bill that would produce additional savings and help close the gap between public sector wages and the on-going adjustment in private sector earnings. The steps to improve the efficiency of health and education spending being planned with World Bank advice should, over time, yield savings. There may also be scope to deepen and accelerate the planned reform of the social security system.

6. A strategy to increase revenues would complement the adjustment. The mission welcomes the tax compliance strategy being prepared and the enhancement of resources for tax enforcement. Streamlining tax incentives would also bolster collections, while a real estate tax, which is progressive by nature, would widen the tax base over time. Any proposed changes to the tax system should be placed in the context of a medium-term tax strategy that aims at enhancing both medium-term revenue and economic growth.