OREANDA-NEWS. May 20, 2011. 1. Determined policy responses to the crisis during 2009 helped set the foundation for the economic recovery that started in 2010. Sizeable fiscal adjustment limited the widening of the fiscal deficit; wage adjustment underpinned significant gains in competitiveness; and confidence in the banking system was maintained.

2. Booming exports and strengthening domestic demand are expected to support rapid economic growth in 2011-12. Real GDP is projected to grow by 6 percent in 2011 and 4? percent in 2012. Private consumption is being boosted by increasing confidence that the recovery is robust. Strong private fixed investment reflects rising corporate profitability and capacity utilization. Solid employment growth is reducing the unemployment rate and contributing to increasing wage growth. Core CPI inflation turned positive in April, while headline CPI inflation is being boosted temporarily by high food and energy prices. Risks to the growth forecast are balanced: domestic demand could surprise on the upside, but sovereign financing concerns elsewhere in Europe could spill over to funding pressures for Lithuania.

3. Rapid economic growth is reducing the fiscal deficit, but additional measures are needed to achieve the target for 2012. Under its latest Convergence Program, the government aims to cut the general government deficit to 5.3 percent of GDP in 2011 and 2.8 percent of GDP in 2012. With strong economic growth boosting government revenue, the target for 2011 is likely to be achieved. The target for 2012 is appropriate, given the need to stabilize the debt-to-GDP ratio, preserve euro adoption aspirations, and dampen aggregate demand at a time of strong economic growth and tightening capacity constraints. Assuming that the wage bill is kept unchanged in nominal terms, we project a fiscal deficit of 4 percent of GDP in 2012. Therefore, additional fiscal measures of 1? percent of GDP are needed to achieve the target. With the recovery firmly entrenched, additional fiscal consolidation should start as soon as possible.

4. Regarding the composition of additional fiscal adjustment, we recommend expanding wealth taxation. Given the low level of wealth taxation in Lithuania, we suggest introducing taxes on residential real estate and motor vehicles. These taxes are less distortive than other taxes, are progressive, and could increase revenue substantially and quickly. It is also important to eliminate exemptions from corporate and personal income tax.

5. To achieve the medium-term objective of a fiscal surplus of ? percent of GDP, further progress is needed on structural fiscal issues:

• Pension reform: we support an increase in the retirement age, the separation of the basic social pension and the introduction of means testing, and limited government matching of individual contributions to the second pillar.

• Tax compliance: we welcome the actions taken to strengthen revenue administration, such as improved targeting of different taxpayer segments, the enhancement of border monitoring, and more extensive use of cash registers, and support further efforts.

• State-owned enterprise reform: we welcome the strengthening of transparency regarding state-owned assets, and support the analysis of the social functions of state-owned enterprises and the development of governance reforms.

6. The banking system as a whole is on the mend, but challenges remain. The average non-performing loan ratio has stabilized. The combination of lower loan-loss provisioning and wider interest margins helped banks post small profits for the first time since 2008. Capital adequacy and liquidity ratios remain well above regulatory minima. However, bank supervisors should continue to closely monitor the sufficiency of all banks’ loan loss provisions and ask banks to raise capital where needed under a strict timeframe. With improved conditions, banks’ lending standards have eased, suggesting that credit is available for sound borrowers.