OREANDA-NEWS. November 30, 2011. The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Lithuania.1

Background

The economy has staged an impressive recovery, based on a supportive global environment and determined policy adjustment. After contracting sharply in 2008-09, economic activity grew by 1? percent in 2010 and a robust 6? percent in the first half of 2011. The main driver of the recovery was export growth, underpinned by strong external demand and sharp nominal wage declines that restored competitiveness. There are early signs of a reallocation of resources towards tradable sectors, such as rapid growth of employment in the transport sector and an increase in the share of foreign direct investment going to manufacturing.

The export-led recovery has over the past year broadened to domestic demand, lowered unemployment, and stabilized wages. With higher domestic demand stimulating imports, the current account has moved from a slight surplus in 2010 to a small deficit in 2011. External debt has fallen since 2009 as foreign-owned banks have reduced liabilities to their parents, but is still relatively high. Higher energy and food prices pushed up inflation in early 2011, but inflation has slowed recently in line with international commodity price trends.

The fiscal deficit narrowed from 9.2 percent of GDP in 2009 to 7.1 percent of GDP in 2010, and has continued to contract thus far in 2011. Fiscal consolidation reflected mostly reductions in wages and social benefit payments. The government has fully financed its needs in 2011, but has some 8 percent of GDP in gross financing needs in 2012.

The banking system as a whole is on the mend, but pockets of weakness remain. Nonperforming loans have stabilized, net interest margins have risen, the average capital adequacy ratio is above the pre-crisis level, and liquidity has increased. However, a few banks have set aside lower provisions for losses than others despite having higher nonperforming loan ratios.

Executive Board Assessment

Executive Directors commended the authorities for Lithuania’s impressive economic recovery, noting in particular the sizeable fiscal consolidation, the maintenance of confidence in the banking system, and the significant wage adjustment that underpinned gains in competitiveness. The export-led recovery has broadened to domestic demand and reduced unemployment. Given heightened uncertainty in the external environment, Directors underlined the importance of continued vigilance and sustained progress in strengthening fiscal, financial, and structural policies.

Directors supported the authorities’ goal of further reducing the fiscal deficit, thereby putting government debt on a downward path. They considered it desirable to rely on sustainable measures, including the expansion of wealth taxation and broadening tax bases, while protecting spending on public investment and the most vulnerable people from further cuts. Directors saw merit in preparing a contingency plan in the event that downside risks to growth materialize. Over the medium term, Directors recommended further strengthening tax compliance, the fiscal framework, the pension and health care systems, and the governance of state-owned enterprises.

Directors observed that the banking system as a whole is liquid and well capitalized. Addressing remaining pockets of weakness is a priority, including through conservative risk assessments, appropriate loan loss provisions, and further capital increases where necessary. Directors also emphasized the need for a broader range of bank resolution tools and more effective personal and corporate insolvency regimes, along the lines of European and global initiatives. They looked forward to progress in unifying financial supervision under the central bank.

Directors underscored that enhancing labor participation and facilitating labor reallocation to tradable sectors are key to sustainable growth. They supported the authorities’ intention to expand the use of fixed-term contracts and make full use of EU structural funds to overcome skill mismatches. Directors called for a cautious approach to increasing the minimum wage, consistent with productivity developments. Further efforts to improve the business environment are also crucial.