OREANDA-NEWS. Fitch Ratings has affirmed Lithuania's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'A-'. The Outlooks are Stable. The issue ratings on Lithuania's senior unsecured foreign and local currency bonds have also been affirmed at 'A-'. The Country Ceiling has been affirmed at 'AAA' and the Short-term foreign currency IDR at 'F1'.

KEY RATING DRIVERS
Lithuania successfully joined the eurozone on 1 January 2015, becoming its 19th member. As a small, open economy, adoption of the single currency underpins Lithuania's ratings, reducing credit risks associated with foreign currency exposures on the sovereign's balance sheet and in the banking system. The euro's reserve currency status also enhances the sovereign's fiscal and external financing flexibility, while Lithuanian banks will gain access to ECB liquidity facilities.

Lithuania's ratings are also supported by its stronger fiscal position than 'A' range peers and growth above the regional average. However, the ratings are constrained by Lithuania's low income per capita and a high net external debtor position.

We expect Lithuania to continue its strong growth performance. The economy is projected to grow close to potential, with real GDP growth of 3% and 3.5% for 2015 and 2016 respectively. Economic growth will be mainly driven by domestic demand. Resilient household consumption, helped by a low inflation environment and higher wages, in addition to investment growth, will offset a weak outlook on net exports.

Risks to our baseline projection are on the downside. Lithuania's trade and transportation sectors are particularly vulnerable to developments in the Russian economy. Russia took up almost 21% of Lithuania's total export market in 2014, of which 88% were re-exports. Since August 2014, Lithuania's exports to Russia have fallen 62%. There is evidence that Lithuanian exporters have redirected some restricted exports originally bound for Russia to other important trade partners in EU and CIS countries. However, aggregate export growth is still weak. Negative spill-overs from a weak Russian economy will also be felt in Lithuania's agriculture and transportation sectors.

Lithuania's fiscal finances stand out favourably against its 'A' range peers. Our latest projections point to a fiscal deficit and general government debt ratio of 1.5% and 41.5% of GDP respectively in 2015; both ratios below the 'A' median fiscal deficit of 2.2% and debt ratio of 46.8%.

A stable banking sector supports Lithuania's ratings. Coinciding with its membership into the eurozone, Lithuania's banks entered the banking union with strong capital adequacy ratios (Tier 1 at 20.9% in 2014). The ratio of loan-to-deposits, at 90.6% in 2014, is moderately high, but significantly below its peak of close to 200% in 2008. Fitch views positively the large presence of Scandinavian banks in Lithuania's banking sector, given their financial strength and high home supervision standards. A high level of foreign ownership in the sector reduces the risk of financial sector liabilities migrating onto the sovereign balance sheet.

Partially constraining Lithuania's ratings is the country's net external debtor position (to the tune of 25.1% of GDP in 2014), which stands out as a weakness against the strong median net creditor position (12% of GDP in 2014) of its 'A' range peers. On-going deleveraging in the banking sector, future reduction in sovereign debt, and modest equity FDI inflows should help gradually reduce Lithuania's external liabilities in the long-term.

Lithuania's ratings are also weighed down by its lower GDP per capita relative to higher-rated peers. Addressing moderate structural rigidities in the economy (i.e. high unemployment, low domestic savings) will support gradual convergence to income levels consistent with rated peers.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced. The main risk factors that, individually or collectively, could trigger positive rating action are:

- A longer track record of strong and stable growth that fosters higher income per capita, without re-emergence of macroeconomic imbalances
- A sustainable improvement in external finances in conjunction with a reduction in external debt ratios

The main factors that could, individually, or collectively, trigger negative rating action include:
- A severe negative shock that undermines macroeconomic, fiscal and financial stability
- Deterioration in Lithuania's public debt dynamics, for example, from sustained fiscal slippage and/or economic underperformance
- Deterioration in external finances, for example, associated with overheating of the domestic economy

KEY ASSUMPTIONS
Fitch assumes that the government will continue to tighten its fiscal stance to reach a structural budget deficit of 1% of GDP.

Fitch assumes the eurozone will avoid long-lasting deflation, such as that experienced by Japan from the 1990s. Fitch also assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term.