OREANDA-NEWS. September 29, 2015. Fitch Ratings has affirmed Lithuania's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'A-'. The Outlook is 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
The affirmation and Stable Outlook reflect the following factors:

Lithuania's ratings are supported by its stronger fiscal position than its 'A' rating peers, a sustained decrease in macroeconomic imbalances, as well as the strengthened institutional and policy framework that comes with eurozone membership. However, the ratings are constrained by the country's low GDP per capita and high net external debt/GDP.

Growth is in line with peers. Economic activity weakened in 1H15, weighed down by net exports, which have been negatively affected by recession in its largest trading partner, Russia. As a result, Fitch has revised down its 2015 real GDP forecast to 2.0% from 3.0% six months ago. Our expectation is that headline growth will continue to be held up by a resilient domestic sector, driven by higher household consumption and gradual recovery in private sector investment. For 2016 and 2017, we forecast real GDP growth of 2.8% and 3.2%, respectively.

Risks weigh on our latest macroeconomic baseline, with the major one being Lithuania's exposure to Russia's economy. The sharper than previously anticipated fall in Russian demand for Lithuanian exports has had negative repercussions for some of Lithuania's key sectors, notably agriculture and transportation. On the other hand, Lithuanian exporters have managed to increase export growth to EU and non-EU countries, which partially mitigates the extent of negative spill-over. Other potential risks to Lithuania's economy are an economic slowdown in other key trading partners and weak investment.

Lithuania's stronger fiscal position than the 'A' rating median remains a key support to the rating. Our latest projections point to a general government deficit of 1.5% of GDP and a government debt ratio of 42.0% of GDP for 2015. Both ratios would be below the 'A' median fiscal deficit of 2.4% and debt ratio 47.2%. Fitch's projection for a wider fiscal deficit in 2015 than in 2014, when the deficit was 0.7% of GDP, reflects the slowdown in economic growth, as well as a lesser impact from one-off measures (mainly the asset liquidation of proceeds by the Deposit Insurance Fund in 2014 which accounted for 1.3% of GDP). For 2016 and 2017, we forecast fiscal deficits 1.5% and 0.9% of GDP, respectively, due to consolidation measures and strengthening growth.

Lithuania's banking sector strengthened upon eurozone membership, becoming part of the ECB's Single Supervisory Mechanism and gaining access to ECB liquidity. The sector is well capitalised (Tier 1 capital adequacy ratio at 23.4% Q215), and on-going deleveraging has improved banks' balance sheets, with non-performing loans now at 6.4% (Q215) compared with a peak of 20.4% in 2010. Fitch views positively the high level of foreign ownership in the banking sector, which reduces the risk of financial sector liabilities migrating onto the sovereign balance sheet.

Lithuania's ratings are constrained by the country's low level of income per capita. Structural rigidities in the economy (including high unemployment, low domestic savings) hamper the economy's growth potential and therefore the convergence in income levels with higher rated peers. Adopting a new Labour Code, currently under consideration in parliament, which aims to improve the flexibility of the labour market and foster a better business environment, would be a positive step, in Fitch's assessment.

The net external debtor position stands out as a weakness against the median net creditor position (23.3% of GDP estimated) of its 'A' range peers. For 2015, Fitch is forecasting a net external debtor position of 27.5% of GDP, slightly higher than in 2014 where the ratio was 24.5% of GDP. The increase is due to a higher net debt position for the sovereign as a result of euro adoption which affects international reserves, and the domestic banking sector turning into a small net creditor from its debtor position in 2014.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main factors that could, individually or collectively, trigger positive rating action include:
- A longer track record of strong and stable economic growth that fosters higher income per capita, without the re-emergence of macroeconomic imbalances.
- A sustainable improvement in external finances in conjunction with a reduction in external debt ratios.

The main risk factors that, individually or collectively, could trigger negative rating action are:
- 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 Lithuania's main economic partners in the eurozone will benefit from a gradual economic recovery. The European Central Bank's asset purchase programme should help underpin inflation expectations, and supports our base case that the eurozone will avoid prolonged deflation. Nevertheless, deflation risks could re-intensify in case of adverse shocks.

Fitch forecasts that the Russian economy will contract by 3.5% in 2015 and then grow by 1% in 2016.