OREANDA-NEWS. March 28, 2016. Fitch Ratings has affirmed Lithuania's Long-term foreign and local currency Issuer Default Ratings (IDR) at A-', with Stable Outlooks. 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's ratings are supported by institutional strengths and a policy framework that come with eurozone membership, as well as its government's stable fiscal finances. However, the ratings remain constrained by the country's weaker external finances and lower per capita income than similar 'A' rated peers.

Fitch forecasts Lithuania to grow 2.9% in 2016. Economic growth will be predominately domestic led, with household consumption the main driver as supportive fiscal policies and robust growth in real wages will help boost levels of disposable income. Positive contributions to growth are also expected to come from investment, although at a slower pace than in 2015 as use of EU funds temporarily slows due to the start of a new programme period (2014-2020). With a strong momentum in domestic demand for 2016, import growth is projected to continue outpacing export growth for a second year.

Downside risks weigh on Fitch's macroeconomic baseline. We continue to expect a negative impact on Lithuania's export and transportation sectors from the prolonged recession in Russia (its largest export trading partner), and the imposed Russian embargo on certain EU food products. Fitch estimates that the direct impact from Russia shaved as much as 1.0pp off Lithuania's GDP growth in 2015. This impact should be lower in 2016. With the subdued export environment, Lithuania's current account deficit is estimated to have widened to 2.5% of GDP in 2015 from a surplus of 3.5% in 2014.

Strong front-loaded fiscal consolidation in recent years have helped bring Lithuania's fiscal finances in line with 'A' range peers. General government debt estimated at 42.6% of GDP in 2015 is consistent with the 'A' median of 44.6%, while the fiscal deficit at 0.9% of GDP is below the 'A' median of 2.1%.

For 2016, we expect a fiscal deficit close to 1.3% of GDP. Widening of the deficit is consistent with government plans to strengthen social assistance and public investment in the economy, while implementing better tax administration. However, these measures are being undertaken in an environment of deteriorating demographics. The European Commission estimate age-related costs will increase by 3.7% of GDP by 2040, on unchanged policies, more than twice the EU average of 1.2% of GDP. Lithuania has one of the lowest tax revenue-to-GDP ratios in the EU (28% against the EU average of 40%).

Lithuania's banking sector benefits from being 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 24.3% 2015), and on-going deleveraging has improved banks' balance sheets, with non-performing loans now at 5.5% (2015) 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 remain constrained by its weaker external finances compared with its 'A' peers. Since peaking in 2009 (at 38.9% of GDP), Lithuania's net external debt position has stayed on a downward trend (22.4% of GDP, 2015). However, its position compares unfavourably against the median net external creditor position of its 'A' range peers (20.4% of GDP). Fitch projects a gradual reduction in Lithuania's net external debt/GDP ratio in 2016, driven mainly by on-going deleveraging in the banking sector.

Structural rigidities in the economy (including high unemployment, low domestic savings) also constrain Lithuania's rating, given that it weighs on 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 to improve competiveness.

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 sustainable improvement in external debt ratios.
- A longer track record of strong and stable economic growth that fosters higher income per capita, without the re-emergence of macroeconomic imbalances.

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
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.