Lithuania: Risk Assessment
Country Risk Rating
Business Climate Rating
- Sound public and external accounts in normal times
- Banking system dominated by three Scandinavian institutions
- Diversification of energy supply (Klaipeda gas terminal, shale gas potential, electricity links with Poland and Sweden)
- Member of the EU, the Eurozone and NATO
- Before the war, Russia was the main trading partner of Lithuania
- Tight labor market: shrinking workforce (emigration of skilled young people) and high structural unemployment
- Large informal economy (22% of GDP)
- High income disparity between the capital and the regions, particularly in the northeast, where poverty persists
- Limited value-added of exports (mineral products, wood, agri-food, furniture, electrical equipment)
THE ECONOMY HITS THE BRAKES AFTER STRONG GROWTH
The Lithuanian economy was on a solid growth trend. However, with the Russian invasion of Ukraine, the outlook changed abruptly. Russia was Lithuania’s largest trading partner, representing 10.8% of goods exports (No. 1 in 2021) and 12.1 % of imports (No. 2). Sanctions and trading bans now impact these trade flows. The duplicate accounts for Belarus, which was on the import side Lithuania’s ninth-largest trading partner (3.5% of all goods imports in 2021), and the export side, the 11th export destination (3.0%). The most significant share of imports from Russia was oil and natural gas. Indeed, in 2021, Russia accounted for 40% of all natural gas imports and 83% of all oil and refined oil products to the Baltic country. That said, Lithuania was the first EU country to stop all energy imports from Russia in mid-May 2022. The main reason for this is the LNG terminal on the coast in Klaipeda, together with the Klaipeda pipeline into the country’s interior, which made Lithuania very flexible in diversifying its gas sources. However, energy independence from Russia came at a high price. Due to soaring energy and food prices, headline inflation reached 24% year-over-year in early autumn 2022, the highest level of all Eurozone countries. For Lithuania, this was the highest inflation rate since 1996. Consumer prices are expected to increase further over 2023 but slower than in 2022. Therefore, the inflation rate should shrink noticeably but remain very elevated. The explosion of consumer prices has slashed the purchasing power of consumers, with private consumption (62% of nominal GDP) and private investments (22% of GDP) decreasing sharply in 2022. In 2023, the decrease in savings and higher interest rates will negatively affect both. Against this backdrop, private consumption could remain slightly more robust than investments, given the very positive labor market situation. With an unemployment rate of around 8.3% at the end of 2022, the jobless rate has dropped below the pre-pandemic level. This could boost consumer confidence. Interest rates will be highly dependent on ECB’s monetary policy. The central bank already hiked interest rates by 250 basis points to 2.5% for the primary refinancing rate at the end of end-2022. More rate hikes are in the pipeline and are expected to reach 3.50% and 4.0% by the end of 2023. In addition, from March 2023, the ECB balance sheet will be reduced by EUR 15 billion per month. From the end of Q2, this monthly reduction will be increased. External trade (exports represent 92% of GDP and import 84%) will also affect economic growth. Although Lithuania re-allocated and diversified trading relationships last summer. Its main export destinations are Latvia, Germany, and Poland, where demand should decrease over the winter and slowly recover over the year’s second half. Some support, however, will come from the government. First, the EU’s Recovery Fund (NextGenerationEU) has reserved EUR 2.2 billion in grants (4.5% of GDP) for Lithuania between 2021 and 2026. This will support longer-term infrastructure programs. In addition, in 2022, the government began rolling out measures representing 4.1% of GDP which will continue in 2023 to help private households and companies cope with high inflation. This should support the economy, especially over the winter months.
BUDGET DEFICIT RISES WHILE CURRENT ACCOUNT DEFICIT FALLS
The public deficit widened somewhat in 2022 due to inflation support measures and high expenditures to support Ukrainian refugees. Both are expected to continue as is or even increase in 2023. Lower tax revenues on the back of lower economic growth will push the deficit above the Maastricht line of 3%. Public debt is, therefore, likely to increase in 2023 but remain below the pandemic level. The current account switched to a deficit in 2022 due to the change in trade patterns, especially with Russia, and extremely high energy import prices. In 2023, Lithuania’s goods trade is expected to be more diversified, which should somewhat improve the trade- and, therefore, the current account balance.
WAVERING PUBLIC SUPPORT
Since October 2020, Prime Minister Ingrida Šimonytė of the conservative “Homeland Union” party, which holds 50 out of 141 seats in Parliament, has led a coalition together with the Liberal Movement (12 seats) and the Freedom Party (11 seats). The government (especially the Homeland Union) lost some support from the population after poor handling of migration flows from Belarus in mid-and late- 2021. However, with the start of the war in Ukraine in the spring of 2022, the government gained some popularity as the common enemy and restored cohesion among the population and political parties. Because of the shared border with Belarus and the Russian exclave of Kaliningrad, Lithuania has a sizeable geopolitical security issue. EU and NATO memberships are limiting the threat of military confrontation. Still, Lithuania keeps a very hawkish stance against Russia and even banned the transit of some goods to Kaliningrad as a part of EU sanctions in June 2022. This stance could lead to retaliatory action from Russia. e.g., trade sanctions or cyber-attacks.