20230904-IMF-Republic_of_Lithuania_2023_Article_IV_Consultation-Press_Release_Staff_Report_and_Statement_by_the_Executive_Director_for_the_Republic_of_Lithuania_76页_1mb

Summary of the 2023 Article IV Consultation with the Republic of Lithuania

Core Content

The IMF conducted the 2023 Article IV consultation with the Republic of Lithuania, resulting in a staff report, a press release, and a statement by the Executive Director. The consultation assessed Lithuania's economic performance, risks, and policy responses to recent shocks, particularly inflation and geopolitical tensions.

Main Points and Key Information

Economic Performance and Shocks

• Economic Resilience: Lithuania managed to weather a series of unprecedented external shocks due to strong macroeconomic fundamentals and a decisive policy response.
• Economic Contraction: High inflation and rising interest rates, combined with weak external demand, led to an economic contraction in the last quarter of 2022 and early 2023.
• Labor Market: The labor market remained broadly resilient with high wage growth, though real wage growth was negative for the last year. The influx of 80,000 Ukrainian refugees helped moderate some labor market bottlenecks.
• Export Growth: The export sector, particularly road freight, saw significant growth due to cost advantages, low taxation, and a flexible labor market. The share of exports to Russia, Ukraine, and Belarus fell from 29% in 2014 to 18% in 2021, and further to 12% in 2022, due to geopolitical tensions.
• Inflation: Headline inflation reached an annual average of 19% in 2022, one of the highest in the eurozone, alongside Estonia and Latvia. While inflation has fallen to 10% in May 2023, it remains significantly above the eurozone average. Core inflation remains high, reflecting supply bottlenecks and robust demand recovery post-pandemic.

Outlook and Risks

• Economic Recovery: The economy is expected to recover later in 2023 and 2024, supported by domestic and external demand.
• Key Risks: The biggest risk is persistently higher inflation than the Euro Area, which could erode competitiveness and slow convergence. External risks include an escalation of Russia's war in Ukraine, which might lead to higher energy and food prices.
• Monetary Policy: Monetary conditions have tightened, but remain looser than warranted by domestic conditions. The onus is on fiscal policy to contain inflationary risks.

Policy Recommendations

• Fiscal Policy: The fiscal stance should be tightened to reduce inflationary pressures, while preserving public investment. Reactivation of the domestic fiscal rule will help in this effort.
• Structural Reforms: Long-overdue structural reforms in education, healthcare, and labor market flexibility are necessary to enhance productivity and support further income convergence with Western Europe.
• Climate Policies: Developing renewable energy sources and improving energy efficiency are essential for climate change mitigation and energy security. A carbon tax should be applied in sectors not covered by the EU Emission Trading System (ETS).
• Financial Sector: The financial sector is resilient with high liquidity and capital buffers, but risks from higher interest rates and volatile markets need to be managed. The levy on banks should be temporary to avoid negative impacts on foreign investment and efficiency.
• EU Funds Utilization: Efficient use of EU funds should be prioritized to enhance private sector productivity.

Key Economic Indicators (2018–2028)

| Indicator | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 |
|----------|-----|-----|-----|-----|-----|-----|-----|-----|-----|-----|-----|-----|
| Real GDP Growth (%) | 4.0 | 4.6 | 0.0 | 6.0 | 1.9 | -1.4 | 2.9 | 2.7 | 2.5 | 2.2 | 2.1 |
| Domestic Demand (Contribution to Growth) | 3.3 | 1.3 | -3.8 | 6.7 | 1.3 | -1.1 | 2.7 | 2.6 | 2.3 | 2.1 | 2.0 |
| Net External Demand (Contribution to Growth) | 0.7 | 3.3 | 3.8 | -0.7 | 0.6 | -0.2 | 0.2 | 0.2 | 0.2 | 0.2 | 0.2 |
| General Government Gross Debt (%) | 33.7 | 35.8 | 46.3 | 43.7 | 38.1 | 36.7 | 35.0 | 33.5 | 32.4 | 31.5 | 30.8 |

Key Policy and Structural Recommendations

• Fiscal Policy: A disinflationary stance is needed, with a lower-than-budgeted deficit and a contractionary fiscal stance in line with the domestic fiscal rule.
• Structural Reforms: Accelerate reforms in healthcare and education, and enhance the implementation of the Recovery and Resilience Plan.
• Labor Market Flexibility: Continue to support a flexible labor market and ensure that wage growth remains aligned with productivity.
• Financial Sector: Maintain the flexibility of the financial system, monitor non-systemic vulnerabilities, and enhance supervisory capacity and AML/CFT frameworks.
• Energy and Climate: Develop renewable energy sources, improve energy efficiency, and consider a carbon tax for sectors outside the EU ETS.

Conclusion

The IMF acknowledged Lithuania's successful convergence process and its ability to manage external shocks through strong fundamentals and policy responses. However, the country faces ongoing inflationary pressures and risks from both domestic and external factors. The focus should remain on fiscal discipline, structural reforms, and maintaining financial stability to support sustainable growth and convergence with Western Europe.