November 13, 2017

An International Monetary Fund (IMF) mission visited Vilnius during November 7–13, 2017, to discuss recent economic developments and policy priorities with the Lithuanian authorities. At the conclusion of the visit, Borja Gracia, IMF mission chief for the Republic of Lithuania, made the following statement:

"Lithuania’s economy is experiencing rapid, broad-based growth. Private consumption continues to be the main contributor, supported by strong wage and credit growth. Exports are performing better than expected thanks to a more favorable external environment, particularly in Russia and the euro area. Investment is rebounding, despite low utilization of EU funds. We expect growth to be 3.5 percent in 2017 gradually converging to its potential of around 3 percent over the medium-term.

"Since 2013, wages have grown faster than productivity. So far, this trend does not seem to have adversely affected the economy’s competitiveness, but if it were to continue it could damage export growth and raise inflation. In this context, further increases in the minimum wage—which at nearly 50 percent of the average wage is already high—would further increase risks in this area.

"Fiscal performance remains strong. With tax revenues benefitting from strong wage and consumption growth, and subdued spending, the budget will remain in surplus, compared with an expected deficit of 0.7 percent of GDP. The recent fiscal performance and the medium-term fiscal plan place debt on a firmly declining trajectory. Given the better-than-expected economic performance and emerging inflationary pressures, fiscal policy over 2016-17 has been appropriately countercyclical.

"Going forward, fiscal policy should strike the right balance between maintaining a prudent stance and addressing social demands. The draft 2018 budget projects a general government surplus of 0.6 percent of GDP, in line with Lithuania’s fiscal rules. The main objectives of the budget include the reduction of poverty and inequality, by increasing pension and other social benefits; the support of entrepreneurship and innovation through tax incentives; and the prioritization of healthcare and defense spending in line with NATO obligations. The budget also introduces measures to increase the progressivity in the tax system and to reduce preferential tax treatment to some sectors of the economy.

"Fiscal structural reforms should focus on growth friendly measures that will support the authorities’ social program. On the revenue side, the emphasis should be on rebalancing taxes away from labor towards capital and wealth, and on improving compliance. On the expenditure side, the focus should be on creating space for additional social spending by improving efficiency, particularly in education and healthcare. Pension reform to ensure social as well as fiscal sustainability is also a priority, particularly given adverse demographic trends.

"Lithuania’s financial sector is well capitalized and highly liquid. Credit has been expanding rapidly since 2016, although from a low base. Its growth has been accompanied by a rapid increase in real housing prices (which however remain well below pre-crisis levels). The Bank of Lithuania is pro-actively monitoring developments in this area and possesses the necessary macroprudential tools to curb excessive credit growth if necessary. Potential spillovers from vulnerabilities in Nordic parent banks, which control much of Lithuania’s financial sector, are also a potential risk. Therefore, cooperation within the Nordic-Baltic Group should be further strengthened, including through the planned crisis simulation exercise.

"Structural reforms will be critical to increase potential growth and reaccelerate income convergence with other Eurozone economies after the significant slowdown in productivity that followed the crisis. In the absence of stronger productivity growth or measures to boost labor supply, it will be difficult to sustain the current high growth rates without external imbalances reemerging. With the economy in a cyclical upswing, now is an opportune time to implement reforms. In this connection, the introduction of the new labor code is a positive development that could result in higher productivity. Comprehensive education reform remains the top priority given poor educational outcomes and the high cost of the system. Other priority areas include healthcare, innovation and state owned enterprises."