Perspectives on Projections of Lithuanian Economic Indicators (December 2008)

As Part of Risks Foreseen Have Materialised,DraftStateBudget Is Based on Stable Gross Domestic Product Values

Vilnius, December 15. The adjusted draft State budget, likewise the initial draft State budget, is based on cautious economic indicator projections, having regard to the recommendation by the International Monetary Fund to Lithuania to strive for a smooth deceleration in economic development, but also to prepare for a possible sharp slowdown in economic growth. Taking the scenario of slowdown in economic development as the basis for the draft State budget for 2009, the Government strengthened the measures necessary to ensure that financing commitments of the government to appropriation managers would be met overcoming all the challenges that arose due to tax administration improvement plans that were unsoundly ambitious this year, uncollected budget revenue and after-effects of the global financial crisis. In order to ensure financing stability short-term and long-term measures are planned. Long-term financing stability measures will be proposed by the reform of the general government finance planning system, and short-term measures are envisaged by the draft State budget, which has been cautiously adjusted based on the risks materialised.

The adjusted draft budget meets the urgent need to preserve a sustainable demand necessary for economic development. The projected State budget deficit will enable implementation of the task of the general government deficit representing one and a half to two point one percentage point of GDP, stabilisation of public finances, restoration of confidence of foreign investors in the Lithuanian business plans, more rapid reduction of interest rates, mitigation of negative effects of the multi-annual rise in prices, which will show in 2009, recovery of the investment in 2010, and making use of the last opportunity to lay down the foundations for GDP growth in 2011. The proposed reduction in general government expenditure and increase in taxes reduce consumption just to the extent required for a rapid reduction in the inflation rate and moderation of the multi-annual external imbalance, the current account deficit.

An immediate adoption and principled implementation of this budget would restore the financing of cheaper current assets of business and more abundant investment; therefore, it would ensure a stronger aggregate demand, which more than fully compensates the required reduction in government consumption. In case of failure to implement the plans of the draft budget to restore the confidence of financial markets in high ratings of the financial liabilities of Lithuania, the aggregate demand and GDP would have been lower by a few percentage points.

GDP

In the 4^th quarter of 2008, a short outbreak of the renewed global financial crisis gave rise to the interest on loans and limited crediting; therefore, the projection of real gross domestic product (GDP) growth of 5.3%, which has been stable for two years, is reduced to 3.5%. A very sharp rise in the interest rates and the strengthened distrust in financial markets provoked a rapid self-adjustment of the annual Lithuanian external imbalance; therefore, it is likely that in the 4^th quarter, there will be a start of recession. The envisaged GDP value is reduced by almost LTL 1,500 million, as declining investment is not compensated by still increasing consumption. The projection of consumption is increased by LTL 1,322 million.

The updated draft budget enables accelerating restoration of confidence by financial markets; therefore, the projected nominal GDP value for the years 2009 – 2011 remains the same as in the initial draft budget.

Confidence in a rapid economic stabilisation is strengthened by greatly improving Lithuanian terms of trade. The Lithuanian terms of trade having improved by 4 percentage points over the 1^st half-year of 2008 show that this year the Lithuanian trade deficit will improve by a few percentage points of GDP. Oil prices having decreased by half over the 2^nd half-year of 2008 would improve the current account balance of the upcoming year by almost two percentage points. The central scenario foresees that Lithuania’s current account deficit in 2009 will shrink to 5.3 percent of GDP from 12.5 percent of GDP in 2008.

In 2009, the earlier projected GDP growth is still possible in case more entrepreneurs rationally chose the strategy for enhancing business volumes and stabilising prices; however, the data of the 3^rd quarter of the current year does not provide with the basis for drafting budget indicators under such a scenario. Thus, the indicators of the State budget and municipal budgets have been adjusted taking into account that the risks of macroeconomic environment related to the impact of irrational inflationary expectations on reduction in production volumes, indicated in the initial draft budget, partially materialised. The increase in GDP deflator in the 3^rd quarter indicating the growth of profit by enterprises, when global prices for oil and foodstuffs decrease and wages are under stabilisation in Lithuania, warns that some entrepreneurs choose irrational short-term profit strategies. Some economic participants by ignoring a change in credit growth, which over the 3^rd quarter of 2008 decreased by about 6 percentage points, and its impact on the narrowing of domestic demand aim only at short-term profit, preserve or increase prices without making use of a potential production growth and dismissing the staff. In 2008, the construction sector missed the opportunity of proactive reduction of the prices by 20% up to the level acceptable to the whole economy; therefore, the budget indicators have been updated taking into account the scenario that due to high tariffs in this sector the volume of production will decrease by a third. Hence, while cautiously planning public finances following the scenario of a slowdown in economic development in 2009, a decline by 4.8% of GDP in growth volumes is projected to take place. Two thirds of total decline in economic production volumes will take place in the construction sector. The volumes of production and services will decline in all sectors that over recent years became dependent on demand financed by short lived credit increases: retail and wholesale trade, transportation, real estate, public management. After the implementation of economic policy objectives envisaged in the draft budget, the growth of key economic sectors would be preserved: export-oriented industry and agriculture would be growing.

Economic indicator projections are drafted with an assumption that energy prices after decommissioning of Ignalina NPP at the end of 2009 will aggravate the Lithuanian industrial development, and in 2010, a decline in GDP growth will represent 0.2%, while in 2011, after final stabilisation of prices, it will approximate a rapid potential growth of 4.5%.

Average Wages and Consumer Prices

Although irrational short-term profit seeking strategies prevented the planned disinflation, the data of the 4^th quarter shows that imported disinflation took an accelerated pace: in December, the HICP inflation rate was reduced to 9.0% (10.3%*), while the projected average annual inflation rate for the upcoming year remained unchanged, even having regard to the foreseen increases in VAT and excise duties. At the moment the disinflation that has started will make presumptions for economic growth in the years 2010-2011.

Considering inertia of the labour market and disinflation trends that emerged in July 2008, the Ministry of Finance leaves unchanged projections of the average national wages for the current year. It is envisaged that this year, as compared with the year 2007, the average wages will increase by 20%. The data of the 3^rd quarter shows that a sharp increase in unemployment due to the rise in activity level of the residents of working age that reached a record of 69.2% forms presumptions for strengthening the stabilisation of wages in the private sector that has already started. The growth of wages will gradually approximate the labour productivity growth: in 2009, the average wages will increase by 4.3% in the country (9.8%*), in 2010 – by 2.3% (2.4%*), in 2011 – by 3.4% (3.2%*). It is projected that in 2011 the average wages before taxes will make up LTL 2,386.5. Due to irrational short-term profit seeking strategies, a greater increase in unemployment is foreseen: in 2008, the unemployment will increase to 5.6% (4.9%*), in 2009 – 7.8% (6%*), in 2010 – 8.5% (6.2%*), in 2011 – 8.6% (6.1%*).

High fuel prices, commitments to increase excise duties, inflation in 2006–2008 is not a rational basis for forming long-term inflation expectations. The evidences of the credit growth downturn emerged in the first half of this year; therefore, the central scenario projects that at the end of 2011 after weakening affect of excise duties on tobacco and feasible impact of decommissioning of Ignalina NPP, the effect of deflation credit growth will be observed and the average annual price level decrease will account for 0.1 % (2.3 %*). Deflationary pressure on local producers will be faced also in 2010; however, due to decommissioning of Ignalina NPP, inflation would undergo a jump of about 2 percentage points as a result of increasing electricity prices: increasing electricity prices will be compensated by deflation processes taking place in other sectors. In 2009 comparatively accelerated inflation will remain due to inflationary expectations which forced up for a short period in 2008, the subsequence of which will shift to 2009 from inertia based on a presumption of the lack of business rationality. In 2009 average annual inflation will make up to 5.4 % (5.4 %*), in 2010  – about 3.6 % (3.6 %*).

Based on the currency board arrangements, a fixed exchange rate of the euro against the litas guarantees the average multi-annual inflation to remain close to eurozone inflation.

* - earlier projection