05-09-2023

IMF forecast for Lithuania: the economy will recover significantly, but it is important to continue boosting competitiveness

According to the assessment of the International Monetary Fund (IMF) published today, Lithuania’s economy will slightly contract this year due to domestic and foreign demand dampened by inflation. However, the country’s economy will bounce back to growth next year due to a pick-up in consumption and higher public investment. Although the competitiveness of Lithuania’s external sector has strengthened over the past decade, the IMF encourages to pay further attention to measures ensuring long-term growth of potential output. 

“After a technical recession recorded at the beginning of the year, Lithuania’s economy stabilised in the second quarter, and prices fell for the fourth consecutive month in August. The resilience of Lithuania’s economy is driven by a strong labour market, relatively low private sector indebtedness and recovering real income of households, as well as significant corporate and bank reserves. However, we do not have the luxury of time: all institutions need to focus on measures ensuring that Lithuania’s economic growth is sustained. We see risks to economic growth and financial stability in the context of persistent uncertainty, which is mostly linked to russia’s war against Ukraine,” says Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania.

“Against the backdrop of persistent uncertainty, the Government is pursuing a responsible fiscal policy which supports economic growth and helps to maintain long-term sustainability of public finances. Lithuania’s economy demonstrates resilience in the face of challenges, as illustrated by positive data on economic growth in the second quarter. In addition, the labour market remains strong, including rapid wage growth which exceeds the inflation rate, leading to a growing purchasing power of households. It is important to continue structural reforms in areas that increase the long-term potential for economic development, such as education and health,” says Gintarė Skaistė, Minister of Finance.

The IMF highlights that, despite the energy price shock, Lithuania’s economy remains competitive. This is mainly due to productivity growing faster than wages in the last decade, especially in the exporting manufacturing sector, as well as a flexible labour market, allowing the economy to adjust to shocks. The IMF also welcomes the civil service reform approved this year, which will contribute to labour market flexibility and the efficiency of the public sector. To continue increasing productivity and raising the standard of living, the IMF emphasises the importance of implementing structural reforms, especially in education and health.

According to the IMF, Lithuania’s economy may contract by 1.4% this year before growing by 2.9% next year. It should be noted that the IMF forecast was prepared before the very positive GDP and labour market data for the second quarter of 2023 were published. 

According to the IMF, the biggest risk to Lithuania’s economy is the scenario where inflation in the country remains significantly higher than the euro area average over a longer period of time, as this would reduce both domestic and foreign demand due to negative effects on competitiveness. 

However, recently the gap between inflation in Lithuania (6.4% in August) and the euro area (5.3% in August) has narrowed, while domestic prices have been declining for the fourth consecutive month (-0.2% in August). Moreover, as Lithuania’s economy is catching up with other euro area economies, slightly higher inflation in Lithuania is a normal part of the convergence process.

According to the IMF forecasts, annual inflation in Lithuania will decline from 6.4% in August to 4.1% at the end of 2023, and it should amount to 3% at the end of 2024. 

The IMF recommends gradually tightening the fiscal policy, as foreseen in the Stability Programme of Lithuania for 2023, thereby contributing to the curbing of inflation. It is highlighted that this year, due to the lower-than-expected demand for compensation for energy costs, unspent funds need to be redirected towards reducing the budget deficit.

The IMF views the package of tax change proposals approved by the Government as a step in the right direction. The IMF underlines the need to shift the tax burden away from labour income to assets and capital, reduce the number of tax incentives and introduce environmental taxes. According to the IMF, this would enhance income redistribution through the state budget. 

The IMF stresses that Lithuania’s banking sector is particularly resilient due to high liquidity and capital buffers, as well as significant improvement in profitability due to unusual circumstances. House price levels are stabilising and their overvaluation is declining. It is stressed that growing loan interest rates as a result of rising key interest rates pose significant risks to the financial sector, therefore it is important to closely monitor developments in the sector. The IMF also mentions that the bank solidarity contribution must be a temporary measure.

The IMF also welcomes Lithuania’s progress in the prevention of money laundering and terrorist financing, including the increase of resources for the financial sector supervision. According to the IMF, it is crucial to further strengthen the risk management framework in the country’s financial sector, including the crypto-asset sector.

IMF Country Report on Lithuania

IMF and Lithuania

Lithuania has been a member of the IMF since 1992. Currently, the membership of the IMF includes 190 countries. Annual country consultations with the IMF are organised in accordance with Article IV of the IMF’s Articles of Agreement, which obligates the IMF member states to implement policy measures that ensure economic and financial stability.

During these consultations, IMF representatives meet with representatives of the Government, the Bank of Lithuania, private sector and non-governmental organisations, politicians and economic experts who jointly assess the country’s economic development and prospects. The IMF also issues consultation reports and recommendations.

This year, the mission to Lithuania took place from 31 May to 13 June, and the subsequent report was approved by the IMF Board on 28 August and published on 5 September.