Republic of Lithuania: IMF Executive Board Concludes Article IV Consultation

Stocks and Financial Services Press Releases Tuesday June 26, 2018 09:30
IMF--26 Jun--International Monetary Fund
On June 20, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with the Republic of Lithuania.

The economy picked up steam in 2017, following two years of sluggish growth. Real GDP expanded by 3.9 percent largely because of the acceleration of investment, which benefited from credit growth and high capacity utilization. Private consumption remained the main engine of growth, though it was held back by decelerating real wages. The external current account swung to a modest surplus with exports benefiting from past investments in export capacity and improved external demand. Rising wages, driven by a tightening labor market, and tax hikes led to a spike in inflation to 3.7 percent. With positive macroeconomic conditions, the government continued to consolidate public finances resulting in a headline budget surplus for the second year in a row. Data for the first quarter of 2018 point to a modest deceleration of the economy and inflation.

With Lithuania's economy expanding well above potential, growth is expected to moderate over time to a more sustainable pace. Growth in 2018 is projected at 3.2 percent, mainly because of weaker exports after a very strong performance last year and a slowdown of consumption driven by negative employment growth. Investment spending should pick up, however, thanks to faster EU funds absorption. Inflation is projected to moderate because of the waning effects of the 2017 tax hikes, lower wage increases, and a slowing economy.

Being a small open economy, Lithuania is highly vulnerable to a retreat from global trade, renewed euro area strains, geopolitics and global growth. On the domestic front, emigration and population aging, and lack of reforms are the main risks to the economic outlook.

Executive Board Assessment

Executive Directors welcomed Lithuania's strong economic performance supported by impressive macroeconomic management. The economy is rebounding and internal and external imbalances have been corrected. However, Directors noted that ambitious reforms are needed to address the significant medium?term structural challenges, including tackling adverse demographics as well as high poverty and income inequality, and ensuring continued convergence to the euro area income levels.

Directors commended the authorities for pursuing countercyclical fiscal policy in recent years. Recognizing that Lithuania is a small open economy with no independent monetary policy, they considered that adequate fiscal buffers are needed to address external shocks and medium?term fiscal pressures. Directors agreed that a broadly neutral fiscal stance over the medium?term would strike the right balance between rebuilding buffers and addressing pressing social needs. They noted that the authorities could use some of the available fiscal space to finance productivity?enhancing reforms while maintaining moderate structural surpluses and a declining debt path. Noting that there is scope to simplify the existing fiscal framework, a number Directors highlighted the need to safeguard its counter?cyclical nature.

Directors agreed that pension reform is important for reducing old?age poverty while safeguarding fiscal sustainability. They welcomed recent increases in minimum pensions and the transfer of the social assistance element to the state budget. Directors noted that increasing participation is essential for the success of the reform. They emphasized the need for broad political and social consensus to ensure stability and long?term success of the pension system.

Directors acknowledged that the financial system is sound and that recent credit and housing market developments do not pose risks to financial stability. Given the rapid growth in housing prices and credit and that spillovers from Nordic parent banks could pose risks, they encouraged the authorities to continue using macroprudential policy proactively to address systemic risks and cooperating closely with banks' home?country authorities.

Directors underscored the importance of continued productivity gains for sustainable improvement in wages and living standards. They noted that while low wages are increasingly posing challenges, excessive high wage growth above productivity could harm competitiveness. To ensure convergence with Western European living standards, Directors encouraged the authorities to implement reforms that boost productivity growth. Top priorities are education and healthcare reform, including rationalizing and consolidating bloated networks.

Directors underscored the importance of boosting labor supply to mitigate demographic pressures and raise potential growth. They agreed that policies in this area should include reducing the labor tax wedge, linking retirement to life expectancy, tightening early retirement schemes, retraining programs, and immigration.

Directors agreed that additional resources may be needed to reduce social disparities and address aging?related pressures. While welcoming recent tax proposals, they encouraged the authorities to consider greater reliance on capital and wealth taxes instead of labor. Given Lithuania's low tax ratio, Directors also urged more ambitious reforms to mobilize revenues allowing greater use of targeted social programs to tackle social disparities.

It is expected that the next Article IV consultation with the Republic of Lithuania will be held on the standard 12?month cycle.

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