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Access to NextGenerationEU funds and plans to create a pan-Baltic capital market will help the country overcome current challenging economic conditions. Kit Gillet reports.

Just when the impact of the Covid-19 pandemic seemed to be subsiding, the war in Ukraine threw many global economies into further uncertainty. Lithuania was not alone in being hit by these two crises, but its proximity to Ukraine and historical reliance on Russia for gas have made the country particularly vulnerable to the latest geopolitical developments.

“If we didn’t have the Russian invasion taking place, we would probably be very optimistic and be planning a number of elements [for Lithuania]. This has slightly affected the attitude of the players,” says Tomas Kairys, head of the Baltic states at the European Bank for Reconstruction and Development (EBRD). “We have seen, unfortunately, investor sentiment turning to an extent against the countries bordering the conflict. Access to the international capital markets remains significantly constrained.”

War shockwave

Lithuania joined the EU and Nato in 2004, and became the 19th country to adopt the euro as its currency in January 2015. This was a relatively straightforward step, given that the country had pegged its previous currency, the litas, to the euro back in 2002.

In the immediate aftermath of Russia’s invasion of Ukraine in February, Lithuania’s government put in place measures to further extricate itself from Russia. It also became one of the fiercest advocates of EU sanctions against Russia.

In April, the country became the first member state to expel its Russian ambassador. The Lithuanian authorities also announced that they would no longer import Russian gas, but would instead rely on liquefied natural gas delivered to its terminal in Klaipeda, which was opened in 2014. In 2020, an estimated 18% of Lithuania’s total primary energy consumption came from Russian natural gas imports. “Years ago, my country made decisions that today allow us with no pain to break energy ties with the aggressor. If we can do it, the rest of Europe can do it too,” Gitanas Nausėda, Lithuania’s president, wrote on Twitter at the time.

However, the country has not been exempt from the energy crisis hitting Europe. Facing rising energy prices, the Lithuanian government is expected to present a package of financial support which would be among the largest in the EU, at around 2% of national gross domestic product (GDP).

Shrinking economy

In the midst of the Covid-19 pandemic, Lithuania suffered a mild recession in 2020, with the economy contracting by around 0.1%, before growing by 6% in 2021. However, the war in Ukraine has further affected growth predictions, with Fitch Ratings lowering its growth forecast for the country from 3.9% in 2022 to 1.9%.

The rating agency is not alone in forecasting minimal growth for the country, despite its relative economic success in handling the global pandemic. “Our reaction was one of the best in Europe. Our GDP in the pandemic year was zero change. We avoided the negative impact on the economy in general,” says Simonas Krėpšta, a board member at the Bank of Lithuania.

Mr Krėpšta adds that despite a considerably slowing economy in the second half of this year, the country expects to see economic growth of 2.1% in 2022, with growth of around 0.9% forecast for 2023. “We see a slowdown in the economy, but we don’t see a long-term recession,” he says. “The labour market looks very strong, even today. The second quarter results were astonishing. We had the lowest unemployment rate since 2007. A lot of our companies experienced a very harsh crisis in 2008, so they know how to act in difficult circumstances.”

In June, Fitch Ratings affirmed Lithuania’s long-term foreign-currency issuer default rating at ‘A’ with a stable outlook, highlighting the country’s resilient export sector, sufficient fiscal policy space and low private sector indebtedness which, it said, “should help mitigate negative repercussions from the war in Ukraine and high inflation”.

Sky-high inflation

One lingering cause for concern is high rates of inflation. Euro area annual inflation hit 10% in September, up slightly month on month, with Lithuania having the second-highest annual inflation rate in the eurozone, at 22.5%, behind Estonia (24.2%). Authorities in Lithuania now expect annual average inflation of around 18% for this year, dropping to about 6% in 2023, under the assumption that energy prices on the international markets will stabilise.

This level of inflation is likely to have a marked impact on both households and businesses. At the same time, in 2021 Lithuania’s headline government deficit dropped to 1% of GDP, from 7.3% in 2020, due to underspending on Covid-19 measures and an adjustment of defence spending.

Even so, Lithuania remains a country with a relatively low public debt-to-GDP ratio, with public debt falling to 44.3% of GDP at the end of 2021, with Fitch projecting that it will decline further to 42.1% by the end of 2022. For 2022, Fitch expects a deficit of 4.4% of GDP due to additional spending as a result of the impact of Russia’s invasion of Ukraine.

Lithuania is also well shielded by its membership of the eurozone. “Since 2015, the government of Lithuania has borrowed more than €16bn in domestic and international markets,” says Inga Skisaker, chief executive of Swedbank Lithuania, the country’s largest bank. “Thanks to the membership in the eurozone, the average interest paid was between 1% and 2% lower than in other central and eastern European countries. It allowed us to save hundreds of millions of euros in interest.”

EU support

The war in Ukraine is not the only geopolitical situation in which Lithuania has been caught up. It was reported in January that Taiwan was setting up a $200m fund to invest in Lithuania, with Taipei aiming to reward the country for its diplomatic support after it agreed to let Taiwan open a representative office — a de facto embassy — in Vilnius under its own name, rather than a Taipei Representative Office as in other European countries.

At the same time, access to EU funding is creating ambitious economic targets for the country. In July 2021, the European Commission endorsed Lithuania’s recovery and resilience plan, under which it would receive €2.2bn in NextGenerationEU (NGEU) funding.

“The fact that Lithuania is in the EU and has access to this huge amount of EU money coming in will be a boost to the economy,” says the EBRD’s Mr Kairys, who points out that relative to GDP, Lithuania is expected to receive a total of almost 6.6% of 2018 GDP in NGEU funding and can borrow up to 6.8% of gross national income for investment under the NGEU.

Lithuanians are prioritising investments already very well, he adds. “They’re targeting money to renewables, to green energy. They are clearly prioritising that and I truly believe that that’s going to have a positive effect.”

Others also see real, long-term economic impact coming from access to this money. “These funds should result in long-term economic growth, and they should be invested in education and social issues, and so on,” says Bank of Lithuania’s Mr Krėpšta. “That should bring the economy in general to the next level in terms of innovation. That is in the longer term, five to 10 years, because we really want to invest in structural matters that drive long-term growth in the economy.”

Pan-Baltic capital market

At the same time, there is a drive to create a stronger capital market in the country and across the region. In 2017, Latvia, Lithuania and Estonia signed a memorandum regarding the creation of a pan-Baltic capital market, with the main goal to make the Baltic states more visible to foreign investors and attract investment through a common capital market.

This is seen as one way for the countries, which have a combined population of just over six million, to overcome their size limitations. The three states have agreed to work together on the necessary measures, including the establishment of the underlying legal framework, the introduction of new instruments and the creation of the necessary market infrastructure.

“We’re talking about potentially creating a regional capital market and regional index, and supported recently adopted covered bond legislation enabling issuances with a pan-Baltic pool of assets. We have been very successful in introducing commercial paper issuances in the local market,” says Mr Kairys of the EBRD, which has been involved in discussions about establishing a pan-Baltic capital market.

He adds that authorities have also started following up on some of the EBRD’s recent recommendations. “They’re working to establish a sustainable finance institute in Lithuania, and are trying to make the corporate law more flexible and more helpful to emphasise and enhance local issuances.”

The central bank’s Mr Krėpšta says it has a clear goal to increase market capitalisation, which is still relatively low across the Baltic countries, at about 10% of GDP, “which is unused potential for us as a country and also for investors”, he says.

It is a positive sign that the country is planning ahead ambitiously, rather than focusing on short-term survival amid the current challenging conditions.


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