DNB analysts: Economic downturn reined in, economy at crossroads

The latest macroeconomic data show that Lithuania managed to put tension in public finance under control and earned the respect of markets in this way. DNB analysts forecast that the gross domestic product of Lithuania will grow by about 3.0% annually in the next couple of years, while real wages will enter into the positive territory this year for the first time in four years. In addition to internal factors, Lithuania’s economic development will be mostly affected by cracks appearing in the European single currency union which will have a negative impact on key export partners and the cost of borrowing.

‘The crisis in the Lithuanian economy marks a breaking point: the booming construction industry which supported growth until 2008 has been replaced by exporting sectors as the main driver of the economy. Such a shift in the national economy means that household income and labour market will need time to adjust to the new economic realities and return to the pre-crisis level,’ said Rokas Bancevičius, Senior Analyst at DNB, during the presentation of the latest issue of the Lithuanian Economic Outlook by the Economic Research Team.

According to DNB analysts, growing export volumes in recent years were the basis for economic growth in the country. They find it worrying that export revenues remain largely beyond the Lithuanian economy. The profitability of Lithuanian companies has almost reached its pre-crisis level (4.4% profit on income in 2011 compared to an average of 7% in 2005–2007) and was positive for the second year in a row. Nevertheless, income generated has often been frozen in bank accounts as the volume of time deposits maturing in more than two years went up sharply last year by 80% in the banking system while the volume of investments rose by merely 1.3 percentage points in the country (from 16.3% of GDP in 2010 to 17.6% of GDP last year).

‘Weak investment flows to boost production in Lithuania are often explained by uncertainty surrounding the development of the global economy and by a more cautious lending policy of banks. However, it is important to see that the investment flow in Lithuania was the weakest among all Baltic states even though both uncertainty about the future and lending policy of banks were virtually the same across the region,’ says Bancevičius.

Employees have not felt the improving financial standing of companies so far. Last year, the nominal average wage in the country grew at a slower pace than inflation so the real average salary shrank by almost 1%. This year should mark a slight increase in real wages for the first time in four years as nominal salaries will rise by 4% and inflation should fall to 3.2% at the end of the year because of the likely decline of oil and grain prices on the international market.

The unemployment rate, which continues to stimulate emigration, should fall slightly but will remain high. It can only be reduced to single digits with continuous focus on domestic and foreign direct investment in the coming few years.

DNB analysts say that a tight rein of public finance is probably the biggest achievement of Lithuania during the downturn. Lithuania earned the trust of markets and is able to borrow now at a much lower cost than countries in Southern Europe. Analysts forecast that Lithuanian and Estonian economies should grow at a similar pace of 2.5–3% in 2012 which, in addition to internal factors, will be also affected by cracks appearing in the European single currency union which may have a negative effect on the cost of borrowing.

‘In addition, financial shocks in Western Europe would undermine export revenues and would rock the Lithuanian economy which has been on an even keel lately. Still, we believe that the risk of a sharp contraction of export volumes and slowing GDP growth this year remains below average,’ says Bancevičius.

In their sectoral analysis of the economy, DNB analysts note that companies operating in the light industry have good growth prospects as they are able to adapt quickly to changes in demand and become more attractive to Western suppliers because of their geographic proximity compared to Chinese manufacturers. The agricultural industry should anticipate a decade of higher agricultural produce prices, while wood processing companies have secured long-term contracts with strong partners in the West. Significant positive changes have been seen in the construction industry which is very important for the domestic market, even though volumes of work have remained at a much lower level than in 2009.

Projections of key macroeconomic indicators

The electronic version of the Lithuanian Economic Outlook and presentation materials are available online at www.dnb.lt/apzvalgos.