DNB analysts: Lithuania's economy to face sustainability challenges on obstacle course

Despite Russia's embargo and the complicated situation in top export markets, Lithuanian economic growth in 2014 will be among the fastest in the EU member states. DNB economists forecast that Lithuania's real gross domestic product (GDP) will grow by 2.8% in 2014, while in the neighbouring Latvia and Estonia economic growth will be slower this year: 2.4% and 1.7% respectively.

Lithuanian economic growth this year was secured by a strong burst in the domestic demand, i.e.  consumption and investments were growing faster. The environment was rather benign: recovering corporate profitability, rising  salaries, low inflation, increasing individual purchasing power, low interest in the market, and positive Euro introduction effect, which has already reduced the country's borrowing rates. Meanwhile, some domestic activities  in Latvia and Estonia have run out of steam this year.

DNB analysts presented the "Baltic Economic Outlook" earlier today. They forecast that Lithuanian GDP growth in 2015 will be slightly slower at 2.6%. The economic growth forecast in Latvia and Estonia makes 2.5% and 2% respectively.

"Lithuania's domestic market is shallow with limited growth potential, thus we are very much dependent on exports. But  it is obvious that gaining momentum in the export growth will not be easy due to the complicated situation in Lithuania's key markets, while capturing new markets takes time. The investment processes, which supported the growth this year, are very sensitive to business expectations and the ongoing uncertainty is not helpful here either. Therefore, next year we will see more moderate Lithuanian economic growth“, - says Indrė Genytė-Pikčienė, DNB bank‘s chief analyst.

Domestic demand and the EU support is helping, but will this be enough?

Lithuanian economic growth was sustained by the growth of sectors targeting domestic demand - construction, domestic trade, and commercial services – and the EU support. Last year Lithuania did not fully assimilate earmarked funds and some financing was transferred to this and next year. In 2015 the projected support from the EU structural funds is LTL8bn, 7.6 percent more than planned use this year. 

The construction sector has been particularly dynamic this year: in the first half of the year the construction volumes within the country saw an annual increase of 21 percent at comparative prices. The growth of the construction sector next year will be effected by the European Union's structural funds support, which is budgeted to be higher than this year. However, the overall situation will not be very friendly to the construction and real estate businesses due to changed expectations of the market participants, uncertainty, and  oversupply in the residential real estate market..

The domestic trade was also growing rapidly, reflecting household consumption trends. In Q3 this year the growth accounted for 4.6%. Higher growth in sales of other than first-necessity goods  illustrates the increasing individual purchasing power. These processes were sustained by increasing salaries and low inflation. According to DNB analysts' forecast, the average salary this year will be rising 4.5%, while the average annual inflation will come close to zero to make 0.2%.

How to stimulate growth?

According to DNB analysts, some homework has to be done in order for  exporters to succeed in the international market, i.e. the government representatives have to improve the business conditions for investors, while businesses have to devote more attention and resources to improve productivity.

We will not see a dynamic recovery in the western economies next year, the geopolitical tension between Russia and the West is likely to last, and Russia's economy is forecasted to fall into recession. For the country's exporters to remain competitive, they will have to diversify their exports and actively search for alternative markets.

Another economic lever and a long-term investment in the economic development would be improvement of business conditions to companies intending to invest in Lithuania. Although Lithuania retained the 24th position among 189 counties in the World Bank's Doing Business rating, the country still has lots of unused reserves to improve the business conditions and to attract foreign investments. Thus, the same position for the second subsequent year is not an achievement.

I. Genytė-Pikčienė notes that the wage growth has been exceeding the productivity growth for the second year. This decreases Lithuania's competitive advantage in the international market.

"The increasing costs of labour as well as structural limitations to the labour market with lack of qualified staff are posing a serious challenge to the employers. Therefore, to retain business efficiency businesses have no other way but to improve the efficiency and reduce the labour-intensity. Although low interest rates and strong  financial position enable them to do that, the modernisation is still impeded by the increased uncertainty and the companies' concern about the future “, DNB bank's chief analyst says.

Key macroeconomic indicators for the Baltic Countries