DBRS Confirms Republic of Lithuania at A (low), Stable Trend

DBRS Ratings Limited (DBRS) has confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at A (low) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings remains Stable.

The Stable trend reflects DBRS’s view that risks to the ratings are broadly balanced. Last year, GDP growth was stronger than expected, estimated at 3.8%, as the external environment improved. GDP growth is expected to track economic potential in the medium term. The debt-to-GDP ratio is low relative to the euro system average and the trend is improving. The structural challenges facing Lithuania remain broadly unchanged.

The A (low) ratings are underpinned by Lithuania’s sound fiscal position and its low public debt. Progress with the reform agenda, including measures to help narrow income inequality such as reducing the tax burden on low income earners, and efforts to improve tax compliance, further support the ratings. Euro system membership since 1st January 2015 is a key credit strength.

Credit challenges relate to structural factors including income inequality; weak productivity growth and a low investment rate; the declining and ageing population and economic informality. Lithuania’s small and open economy is sensitive to external shocks, although this is mitigated by the fact that current macro-economic imbalances are small.

Lithuania has a good fiscal track record since 2014 of primary surplus positions and lower debt servicing costs, due to moderate economic growth and consolidation efforts in the aftermath of the global financial crisis. Underpinned by expenditure ceilings and an independent fiscal council, the fiscal framework allows for effective counter-cyclical policy. As a euro system member, Lithuania also benefits from the European Commission (EC) economic governance and fiscal framework. The general government budget position is expected to have remained in surplus in 2017 and is forecast in surplus in 2018. The more expansionary stance last year resulted from the fiscal costs of the New Social Model, which includes reform to labour regulations and temporary income support for the unemployed. Budget 2018 main objectives include the reduction of poverty and inequality, tax incentives for entrepreneurship and innovation, improved healthcare and defence spending of 2% of GDP in line with NATO obligations. DBRS views the 2018 budget as addressing the country’s needs without jeopardizing fiscal discipline.

Lithuania has several structural challenges to public expenditures. It has one of the fastest ageing populations in the European Union (EU). To illustrate the demographic challenge, the old-age dependency ratio is expected to rise to one senior (person above 65 years old) per 1.2 workers in 2040 from one senior per 2.4 workers in 2013. Since 2012 the retirement age has been gradually increased and will reach 65 in 2026 for both men and women. Another key government challenge is fighting tax evasion as Lithuania’s informal economy is one of the largest relative to the size of its economy among EU countries. Corruption, under reporting of business income, and envelope wages remain pervasive and obstruct a more efficient allocation of resources. The Stockholm School of Economics in Riga measured Lithuania’s shadow economy at 16.5% of GDP. According to the IMF, when comparing revenues with the economy’s tax capacity, Lithuania’s tax collection level is estimated at 61% against 77% for central European economies in 2014.

With its small and open economy, Lithuania’s public debt ratio, albeit currently low, is vulnerable to external shocks. In the global financial crisis, the debt-to-GDP ratio rose to 36.0% (2010) from 15.4% in 2008. Since then, fiscal structures are in place to mitigate fiscal risk. Moreover, Lithuania still has one of the lowest debt ratios among EU countries, forecast at 37.5% in 2017 compared with the EU average of 83.5%. The debt ratio is expected to decline to 35.0% in 2018 according to the IMF. With just EUR 154 million of short-term debt, the government applies a conservative debt management strategy of extending debt duration in a low yield environment. The weighted-average term to maturity of central government debt is 6.8 years. Several debt controls are in place, including limits for municipalities’ borrowing and debt, while the Social Security Funds (Sodra) can only borrow with permission from the Ministry of Finance.

After annual average GDP growth of around 2.0% in 2015-16, growth outcomes over the next few years are expected to show notable acceleration. The EC estimates GDP growth at 3.8% in 2017 and forecasts 2.9% GDP growth this year. In 2017, wage growth supported private consumption, although Lithuania’s inflation rate that increased to 3.9% year-on-year in December related to higher oil and food prices and increases in indirect taxes, as well as decreases in employment, are beginning to have a moderating effect on growth. Buoyant external demand and the recovery of investment were growth- supportive factors. Over the medium-term, GDP growth should return to economic potential of around 3%. The country will remain a net beneficiary of EU structural funds, with EU net inflows of 4.2% of GDP in 2017, rising to 5.4% in 2020. However, the impact of Brexit on the size and composition of the EU budget is unknown and in the longer term could have negative implications for Lithuania’s EU funds allocation and for economic development. Income per capita adjusted for purchasing power parity is still only slightly above two-thirds of the euro area average and future improvement is contingent on productivity gains.

The majority of the banking sector is foreign-owned, therefore spill overs from vulnerabilities in parent banks are potential risks going forward. To co-ordinate risk management, Nordic-Baltic co-operation is being strengthened. That said, capital adequacy and asset quality have recovered from the financial crisis and currently the financial sector is well capitalised and highly liquid. DBRS is monitoring the pace of credit growth, for example loans for house purchase, which are currently growing at an annual rate of 8.5%, but DBRS views the credit recovery as consistent with extended catch-up from the crisis period of heavy de-leveraging. Since the crisis, the loan-to-deposit ratio has halved to 100% from 200%. Moreover, private sector debt is relatively low – non-financial corporations’ debt-to-GDP ratio amounted to 41.42% and household debt-to-GDP ratio at 22.61%, in Q2 2017.
During the crisis, net capital outflows occurred, and as internal demand contracted while maintaining the peg to the euro, internal devaluation improved competitiveness, thereby rebalancing the economy. The current account deficit as a share of GDP peaked at 15% in 2007, but swiftly narrowed due to the internal devaluation. In 2017, the IMF estimates the current account deficit at 1.6% of GDP, falling to 1.4% this year. From a stock perspective, a negative international investment liability position of 39.8% of GDP was recorded at end-September 2017, partly reflecting the financial sector’s funding from foreign-parent institutions.

Successive multi-party government coalitions have helped to promote stable policies and institutions. There are 141 seats in Lithuania’s unicameral legislature (Seimas) with a multi-party system. Usually no single party wins an outright majority, so coalitions are needed. Since independence in 1990, Seimas has had 16 prime ministers from six different political parties. Since the 2016 election Seimas has included politicians representing six factions and a mixed group of five independents. After having only three seats during the previous four years, Farmers and Greens Union managed to obtain 56 seats in the last election, mostly because of the Liberal Movement’s corruption scandal. DBRS is of the view that EU and NATO membership are likely to provide a broadly stable political environment for Lithuania, but unexpected geopolitical shifts in Europe could pose significant risks.

RATING DRIVERS

Potential upward rating drivers include: (1) stronger performance in investment and productivity growth or (2) increased evidence that fiscal discipline will be sufficient to result in a sustained reduction in the debt ratio.
Potential negative rating drivers include: (1) a return of significant macroeconomic imbalances, particularly if accompanied by an erosion in the structural fiscal balance or (2) a material deterioration in growth prospects, potentially exacerbated by an acceleration in emigration.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A – BBB (high) range. The main points of the discussion within the committee included the public debt ratio, the GDP growth trajectory, socio-political factors and the country’s future resilience to economic shocks.

KEY INDICATORS

Fiscal Balance (% GDP): 0.3% (2016); 0.1% (2017F); 0.5% (2018F)
Gross Debt (% GDP): 40.2% (2016); 37.5% (2017F); 35.0% (2018F)
Nominal GDP (EUR billions): 38.7 (2016); 41.6 (2017F); 44.5 (2018F)
GDP per Capita (EUR thousands): 13.5 (2016); 14.7 (2017F); 16.0 (2018F)
Real GDP growth (%): 2.3% (2016); 3.8% (2017F); 2.9% (2018F)
Consumer Price Inflation (%, eop): 0.7% (2016); 3.8% (2017F); 2.9% (2018F)
Domestic Credit (% GDP): 63.3% (2016); 64.1% (Jun-2017)
Current Account (% GDP): -0.9% (2016); -1.6 % (2017F); -1.4% (2018F)
International Investment Position (% GDP): -43.2 (2016); -39.8 (Sept-2017)
Gross External Debt (% GDP): 85.6 (2016); 82.2 (Sept-2017)
Governance Indicator (percentile rank): 82.2 (2016)
Human Development Index: 0.85 (2015)

Notes:

All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Ministry of Finance, International Monetary Fund, OECD, European Commission, United Nations Development Program (UNDP), Haver Analytics, Eurostat, World Bank, Bank of Lithuania, Stockholm School of Economics in Riga, Lithuania Department of Statistics, European Central Bank. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Nichola James, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director – Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: July 21, 2017

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