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

DBRS Ratings Limited (DBRS) 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.

KEY RATING CONSIDERATIONS

The Stable trend reflects DBRS’s view that risks to the ratings are balanced. Fiscal discipline continues and the debt-to-GDP trajectory is improving. GDP growth has been stronger than expected, at 3.6% in the first quarter on a seasonally adjusted annual basis, as private consumption, industry and construction perform well. On the other hand, tensions in global trade are intensifying, which pose downside risks to growth, particularly for a small and open economy like Lithuania. Early signs of productivity improvements should contribute to Lithuanian firms’ cost competitiveness. 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. DBRS views Lithuanian membership of the OECD on the 5th July 2018 as a credit strength; meeting OECD standards and benchmarks, for example, underpin sound governance. Progress with the reform agenda, including measures to help narrow income inequality such as reducing the tax burden on low income earners, as well as efforts to improve tax compliance, further support the ratings. Euro system membership since 1st January 2015 is another key credit strength. Credit challenges relate to structural factors including income inequality; scope for further productivity improvements; a low investment rate; the declining and ageing population and economic informality. While the Lithuanian economy is sensitive to external developments, this vulnerability is mitigated by the absence of clear macroeconomic imbalances.

RATING DRIVERS

Potential factors for positive rating action 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 high credit growth or private sector dis-savings or (2) any erosion in the structural fiscal balance that significantly deteriorates debt dynamics.

RATING RATIONALE

Primary Surplus in Recent Years Points to a Good Fiscal Track Record

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 remained in surplus in 2017, 0.5% of GDP compared with 0.3% in 2016 and is forecast by the EC to remain in surplus this year, 0.5%. The surplus position is despite spending from the New Social Model, which includes reform to labour regulations and temporary income support for the unemployed.

Strong economic growth and higher revenues have allowed the government to increase spending while maintaining a surplus position. Budget 2018 increases expenditure towards the reduction of poverty and inequality, tax incentives for entrepreneurship and innovation, improved healthcare and an increase in defence spending to 2% of GDP in line with NATO obligations. DBRS views the 2018 budget as addressing the country’s needs without jeopardizing fiscal discipline.

An Ageing Population and High Levels of Economic Informality Weigh on Lithuania’s Fiscal Position

Lithuania has one of the fastest ageing populations in the European Union (EU). To illustrate the demographic challenge, the old-age dependency ratio (15-64) is expected to rise to 63.9% in 2060 from 29% in 2016 according the European Commission. To help combat the challenge, the government implemented a reform in 2012 that gradually increases the retirement age for both men and women to reach 65 years in 2026, from 63.5 years for men and 62 years for women in 2017.

Another key government challenge is fighting tax evasion from Lithuania’s informal economy, measured as 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, better than Latvia’s but well above the EU average. 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.

Public Debt Ratio is Low, But the Small Size of the Economy Risks Vulnerability to External Shocks

With its small and open economy, Lithuania’s public debt ratio, albeit currently low, is vulnerable to external shocks. Following the global financial crisis, the debt-to-GDP ratio rose to 36.2% in 2010 from 14.6% in 2008. However, Lithuania still has one of the lowest debt ratios among EU countries, at 39.7% in 2017 compared with the EU average of 86.7%. The debt ratio is expected to decline to 36.0% by the end of this year according to the EC and rise to 38.2% next year due to planned pre-financing of 2020 bond redemptions.

With just EUR 104 million of short-term central government debt at end-March 2018, 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 7.4 years at end-March 2018. 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.

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, EC data points to a current account deficit of 1.5% of GDP, rising to 2.3% this year and 2.9% next year. From a stock perspective, a net international investment liability position of 35.5% of GDP was recorded at end-2017.

Higher Rates of Capital Investment and Strong Income Growth Support Productivity Growth

After annual average GDP growth of just over 2.0% in 2015-16, growth advanced last year to 3.9%, and should remain above trend over the next few years. The EC forecasts growth of 3.1% this year and 2.6% next year. Buoyant domestic and external demand and high capacity utilisation are providing support to the recovery of investment. In addition, high wage growth underpins private consumption growth, and Lithuania’s elevated inflation rate will slow as the effects of excise duty hikes in 2017 fade. 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 planned 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.

Wage growth is highly linked to policy changes such as the higher minimum wage and to skills shortages, but income per capita adjusted for purchasing power parity is still only slightly above two-thirds of the euro area average. Future improvement is partially contingent on productivity gains. Productivity began to recover last year and should continue to strengthen this year.

Risks to Financial Stability Appear Contained

Most of the Lithuanian banking sector is foreign-owned, therefore spill overs from vulnerabilities in parent banks is a persistent risk. That said, the financial sector is well capitalised and highly liquid. Nordic-Baltic co-operation is also being strengthened. While mortgage growth is high, at an annual rate of 8.8% as of May 2018, DBRS views the credit recovery consistent with extended catch-up following the significant crisis-related de-leveraging. The loan-to-deposit ratio has more than halved to 98% in May 2018, from 200% before the crisis. Moreover, private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to 41.4% and the household debt-to-GDP ratio was 26.4% in 2017.
Notwithstanding the Stable Political Environment, Unexpected Geopolitical Shifts in Europe Could Pose Significant Risks

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 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): 0.5 (2017); 0.5 (2018F); 0.3 (2019F)
Gross Debt (% GDP): 39.7 (2017); 36.0 (2018F); 38.2 (2019F)
Nominal GDP (EUR billions): 41.9 (2017); 44.3 (2018F); 46.6 (2019F)
GDP per Capita (EUR): 14,831 (2017); 15,897 (2018F); 16,874 (2019F)
Real GDP growth (%): 3.9 (2017); 3.1 (2018F); 2.6 (2019F)
Consumer Price Inflation (%): 3.7 (2017); 2.7 (2018F); 2.2 (2019F)
Domestic Credit (% GDP): 113.6 (2017)
Current Account (% GDP): -1.5 (2017); -2.3 (2018F); -2.9 (2019F)
International Investment Position (% GDP): -35.5 (2017)
Gross External Debt (% GDP): 83.2 (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: January 19, 2018

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