DBRS Morningstar Confirms Republic of Lithuania at “A”, Trend Changed to Stable

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at “A”. At the same time, DBRS Morningstar confirmed the Republic of Lithuania’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trends on all ratings are changed from Positive to Stable.

DEVIATION FROM DBRS MORNINGSTAR’S EU CALENDAR

This is a deviation from DBRS Morningstar’s EU Sovereign, Sub-Sovereign, and Supranational Calendar due to new information becoming available on the creditworthiness of the issuer related to the Coronavirus Disease (COVID-19). DBRS Morningstar believes that this new information makes it inappropriate to wait until the next scheduled review of the issuer on the 10 July 2020. The credit rating considerations and rationale are presented below.

KEY RATING CONSIDERATIONS

The change in the trend from Positive to Stable reflects DBRS Morningstar’s view that the global Coronavirus Disease poses downside risks to Lithuania’s near term fiscal and debt outlook. Since 2009, Lithuania has diversified its economic structure and improved its economic resilience and in 2019 the country remained among the euro area’s top growth performers growing by 3.9%. However, the confinement measures to prevent the spread of the virus and the halt in economic activity will lead to a sharp contraction in GDP this year. Lithuania’s past balance sheet repair provides some fiscal capacity to implement policy measures to mitigate the economic impact, but the shock will still result in a high fiscal deficit and increase the public debt ratio in 2020. The deterioration in DBRS Morningstar’s assessment of the “Fiscal Management and Policy” and the “Debt and Liquidity” building blocks were the key factors for the trend change.

The “A” ratings are underpinned by Lithuania’s otherwise sound fiscal position and its low public debt ratio. DBRS Morningstar views Lithuanian membership of the OECD in 2018 as a credit strength; meeting OECD standards and benchmarks, for example, underpin sound governance. Euro system membership since 1st January 2015 is another key credit strength. Progress with the reform agenda, including measures that reduce the tax burden on low income earners and narrow the employers’ tax wedge, as well as efforts to improve tax compliance, further support the ratings. Credit challenges relate to structural factors including income inequality; the need for further productivity improvements; a still low investment rate; the declining and ageing population; and economic informality.

RATING DRIVERS

Factors for an upgrade include: (1) steering an effective fiscal policy to address the COVID-19 crisis (2) additional measures to improve long-term fiscal sustainability, and (3) active government policies to raise the supply of skilled workers.

The ratings could be downgraded: (1) if the current shock leads to significant macroeconomic imbalance or (2) failure to stabilize the rise in the public sector debt in the longer term.

RATING RATIONALE

Confinement Measures to Lead to a Sizeable Economic Loss in 2020

The Lithuanian authorities have imposed strict measures to contain the spread of the virus. As of 20 May 1,577 cases and 60 deaths have been confirmed. The national lockdown started on 16 March and restrictions will be in place until at least the end of May. The measures include closures of non-essential businesses, educational institutions, a ban on public gatherings and the closure of borders. The government has announced the gradual relaxation of some of the lockdown restrictions on a measure-by-measure basis since mid-April.

The Lithuanian economy is projected to contract this year as the confinement measures result in a sizeable economic loss. The coronavirus pandemic is affecting the economy through various channels. Emergency measures such as travel restrictions and closure of borders combined with depressed global demand pose an elevated risk to exports of goods and services and are expected to have a severe impact on Lithuania’s transportation sector, a recent contributor to growth, accounting for more than 10% of GDP. The impact of the lockdown including its impact on the labor market will negatively affect consumption, whilst investment is set to decline this year not least because uncertainty is high.

In the context of the highly uncertain environment, the Ministry of Finance in its Stability Programme estimates two alternative scenarios depending on the duration and severity of the economic shock. Compared with 3.9% GDP growth in 2019, in the first scenario it estimates that GDP could contract by -2.8% this year and recover by 5.4% in 2021 and in the second scenario by -7.3% and 6.6%, respectively. The unemployment rate could increase from 6.3% in 2019 to 8.7% this year (7.2% in 2021) in the first scenario and by 10.5% this year (8.1% in 2021) in the second scenario. Under assumptions about easing the restrictive measures in the second half of the year, the European Commission (EC) forecasts GDP to decline by 7.9% this year, before returning to growth of 7.4% in 2021.

Lithuania’s Economic Recovery is Highly Contingent on the Recovery of its EU Trade Partners, but the Current Account to Remain in Surplus

In DBRS Morningstar’s view, the shape of the recovery will depend on the efficacy of the containment measures, the effectiveness of the economic stimulus measures, and also the recovery in Lithuania’s main trading partners. This is important given Lithuania’s open economy. In terms of the external accounts, since 2009 Lithuania’s external position has strengthened significantly, shifting its current account position from a 15% deficit in 2007 to a small surplus in 2017. The current account surplus increased to 4.3% of GDP in 2019 from 0.3% the year before, supported by strong exports of services and a positive secondary income balance and despite the crisis is expected to remain in positive territory in 2020 and 2021. From a stock perspective, a net international investment liability position of 60% of GDP in 2009 has decreased to 24% at the end of 2019.

Expansionary Fiscal Policy Will Result in a Fiscal Deficit and an Increase in Public Debt

The government’s response to the pandemic is a combination of economic and financial measures amounting to around EUR 6 billion (or 12% of GDP). Measures announced so far include additional spending for the health system and measures to preserve jobs and household income, and government guarantee schemes for agriculture and SMEs. In addition, the government has established a fund with a target of EUR 1 billion to provide liquidity to medium and large sized enterprises to accelerate public and private investment.

After a fiscal surplus of 0.3% of GDP in 2019, the support package to mitigate the impact of the pandemic will lead to a sizeable fiscal deficit in 2020, estimated at 7% of GDP by the European Commission (EC). The deterioration of the fiscal outlook weighs on DBRS Morningstar’s assessment of the “Fiscal Management and Policy” building block. Since 2014, Lithuania has strengthened its budget position due to favorable economic conditions and strong revenue growth. In addition, it has benefited from its euro area membership and the EC’s economic governance remaining committed to a prudent fiscal strategy. However, the coronavirus shock adds to Lithuania’s key fiscal challenges, including its ageing population and tax evasion from Lithuania’s informal economy. Lithuania has one of the fastest ageing populations in the 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 EC. Moreover, Lithuania’s informal economy is measured as one of the largest relative to the size of its economy among EU countries, remains pervasive and obstructs a more efficient allocation of resources.

The current economic shock will lead to a higher debt-to-GDP ratio this year. Given the increased financing needs for the implementation of the Economic and Financial Action Plan to tackle the economic implications of the pandemic, Lithuania has increased its borrowing limit to an additional EUR 5 billion. Public debt is set to increase from 36.3% of GDP in 2019 to 48.5% according to the EC’s forecast. This has weighed on DBRS Morningstar’s qualitative assessment of the “Debt and Liquidity” building block. 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 was 10 years at end-March 2020. Almost all central government foreign debt is fixed rate and all the debt is in euros. The favorable environment in the international bond markets have led to a further decline in interest costs to 0.9% in 2019 from 1.5% of GDP in 2015.

Covid-19 Pandemic Will Put Banks Under Pressure, However Risks to Financial Stability Appear Contained

Most of the banking sector is foreign-owned, therefore, spillovers from parent banks due to the pandemic pose a risk to Lithuania’s financial stability. That said, the financial sector is highly liquid is well capitalized with the capital adequacy ratio at 19.9% at the end of 2019. Moreover, private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to 46.3% and the household debt-to-GDP ratio was 25.1% at the end of 2019. To maintain credit supply to the economy and to mitigate the effects of the pandemic, the Bank of Lithuania has reduced the counter-cyclical capital buffer (CCyB) from 1% to 0% allowing banks to provide up to EUR 1 billion in loans to businesses and individuals. In total, the Bank of Lithuania in order to support banks’ lending capacity announced measures to reduce capital adequacy requirements, liquidity reserves and other supervisor measures worth EUR 2.5 billion.

Notwithstanding the Stable Political Environment, Unexpected Geopolitical Shifts in Europe Could Pose Significant Risks

Presidential elections last May delivered a change in leadership, as Dalia Grybauskaitė’s presidency since 2009, was term limited. Her successor Gitanas Nausėda is expected to maintain policy continuity. DBRS Morningstar 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. Parliamentary elections are scheduled for October this year. Usually no single party wins an outright majority, so coalitions are needed. Successive multi-party government coalitions have helped to promote stable policies and institutions. DBRS Morningstar views that the decision by the Seimas of Lithuania to lower the current election threshold to 3 percent is likely to lead to a more fragmented parliament in the upcoming election.

ESG CONSIDERATIONS

Social factors (S) such as human capital and the level of productivity are among key drivers behind this rating action.
Compared with its euro system peers, Lithuania’s per capita GDP is relatively low at $19,498 in 2019.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments.
https://www.dbrsmorningstar.com/research/361360

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (17 September 2019) https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include: Ministry of Finance (Stability Programme April 2020, Investors Presentation April 2020, Bank of Lithuania (Lithuania’s economic development and outlook, 27 March 2020), International Monetary Fund, OECD, European Commission (Spring 2020 Economic Forecast) , Bank for International Settlements, United Nations Development Program (UNDP), Eurostat, Stockholm School of Economics in Riga, Lithuania Department of Statistics, European Central Bank, World Bank, Haver Analytics. DBRS Morningstar 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.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/361359

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Nichola James, Managing Director, 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 10, 2020

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