DBRS Morningstar Changes Trend on Republic of Lithuania To Positive, Confirms Ratings at “A”

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 to Positive.

KEY RATING CONSIDERATIONS
The Positive trends reflect DBRS Morningstar’s view that the economic resilience of the Lithuanian economy appears to be strengthening. Even when confronted with the pandemic the economy showed a remarkable resilience recording a 0.9% real GDP decline, one of the lowest in the euro area. Strong signs of recovery started to emerge despite the fact that some restrictions are still in place, with the economy growing by 1% YOY in the first quarter of 2021. Nevertheless, the uncertainty remains high and the strength of the recovery will depend on Lithuania’s ability to contain new outbreaks of the virus and on the progress with the COVID – 19 vaccination rollout. An additional deterioration in the health care situation could require further extension of support measures and delay fiscal repair.

The “A” ratings are underpinned by Lithuania’s otherwise sound fiscal position and its low public debt ratio. The sizeable fiscal package to mitigate the impact of the pandemic have increased the deficit and placed the public debt ratio on an upward trend. However, Lithuania’s sound fiscal position in the years prior to the crisis and the relatively low debt at 47.3% in 2020 compared to its euro area peers allows the authorities space to provide stimulus to mitigate the impact of the COVID-19 shock. Lithuania’s euro system membership is another key credit strength. The EU’s Recovery and Resilience Facility will likely allocate EUR 2.2 billion of grants to Lithuania and this could help raise growth potential. Nonetheless, credit challenges remain related to structural factors including income inequality; regional disparities; the need for further productivity improvements; the declining and ageing population; and economic informality.

RATING DRIVERS
Factors that could lead to an upgrade include: (1) evidence of continued economic resilience, and (2) continued effective fiscal response to address the COVID-19 crisis, coupled with measures to preserve long term fiscal sustainability.

Factors that could lead to a downgrade include: (1) failure to stabilize the public sector debt ratio in the longer term, or (2) the emergence of significant macroeconomic imbalances. DBRS Morningstar could return the trend to Stable if there is a longer than expected economic shock that significantly delays repair to the public balance sheet.

RATING RATIONALE
Economic Contraction in 2020 Was One of the Lowest in the Euro Area, Underpinned by Positive Net Exports

The economic contraction in Lithuania was less pronounced than initially anticipated and one of the lowest in the euro area. Real GDP contracted by 0.9% in 2020 compared to a 6.6% drop in the euro area. This was due to the comparatively low infection rates in the first wave of the pandemic that allowed the smooth reopening of the economy in the second half of 2020 and the targeted support measures introduced by the government. In addition, the buoyant performance of high value added sectors such as manufacturing and the low reliance on the hardest hit sectors of the economy such as tourism, limited the economic impact. The resilience of Lithuanian real exports and depressed imports more than offset the negative contribution of private consumption and investment caused by the closure of businesses and mobility restrictions.

Despite the new restrictions imposed in early November last year, preliminary data show that the Lithuanian economy continues to show signs of resilience, growing by 1% YOY in the first quarter of 2021, mainly driven by strong growth in the manufacturing sector. The government forecasts a rebound of 2.6% in 2021 and 3.2% in 2022, which is likely to be revised upwards, indicating higher adaptation of households and businesses to the pandemic environment. Furthermore, the NGEU funds constitute an upside risk for the economy. Lithuania is set to receive EUR 2.2 billion of grants under the Recovery and Resilience Fund with planned allocations in green and digital transition projects, social policies and to help facilitate the implementation of reforms and investments in education, health, research and development and the public sector.

Significant Strengthening in the External Position

The current account surplus more than doubled in 2020, reaching 8.4% of GDP from 3.3% in 2019. The increase can be largely attributed to the improvement in the goods and services balance from 5.2% of GDP in 2019 to 9.7% in 2020 due to the decline in imports of goods and the mild decline of exports. Lithuania’s external position has strengthened significantly, with its current account position shifting from a 15.0% deficit to GDP ratio in 2007 to a 3.3% surplus in 2019. Lithuania’s strong external performance has been supported by strong exports of services and a positive secondary income balance. The current account is expected to remain in positive territory. Current account surpluses have resulted in a decline in the net international investment liability position from 60% of GDP in 2010 to 15.6% at the end 2020.

Extraordinary Fiscal Measures Have Increased Fiscal Deficits

Extraordinary measures to deal with the pandemic resulted in a fiscal deficit of 7.4% of GDP in 2020, slightly improved from the 7.6% estimate in the 2021 draft Budget. In 2020 the government introduced a fiscal package to support households and businesses of around 6.2% 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 SMEs and agriculture. In addition, government schemes are in place to provide liquidity to medium and large sized enterprises to accelerate public and private investment. According to Lithuania’s Stability Programme 2021, the expansionary policy will continue this year with the fiscal deficit expected to remain high at 8.1% of GDP, before starting to decline gradually. Lithuania has a track record of prudent fiscal management and in DBRS Morningstar’s view the government will likely continue promoting policies that ensure fiscal sustainability.

However, ageing population and tax evasion continue to pose challenges to Lithuania’s long-term fiscal sustainability. Lithuania has one of the fastest ageing populations in the EU with the old-age dependency ratio (15-64) expected to rise to 66% in 2070 from 32.9% in 2019 according the EC. Moreover, Lithuania’s informal economy, which is estimated at around 18% of GDP, remains pervasive and obstructs a more efficient allocation of resources.

Support Measures have Increased the Public Debt Burden, but the Ratio to Remain Below 60%

Higher fiscal deficits contributed to a 11.3 percentage points increase in the public debt to GDP ratio from 35.9 in 2019 to 47.3% in 2020. According to the government’s forecasts debt is expected to increase further to 52.1% in 2021 and to peak at 57.9% in 2023-24. The weighted-average term to maturity of central government debt was 9.5 years at end-March 2021. Almost all central government foreign debt is at fixed rates and all the debt is in euros. The favorable environment in the international bond markets has achieved a low weighted average interest cost of the debt stock at 1.5% in 2020.

Risks to Financial Stability Appear Contained

The implications from the COVID-19 crisis for the Lithuanian banking sector have been mild thus far. The CET1 capital ratio stood at 21.4% in 2020 and the leverage ratio remained high at 6.7%. The Bank of Lithuania has maintained the counter-cyclical capital buffer (CCyB) at 0% helping banks to provide liquidity to businesses and individuals. The Lithuanian banking system is highly concentrated, with three foreign-owned banks accounting for 83% of market share, therefore spillovers from parent banks due to the pandemic pose a risk to Lithuania’s financial stability. Private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to around 38% and the household debt-to-GDP ratio was 25% at the end of June 2020. The Bank of Lithuania has taken steps to ensure a flow of credit to the economy and also to assist households and businesses facing temporary financial difficulties.

DBRS Morningstar Expects Policy Continuity From the New Centre-Right Coalition Government.

Following the parliamentary elections in October 2020 a three party centre-right government was formed, led by Prime Minister Ingrida Simonyte who previously served as Finance Minister between 2009 to 2012. DBRS Morningstar views that the new coalition government will likely maintain policy continuity, as successive multi-party government coalitions have helped to promote stable policies and institutions. 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. Nonetheless, Lithuania performs strongly in the World Governance Indicators.

ESG CONSIDERATIONS
Human Capital and Human Rights (S) is a key driver behind this rating action. Compared with its euro system peers, productivity and human capital as measured by Lithuania’s per capita GDP is relatively low at USD 19,917 in 2020.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/378825.

EURO AREA RISK CATEGORY: LOW

Notes:
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

All figures are in EUR 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, https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include Ministry of Finance (Lithuanian Stability Programme 2021, Investors Presentation July 2020), Bank of Lithuania (Financial Stability Review 2020, Banking Activity Review 2020), International Monetary Fund April 2021, OECD, European Commission (Spring 2021 Economic Forecast, 2020 European Semester: Country Report, Assessment of the final national energy and climate plan of Lithuania), Bank for International Settlements, National Energy and Climate Action Plan of the Republic of Lithuania for 2021-2023, European Centre for Disease Prevention and Control, United Nations Development Program (UNDP), Eurostat, Stockholm School of Economics in Riga, Lithuania Department of Statistics, Social Progress Imperative, 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.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/378827.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Thomas Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: November 20, 2020

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