DBRS Morningstar Upgrades Republic of Lithuania to A (high), Trend Changed to Stable

DBRS Ratings GmbH (DBRS Morningstar) upgraded the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings to A (high). At the same time, DBRS Morningstar upgraded its Short-Term Foreign and Local Currency – Issuer Ratings to R-1 (middle). The trend on all ratings has been changed to Stable from Positive.

KEY RATING CONSIDERATIONS
The ratings upgrades reflect DBRS Morningstar’s assessment that the resilience of the Lithuanian economy has strengthened. Despite the COVID-19 crisis, Lithuania’s diversified economic structure and targeted fiscal measures limited the impact on the economy in 2020. Real GDP returned to its pre-pandemic levels already in the first quarter of 2021. The recovery has been broad based thus far with real GDP growing by 5.2% YOY from January to September 2021. Lithuania entered the COVID-19 crisis having corrected the major macroeconomic imbalances that led to the deep recession in 2009. The sound fiscal position prior to the COVID-19 crisis and its relatively low debt, at 35.9% of GDP in 2019, compared to its euro area peers allowed the authorities space to provide stimulus to mitigate the impact of the COVID-19 shock. The improvement in the Economic Structure and Performance building block was the key factor for the upgrades.

The ratings are underpinned by Lithuania’s stable fiscal framework and its low public debt ratio. The sizeable fiscal package to mitigate the impact of the pandemic have increased the deficit and the public debt ratio. However, Lithuania’s commitment to prudent fiscal policies will likely continue and the ongoing economic recovery will help return the debt ratio to its pre-pandemic downward trend. 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 one or more of the following: (1) evidence of additional economic resilience by raising income and productivity levels; or (2) continued strengthening in public sector balance sheets.

Factors that could lead to a downgrade include: (1) material worsening in the public sector accounts, or (2) the emergence of significant macroeconomic imbalances.

RATING RATIONALE
Lithuania’s Economy Has Recovered to Pre Pandemic Levels, Domestic Demand Will Drive Growth

Following a mild contraction of 0.1% in 2020, the Lithuanian economy returned to its pre-pandemic levels in the first quarter of 2021,with real GDP growing by 5.0% YoY in the first half of the year. The recovery is supported by the buoyant performance of high value added sectors such as manufacturing, while the laggard recovery of low value added sectors has limited economic impact. On the back of high adaptation of households and businesses to the pandemic environment, domestic demand showed resilience, while increased external demand resulted in strong export growth for Lithuanian goods. The labour market is also recovering with the unemployment rate falling to 6.7% in the third quarter of 2021. Despite positive net migration since 2019, labour shortages continue to persist, especially in the manufacturing and construction sectors. This has contributed to fast wage growth as the gap with peers is gradually closed. The European Commission forecasts real GDP growth of 5.0% in 2021 and of 3.6% in 2022. The evolution of the pandemic remains a key downside risk for the forecast. Moreover, prolonged disruptions in supply chains and labour shortages due to skills mismatches as well as increased energy prices could dent growth.

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 for green and digital transition projects, for social policies and for reforms and investments in education, health, research and development and the public sector. Over the next decade, Lithuania with its EUR 17.1 billion National Progress Plan, will attempt to address its long standing challenges related to low productivity growth, labor shortages due to skills mismatches and the ageing population, and further increase economic resilience leading to a sustainable income convergence with its euro area peers.

Current Account to Return to its Pre Pandemic Levels

In the aftermath of the global financial crisis (GFC), Lithuania’s external position strengthened significantly, with its current account position shifting from a 15.0% deficit-to-GDP ratio in 2007 to a 4.3% surplus in 2019. Lithuania’s favourable external performance has been supported by strong exports of services and a positive secondary income balance. In 2020 the current account recorded a sizeable surplus of 7.4% of GDP driven by strong exports by the chemical and furniture industries and subdued imports. However, the anticipated increase in domestic demand will likely return the external position to its pre-pandemic levels. From a stock perspective, Lithuania’s net international investment position amounted to -12% at the end of June 2021.

Improving Fiscal Metrics As the Economy Strengthens and Temporary COVID-19 Measures are Wound Down

Lithuania’s prudent fiscal policy before the pandemic gave the government ample fiscal space to weather the impact of the COVID-19 shock. The support package to mitigate the impact of the pandemic resulted in a high fiscal deficit of 7.4% of GDP in 2020. The government introduced a set of targeted economic and financial measures to support households and businesses with expenditure measures estimated at around 5.5% of GDP in 2020. Despite the higher expected fiscal deficits, since 2014 Lithuania has strengthened its budget benefiting from its euro area membership and the EC’s economic governance, remaining committed to a prudent fiscal strategy. Fiscal policy will continue to be accommodative in 2021 and 2022. However, the strong rebound in 2021 thus far and the lower take up of measures will result in a more favorable fiscal outcome than initially anticipated. The Draft Budgetary Plan 2022 foresees a 4.4% deficit significantly improved from previous estimates. In 2023 the EC expects the deficit to fall to 1.1%.

However, the coronavirus shock adds to Lithuania’s key fiscal challenges, including its ageing population and tax compliance issues. Lithuania has one of the fastest ageing populations in the EU with the old-age dependency ratio (15-64) expected to rise to 63.9% in 2060 from 29% in 2016 according the EC. Moreover, Lithuania’s informal economy, remains large estimated at 20.4% of GDP in 2020 and obstructs a more efficient allocation of resources.

Lithuania’s Public Sector Debt Burden is Comparatively Low

The public debt-to-GDP ratio increased last year due to the economic downturn and higher fiscal deficits. Given the increased financing needs to tackle the economic implications of the pandemic public debt increased from 35.9% of GDP in 2019 to 46.6% in 2020. According to the 2022 Draft Budget, the debt ratio is projected to decline marginally in 2021. The weighted-average term to maturity of central government debt was 9.3 years at end-June 2021. Almost all central government foreign debt is at fixed rate and all the debt is in euros. The favorable environment in the international bond markets has led to a further decline in interest costs to 0.7% of GDP in 2020 from 1.3% in 2016. The International Monetary Fund (IMF) forecasts the public debt ratio to fall below 40% of GDP by 2025.

Risks to Financial Stability are Contained

Lithuania’s economic resilience and the strong metrics of the banking sector before the pandemic have mitigated the impact of the COVID-19 shock on financial stability. Lithuania’s banking system entered the crisis with strong profitability, sound capitalization, with the CET1 ratio standing at 21.4% in January 2021 and a good liquidity position. The impact on banks’ asset quality has been limited, with only 2.7% of the loan portfolio making use of the payment holidays. The banking system in Lithuania is highly concentrated, with three foreign-owned banks accounting for 85% of market share, therefore spillovers from parent banks due to the pandemic pose some risk to Lithuania’s financial stability. House prices continued to record strong growth as demand for housing remained robust in 2020, however housing affordability has improved substantially. The debt-to-GDP ratio of non-financial corporations amounted to 39.4% and the household debt-to-GDP ratio was 24.2% at the end of June 2021, both very moderate levels.

Policy Continuity Is Expected, But Geopolitical Risks Are Elevated

Last year’s elections delivered a victory for the center-right party Homeland Union, which led to a new coalition government, formed by three-parties. DBRS Morningstar takes the view that Lithuania’s new government will likely maintain policy continuity, as successive multi-party government coalitions have promoted stable policies and institutions, as measured also by the high scores in the World Governance Indicators. EU and NATO membership are likely to provide a broadly stable political environment for Lithuania, however, recent geopolitical tensions between the European Union and Belarus have resulted in sanctions against the Belarusian regime and increased the flows of migrants at the Lithuanian border. The EU sanctions on Belarus are expected to have a limited impact on Lithuanian GDP.

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 19,981 in 2020. DBRS Morningstar has taken these considerations into account within the ‘Economic Structure and Performance’ building block.

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/388369.

EURO AREA RISK CATEGORY: LOW

Notes:
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/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). 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 (Draft Budgetary Plan 2022, Investors Presentation September 2021), Bank of Lithuania (Financial Stability Review 2021, Banking Activity Review 2020), International Monetary Fund October 2021, 2021 Article IV Consultation- Press Release; Staff Report; and Statement by the Executive Director for the Republic of Lithuania, September 2021), OECD, European Commission (Autumn 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 (Shadow Economy Index for the Baltic Countries), 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/388370.

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: May 21, 2021

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