DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar confirmed its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s assessment that the improved resilience of the Lithuanian economy offsets the challenges posed by Russia’s invasion of Ukraine. Lithuania’s strong fundamentals before the pandemic and the targeted fiscal measures limited the impact on the economy in 2020. The economy rebounded strongly in 2021, posting a 4.9% real GDP growth rate. Nevertheless, disruptions in supply chains and increased energy and commodity prices will contribute to GDP growth slowing to 1.6% this year. High inflation and the need for additional measures to mitigate its impact on households and businesses will add to public finance costs. However, the sound fiscal position prior to the COVID-19 crisis and the relatively low public debt ratio -below 50%- compared to its euro area peers, allows the authorities space to provide stimulus to mitigate the impact of high prices and to maintain its gas supply independence from Russia. DBRS Morningstar views Lithuania’s decision to stop importing oil and gas from Russia as an important step towards enhancing the country’s energy security.
The ratings are underpinned by Lithuania’s euro system membership, stable fiscal and macroeconomic framework, and its low public debt ratio. Lithuania’s commitment to prudent fiscal policies will likely continue and the diverse economic structure will help return the debt ratio to its pre-pandemic downward trend. The EU’s Recovery and Resilience Facility is set to 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.
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.
Following a Strong Rebound in 2021, Real GDP Growth Will Slow This Year
The Lithuanian economy showed remarkable resilience during the COVID-19 pandemic. Real GDP remained broadly unchanged in 2020, followed by 4.9% real growth in 2021, driven by robust private consumption and strong export growth. The recovery was supported by the buoyant performance of high value added sectors such as manufacturing, while the slower recovery of low value added sectors had limited economic impact. The labour market has also recovered with the unemployment rate falling to 6.9% in March 2022 from 7.4% a year earlier. Nevertheless, labour shortages continue to persist, especially in high value added sectors such as information and technology and financial and insurance activities, that reported job vacancy rates above 3% in Q4 2021. This has contributed to fast wage growth, converging gradually with the EU average, although remaining still behind its Baltic and euro area peers.
Russia’s invasion of Ukraine creates renewed uncertainty for Lithuania’s economic outlook. Prolonged disruptions to supply chains and increased energy prices will dent growth. The government expects economic growth to slow this year to 1.6% from 3.7% previously forecast. The impact of the conflict on the Lithuanian economy will be transmitted through multiple channels. The sanctions imposed on Russia and Belarus will have an adverse impact on Lithuanian exports of goods. In 2021, the share of exports of goods to Russia reached 10.8% and to Belarus around 3% of total exports, although most of it consists of re-exports, limiting the impact on the economy. The share of goods of national origin to Russia are limited to below 2%. Moreover, disruptions to imports of raw materials, mainly metals and wood, could result in higher costs for Lithuanian producers. Private consumption will also be affected as high inflationary pressure will restrain households’ purchasing power, while high energy prices and supply chain disruptions will constrain business investment. However, government support measures will most likely mitigate somewhat the impact of high energy costs on the economy. Real GDP growth is expected to gather pace in 2023 and 2024, 2.5% and 3%, respectively, supported also by Next Generation EU funds.
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 National Progress Plan, will continue to address its long standing challenges related to low productivity growth, labor shortages due to skills mismatches, and the ageing population. This will potentially help further increase economic resilience leading to sustainable income convergence with its euro area peers.
Moderate Adverse Impact on External Accounts Related to the Impact of Russia’s Invasion of Ukraine
Lithuania’s current account recorded a sizeable surplus of 7.4% of GDP in 2020 due to strong export growth in the chemical and furniture industries and subdued imports. In 2021, the external position returned more in line with its pre-pandemic levels, with a current account surplus of 1.5% of GDP. Russia’s invasion of Ukraine is expected to adversely affect Lithuania’s foreign trade with Russia, however, DBRS Morningstar notes that the small share of goods of Lithuanian origin indicates that the losses could be compensated for by other EU markets, limiting the extent of more permanent export market losses. Nevertheless, exports will be affected by the decline in foreign demand, due to the implications of the conflict in Ukraine. Before the pandemic, 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, making the economy more resilient to external shocks, according to DBRS Morningstar. From a stock perspective, Lithuania’s net international investment position amounted to -7.2% at the end of December 2021.
Fiscal Metrics Improved In 2021; the Conflict in Ukraine Leads to New Support Measures
Prior to the pandemic, Lithuania managed to strengthen its fiscal position and to restore fiscal buffers that gave the government ample fiscal space to mitigate the COVID-19 shock. The fiscal support to weather the impact of the pandemic on businesses and households resulted in a high fiscal deficit of 7.3% of GDP in 2020. Fiscal policy continued to be accommodative in 2021, resulting in a 1% fiscal deficit, significantly improved from initial estimates, due to strong revenue performance. New measures to mitigate the effects of high inflation, increased spending on investments to support energy independence, and spending for the support and resettlement of Ukrainian refugees will deteriorate the fiscal position this year leading to a fiscal deficit of 4.9% of GDP, according to the government. Despite the higher expected fiscal deficit, since 2014 Lithuania has strengthened its budget, benefiting from its euro area membership and from the EC’s economic governance framework, remaining committed to a prudent fiscal strategy. The Stability Programme foresees a gradual rebalancing, ensuring fiscal sustainability in the medium term.
However, Lithuania’s key fiscal challenges remain, 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 in 2020 to 46.6% of GDP from 35.9% in 2019 due to the increased financing needs to tackle the economic implications of the pandemic. Strong nominal GDP growth and an improved fiscal position in 2021 reduced the public debt ratio to 44.3% of GDP. Despite the higher financing needs due to the pandemic, Lithuania declined further its interest costs to 0.1% of GDP in 2020, taking advantage of favourable financing conditions. The weighted-average term to maturity of central government debt was 9.3 years at end-February 2022 and almost all central government foreign debt is at fixed rate and all the debt is in euros.
Strong Metrics Before the Pandemic; Banking System Remains Well Capitalized
The Lithuanian banking sector weathered the shock caused by the COVID-19 pandemic thanks to its strong metrics before the crisis. Lithuania’s banking system maintained its strong capital position, with the CET1 ratio standing at 23.6% in January 2022 and its good liquidity position. The impact on banks’ asset quality has been limited, with the share of non-performing loans at 1.0% in the household loan portfolio and 1.7% in the corporate loan portfolio at the end of January 2022. The banking system in Lithuania is highly concentrated, with three foreign-owned banks accounting for 85% of market share, hence risks to financial stability are associated with the spillovers from Nordic economies. However, direct exposures to Russia appear to be limited. House prices continued to record strong growth as demand for housing increased after the lifting of pandemic related restrictions, however, risks appear to be manageable. The debt-to-GDP ratio of non-financial corporations amounted to 37.1% and the household debt-to-GDP ratio was 23.9% at the end of December 2021, both very moderate levels.
Geopolitical Risks Are Elevated; Lithuania is the First EU Country to Become Independent of Russia Gas
Russia’s invasion of Ukraine has elevated the geopolitical risks in the Baltic region. In response to the increased energy security risks, Lithuania is the first EU nation to become independent of Russian gas imports, which will be replaced by liquified natural gas (LNG) supplies from the Klaipeda LNG terminal. DBRS Morningstar takes the view that despite the adverse economic impact from the conflict in Ukraine, Lithuania’s decision to stop gas imports from Russia is a significant step in enhancing its energy security. Furthermore, Lithuania benefits from its EU and NATO membership, which reduces the risks from potential Russian aggression. Lithuania also has a stable political system and strong institutions also reflected in the high scores in the World Governance Indicators. 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.
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 23,473 in 2021. 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/397136.
EURO AREA RISK CATEGORY: LOW
All figures are in Euros (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: https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
The sources of information used for this rating include Ministry of Finance (Stability Programme 2022, Investors Presentation April 2022), Bank of Lithuania (Lithuanian Economic Review March 2022, Banking Activity Review 2021, Macroeconomic Projections March 2022), International Monetary Fund April 2022, 2021 Article IV Consultation- Press Release; Staff Report; and Statement by the Executive Director for the Republic of Lithuania, September 2021), OECD, European Commission (Spring 2022 Economic Forecast, 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/397137.
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 19, 2021
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