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

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 risks to the ratings are balanced. Lithuania’s strong fundamentals before the pandemic, the targeted fiscal measures and the low reliance on contact intensive sectors limited the impact on the economy in 2020. The economy rebounded strongly in 2021, posting 6.0% real GDP growth, and an additional 1.9% last year, despite the energy crisis and high inflation. GDP is expected to slow to 0.5% this year and to grow at an annual average rate of 3% in 2024-2026 according to Lithuania’s Stability Programme for 2023. Despite fears that the support measures to mitigate the impact of high energy costs on households and businesses would take a toll on public finances, the fiscal deficit as a share of GDP last year was better than anticipated due to both lower spending and higher revenues, amounting to 0.6%, and is expected to be 2.2% this year. 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, allowed the authorities space to provide stimulus to mitigate the impact of high prices and to maintain its gas supply independence from Russia, enhancing the country’s energy security. DBRS Morningstar takes the view that Lithuania will remain committed to prudent fiscal policies and to rebalancing the public sector account as soon as better economic conditions allow.

The ratings are underpinned by Lithuania’s euro system membership, stable fiscal and macroeconomic framework, its low public debt ratio and its resilient export-oriented economy. Lithuania’s commitment to prudent fiscal policies will likely continue and will help the debt ratio return to its pre-pandemic downward trend. Lithuania’s economic structure benefits from a large export sector with strong integration into key regional supply chains. Exports of goods and services as a share of GDP stood at 80.4% in 2021 compared to 49.5% for the euro area. 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. Investments and reforms under the Recovery and Resilience Plan, which is set to allocate EUR 2.2 billion of grants, could help Lithuania raise its growth potential.

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) strengthening in the public sector balance sheet.

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

High Inflation is Resulting in Slower Growth

The Lithuanian economy continued on a strong recovery path in 2021, after showing remarkable resilience during the COVID-19 pandemic. Real GDP grew by 6.0% in 2021, driven by robust private consumption and investment growth. GDP increased by an additional 1.9% last year. The recovery was supported by the buoyant performance of high value added sectors such as manufacturing, while the small reliance on high contact intensive sectors had limited the losses during the pandemic. The unemployment rate continued to decline to 5.6% in 2022 from 6.7% a year earlier. However, labour shortages continue to persist with the job vacancy rate standing at just 1.7% at end 2022. The highest vacancy rates have been recorded in financial and insurance services and information and communication sectors with the job vacancy rates above 3% in Q2 2022, likely reflecting skills mismatches. This has contributed to wage growth over 10% in almost all service and industry sectors.

The Lithuanian economy grew by 1.9% last year, supported in particular by investment. Growth was recorded in manufacturing, information and communications, and financial services sectors. However, signs of slowdown in economic activity started to emerge in the fourth quarter of last year. The high inflation rate and the worsening external environment will result in lower growth of 0.5% this year. High energy and food prices have led to a surge in CPI inflation, which amounted to 14.5% in April 2023, albeit significantly below its peak. As economic activity remained broadly unchanged during the pandemic, prices started to increase earlier in Lithuania than in most other euro area countries, with inflation already high at 12.4% YoY in January 2022. The high share of energy, food, and transport goods in the purchasing basket and the high dependance on oil and gas as Lithuania achieved early independence from Russian supplies, have significantly affected the price level in Lithuania, and inflation is expected to average 8.7% this year and 2.1% next year, compared with a very high 18.9% in 2022.

High inflation is eroding households’ purchasing power, while high energy costs are curbing business investment. The slowdown in the global economy and the deteriorating economic environment in Lithuania’s main trading partners are also expected to have an adverse impact on exports of Lithuanian goods and services. The impact of sanctions imposed on Russia and Belarus have had limited effect on the Lithuanian economy thus far, as the exports of goods to Russia (10.8% of total exports in 2021) and to Belarus (3%), mainly consist of re-exports, therefore limiting losses for the domestic economy.

Lithuania is set to receive EUR 2.2 billion of grants under the Recovery and Resilience Fund with planned allocations for green (37.8%) and digital transition projects (31.5%); for social policies; and for reforms and investments in education, health, research and development and the public sector. In August 2021, Lithuania received EUR 289 million of pre-financing. Under the EU Budget Lithuania is also expected to receive EUR 6.81 billion, which aims to address its long-standing challenges related to low productivity growth, labor shortages due to skills mismatches, and the ageing population. This could potentially help further increase economic resilience leading to sustainable income convergence with its euro area peers.

Subdued External Demand and Higher Import Costs Has Widened the Current Account Deficit

Before the pandemic, Lithuania managed to strengthen its external position significantly. The current account shifted from a deficit position of 15.0% of GDP in 2007 to a surplus position of 3.5% in 2019, making the economy more resilient to external shocks. The strong export growth in the chemical and furniture industries, together with subdued import growth resulted in a high current account surplus of 7.3% of GDP in 2020. In 2021, the current account balance amounted to a surplus of 1.1% of GDP.

The sanctions imposed on Russia and Belarus have had limited impact on total Lithuanian exports of goods thus far. The share of goods of national origin to Russia were limited to 1.1% of exports in 2021. 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. However, disruptions to imports of raw materials and elevated energy import costs, have resulted in higher costs for Lithuanian producers, especially in the chemical industry (fertiliser production). The current account deteriorated last year to a deficit of 5.1% of GDP due to the increases in import costs, lower foreign demand for Lithuanian exports and a deterioration in the primary income balance. This year the deficit could shrink to 3.0%. From a stock perspective, Lithuania’s net international investment position (NIIP) improved to -7% of GDP at the end of December 2022, significantly improved from -47% in June 2016.

Fiscal Outcome Better Than Anticipated in 2022, But A Higher Deficit is Foreseen in 2023

Lithuania’s prudent fiscal policy before the pandemic gave the government ample fiscal space to mitigate the COVID-19 shock. The fiscal measures to mitigate the impact of the pandemic on businesses and households resulted in a high fiscal deficit of 7.3% of GDP in 2020. Higher revenues and lower take-up of COVID-19 measures led to a considerable improvement in the fiscal position in 2021. The fiscal deficit narrowed to 1.0% of GDP, much better than initially anticipated (7.0% of GDP). In 2022, the fiscal deficit was also lower than initial estimates due to higher revenues and lower expenditures. The deficit came in at 0.6% of GDP. The Lithuanian government has introduced measures to mitigate the impact of high energy prices for households and businesses and these are gradually being wound down. The fiscal support, with an estimated cost of around 2.0% of GDP, consists of measures aiming to enhance energy independence, provide subsidies for energy bills, support for the resettlement of Ukrainian refugees, increase military spending, and provide transfers to state-owned enterprises that were adversely affected by the sanctions to Russia and Belarus. Higher spending for the cost of living crisis and investments, is estimated to result in a fiscal deficit of 2.2% of GDP in 2023.

DBRS Morningstar takes the view that Lithuania remains committed to prudent fiscal policies, supported also by its euro area membership and the EC’s economic governance framework. Nevertheless, 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, which obstructs a more efficient allocation of resources.

Lithuania’s Public Sector Debt Ratio is Comparatively Low

The increased financing needs to tackle the economic repercussions of the pandemic, resulted in a 10.5 percentage-point increase in the public debt ratio from 35.8% of GDP in 2019 to 46.3% in 2020. The public debt ratio declined in 2021 and 2022 due to the strong nominal GDP growth and the improved fiscal position, reaching 38.4% last year. Lithuania’s debt ratio remains one of the lowest in the euro area. An additional improvement to 37.8% is expected this year. Lithuania’s interest costs as a share of GDP were at historically low levels at -0.1% of GDP at the end of 2022, although they will rise to 0.7% in 2025. Moreover, the weighted-average term to maturity of central government debt was 8.8 years at end-February 2023. In addition, all the debt is in euros and almost all central government foreign debt is at fixed rates.

Banking System Remains Well Capitalized, Higher Interest Rates Will Put Pressure on the Real Estate Market

The strong metrics before the pandemic helped the Lithuanian banking sector to withstand the COVID-19 shock. Lithuania’s banking system has maintained its strong capital position, with the CET1 ratio at 20.3% in June 2022 and a good liquidity position. The impact on banks’ asset quality has been limited, with the non-performing loans ratio standing at 0.5% in December 2022. However, very high inflation and increasing interest rates could affect the asset quality of households’ and business’ loan portfolios. Pressures on disposable income from higher inflation and rising interest rates could also lead to a correction in real estate prices, which have experienced 17% growth in 2022, while wage growth recorded an increase of 13.4%.

Authorities have undertaken measures to mitigate the risks to financial stability by tightening the down payment requirement of second homes at 30% of the value of the property (February 2022) and setting a 2% sectoral systemic risk buffer (SRB) rate for the residential property market loan portfolio (July 2022). In addition, both households and non-financial corporations (NFCs) show moderate level of indebtedness, with the debt-to-GDP ratio of NFCs amounting to 42.4% and the household debt-to-GDP ratio at 23.3% in Q2 2022. Risks to financial stability in Lithuania are associated also with spillovers from Nordic economies, since the Lithuanian banking system is highly concentrated, with the two largest Swedish banks accounting for 65% of banking sector assets.

Geopolitical Risks Are Elevated; Lithuania was the First EU Country to Become Independent of Russian Gas

Lithuania has a stable political system and strong institutions. This is reflected in the high scores in the Worldwide Governance Indicators. The last elections delivered a victory for the center-right party Homeland Union, leading to a new coalition government, formed by three-parties, which will most likely maintain policy continuity. Russia’s invasion of Ukraine has elevated the geopolitical risks in the Baltic region. In response to the increased energy security risks, Lithuania was the first EU nation to become independent of Russian gas imports, which have been replaced by liquified natural gas (LNG) supplies via the Klaipeda LNG terminal, with enough capacity to meet gas demand in Lithuania. DBRS Morningstar takes the view that Lithuania’s decision to halt gas imports from Russia significantly enhances its energy security. Lithuania also benefits from its EU and NATO membership, which reduces the risks from potential Russian aggression.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
Human Capital and Human Rights (S) affects the ratings assigned. Compared with its euro system peers, productivity and human capital as measured by Lithuania’s per capita GDP is relatively low at USD 23,385 in 2021. DBRS Morningstar has taken these considerations into account within the ‘Economic Structure and Performance’ building block.

There were no Environmental or Governance factor(s) that had a significant or relevant effect on the credit analysis. 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 (May 17, 2022) 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/414269.

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 (August 29, 2022) https://www.dbrsmorningstar.com/research/401817/global-methodology-for-rating-sovereign-governments. In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include Ministry of Finance (Lithuania’s Stability Programme for 2023), Ministry of Finance (Draft Budgetary Plan 2023, Investors Presentation March 2023), Bank of Lithuania (Lithuanian Economic Review March 2023, Banking Activity Review 2021, Macroeconomic Projections September 2022, Financial Stability Review 2022), International Monetary Fund April 2022, 2022 Article IV Consultation- Press Release; and Staff Report; Republic of Lithuania, July 2022), OECD, European Commission (Assessment of the final national energy and climate plan of Lithuania, Lithuania 2022 Country Report), Bank for International Settlements, National Energy and Climate Action Plan of the Republic of Lithuania for 2021-2023, 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/414271.

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: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: November 18, 2022

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