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 CREDIT RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s assessment that the risks to the credit ratings are balanced. High inflation, tighter monetary policy, and the weaker external environment are expected to have a negative impact on the economic growth metrics in 2023. After posting 6.3% real GDP growth in 2021, and an additional 2.4% last year, the Lithuanian economy is expected to contract this year, by 0.4% according to the European Commission (EC). Nevertheless, economic activity is expected to accelerate next year as private consumption starts to recover and European Union funds are absorbed into the economy. The sound fiscal position prior to the COVID-19 pandemic and the relatively low public debt ratio - below 40% in 2019, compared to its euro area peers, allowed the authorities space to provide stimulus to mitigate the impact of high energy prices and to maintain its gas supply independence from Russia, enhancing energy security. Due to both lower spending and higher revenues, the fiscal deficit as a share of GDP last year was better than anticipated, amounting to 0.6%, and is expected at 1.9% this year. DBRS Morningstar takes the view that Lithuania will remain committed to prudent fiscal policies and to rebalancing the public sector accounts as soon as more favourable economic conditions allow.

The credit ratings are underpinned by Lithuania’s euro area 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 87% in 2022, compared to 55% 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 2.3 billion of grants, and EUR 1.55 billion of loans could help Lithuania raise its growth potential.

CREDIT 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) a durable 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.

CREDIT RATING RATIONALE

The Economy Will Contract This Year; EU Funds Will Support Growth Next Year

The economy showed remarkable resilience during the pandemic, with real GDP remaining unchanged in 2020, followed by 6.3% growth in 2021. Real GDP increased by an additional 2.4% last year, supported in particular by investments. Strong performance was observed in several sectors of the economy such as in manufacturing, information and communications services and financial services. However, signs of weakening in economic activity started to emerge in the fourth quarter of 2022. High energy and food prices have led to a surge in harmonized consumer price inflation (HICP) to almost 20% in 2022. High inflation is eroding households’ purchasing power and the slowdown in the global economy and the deteriorating economic environment in Lithuania’s main trading partners are having an adverse impact on exports of Lithuanian goods and services. In the first half of 2023, the Lithuanian economy contracted by 0.8% on an annual basis. The EC forecasts real GDP to fall by 0.4% this year and to grow by 2.5% in 2024. The unemployment rate stood at 6.8% of the workforce in the first half of 2023 after declining to 5.9% in 2022, from 7.2% a year earlier. However, the labour market in Lithuania remains tight. Labour shortages continue to persist with the job vacancy rate standing at 2.0% in H1 2023. The highest vacancy rates have been recorded in information and communication services and in financial services, with the job vacancy rates around 2.5% in Q2 2023, likely reflecting skills mismatches. This has contributed to annual hourly wage growth of 12.4% in the second quarter of 2023.

As energy and food prices have moderated, HICP started to decelerate, averaging 11% in the first nine months of 2023, compared with the same period a year earlier. The latest available data shows the annual rate having declined to 4.1% in September 2023. Falling inflation, eventual easing in financing conditions, and the inflow of EU funds are expected to support economic growth next year, with projections pointing to GDP growth of around 2%. Lithuania is set to receive EUR 2.3 billion of grants from 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. In May 2022, Lithuania received the first disbursement. 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. Despite the successive economic shocks, the Lithuanian economy showed remarkable resilience, supporting our assessment for a positive qualitative adjustment in the “Economic Structure and Performance” building block.

Current Account Is Expected to Return to Its More Typical Levels This Year

In 2022, the current account ratio deteriorated to a deficit of 5.5% of GDP, from a surplus of 1.2% of GDP in 2021, due to the increases in import costs, lower foreign demand for Lithuanian exports and a deterioration in the primary income balance. As energy prices moderate, the current account is expected to remain broadly in balance this year. After the global financial crisis (GFC) 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 sanctions imposed on Russia and Belarus have had a limited impact on total Lithuanian exports of goods thus far. 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). From a stock perspective, Lithuania’s net international investment position (NIIP) amounted to -3% of GDP at the end of June 2023, significantly improved from -47% in June 2016.

Fiscal Outcome Better Than Anticipated in 2022, Lithuania Remains Committed to Prudent Fiscal Policies

Lithuania’s fiscal accounts deteriorated in recent years, due to measures to mitigate the impact of the pandemic and of the energy crisis on businesses and households. This resulted in a high fiscal deficit of 6.5% of GDP in 2020, from a small surplus during the 2016-19 period. In 2021, higher tax revenues and lower take-up of COVID-19 measures led to a considerable improvement, with the fiscal deficit narrowing to 1.2% of GDP, much better than initially anticipated. Similarly, 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 on households and businesses and these are gradually being wound down. The fiscal support, consists of measures aiming to enhance energy independence, provide subsidies for energy bills, provide support for the resettlement of Ukrainian refugees, to increase military spending, and to provide transfers to state-owned enterprises that were adversely affected by sanctions to Russia and to Belarus. This year’s estimates point to a deficit of 1.9%, lower than initially anticipated.

In 2024-2026, the general government deficit is projected to be 2.9% of GDP, 2.5% of GDP, and 2.1% of GDP, respectively. 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 European Commission. Moreover, Lithuania’s informal economy remains large, estimated at 25.8% of GDP in 2022, which obstructs a more efficient allocation of resources.

Lithuania’s Public Sector Debt Ratio Remains Low

Lithuania’s public sector debt ratio remains one of the lowest in the euro area. However, due to the increased financing needs to tackle the economic repercussions of the pandemic and the energy crisis, the government debt ratio increased from 35.8% of GDP in 2019 to 46.3% in 2020. In 2021 the ratio amounted to 43.4% and in 2022, the public debt ratio improved, due to strong nominal GDP growth and the improved fiscal position, amounting to 38.1%. An additional improvement to 37.9% is expected this year. Lithuania’s interest costs were at historically low levels at 0.5% of GDP at the end of H1 2023 and the weighted-average term to maturity of central government debt was 8.7 years at the end of September 2023. In addition, all the debt is in euros and almost all central government foreign debt is at fixed rates.

Risks to Financial Stability Are Contained; Higher Interest Rates Will Put Pressure on the Real Estate Market

Lithuania’s banking system is in a good position to weather the challenges posed by the adverse macroeconomic environment. Lithuanian banks remain liquid, profitable and well-capitalized, with the weighted average Common Equity Tier 1 (CET1) capital ratio at 19.46% in Q1 2023. The impact on banks’ asset quality has been limited thus far, with the non-performing loans ratio standing at 0.4% in Q1 2023. However, very high inflation and increasing interest rates could affect the asset quality of household and business loan portfolios. After years of strong growth in the real estate market, signs of cooling have started to emerge. Pressures on disposable income from higher inflation and rising interest rates, could lead to a prolonged period of low demand for housing, with price growth expected to decline in 2023. The Lithuanian banking system is highly concentrated, with the two largest Swedish banks accounting for 53% of banking sector assets and as such risks to financial stability are linked also with spillovers from Nordic economies.

The Lithuanian authorities have undertaken a series of measures to reduce potential risks to financial stability. These include the setting of a 2% sectoral systemic risk buffer (SRB) rate for the residential property market loan portfolio (July 2022) and the tightening of the down payment requirement of second homes at 30% of the value of property (February 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 40.35% and the household debt-to-GDP ratio at 21.89% in Q2 2023.

Geopolitical Risks Are Elevated; Lithuania Benefits From a Stable Political System

Lithuania has a stable political system and strong institutions as reflected in the high scores in the Worldwide Governance Indicators. The 2020 general election delivered a victory for the center-right party Homeland Union, leading to a new coalition government, formed by three-parties. The next general election will be held in 2024. Russia’s invasion of Ukraine has elevated geopolitical risks in the Baltic region. In response to 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

ESG Considerations had a significant effect on the credit analysis.

Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
The following Social factors had a significant effect on the credit analysis: Human Capital and Human Rights (S) affects the credit 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 24,988 in 2022. DBRS Morningstar has taken these considerations into account within the ‘Economic Structure and Performance’ building block.

Governance (G) Factors
There were no Governance factors that had a relevant or significant 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 (04 July 2023) https://www.dbrsmorningstar.com/research/416784/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/423556.

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 (06 October 2023) https://www.dbrsmorningstar.com/research/421590/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/416784/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 these credit ratings include Ministry of Finance (Lithuania’s Stability Programme for 2023), Ministry of Finance (2024 Draft Budgetary Plan), Investors Presentation October 2023), Bank of Lithuania (Lithuanian Economic Review September 2023, Banking Activity Review 2023/Q2, Macroeconomic Projections September 2023, Financial Stability Review 2023), International Monetary Fund October 2023, Republic of Lithuania: 2023 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Lithuania, OECD, European Commission ( Autumn 2023 Economic Forecast, Assessment of the final national energy and climate plan of Lithuania, Lithuania 2023 Country Report), Bank for International Settlements, National Energy and Climate Action Plan of the Republic of Lithuania for 2021-2030, Eurostat, Stockholm School of Economics in Riga (Shadow Economy Index for the Baltic Countries), Lithuania State Data Agency, Social Progress Imperative, European Central Bank, World Bank, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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://registers.esma.europa.eu/cerep-publication. 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 credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/423548.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Nichola James, Managing Director, Credit Ratings, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Credit Ratings, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: May 19, 2023

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.