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

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed the Republic of Lithuania’s 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 Morningstar DBRS’ assessment that Lithuania’s track record of prudent fiscal policies before the pandemic and the low public debt ratio mitigate the risks to the credit ratings, despite a more challenging macroeconomic environment. After output expanded by 6.3% in 2021 and by 2.5% in 2022, the Lithuanian economy contracted 0.3% in 2023, due to high inflation, tighter monetary policy, and a weaker external environment. Nevertheless, economic activity is expected to accelerate this year as private consumption starts to recover, external demand strengthens, and European Union funds are absorbed into the economy. The Bank of Lithuania forecasts real GDP to grow by 1.6% this year and by 3.1% in 2025. The government’s sound fiscal position prior to the pandemic and relatively low public debt ratio – below 40% in 2019 – compared to its euro area peers provided the authorities with space to deliver stimulus in order to mitigate the impact of high energy prices and to maintain its gas supply independence from Russia. After posting a fiscal deficit of 0.7% of GDP in 2022 and 1.9% in 2023, the deficit is expected to increase further this year to 3.0%, due to temporary measures to support Ukraine and Ukrainian refugees. Lithuania’s track record on prudent fiscal policies supports our view that as soon as more favourable economic conditions allow, Lithuania will be able to rebalance the public sector accounts.

The credit ratings are underpinned by Lithuania’s euro area membership, stable fiscal and macroeconomic framework, low public debt ratio and export-oriented economy. 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 78% in 2023, compared to 51% for the euro area. Nonetheless, credit challenges related to structural factors remain, including income inequality, regional disparities, the need for further productivity improvements, a declining and ageing population, and economic informality. Lithuania is set to benefit from the inflows of EU funds which, along with accompanying reforms, could help 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 Contracted in 2023; Easing Inflation and Improved External Environment Will Support Growth This Year

Following 2.5% GDP growth in 2022, the Lithuanian economy contracted by 0.3% in 2023 due to subdued private consumption and weak export growth. High albeit declining HICP inflation eroded real incomes and high interest rates weighed on household consumption and business investment. Additionally, 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. Weak performance was observed in several sectors of the economy, such as manufacturing, real estate activities and trade, travel, accommodation. Nevertheless, sectors such as construction and information and communication remained resilient. Although the unemployment rate increased from 5.9% in 2022 to 6.8% in 2023, the labour market remains tight. Labour shortages continue to persist with the job vacancy rate standing at 2.0% in 2023, likely reflecting skills mismatches. This contributed to wage growth of 12.6% in 2023.

As energy and food prices have moderated, HICP has started to decelerate, falling to 2.8% in February 2024. The Bank of Lithuania forecasts real GDP to grow by 1.6% this year and by 3.1% in 2025 on the back of the expected recovery in private consumption, improved external environment and increasing flows from EU funds. Lithuania is set to receive EUR 3.9 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. These reforms aim to address Lithuania`s long-standing challenges related to low productivity growth, labor shortages due to skills mismatches, and the ageing population. This could potentially help enhance economic resilience and support income convergence with 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 Has Returned to Surpluses, But External Demand Risks are Elevated

After the global financial crisis, Lithuania managed to strengthen its external position significantly, making the economy more resilient to external shocks. The current account shifted from a deficit position of 15.0% of GDP in 2007 to a surplus position of 3.5% in 2019, However, the war in Ukraine and the subsequent energy crisis led to a deterioration in the current account. The current account worsened to a deficit of 5.5% of GDP in 2022 due to the increase in import costs, lower foreign demand for Lithuanian exports and a deterioration in the primary income balance. Lower energy prices in 2023 resulted in a surplus of 1.9% of GDP, despite the decline in exports. The sanctions due to the war in Ukraine have caused disruptions to imports of raw materials and elevated energy import costs, resulting in higher costs for Lithuanian producers, especially in the chemical industry (fertiliser production). Exports of goods and services declined in 2023, due to the lower demand amongst Lithuania’s trade partners. In 2024, on the back of some improvement in foreign demand, the Bank of Lithuania forecasts a current account surplus of 0.5% of GDP. Nonetheless, to account for the fact that external demand risks remain elevated, Morningstar DBRS applies a negative qualitative adjustment in the “Balance of Payments” building block assessment. Lithuania’s net international investment position (NIIP) amounted to 1.0 % of GDP at the end of 2023, significantly improved from -43% in 2016.

Fiscal Deficit Will Increase in 2024

Measures to mitigate the impact of the pandemic and energy crisis on businesses and households led to the deterioration in the fiscal accounts. From a small surplus during the 2016-19 period, the fiscal position turned into a deficit of 6.5% of GDP in 2020. 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 in 2021 and to 0.6% in 2022. In 2023, the Lithuanian government introduced fiscal measures aiming to enhance energy independence, provide subsidies for energy bills and 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 resulted in a fiscal deficit of 1.9% of GDP, albeit lower than the 4.9% deficit that was initially budgeted.

In 2024, the general government deficit is projected to increase to 3.0% of GDP due to temporary expenditure measures before gradually falling to 2.5% in 2025 and to 2.2% in 2026. Excluding the temporary measures this year, the fiscal deficit is forecast at 2.5% of GDP. Morningstar DBRS expects Lithuania to remain 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 (20-64) expected to rise to 72.4% in 2070 from 33% in 2022, 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.

Despite Running Sizeable Fiscal Deficits, Lithuania’s Public Debt Ratio Remains Low

Lithuania’s public sector debt ratio, at 38.3% of GDP in 2023, is one of the lowest in the euro area, despite the increased financing needs to tackle the economic repercussions of the pandemic and the energy crisis. The government debt ratio increased from 35.8% in 2019 to 43.5% in 2020 before declining to 37.9% and in 2022, due to strong nominal GDP growth and the improved fiscal position. General government debt is projected to increase marginally to 38.9% this year. Lithuania’s effective interest rate on its debt portfolio remains low at 1.5% and the weighted-average term to maturity of central government debt was 8.5 years at the end of February 2024. In addition, all debt is denominated in euros.

Banking Sector Showed Resilience in Recent Crisis; Risks to Financial Stability Are Contained

Lithuania’s banking system remained resilient throughout 2023, despite the challenges posed by the adverse macroeconomic environment. The Lithuanian banking system is highly concentrated, with the two largest Swedish banks accounting for 52% of banking sector assets. As such, risks to financial stability are linked with spillovers from Nordic economies. Lithuanian banks are liquid, profitable and well-capitalized, with the weighted average Common Equity Tier 1 (CET1) capital ratio at 18.7% in Q3 2023. The impact on banks’ asset quality has been limited thus far, with the non-performing loans ratio standing at 1.5% for non-financial corporations and 1.1% for households in Q3 2023. However, very high inflation and increasing interest rates could affect the asset quality of household and business loan portfolios. After growing by 17.6% on average in the 2021-2022 period, real estate price growth moderated to 9.9% in 2023. Pressures on disposable income from higher inflation and rising interest rates, could lead to a further slowdown in the real estate market. In order to reduce potential risks to financial stability, the Lithuanian authorities have undertaken a series of measures, which 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 levels of indebtedness, with the debt-to-GDP ratio of NFCs amounting to 39.9% and the household debt-to-GDP ratio at 21.7% in Q4 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. Successive multi-party government coalitions have helped to promote stable policies and institutions. The next general election will be held this year. 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. Morningstar DBRS 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. As a result of Russia’s invasion of Ukraine, NATO has increased its military presence in eastern Europe.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors
The following Social factor 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 28,479 in 2023. Morningstar DBRS has taken these considerations into account within the ‘Economic Structure and Performance’ building block.

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

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (23 January 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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/431484.

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 (6 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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://dbrs.morningstar.com/about/methodologies.

The sources of information used for this credit rating include Ministry of Finance (Lithuania’s State Budget at a Glance, Lithuania’s Draft Budgetary Plan for 2024), Investors Presentation March 2024), Bank of Lithuania (Lithuanian Economic Review March 2024, Banking Activity Review 2023/Q2, Macroeconomic Projections March 2024, Financial Stability Review 2023), International Monetary Fund (WEO April 2024, 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 (Winter 2024 Economic Forecast, Assessment of the final national energy and climate plan of Lithuania, Lithuania 2023 Country Report, Ageing Report November 2023), 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. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS’ outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS 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 Morningstar DBRS 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/431483.

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

Lead Analyst: Nichola James, Managing Director, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: November 17, 2023

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