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' view that Lithuania's track record of prudent fiscal policies and low public debt mitigate risks to the credit ratings stemming from a challenging macroeconomic and geopolitical environment. After growing by 2.5% in 2022, the Lithuanian economy contracted by 0.3% in 2023. This was due to high inflation, tighter monetary policy, and a weaker external environment. Economic activity is expected to pick up as household purchasing power recovers, external conditions improve, and European Union funds are absorbed into the economy. The Bank of Lithuania forecasts GDP growth of 2.2% this year and 3.1% in 2025. The general government fiscal deficit came in at 0.8% in 2023, much better than initially budgeted (4.9% of GDP) due to the lower energy prices and higher revenues. The deficit is expected to increase this year to 2.4% on the back of higher spending on defense, pensions, social benefits and public wages. Notwithstanding the larger deficit, we expect Lithuania to remain committed to prudent fiscal policymaking. Lithuania's public debt level is 40% of GDP, which is low compared to European peers and provides the government with space to respond to potential shocks, if necessary.

The credit ratings are underpinned by Lithuania's euro area membership, stable macroeconomic policy framework, and low public debt. 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. This compares to 51% for the euro area. Lithuania is also set to benefit from the inflows of EU funds which, along with accompanying reforms, could help raise its growth potential. On the other hand, the small and open nature of the Lithuanian economy renders it vulnerable to external shocks, as demonstrated by the impact of the war in Ukraine. Additionally, credit challenges related to structural factors remain, including income inequality, comparatively low labor productivity, and a declining and ageing population.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade Lithuania's credit ratings if there is evidence of additional economic resilience, such as higher income and productivity levels, or there is a durable strengthening in the public sector balance sheet.

Morningstar DBRS could downgrade Lithuania's credit ratings if there is material deterioration in the public sector accounts or the emergence of significant macroeconomic imbalances.

CREDIT RATING RATIONALE

Economic Activity is Picking Up

After growing by 2.5% in 2022, the Lithuanian economy contracted by 0.3% in 2023. The downturn mainly reflected a challenging macroeconomic environment characterized by weaker external demand and tighter financing conditions. The slowdown in the global economy and the deteriorating economic environment in Lithuania's main trading partners had an adverse impact on exports of Lithuanian goods. Industries such as information and communication, construction and financial and insurance activities performed well while other sectors, such as manufacturing and real estate activities, experienced declining activity. Although the unemployment rate increased to 7.9% in August 2024, the labour market remains resilient. Positive net inward migration and rising unemployment have eased labor shortages and contributed to a moderation in wage growth.

The economy is projected to return to growth this year. The Bank of Lithuania forecasts GDP growth of 2.2% this year and 3.1% in 2025 on the back of a recovery in private consumption, improving external conditions and increasing flows from EU funds. Lithuania is set to receive EUR 3.9 billion of grants and loans from the Recovery and Resilience Fund, of which EUR 0.9 billion has already been disbursed (as of September 2024). Planned allocations will go toward green and digital transition projects, social policies, and reforms and investments in education, health, research and development and the public sector. These reforms aim to address Lithuania's longstanding 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.

The Current Account Has Returned to Surpluses, But External Demand Risks are Elevated

The war in Ukraine and the subsequent energy crisis led to a deterioration in Lithuania's external position. The current account worsened to a deficit of 6.1% 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. As energy prices moderated and the services balance improved in 2023, the current account shifted to a surplus of 1.1%. The sanctions due to the war in Ukraine and the elevated energy import costs resulted in higher costs for Lithuanian producers, especially in the chemicals industry, leading to a reduction in fertilizer exports. This, combined with a decline in crop yields and meat production, lower demand for timber, furniture and articles of wood, resulted in market share losses. In addition, higher price and wage growth seen in recent years point to a deterioration in Lithuania's external competitiveness and, if not accompanied by sustained productivity growth, could weaken its external position. Given its small and open economy, with exports and imports accounting for around 153% of GDP, Lithuania is exposed to external shocks. To account for this, Morningstar DBRS applies a negative qualitative adjustment in the "Balance of Payments" building block assessment.

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. Aside from cost advantages, Lithuania's gains in export markets since the global financial crisis have been supported by a flexible labour market, as well as the complexity and diversity of its exports, which will most likely continue to sustain the resilience of the external sector. Looking ahead, external demand from its major trading partners is expected to recover, with the Bank of Lithuania expecting a current account surplus of 3.2% of GDP in 2024. This helped the net international investment position, to improve from -43% of GDP in 2016 to -4.6 % in 2023.

The Fiscal Deficit is Projected to Increase in 2024 Amid Public Salary Increases and Strong Investment

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 government introduced fiscal measures aiming to enhance energy independence, provide subsidies for energy bills, support the resettlement of Ukrainian refugees, increase military spending, and provide transfers to state-owned enterprises that were adversely affected by sanctions on Russia and Belarus. The result was that the fiscal deficit came in at 0.8% of GDP, considerably lower than the 4.9% deficit that was initially budgeted. Part of this large deviation is explained by the stronger than expected revenue growth and the lower cost of the measures to address the energy crisis.

The general government deficit is forecast to increase to 2.4% of GDP in 2024, 2.5% in 2025, and 2.1% in 2026. Increased spending needs for social benefits, pensions and public wages will be partially offset by increases in tax revenues. Additionally, in June 2024, the Seimas (Lithuanian Parliament) approved the adoption of the Defense Fund package aiming to fund Lithuania's increased defense requirements and large-scale military projects in line with the country's aim of raising defense spending to 3% of GDP over 2025-30 (up from 2.5% budgeted for 2024). With the package, Lithuania is set to generate new revenues in order to cover an additional 0.5% of GDP in defense spending. Lithuania's fiscal track record supports our view that Lithuania will remain committed to sustainable fiscal policy and in line with the EU's new fiscal rules. 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 to the European Commission. Moreover, Lithuania's informal economy remains large, estimated at 26.4% of GDP in 2023, which obstructs a more efficient allocation of resources.

Recent Fiscal Improvement Amid Economic Growth Maintains Lithuania's Public Debt Ratio at Low Level

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 46.2% in 2020 before declining to 38.1% and in 2022. The decline was due to strong nominal GDP growth and the improved fiscal position. General government debt is projected to increase marginally to 39.5% this year and to 43% of GDP next year on the back of anticipated deficits and stock-flow adjustments. The composition of the debt is relatively favorable. Lithuania's effective interest rate on its debt portfolio was low at 1.6% at the end of 2023, the weighted-average term to maturity of central government debt was 8.6 years at the end of August 2024, and all debt is denominated in euros.

Banking Sector Showed Resilience in Recent Crisis

Lithuania's banking system is liquid, profitable and well capitalized, with the weighted average Common Equity Tier 1 (CET1) capital ratio at 19.2 % in Q1 2024. Despite the weaker macroeconomic environment, the impact on banks' asset quality has been limited thus far, with the non-performing loans ratio standing at 1.6% for non-financial corporations and 1.3% for households in Q1 2024. After recording strong price growth, the residential real estate market has cooled down because of tighter monetary policy, with the number of dwellings sold down 14% in 2023 relative to 2022 and house price growth moderating. To reduce potential risks to financial stability, the Lithuanian authorities have undertaken a series of measures, which include the increase in the countercyclical capital buffer requirement to 1.0% from 0.0%. In addition, both households and non-financial corporations (NFCs) show moderate levels of indebtedness, with the debt-to-GDP ratio of NFCs amounting to 41% and the household debt-to-GDP ratio at 22% in Q1 2024. The banking system in Lithuania is highly concentrated, with the two largest Swedish banks accounting for 51% of banking sector assets, hence risks to financial stability are associated with potential spillovers from Nordic economies. Additionally, against the backdrop of the war in Ukraine, the risks of a system-wide cyberattack affecting confidence in the financial system and disrupting critical infrastructure are high, according to the bank of Lithuania.

Geopolitical Risks are Elevated, Lithuania Benefits from a Stable Political System

Following the first round of the parliamentary elections on 13 October 2024, the Social Democratic Party of Lithuania (LSDP) won 19.4% of the vote, followed by the Homeland Union party with 18% of the vote. The runoff vote is set for 27 October, where most single member constituencies will choose between the two leading candidates. The outcome will shape the alliances needed to form a coalition government. Successive multi-party coalitions have helped to promote stable policies and institutions. Morningstar DBRS expects that the new government coalition will remain committed to prudent fiscal policies, given the strong cross-party support for the EU's fiscal framework, and is unlikely to shift its stance on foreign policy. Lithuania has a stable political system and strong institutions, as reflected in the high scores in the Worldwide Governance Indicators

Russia's invasion of Ukraine has elevated geopolitical risks in the Baltic region. As a result of Russia's invasion of Ukraine, NATO has increased its military presence in eastern Europe. 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. Morningstar DBRS takes the view that Lithuania's decision to halt gas imports from Russia significantly enhances its energy security. In terms of geopolitical risks, Lithuania benefits from its EU and NATO membership.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: Human Capital and Human Rights. Compared with its euro system peers, productivity and human capital as measured by Lithuania's per capita GDP is relatively low at USD 27,030 in 2023. Morningstar DBRS has taken these considerations into account within the `Economic Structure and Performance' building block.

There were no Environmental and Governance 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 Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/441448.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 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 these credit ratings include Ministry of Finance Budget at a Glance, Investors Presentation August 2024, Seimas approves the Defense Fund package (June 2024), Bank of Lithuania (Lithuanian Economic Review March 2024, Banking Activity Review 2024/Q1, Macroeconomic Projections September 2024, Financial Stability Review 2024), International Monetary Fund April 2024, Republic of Lithuania: Republic of Lithuania: 2024 Article IV Consultation-Press Release; and Staff Report, OECD, European Commission (Assessment of the final national energy and climate plan of Lithuania, Lithuania 2024 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 Department of Statistics, The Central Electoral Commission of the Republic of Lithuania, Social Progress Imperative, European Central Bank, World Bank, Haver Analytics. Morningstar DBRS 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

Morningstar DBRS 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. Morningstar DBRS' outlooks and 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/441449.

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

Lead Analyst: Jorge Espinosa, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Sector Lead, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: April 19, 2024

DBRS Ratings GmbH, Sucursal en España
Paseo de la Castellana 81
Plantas 26 & 27 28046 Madrid, Spain
Tel. +34 (91) 903 6500

DBRS Ratings GmbH
Neue Mainzer Straße 75
60311 Frankfurt am Main Deutschland
Tel. +49 (69) 8088 3500
Geschäftsführer: Detlef Scholz
Amtsgericht Frankfurt am Main, HRB 110259

For more information on this credit or on this industry, visit dbrs.morningstar.com.