The Lithuanian Economy

Monthly newsletter from Swedbank’s Economic Research Department

by Nerijus Mačiulis and Ieva Vyšniauskaitė No. 04 • 30 September 2010

Public finances are on the right track, but choosing

the right austerity measures for 2011 will be crucial
 Consolidation measures totalling about 10% of GDP during 2009-2010
helped to regain market confidence. Through eight months this year, the
government budget revenue plan has been exceeded by 8.4%.

 Most measures, however, seem temporal and unsustainable. Retaining

market confidence and achieving the strategic goal to join the euro zone in
2014 necessitate further fiscal consolidation measures.

 Any new taxes or increases of the current ones would further dent business
and consumer confidence and postpone investments and consumption; the
government will have to focus on sustainable revenue sources – more
efficient SOEs and a smaller shadow economy. On the expenditure side,
structural reforms and a smaller public sector will have to replace outright
spending cuts.

Public finances steered to calmer income and corporate tax were slightly higher than
waters after the storm expected as well, while excise tax revenues fell
short of expectations by 8.4%.
Lithuanian public finances have stabilised and
market confidence has improved since the end of Revenue sources for state government, Jan-Aug 2010
last year, thanks to the bold austerity measures to
Income tax,
curb the budget deficit, totalling approximately 10% Other, 12.0%
6.1% Prof it tax,
of GDP, adopted for 2009-2010. In the first quarter, 3.4%
Other tax,
the stringent budget consolidation package brought
3.3%
some positive developments, mostly in the
recognition of the government’s efforts by
international institutions and ratings agencies.1
Over the second quarter of the year, the
improvement in public finances was clearly visible Excise tax,
20.7%
amidst better revenues and some reduction in
expenditures. Government budget revenue plan in VAT, 53.8%
first eight months of the year was exceeded by
8.4%, supported by unexpectedly strong value-
added tax (VAT) collections (exceeding the plan by
22.3%, at close to EUR 1.5 billion). Revenues from

1
In February 2010, Standard and Poor’s ratings agency lifted its
outlook for Lithuania to stable from negative on its BBB long- Successful collection of revenues this year can
term debt rating; in March, Fitch and Moody’s ratings agencies
followed by raising their outlooks on BBB and Baa1 ratings,
largely be attributed to conservative planning. The
respectively, from negative to stable as well. On 27 Jan, the EU revenue collection patterns this year, however,
also affirmed that consolidation efforts were sufficient and raise concerns by indicating signs of a large
allowed Lithuania until 2012 to narrow the budget deficit to within procyclical shadow economy.
3% of GDP.
First, lower-than-expected excise revenues can be
attributed to a jump in smuggling and unaccounted

Economic Research Department. Swedbank AB. SE-105 34 Stockholm. Phone +46-8-5859 1000
E-mail: ek.sekr@swedbank.com www.swedbank.com
Legally responsible publisher: Cecilia Hermansson, +46-8-5859 7720
Nerijus Mačiulis + 370 5 258 2237. Lina Vrubliauskienė +370 5 258 2275. Ieva Vyšniauskaitė +370 5 258 2156.
 The Lithuanian Economy
Economic Research Department, Swedbank
Nr 04 • 30 September 2010
cross-border trade. Second, larger-than-expected
VAT collections and below-budget revenues from
income taxes indicate that the shadow labour
market is thriving. VAT collection is less sensitive to
the increase in unaccounted income; furthermore,
informal incomes are “legalised” when making a
purchase. There is a general tendency to avoid
breaching VAT regulations as much easier
loopholes exist--for instance, paying personal
income taxes. To maximise the gains from the
completion of tax reforms over the medium term,
the government must recognize that strengthening
tax compliance is one of the most urgent tasks that
it faces.
General government expenditure, 1H 2010
2.3% Compensation f or
employ ees
Consumption (goods
and serv ices)
27.1%
Consumption of
f ixed capital
41.2% Interest
Subsidies
14.1%
Grants
7.0% Social benef its
2.1%
Other
1.5% 4.8%
The decision of the government to use excess
revenues primarily for reducing debt rather than
increasing expenditure is welcome; this partly
explains the signs of stabilisation of government
debt: at end- July 2010, central government debt,
compared with the previous month, decreased by
EUR 208 million and accounted for 33.1% of the
projected GDP for 2010. Compared with the
beginning of the year, the cost of borrowing has
also decreased: in the beginning of September, the
government launched a seven-year bond issue in
the amount of USD 750 million, with the lowest
coupon (5.125%) achieved for the Baltic region
since October 2007.
Some containment in expenditure areas has also
been visible. Over the first half of the year, general
government2 expenditures overall were down by
4.4% compared with the same period a year ago;
wages and social insurance payments fell by 13.2%
year on year, while social assistance payments
decreased by 5.1% on an annual basis.
2 next year and 3% in 2012, with an ultimate goal of
The general government consolidates state government and
municipality budgets (the national budget), and extrabudgetary
and social security funds.
2 (4)
Unsurprisingly, because of the rapid build-up of
government debt, interest payments were up by a
staggering 84% over the same period. As Sodra
(Lithuanian State Social Insurance Fund)
expenditures were continuously larger than
expected, the deficit continued to widen, reaching
EUR 601.4 million in the first eight months of the
year.
The 2014 euro goal is ambitious, but
not unattainable
Despite successful budget consolidation efforts and
the commencement of the economic recovery in the
second quarter of this year the general government
deficit is expected to reach 8% of GDP in 2010 as
the recovery was primarily driven by exports and
restocking. Higher-than-expected revenues this
year will be offset by the increase in debt- servicing
costs and the omnipresent compliance problems
(regarding income tax and excise collections, for
instance).
General government finances, 2004 - 2012
(% of GDP)
0% 50%
-1% 45%
-2% 40%
-3% 35%
-4% 30%
-5% 25%
-6% 20%
-7% 15%
-8% 10%
-9% 5%
-10% 0%
2004 2005 2006 2007 2008 2009 2010f 2011f 2012f
Debt (rs) Budget position (ls)
Our forecast of a 6% budget deficit for next year
assumes further necessary fiscal consolidation
measures – export-led economic growth without a
sizable rebound in consumption and fixed capital
formation will not be enough. In the very unlikely
event that no new austerity measures are adopted,
the deficit would quickly escalate on the back of
substantial debt-service costs and the expiration of
temporary measures (for instance, freezes on
public wages); as a result, government debt-to-GDP
would exceed the Maastricht criterion of 60% in the
next few years.
It seems that the government is strongly committed
to achieving the convergence deficit targets of 6%
adopting the euro in 2014. Given the rhetoric
adopted since the election, which has emphasized

Economic Research Department, Swedbank
Nr 04 • 30 September 2010
the importance of the stability of public finances, it
is very unlikely that the government will stray from
this road now, even considering the municipal and
government elections approaching in 2011 and
2012.
General government budget, 1Q 2006 – 1Q 2010
300
200
100
0
-100
-200
-300
-400
-500
-600
-700
-800
2006 2007 2008 2009
Budget balance, EURm (ls) Rev enues, y oy (rs)
Expenditures, y oy (rs)
The consolidation package should be broad based,
encompassing both expenditure and revenue
measures. The primary criteria, however, in
adopting these measures, especially on the
spending side, should be clear-cut and, above all,
should ensure a balance between, on one hand,
making short-term savings that can be delivered
swiftly and, on the other, ensuring that long-term
costs are not increased as a result. Balancing the
budget should not come at any cost for society as a
whole – long-term competitiveness and the
consequent public welfare have to remain the
underlying criteria.
Possible sources of sustainable
income
Fiscal consolidation measures that addressed the
revenue side (tax increases, concession and
exemption eliminations, etc.) were too
straightforward and inefficient. Further increases in
current taxes or introduction of new ones would
further depress the sentiment of business,
consumers, and potential foreign investors. Even
potentially stabilising real estate taxes should wait
for economic recovery and be announced well
before their introduction. There are at least two
healthy alternative sources of budget revenues – a
more efficient management of state-owned
enterprises (SOEs) and a smaller shadow
economy. SOEs were valued at EUR 5.2 billion, but
in 2009 their contribution to the state budget in the
form of dividends was only a little more than
EUR 10 million, about 0.05% of GDP. By
comparison, dividends of Estonian SOEs amount to
The Lithuanian Economy
more than 1% of GDP. The government is working
on a strategy to make Lithuanian SOEs more
effective by increasing their transparency and
depoliticising them. One way to do this is to float a
fraction (less than 50%, if they are perceived
strategic objects and state ownership is crucial) of
each enterprise’s shares on the equity market – the
45 requirement to publish quarterly financial
statements would make them more transparent and
private capital would keep an eye on obvious acts
30
of corruption and inefficiencies. The requirement
would also have the positive secondary effect of
15 increasing the liquidity of the Lithuanian equity
market and adding substantial income to the state
0 budget, which would lower debt and its servicing
costs.
-15 The government should keep moving in the
direction of liberalising labour laws and offering
-30 incentives to hire unemployed and create new
2010 workplaces. Minimising unofficial income has
positive effects on both budget income and
expenditure – unjustified unemployment benefits
are reduced and income tax revenues are
increased. Ending the practice of turning a blind eye
to cross-border smuggling and enacting clear
measures to improve border control (and punish its
absence) can substantially increase income from
excise duties.
Doing more with less
The measures that addressed spending – wage,
pension, and other social benefit cuts – were easy
to implement but are unsustainable, temporary, and
sometimes harmful. In particular, the decision to
reduce contributions to second-pillar pension funds
is a measure that undermines the whole idea of
pension reform and addresses today’s problems by
transferring them to the future. Furthermore,
pension and social benefit cuts have a strong, direct
negative impact on household consumption.
Universal wage cuts in the public sector are
temporary and do not solve the main problem there
– inefficiency. A much more agreeable structural
reform would address the necessity, relevance, and
appropriateness of the size of many public
institutions and organizations – there is no doubt
that the same amount and quality of public services
can be provided with fewer disappointed
employees. This would cause a temporary increase
in unemployment (as the workforce would have to
drift from the public to the private sector) but be
beneficial in the long term.
Lithuania is among the leaders in Europe in such
ratios as the number of hospital beds per capita,
school teachers per capita (or has lowest number of
pupils per teacher), and policemen per capita,
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 The Lithuanian Economy

Economic Research Department, Swedbank

Nr 04 • 30 September 2010

which indicates further possibilities for optimising the economic growth periods. This would enable a
spending in these sectors. small country to build up a cushion against future
turbulences in international markets, on which
Another area with an obviously wasteful approach
Lithuania greatly depends. Fiscal austerity
is public procurement – recent scandals in some
measures enacted now must be seen as first steps
SOEs and public institutions show that there is
on the path towards long-term competitiveness and
much room for savings there.
prosperity, not just temporary measures to calm the
There are many paths towards welfare and markets, convince the European Commission, and
prosperity and larger government spending is not allow adoption of the euro.
the only one. The main structural reform that must
take place in Lithuania is a mental one – the social
and political elite must understand that consistent Nerijus Maciulis
budget deficits are unsustainable (not once since Ieva Vysniauskaite
1995 has Lithuania had a budget surplus). A
prudent step towards sustainable public finances
would be setting a long term target not of 3%
budget deficit, but some surplus – at least during

Swedbank
Economic Research Department Swedbank’s monthly newsletter The Lithuanian Economy is published as a service to our
SE-105 34 Stockholm customers. We believe that we have used reliable sources and methods in the preparation
Phone +46-8-5859 1028 of the analyses reported in this publication. However, we cannot guarantee the accuracy or
ek.sekr@swedbank.com completeness of the report and cannot be held responsible for any error or omission in the
www.swedbank.com underlying material or its use. Readers are encouraged to base any (investment) decisions
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Legally responsible publisher
losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
Cecilia Hermansson, +46-8-5859 7720.
monthly newsletter The Lithuanian Economy.
Nerijus Mačiulis, +370 5 2582237.
Lina Vrubliauskienė, +370 5 268 4275.
Ieva Vyšniauskaitė, +370 5 268 4156.

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