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

DBRS Ratings Limited (DBRS) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at A (low) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings remains Stable.

KEY RATING CONSIDERATIONS

The A (low) ratings are underpinned by Lithuania’s sound fiscal position and its low public debt ratio. DBRS views Lithuanian membership of the OECD last year as a credit strength; meeting OECD standards and benchmarks, for example, underpin sound governance. Euro system membership since 1st January 2015 is another key credit strength. Progress with the reform agenda, including measures that reduce the tax burden on low income earners, as well as efforts to improve tax compliance, further support the ratings. Credit challenges relate to structural factors including income inequality; further productivity improvements; a low investment rate; the declining and ageing population and economic informality. Lithuania’s sensitivity to external developments is mitigated by the absence of clear macroeconomic imbalances.

Credit fundamentals appear to be improving. Lithuania has run a fiscal surplus since 2015 and the debt-to-GDP trajectory has declined. GDP growth is expected to have reached over 3% last year, with a strong contribution from domestic demand. Looking ahead, wage and other cost pressures are high and increasing, which along with slower global trade growth that poses downside risks to a small and open economy like Lithuania, may slow GDP growth to 2-3%.

RATING DRIVERS

Potential factors for positive rating action include: (1) a continuation of recent good performance in investment and productivity growth or (2) continuing sound fiscal and public debt management.
Potential negative rating drivers include: (1) a return of significant macroeconomic imbalances, particularly if accompanied by high credit growth or private sector dis-savings or (2) any erosion in the structural fiscal balance that significantly deteriorates debt dynamics.

RATING RATIONALE

A Good Fiscal Management Track Record

Lithuania has since 2014 had primary surpluses and lower debt servicing costs. This was underpinned by expenditure ceilings and an independent fiscal council - the fiscal framework allows for effective counter-cyclical policy. As a euro system member, Lithuania also benefits from the European Commission’s (EC) economic governance and fiscal frameworks. The general government budget position remained in surplus in 2017, 0.5% of GDP compared with 0.3% in 2016 and is estimated by the authorities to have remained in surplus last year at 0.6%. The surplus position may narrow slightly this year to 0.4%, related to the 2018 reform package. Robust economic growth and higher revenues have allowed the government to increase spending while maintaining a surplus position. Budget 2018 increases expenditure towards the reduction of poverty and inequality, tax incentives for entrepreneurship and innovation, improved healthcare and an increase in defence spending to 2% of GDP, in line with NATO obligations. DBRS views the 2018 budget as addressing the country’s needs without jeopardizing fiscal discipline.

At the Same Time, An Ageing Population and Other Factors Weigh on Lithuania’s Fiscal Position

Lithuania has one of the fastest ageing populations in the European Union (EU). To illustrate the demographic challenge, the old-age dependency ratio (15-64) is expected to rise to 63.9% in 2060 from 29% in 2016 according the European Commission. To help combat the challenge, the government implemented a reform in 2012 that gradually increases the retirement age for both men and women to reach 65 years in 2026, from 63.5 years for men and 62 years for women in 2017.

Another key government challenge is fighting tax evasion from Lithuania’s informal economy, measured as one of the largest relative to the size of its economy among EU countries. The practice of under reporting business income and of unreported envelope wages remains pervasive and obstructs a more efficient allocation of resources. Statistics Lithuania published official estimates of the non-observed economy at 14% of GDP in 2016. According to the IMF, when comparing revenues with the economy’s tax capacity, Lithuania’s tax collection level is estimated at 61% against 77% for central European economies in 2014.

Public Debt Vulnerabilities to External Shocks are Mitigated by a Low Public Debt Ratio and Strong Debt Management

With its small and open economy, Lithuania’s public debt ratio, albeit currently low, is vulnerable to external shocks. Following the global financial crisis, the debt-to-GDP ratio rose to 36.2% in 2010 from 14.6% in 2008. However, Lithuania still has one of the lowest debt ratios among EU countries, at 39.4% in 2017 compared with the EU average of 86.7%. The debt ratio is expected to have declined to 34.8% at the end of last year according to the EC and to rise to 37.9% this year, due to planned pre-financing of 2020 bond redemptions. Excluding the planned pre-financing the debt ratio could end this year at 35.0% of GDP.

With just EUR 100 million of short-term central government debt estimated at end-2018, the government applies a conservative debt management strategy of extending debt duration in a low yield environment. The weighted-average term to maturity of central government debt is seven years at end-October 2018. Almost all central government foreign debt is fixed rate and all the debt is in euros. Several debt controls are in place, including limits for municipalities’ borrowing and debt, while the Social Security Funds (Sodra) can only borrow with the permission of the Ministry of Finance.

During the crisis, net capital outflows occurred, and as internal demand contracted while maintaining the peg to the euro, internal devaluation improved competitiveness, thereby rebalancing the economy. The current account deficit as a share of GDP peaked at 15% in 2007, but swiftly narrowed due to the internal devaluation. In 2018, the Bank of Lithuania estimates a current account surplus of 0.1% of GDP and forecasts a small deficit of -0.2% this year. From a stock perspective, a net international investment liability position of 32.6% of GDP was recorded at end-September 2018.

The Lithuanian Economy is Benefitting from Improving Net Migration, but Competitiveness is Hampered by High Wage Growth

After annual average GDP growth of just over 2.0% in 2015-16, growth advanced in 2017 to 4.1% and is estimated around 3.2% last year. Recovering EU funds and high capacity utilisation are providing support to investment growth. In addition, high wage growth underpins private consumption growth, and Lithuania’s elevated inflation rate has slowed as the effects of excise duty hikes in 2017 fade. The country will remain a net beneficiary of EU structural funds, with planned EU net inflows of 4.2% of GDP in 2017, rising to 5.4% in 2020. However, growth could fall below 3.0% in the next two years in part related to weaker net exports. The EC forecasts growth of 2.8% and 2.5% this year and next year, respectively. Over the medium term, the impact of Brexit on the size and composition of the EU budget is unknown. The likely shrunken EU budget could have negative implications for Lithuania’s EU funds allocation and for economic development.

Wage growth is highly linked to policy changes such as the higher minimum wage and to skills shortages, despite an improving net migration balance. Income per capita adjusted for purchasing power parity is still only slightly above two-thirds of the euro area average. Future improvement is partially contingent on productivity gains.

Risks to Financial Stability Appear Contained

Most of the Lithuanian banking sector is foreign-owned, therefore, spill overs from vulnerabilities in parent banks is a persistent risk. That said, the financial sector is well capitalised and highly liquid. Nordic-Baltic cooperation is also being strengthened. While mortgage growth is high, at an annual rate of 8.0% as of November 2018, DBRS views the credit recovery consistent with extended catch-up following the significant crisis-related de-leveraging. The loan-to-deposit ratio has more than halved from 200% before the crisis. Moreover, private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to 44.8% and the household debt-to-GDP ratio was 22.5% in Q2 2018.

Notwithstanding the Stable Political Environment, Unexpected Geopolitical Shifts in Europe Could Pose Significant Risks

Successive multi-party government coalitions have helped to promote stable policies and institutions. There are 141 seats in Lithuania’s unicameral legislature (Seimas) with a multi-party system. Usually no single party wins an outright majority, so coalitions are needed. Since independence in 1990, Seimas has had 16 prime ministers from six different political parties. Since the 2016 election, Seimas has included politicians representing six factions and a mixed group of five independents. After having only three seats during the previous four years, Farmers and Greens Union managed to obtain 56 seats in the last election, mostly because of the Liberal Movement’s corruption scandal. Presidential elections on 12th May will deliver a changed leadership, as Dalia Grybauskaite’s presidency since 2009, is now term limited. DBRS is of the view that EU and NATO membership are likely to provide a broadly stable political environment for Lithuania, but unexpected geopolitical shifts in Europe could pose significant risks.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) – A (low) range. The main points of the discussion within the committee included public debt finances, economic performance, socio-political factors and the country’s resilience to future economic shocks.

KEY INDICATORS

Fiscal Balance (% GDP): 0.5 (2017); 0.6 (2018E); 0.4 (2019F)
Gross Debt (% GDP): 39.4 (2017); 34.8 (2018E); 37.9 (2019F)
Nominal GDP (EUR billions): 42.2 (2017); 44.7 (2018E); 47.7 (2019F)
GDP per Capita (EUR): 14,949 (2017); 16,024 (2018E); 17,219 (2019F)
Real GDP growth (%): 4.1 (2017); 3.2 (2018E); 2.8 (2019F)
Consumer Price Inflation (%): 3.7 (2017); 2.5 (2018E); 2.2 (2019F)
Domestic Credit (% GDP): 112.5 (2017); 116.8 (Jun-2018)
Current Account (% GDP): 0.8 (2017); 0.1 (2018E); -0.2 (2019F)
International Investment Position (% GDP): -35.8 (2017); -32.6 (Sept 2018)
Gross External Debt (% GDP): 83.6 (2017); 80.9 (Sep-2018)
Governance Indicator (percentile rank): 80.3 (2017)
Human Development Index: 0.86 (2017)

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. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include Ministry of Finance, International Monetary Fund, OECD, European Commission, United Nations Development Program (UNDP), Haver Analytics, Eurostat, World Bank, Bank of Lithuania, Stockholm School of Economics in Riga, Lithuania Department of Statistics, European Central Bank. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve-month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Nichola James, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Senior Vice President, Co-Head of Sovereign Ratings, Global Sovereign Ratings

Initial Rating Date: July 21, 2017
Last Rating Date: July 13, 2018

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