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 stemming from a potential temporary increase in fiscal deficits amid a challenging macroeconomic and geopolitical environment. Lithuanian real GDP growth rebounded to 2.7% last year, up from just 0.3% in 2023. The Bank of Lithuania forecasts that economic growth will accelerate to 2.9% this year and 3.0% in 2026-27, supported by strong domestic demand and a gradual recovery of external demand. However, the imposition of U.S. tariffs and the associated retaliation pose downside risks to the economic outlook. The fiscal deficit is projected to widen to 3.0% of GDP in 2025, up from modest deficits of 1.0% on average over 2021-24, driven by higher spending on public wages, social benefits and defence. Proposals to further increase defence spending to up to 5-6% of GDP over 2026-30 will most likely result in fiscal deficits remaining elevated over the medium-term. Notwithstanding the budgetary pressures, Morningstar DBRS expects Lithuania will remain committed to prudent fiscal policy in line with EU fiscal rules. While Lithuania's public debt ratios are expected to increase in the coming years, the level is still low, which provides the government with some fiscal space to respond to potential shocks.

The credit ratings are underpinned by Lithuania's membership in the European Union (EU) and the euro area, its strong political institutions and effective policymaking, and its strong fiscal track record and low public debt. The small and open nature of the Lithuanian economy renders it vulnerable to external shocks, although Lithuania's economic structure also benefits from a large export sector with strong integration into key regional supply chains. Additionally, several structural factors are credit challenges for Lithuania, including relatively low productivity and income per capita levels and an 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

New Government Plans to Further Increase Defence Spending Amid Elevated Geopolitical Risks

The outcome of Lithuania's parliamentary elections in October 2024 resulted in a change in the governing coalition. The Social Democratic Party of Lithuania (LSDP) won the most seats and went on to form a coalition with two other parties, the centre-left and green Democratic Union "For Lithuania" and the populist Dawn of the Nemunas party (NA). Under prime minister Gintautas Paluckas (LSDP), the coalition holds 85 out of 141 seats. However, the inclusion of the populist NA, led by Remigijus Zemaitaitis, is already weighing on the stability of the three-party coalition. The priorities of the new government's programme include enhancing external security while maintaining healthy public finances. The National Defence Council of Lithuania (which includes the President, Prime Minister and Minister of Defence) pledged to increase the country's defence spending to up to 5-6% of GDP (up from the 2025 national defence budget of 3% of GDP) over 2026-30. While this is not a binding target, the coalition is debating new fiscal measures to generate additional revenues, including tax reforms, to fund the extra spending. Morningstar DBRS expects the new coalition will remain committed to prudent fiscal management even if the spillovers from Russia's invasion of Ukraine put additional strain on public finances. 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 raised geopolitical risks in the Baltic region, given their geographical proximity and historical links to Russia. Lithuania's membership in the EU and NATO provides a stable macroeconomic and institutional framework and a strong security arrangement that mitigates the risks of possible Russian aggression. Since Russia's invasion of Ukraine, NATO has increased its military presence in Eastern Europe, including Lithuania, with Germany committing to station a permanent brigade in the country by 2027. In January 2025, NATO announced the launch of a new military activity ("Baltic Sentry") in order to enhance its presence in the Baltic Sea and bolster the protection of critical infrastructure, as hybrid attacks having been on the rise in the region in recent years. To account for the elevated geopolitical risks, Morningstar DBRS applies a negative qualitative adjustment in the "Political Environment" building block assessment.

Fiscal Deficits Are Set to Widen After Better-Than-Budgeted Performances

The Lithuanian budget deficit remained moderate at 1.3% of GDP in 2024, up from narrow deficits of 0.7% in 2022 and 2023. The increase was driven by higher spending on social benefits, public wages, defence, and interest payments. However, due to below-budget spending and stronger-than-expected revenues, the fiscal deficit remained well below the 2.9% level that was initially budgeted. Budget results have largely outperformed targets in recent years despite heightened uncertainty, reflecting the authorities' prudent planning.

Looking ahead, the Lithuanian fiscal outlook is projected to worsen. The 2025 Budget pencils in a 3.0% of GDP deficit this year. The Ministry of Finance (MoF) projects the deficit narrow to 2.4% by 2027. The fiscal deterioration is driven by higher spending on public wages, social benefits (including pension indexation) and defence (budgeted at 3% of GDP in total). Rising interest costs are also adding to budgetary pressures. On the revenue side, the fiscal deterioration is limited by revenue-enhancing measures, including higher excise duties and an increase in the corporate income tax rate by 1 percentage point. Stronger economic growth than anticipated when the budget was drafted could result in somewhat smaller than projected deficits. The proposal to increase defence spending to 5-6% of GDP is not included in the MoF's current fiscal projections. Debates are underway regarding new funding sources, including lowering the VAT gap, personal income tax reform and higher real estate taxes. Lithuania's informal economy remains large, estimated at 26.4% of GDP in 2023, which obstructs a more efficient tax collection. The country also faces rising spending pressures in the medium-term from ageing population and climate change. The National Audit Office implementing the function of a fiscal institution (NAO FI) forecasts ageing-related expenditure to rise to 19.8% of GDP by 2030, up from a projected 17.6% in 2024. Nevertheless, Lithuania's sound fiscal track record supports Morningstar DBRS' view that Lithuania will remain committed to prudent fiscal management in line with the EU's fiscal rules.

Lithuania's Low Public Debt Ratio is Expected to Rise

After falling to 37.3% of GDP until 2023, Lithuania's public debt-to-GDP ratio increased slightly to 38.2% of GDP in 2024. At that level, it remains well below its 2020 pandemic peak of 45.9% and is only 2.6 percentage points higher than in 2019. The MoF expects the public debt ratio to gradually rise, reaching around 50% by 2027, driven primarily by primary deficits and stock-flow adjustments. Despite the projected increase, Lithuania's debt ratio is expected to remain among the lowest in the EU and should still provide some flexibility to respond to shocks. However, higher defence spending could put additional pressure on the outlook for public debt. The NAO FI estimates that if proposed additional defence spending is financed entirely by borrowing, the country's public debt-to-GDP ratio could reach 60% in 2030. As result of a larger debt stock and higher financing costs, the NAO FI forecasts government debt service costs to increase from 0.6% of GDP in 2023 to 1.4% by 2027, which is comparable to the 2010-19 average of 1.5%. Thus, debt affordability should remain manageable. Lithuania benefits from a favourable debt profile, thereby limiting the vulnerability of public finances to interest shocks. The weighted-average term to maturity of central government debt was 8.4 years at the end of December 2024, and all debt is denominated in euros.

The Economy is Recovering but Potential Tariffs Pose Downside Risks

The Lithuanian economy picked up last year following subdued growth in 2023. Domestic demand drove the expansion with robust private and public consumption growth. The Bank of Lithuania forecasts that growth will accelerate to 2.9% this year and to 3.0% in 2026-27. The projected recovery is expected to be supported by both domestic demand and a gradual expansion of external demand. Household consumption should be supported by strong wage growth and low levels of unemployment. Investment is projected to recover thanks to easing financing conditions, a recovery of external demand, as well as increase in public project execution. The MoF projects EU funded expenditure to increase to as high as 3.2% in 2025 and 2.6% of GDP in 2026. Inflation is projected to increase to 3.3% this year, up from 0.9% in 2024, before moderating at 2.6% in 2026-27. This should ease concerns over rising costs impacting Lithuania's competitiveness.

The near-term economic outlook is clouded by geopolitical tensions. The imposition of U.S. tariffs will weigh on the small and open Lithuanian economy. Although direct trade linkages to the U.S. are limited, the impact of rising tariffs will likely feed through to the Lithuanian economy via indirect linkages. The Bank of Lithuania estimates that the country's economic growth rate in 2025-2029 could be up to 1.3 percentage points lower with U.S. tariffs at 20-25% on the EU, Canada, Mexico and China and associated retaliatory tariffs.

The country has a relatively low income per capita compared to its euro area partners. Nevertheless, Lithuania has significantly narrowed the income gap, with real GDP per capita (in purchasing power terms) estimated at 87% of the EU's average in 2023, up by more than 10 percentage points over the past ten years. Over the last few years, the Lithuanian economy has shown remarkable resilience despite successive pandemic, energy, and interest rate shocks. At year-end 2024, Lithuania's real GDP stood 12.2% above its Q4 2019 level, outpacing peers. Lithuania's economic resilience, together with healthy growth prospects, support Morningstar DBRS' positive qualitative adjustment in the "Economic Structure and Performance" building block assessment.

The Current Account Has Returned to Surpluses

Lithuania's overall external position remains sound and benefits from service exports as well as a diversified manufacturing base that is well integrated into regional value chains. The country significantly reduced external imbalances after the great financial crisis. The rebalancing was supported by cost advantages, a flexible labour market and geographical diversification, which led to gains in export markets. This helped reduce Lithuania's net external liability position and shift to a small net external asset position in 2024. The war in Ukraine and the subsequent energy crisis led to a deterioration in terms of trade. As a result, the country recorded a current account deficit of 6.1% of GDP in 2022. With the terms of trade reversing as energy prices declined, the current account swung back to a surplus of 1.1% in 2023. In 2024, the surplus expanded to 2.5% of GDP, driven by an improving trade balance, with the trade deficits in goods narrowing and the trade surplus in services growing. The Bank of Lithuania projects the current account to average a surplus of 1.0% over 2025-27. The purchase of defence equipment and the implementation of EU funded projects could constrain the surplus. 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. As a small open economy in a currency union, with exports and imports accounting for around 141% of GDP, Lithuania's ability to adjust to external shocks can be economically and politically challenging.

Lithuania's Healthy Banking Sector Limits Financial Stability Risks

Financial stability risks are contained. The main risks stem from a protracted period of economic weakness, still tight lending conditions and the prevalence of variable-rate loans that could impair debt repayment. However, low private-sector indebtedness and a resilient labour market mitigate the associated risks. The debt-to-GDP ratio of non-financial corporations (NFCs) amounted to 42% and the household debt-to-GDP ratio was 22% in Q4 2024. The housing market had cooled down in 2023 because of tighter monetary policy, but market activity is picking up again as housing affordability is improving thanks to wage growth and monetary policy easing. The banking system in Lithuania is highly concentrated, with the two largest Swedish banks accounting for almost half of banking sector assets, hence risks to financial stability are associated with potential spillovers from Nordic economies. Moreover, given the geopolitical context, 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. To reduce potential risks to financial stability, the Lithuanian authorities have undertaken a series of measures, including an increase in the countercyclical capital buffer requirement to 1.0%. On aggregate, Lithuania's banking system exhibits strong solvency, liquidity, and profitability. Higher interest rates have spurred banks' profitability while asset quality continues to remain strong, with the ratio of nonperforming exposures at 0.4% as of Q4 2024 according to European Banking Authority data.

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 28,713 in 2024. Morningstar DBRS has taken these considerations into account within the `Economic Structure and Performance' building block.

Governance (G) Factors

The following Governance factor had a relevant effect on the credit analysis: Peace and Security. This G factor is new and was not present in the prior credit rating disclosure. Russia's invasion of Ukraine has raised geopolitical risks in the Baltic region, given their geographical proximity and historical links to Russia, and hybrid attacks have been on the rise in the region in recent years. Morningstar DBRS has taken these considerations into account within the `Political Environment' building block.

Since the last rating action the relevance or significance of the following Governance factor changed: Peace and Security. This Governance factor is now assessed to have a relevant effect on the credit analysis. This reassessment reflects the negative qualitative adjustment in the `Political Environment' building block to account for elevated geopolitical risks.

There were no Environmental 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://dbrs.morningstar.com/research/451820/.

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 (2025-2027 Budget at a Glance; Draft Budgetary Plan 2025; Economic Development Scenario 2025-2028, March 2025; Investors Presentation, March 2025), Seimas of the Republic of Lithuania (Political groups in the Seimas; The Seimas has approved the Programme of the Government, December 2024), Bank of Lithuania (Macroeconomic Projections, March 2025; Lithuanian Economic Review, March 2025; Banking Activity Review 2024/Q3, Financial Stability Review 2024), Ministry of Environment (Final Updated National Energy and Climate Action Plan of the Republic of Lithuania for 2021-2030; Lithuania's First Biennal Transparency Report under the Paris Agreement), National Audit Office of Lithuania (Opinion on the structural adjustment target, November 2024; Management of risks to the fulfilment of milestones and targets of Lithuania`s Recovery and Resilience Plan, December 2024; Opinion on the Endorsement of the Economic Development Scenario, December 2024; Assessment of the Sustainability of General Government Finances in 2025-2050, February 2025), Statistics Lithuania, European Commission (Autumn 2024 Economic Forecast; Commission opinion on the 2025 Draft Budgetary Plan of Lithuania, November 2024; Debt Sustainability Monitor 2024), Statistical Office of the European Communities, European Central Bank, European Banking Authority, International Monetary Fund (WEO and IFS; 2024 Article IV Consultation - Press Release, Staff Report, July 2024; IMF Staff Concludes Visit to Lithuania, February 2025), OECD, World Bank, Bank for International Settlements, Stockholm School of Economics (Shadow Economy Index for the Baltic Countries), NATO and Macrobond. 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 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://dbrs.morningstar.com/research/451818/.

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

Lead Analyst: Max Dietz, Assistant Vice President, Global Sovereign Ratings
Rating Committee Chair: Michael Heydt, Senior Vice President, Sector Lead, Global Sovereign Ratings
Initial Rating Date: 21 July 2017
Last Rating Date: 18 October 2024

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