Lithuania should focus on fiscal structural reforms: IMF
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Economic activity is poised for a pickup this year as the drag from the unfavorable external environment diminishes. Thanks to many years of fiscal effort, the budget deficit now stands at an appropriate level, and over the medium term the focus should be on avoiding any deterioration in structural terms. Sustainably advancing Lithuania's living standards now depends on making determined progress with structural reforms, which ideally should be bound together in a comprehensive and coherent package to provide strategic direction. There are several priorities: better developing and utilizing human resources; supporting the modernization of firms; further improving the business climate; and ensuring that the structure of taxation and public spending is efficient, pro-growth, and equitable. Many of these reforms are complex, including those considered under the "New Social Model." The implications of their design need to be carefully and fully considered before moving ahead. Competitiveness of Lithuanian exports is adequate, but could come under pressure if current wage and productivity trends persist. In this context, efforts to upgrade enterprises should be redoubled and it would be prudent to consider a pause in minimum wage hikes until they can be justified by productivity and competitiveness gains.
Growth should reach 2.7 percent in 2016 and strengthen further in the outer years. As last year, the drivers will be solid private consumption on the back of robust wage growth together with strong investment, reflecting pent-up demand, high capacity utilization, and reviving bank lending. Furthermore, the drag from low exports is set to diminish compared to 2015, primarily due to the easing of recession and currency depreciation in Russia and the CIS, giving GDP growth an upward jolt. Over the medium term, growth is expected to inch up further to around 3½ percent, but this is contingent on further reforms. Risks to this outlook are mainly on the downside. Considering Lithuania's high degree of economic openness, predominately downside risks to the global growth outlook could spill over to the domestic economy through trade channels. Volatile financial conditions abroad could affect Lithuania indirectly via the foreign banks that dominate its financial system, primarily through credit supply channels. Domestic risks relate to future competiveness developments. On the upside, lower-than-projected global energy prices could boost purchasing power further. A credible reform package would send a welcome positive signal and provide improved strategic direction.
The structural fiscal deficit fell to an estimated ½ percent of GDP last year-a level that ensures a reliable rebuilding of fiscal buffers if maintained over time. Expenditure restraint, revenues from buoyant wage and consumption growth, and incipient gains from improved tax administration delivered the final consolidation stretch. If maintained at this level over the medium term, the structural balance would reliably put the public debt ratio on a downward path, after its sharp rise since 2009. As a result, fiscal buffers would be rebuilt to better deal with future shocks and to cushion the rise of agerelated spending to some extent. While the 2016 budget falls somewhat short of achieving a structural deficit of ½ percent of GDP, the gap seems small enough to be bridged by careful budget execution. But there is no room for costly new initiatives this year.
Policy makers can now squarely focus on fiscal structural reforms. The emphasis should be on measures that promote growth and reduce income inequality, which is among the highest in the EUnot only a social concern but also the source of important macroeconomic implications.