Lithuania's economic performance remains encouraging: IMF
The Lithuanian economy entered the COVID-19 crisis on a solid footing with strong growth and ample buffers, improved private sector financial positions, and a well-capitalized, profitable banking system.
These developments reflected years of prudent fiscal and financial sector policies. The strong starting position coupled with the government's decisive policy response and the benefits of euro area membership, have helped make the Lithuanian economy one of the best performers in Europe last year and have set the stage for a strong recovery.
As the recovery quickly gathers pace, policies need to prioritize quality over quantity through more targeted support to the most affected sectors. Going forward, fiscal and macroprudential policies should continue to be used proactively to preserve stability and avoid the reemergence of the imbalances observed prior to the Global Financial Crisis (GFC), particularly if the recovery is stronger than anticipated.
Lithuania should confront its long-standing challenges-including high social disparities and demographic pressures-through the decisive implementation of structural reforms. This is the only way to achieve sustained improvements in productivity and high wage growth going forward.
Economic performance during the pandemic has been among the best in Europe. With GDP falling by just 0.8 percent versus a euro area average of 6.7 percent, the Lithuanian economy experienced the mildest contraction in Europe last year.
Growth momentum has picked up in the first quarter of this year despite lockdown restrictions. A decisive policy response from the government has helped support incomes, mitigate the rise in unemployment, and preserve the financial health of businesses.
Exports recovered quickly in the second half of last year. The impact of the pandemic varied across sectors, with a strong recovery in manufacturing but with service sectors being harder hit.
Output has already exceeded its pre-pandemic level in the first quarter of this year. The private sectorhouseholds and businessesentered this crisis without significant imbalances and in a strong financial position that has been preserved by COVID related support measures.
This has set the stage for a vigorous recovery in output and employment, led by domestic demand and benefitting from solid external demand. Combined with temporarily higher energy prices, this will result in higher inflation this year.
The external position is strong, partly due to temporary factors that will go away with the recovery (such as low consumption and investment as a result of lockdown restrictions). The strength of the external position is also explained by hard fought gains in competitiveness during the recovery that followed the GFC and that have resulted in the strongest increase in exports in the Baltics.
Next Generation EU funds, including Recovery and Resilience Funds (RRF), will support medium-term growth, ameliorating demographic pressures.
If efficiently used, these funds will support private and public investment and productivity growth, thereby facilitating sustainable high wage growth. Pressures from aging persist and will intensify going forward despite recent improvements in migration flows-Lithuania experienced a population increase in 2020 for the first time in over 30 years.
Risks are broadly balanced in the short-term, but there is a significant upside growth potential over the next few years.
With the recovery accelerating in the second half of this year, and in the absence of future lockdowns as uncertainty dissipates with vaccinations advancing, growth can surprise on the upside and result in higher inflationary pressures. If left unchecked, these dynamics could eventually erode competitiveness in the export sector and lead to the reemergence of macroeconomic and financial imbalances. On the downside, risks include weaker than expected external demand and geopolitical risks.
Unlike the global financial crisis of 2008, the COVID-19 pandemic is expected to have only a temporary negative impact on the Lithuanian economy.
The large policy response and strong fundamentals of the economy prevented a severe recession and permanent economic losses. Support via subsidies has helped solidify the financial position of households and businesses. In the labor market, employment was largely preserved, particularly in manufacturing, and the impact on the most affected sectors should be temporary provided a sustained recovery takes hold in the second half of this year.
The unprecedented policy response to the crisis was supportive of activity and incomes, and reasonably targeted. Following years of prudent policies, large fiscal space and lower borrowing costs enabled the government to increase spending to support workers, businesses, and the healthcare system. Macroprudential and monetary policies also provided substantial support.