Washington, DC: An International Monetary Fund (IMF) mission, led by Borja Gracia, visited Vilnius to meet with the Lithuanian authorities from January 29–February 2 to discuss recent economic developments and policy priorities. The team met with the Ministry of Finance, the Ministry of Economy, the Bank of Lithuania, other government agencies, representatives from the private sector, banks, and other stakeholders. At the conclusion of the visit, Mr. Gracia issued the following statement:
"The negative terms-of trade shock caused by Russia's invasion of Ukraine resulted in high inflation and increasing interest rates weighing on households' purchasing power and firms' investment appetite. This, combined with weak external demand, resulted in a mild contraction of the economy last year. However, external demand is expected to recover this year while the labor market remains strong with robust wage growth above inflation since last summer. Looking forward, economic growth is expected to accelerate during 2024 and beyond.
"Inflation continued to decline rapidly to 1.6 percent at the end of last year, after peaking at 22.5 percent in mid-2022, driven largely by the correction in energy and food prices, as well as ECB's monetary policy tightening. This correction in inflation dynamics, expected to continue in the earlier part of this year, will support the recovery in disposable income and thus domestic demand. Although core inflation remains at an elevated level compared to the pre-crisis period, it is also showing significant signs of disinflation across the economy. However, while Lithuania's inflation differential vis-à-vis the rest of the eurozone is now consistent with historical averages, the relatively higher inflation and wage growth than some trading partners over the last two years has left price and wage levels elevated which may erode competitiveness and slowdown convergence going forward.
"Accommodating new and pre-existing spending pressures will require additional revenues under the existing fiscal targets. Spending pressures relate to permanently higher defense spending; negative demographics; a pension system that while fiscally sustainable it is not socially sustainable as it projects declining replacement ratios from already current low levels; and moderately increasing interest payments on debt over the next few years. In addition, reducing high poverty rates and social disparities, especially at the regional level, will require more and better social programs. Therefore, even though Lithuania continues to enjoy a comfortable fiscal space and low debt, accommodating additional expenditures will require revenue-generating tax reforms, improved expenditure efficiency and/or a moderate relaxation of fiscal targets.
"Lithuania's banking system—one of the most cost-efficient in Europe—enjoys an unprecedented surge in profitability due to mostly variable rate mortgages and deposits that are not very interest sensitive. This is despite the temporary levy on banks introduced last year. This levy should remain temporary to avoid being perceived as a tax on foreign investment and minimize the potential negative impact on efficiency. Balance sheet risks from higher interest rates and weaker activity are contained with large capital buffers and high profitability able to absorb potential losses. The real estate market has undergone a gradual, orderly correction and prices are now at a level broadly consistent with fundamentals."
