IMF Executive Board Concludes Article IV Consultation with the Republic of Lithuania | WPN World People News

On July 30, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Lithuania and considered and endorsed the staff appraisal without a meeting.

The economy exceeded expectations in 2018. Real GDP expanded by 3.5 percent with external demand more resilient than expected and without pre-crisis imbalances reemerging. A strong contribution in net exports helped the current account reach its highest surplus in four years. Private consumption growth accelerated with better-than-expected employment growth and a rebound in real wage growth. The labor market remains tight with labor costs among the fastest growing in the EU, but without inflationary pressures. With a positive macroeconomic environment, the government has achieved a higher fiscal surplus for the third year in a row. Data for the first quarter of 2019 suggest that the economy’s growth momentum has carried over into this year.

With Lithuania’s economy expanding above potential, growth is expected to moderate in the next few years to a more sustainable pace. Growth in 2019 is projected at 3.2 percent, mainly because a moderating labor market will slow down consumption and exports will decelerate after a strong start early this year. Investment will depend on policy predictability, reform efforts and the business environment.

As a small open economy, Lithuania is vulnerable to a weakening external environment characterized by slower growth in Europe, continued trade tensions, uncertainty around Brexit conditions, and geopolitical risks. Domestically, emigration, population aging, and slow progress in implementing key aspects of the government’s reform agenda are the main risks to the economic outlook.

Executive Board Assessment

In concluding the Article IV consultation with the Republic of Lithuania, Executive Directors endorsed the staff’s appraisal as follows:

The Lithuanian economy has continued to enjoy a strong macroeconomic and fiscal performance, but long-term challenges remain largely unaddressed. Prudent fiscal policy, a flexible labor market, and proactive macroprudential policies have been critical to preserve stability and should be maintained. The recovery has avoided the emergence of the large imbalances of the past and better positioned Lithuania to face external shocks and future economic downturns. However, Lithuania still confronts severe demographic pressures, large social disparities, and external uncertainty that can only be addressed with structural reforms. This is the only way to ensure sustained high wage growth and improved living standards.

The continued strong economic performance suggests that a neutral fiscal stance would have been preferable this year. Going forward there are heightened risks to revenues and increased spending pressures from social needs that are partly countered by conservative economic projections. Gains from combating informality are difficult to predict while the revenue impact of recent reforms is uncertain. Thus, revenue buoyancy may largely reflect cyclical factors. Without commensurate increases in revenues, spending pressures are increasing budget rigidities.

Macroprudential policy is being used proactively to prevent systemic risks. Signs that moderate cyclical systemic risks are emerging led the Bank of Lithuania to raise the countercyclical buffer to one percent in mid-2018. The financial system remains sound, liquid, and profitable.

The external position is stronger than implied by fundamentals and desirable policies. However, under unchanged policies, Lithuania’s current account should gradually converge towards its medium-term norm.

Despite growing urgency, education and healthcare reforms have failed to deliver. Maintaining large and inefficient networks comes at the cost of quality and opportunities. Only comprehensive reform will allow Lithuania to produce the competitive and well-paid workforce needed to tackle income and social disparities. Thus, planned wage increases in these sectors should be made conditional on progress in network optimization.

Pension and tax reforms go in the right direction, but remaining challenges will require future compromises. Tax reform could have been more ambitious in shifting taxes away from labor. The reduction of tax exemptions and privileged regimes is also needed. On pensions, reform has ensured the financial, but not social, sustainability of the system. Low and declining pensions will increase pressures to boost basic pensions, which have been transferred to the budget this year. This represents a fiscal risk over the medium-term.

ALMP should be strengthened to effectively address skill mismatches and increase labor force participation. Current funding is low and relies excessively on EU funds and its composition inadequately reflects cyclical conditions or the needs of the labor market. Thus, reliance on employment subsidies should decrease and focus on the most disadvantaged groups only. The emphasis should shift to well-designed training curricula to upskill the labor force.

Lithuania faces a difficult tradeoff between maintaining a low and competitive tax system and strengthening the social safety net. With discretionary spending already low, further increases in social spending will likely require higher revenues. To ensure the most efficient use of limited resources, targeted social spending should be the main tool used. In this connection, the design and generosity of child benefits should balance their positive impact on reducing child poverty against the potential disincentives to work, particularly for women.

Fintech provides big opportunities to improve financial services and produce high-skill jobs, but it also brings challenges, particularly related to anti-money laundering. The authorities’ efforts to promote fintech are already delivering results. Fintech companies will introduce some healthy competition, initially in the payment services segment. The larger focus on cross-border transactions represents a shift in the business model of the financial system that will bring new challenges for supervision, particularly regarding AML/CFT. The authorities’ efforts to implement the 2018 MONEYVAL recommendations and enhance inter-agency coordination should be complemented by adequate resources across all agencies involved.

Source: International Monetary Fund