Scope upgrades Lithuania’s credit rating to A and revises the Outlook to Stable
|Improvements in economic resilience and the external position drive the ratings upgrade. Adverse demographics, wage-productivity growth imbalances and exposure to external shocks remain credit challenges.|
In addition, the Covid-19 crisis has not caused exceptional macroeconomic imbalances, with household and non-financial corporations’ debt ratios at low levels as of Q3 2020, at 24.3% and 38.6% of GDP respectively, nearly unchanged compared with 2019 levels5. Scope considers Lithuania’s Nordic-dominated banking sector to be in a good position to absorb the current economic shock. The banking sector is highly profitable compared with those of euro-area peers, is highly capitalised and displays strong asset quality. As of Q3 2020, the system-wide tier 1 capital ratio was 21.8% of risk-weighted assets, among the highest in the euro area, and the non-performing loan ratio was just 1.2%6.
The second driver for the rating upgrade is Lithuania’s improved external position. Net external debt declined to 3% of GDP in Q3 2020, down from 13.1% one year before, and the net international investment position improved to -18.2% of GDP in the same quarter, from -27.8% in Q3 2019. Lithuania has been continuously gaining global export market share over recent years, supported by improvements in the value-added structure of exports. Despite rising unit labour costs, growing 3% annually over 2017-19 relative to that of the euro-area average, relative wages of Lithuania still compare favourably against relative productivity when compared with the euro-area average, and wage growth has not significantly undermined the competitiveness of Lithuania’s export sector. Annual net earnings in purchasing-power-standard terms amounted to 54% of the euro-area average in 2019, while productivity (per person) was 72% of the euro-area average in the same year. Supported by this, the current-account surplus widened to 3.3% of GDP in 2019, from 0.3% of GDP in 2018. According to the Bank of Lithuania’s December 2020 projections, the current-account surplus is forecast at 8% of GDP in 2020 before 7.3% of GDP in 2021. This could further improve Lithuania’s external finances.
Important for the country’s medium-term growth prospects and external resilience is Lithuania’s ability to improve the security and sustainability of its energy supply and diversify domestic energy sources. Here, Scope notes positively that the connection of the Baltic states’ with continental Europe’s gas and electricity networks is planned by 2022 and by 20257 respectively. In Scope’s view, this will support Lithuania’s economic resilience.
Looking ahead, Scope believes Lithuania’s track record of fiscal discipline has provided the government with fiscal space to absorb the Covid-19 crisis short term. The government’s fiscal measures adopted last year to mitigate the impact of the COVID-19 pandemic amounted to 5.9% of GDP8, of which 1.5% of GDP was directed to short-time work schemes, with the rest comprising of subsidies to businesses, additional funds for public investment and social security benefits. The budgetary impact of state guarantees to firms affected by the pandemic is small (state guarantees amount to around 2.1% of GDP), given the low take-up of guarantees at just 0.2% of GDP as of December 2020. For 2021, the draft budgetary plan foresees discretionary fiscal measures of 3.9% of GDP.
Medium term, the budget framework reform9, which incorporates medium-term strategic goals and expenditure reviews in the design of budgets starting 2022, could improve the longer-term effectiveness of public spending. Improving tax collections will also be important for medium-run fiscal dynamics, considering the still-sizeable shadow economy and comparatively restricted tax base in Lithuania.
As a result of fiscal stimulus and cyclical fiscal deterioration, Scope estimates Lithuania’s general-government balance to have deteriorated from a surplus of 0.3% of GDP in 2019 to a deficit of 8% of GDP in 2020 before narrowing to a deficit of 6% of GDP this year. This is slightly more optimistic than the government’s expected deficits of 7.6% of GDP and 7% of GDP in 2020 and 2021, as presented in the draft budgetary plan. Scope expects the general government debt-to-GDP ratio to increase from around 36% of GDP in 2019 to 46% of GDP in 2020 and further to 51% of GDP in 2021 due to large projected fiscal deficits in 2020-21. Thereafter, Scope expects the public-debt ratio to stabilise, remaining below the EU’s 60% Maastricht threshold.
Risks related to deterioration in Lithuania’s short- to medium-term fiscal dynamics are mitigated by favourable debt financing costs, with the 10-year government bond yield at close to 0% at time of writing, anchored by Lithuania’s access to the European Central Bank’s asset purchase facilities, alongside a long weighted-average maturity of debt, of 9.2 years, and improving debt structure. Lithuania’s foreign-currency denominated debt (reflecting two Eurobonds denominated in USD), totalling USD 2.85bn, will be repaid by 2022 through accumulated pre-financing.
In addition, together with Estonia, Latvia and the European Bank for Reconstruction and Development, Lithuania is planning to develop a Baltic commercial-paper market10. In Scope’s view, this will enhance market liquidity and the resilience of Lithuania’s private sector to economic shocks.
Despite these credit strengths, Lithuania faces a number of challenges.
The pandemic has had a significant negative impact on the labour market, mitigated by government-subsidy schemes. The unemployment rate increased to 10.4% as of November 2020, from 6.1% at the beginning of last year. The percentage of employed persons in the working-age population fell from 73.4% as of Q1 2020 to 70.5% as of Q3 2020 – representing a steeper deterioration than those seen in other central and eastern European member countries of the EU. Scope expects only a gradual recovery in the Lithuanian labour market and in wage growth by 2022.
Lithuania’s medium-term growth is hindered by demographics, reflecting an ageing population and shortages of skilled labour. The old-age dependency ratio (those aged 65 years and over as a percentage of those aged 15-64) will increase to 41% by 2030, from 31% in 2020, representing the highest such increase among EU-27 economies. Labour productivity grew solidly before the crisis (averaging 3.6% annually between Q1 2017 and Q1 2020). However, productivity growth remained under real wage growth. Positively, the government set up the Innovation Promotion Fund in 2021 to increase public financing for innovation and stimulate private investment. Total expenditure on research & development across all sectors amounted to 1% of GDP in 2019, significantly under a euro-area average of 2.2% of GDP. This is in part due to the large share of smaller firms in the Lithuanian economy, with such firms spending less on R&D. Importantly, immigration has exceeded emigration since 2019 (by around 10,000 persons in 2019 and 20,000 persons in 2020). In Scope’s view, this mitigates labour shortages in some sectors and raises potential growth.
Lithuania’s small, open economy remains vulnerable to external shocks and is reliant on external demand, due to a large export sector (in goods and services) relative to the size of the economy, of around 75%. The recent reform of the EU road transport sector (as part of the EU Mobility Package), which requires truck drivers to return to their home countries regularly to improve working conditions, could negatively impact Lithuania’s transportation services to the rest of the EU, which account for 14% of total exports.
Lithuania’s banking sector is exposed to concentration and spill-over risks due to integration with neighbouring banking systems. Two Swedish banks, Swedbank and SEB, account for 63% of Lithuanian bank assets. Cross-border money-laundering risks are curbed by the small share of non-resident deposits, at 1.9% of total deposits as of November 2020, significantly under that of Latvia (19.1%) and Estonia (9.8%). At the same time, the swift expansion of FinTech, while benefitting the quality of the financial infrastructure, also brings new challenges for anti-money-laundering supervision.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘aa-’ for the Republic of Lithuania. Lithuania receives a one-notch positive adjustment for the euro’s status as a global reserve currency under the reserve currency adjustment. As such, a ‘aa’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.
For Lithuania, no relative qualitative credit strengths have been signalled. The following relative credit weaknesses have been identified: i) growth potential of the economy; ii) macro-economic stability and sustainability; iii) fiscal policy framework; iv) current account resilience; v) resilience to short-term external shocks; vi) financial imbalances; vii) environmental risks; and viii) social risks.
The QS generates a three-notch downward adjustment and indicates A long-term ratings for Lithuania.
A rating committee has discussed and confirmed these results.
Factoring of Environment, Social and Governance (ESG)
Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weight in the quantitative model (CVS). Under governance-related factors in the CVS, Lithuania’s performance is average compared with that of central and eastern European sovereign peers as assessed under the World Bank’s Worldwide Governance Indicators. In general, policymaking in Lithuania has been largely effective and enjoyed relative continuity.
Lithuania’s performance across key social factors is mixed. This is reflected in above-EU-average poverty ratios, although ratios are declining (26.3% of the population was at risk of poverty or social exclusion in 2019, compared with 20.9% for the EU-27 as an entirety), relatively high levels of income inequality, but high labour-force participation rates. The European Commission’s Digital Economy and Society Index 2020, which assesses EU member states’ digital competitiveness, ranks Lithuania as average (13th) among the EU-27. Lithuania ranks 20th among the 193 countries on the United Nations’ E-Government Survey 2020, which measures effectiveness in the delivery of public services via information and communication technologies.
Environmental factors are explicitly considered in the rating process via the environment sub-category under the ESG risk pillar. The share of renewable energy in total energy consumption in Lithuania stood at 25.5% in 2019, which exceeds the EU’s average of 19.7% and the national target for 2020 of 23%. Lithuania has an ambitious plan to increase this share to 45% by 2030, including by making use of EU development funds, such as EUR 385m in EU funding for renewable-energy installations. The synchronisation of the Baltic States’ electricity networks with the European network, recent liberalisation of the retail-electricity market and the encouragement of households to self-generate and store solar electricity support Lithuania’s objectives for energy sustainability.
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