Economic Development Scenario for 2016–2019

Economic Development Scenario for 2016–2019

The Economic Development Scenario was prepared on the basis of the statistical data published by 10 March and the information obtained, which, following Government of the Republic of Lithuania Resolution No 154 of 18 February 2016, was presented by the Ministry of Environment of the Republic of Lithuania, Ministry of Social Security and Labour of the Republic of Lithuania, Ministry of Transport and Communications of the Republic of Lithuania, Ministry of Economy of the Republic of Lithuania, Ministry of Foreign Affairs of the Republic of Lithuania, and the Ministry of Agriculture of the Republic of Lithuania. Key assumptions of the external economic environment (trading partner development, oil prices, EUR / USD exchange rate) correspond to the European Commission Winter 2016 Forecast.

The Economic Development Scenario was coordinated with the Ministry of Economy of the Republic of Lithuania, Ministry of Social Security and Labour of the Republic of Lithuania, Bank of Lithuania and the National Audit Office of Lithuania.

After the entry into force of the Republic of Lithuania Constitutional Law on the Implementation of the Fiscal Treaty on 1 January 2015, the conclusion on this Economic Development Scenario has to be presented by an independent budgetary policy control institution, the functions of which by Republic of Lithuania Law on National Audit Office No I-907 were assigned to the National Audit Office of Lithuania.

The Economic Development Scenario for 2016-2019 prepared by the Ministry of Finance envisages that decreased dependence on the Russian market, relatively stable development of the main Lithuanian export markets (based on the European Commission Winter 2016 Forecast), economic stimulus policy carried out at EU level in the medium term will serve as the basis for the Lithuanian economic growth to be faster than in 2015 and balanced. In 2016 Lithuania’s GDP growth might be by 0.6 percentage points higher than in the previous year – about 2.5%. Projection of lower growth for 2016 than the expected one in autumn 2015 was predetermined by the evaluation of the changed external environment and the changes in construction and agricultural activities. It is projected that in 2016, as a result of decrease in dependence on the Russian market and recovery of external demand, acceleration in exports of goods and services will enable even higher growth of GDP in 2017 – about 3.2%.

In subsequent years of the medium term due to unfavourable demographic trends slightly slower GDP growth than in 2017 is projected; however, it should be still above 3%.

It is projected that recent tightening of the labour market (mismatch between the supply and demand for labour) will strengthen in the medium term. Deflationary processes will end already in 2016, while increasing prices will reduce the purchasing power of the population and will slightly dent household consumption; however, it will remain an important GDP growth component throughout the medium term.

In recent years the external environment has not been favourable for the Lithuanian exporters; still it was a great stimulus for reorienting export flows to more stable markets. In 2015 the main markets of goods of Lithuanian origin were Germany, Latvia, USA, Poland, United Kingdom, Sweden, Netherlands, Estonia, Norway and France. In 2015 Russia was outside the top 10 main export markets of goods of Lithuanian origin – it ranked just 15th, and the share of exports of goods of Lithuanian origin to Russia fell by almost half – from 4.3% in 2014 to 2.3% in 2015. The volumes of the Lithuanian exports of goods increased by 0.4%, while together with services – by 1.2%, and it predetermined about 0.9 percentage points of the GDP growth rate in 2015.

Rapid reorientation of the Lithuanian exporters to more stable markets resulted in that exports of goods of Lithuanian origin decreased just by 2.4% (at current prices) in the previous year. Mineral products excluded (negative impact on the value of which was made by decreased oil prices), the value of exports of goods of Lithuanian origin increased by 2.7%. Following the evaluation of unfavourable external environment conditions, it is a good result showing flexibility and competitiveness of the Lithuanian exporters. However, as the export volume growth rate slowed down, in 2015 the main engine of economic growth was domestic demand.

The active investment process had influence on rapid domestic demand growth – expenditure on gross fixed capital formation in 2015 increased by almost twice more rapidly than in 2014 – by 10.3%. High level of production capacity utilisation in 2015 (73.9%) boosted growth of investments in tangible fixed assets. In 2015 investments in manufacturing increased by 15.3% (in particular strong growth was in the second and the third quarters, 25% and 34%, accordingly). The increase in investments was also stimulated by the implemented strategic Lithuanian electricity energy projects and the objective to finish the projects financed from the 2007-2013 EU Structural Funds assistance period.

In 2015 low oil prices was a favourable factor for Lithuania, resulting in the increase in the purchasing power of the population and the decrease in production costs. Due to the increased purchasing power household consumption expenditure (at constant prices) in 2015 were by 0.7 percentage points higher than in 2014. Oil refinery business in Lithuania in particular benefited from the profit margin that increased more than two-fold (largely resulting from decreased oil prices). Exports of oil products (at constant prices) in 2015 increased by about 12%, and financial results of oil refinery business were the best ones since 2006. Cheaper fuel mitigated a negative impact of Russian recession and embargo on transport sector and had a positive effect on the results of other sectors, where transportation costs make a significant share of operating costs, such as trade, tourism and agriculture sectors. The activities of wholesale and retail trade, repair services of motor vehicles and motorcycles, transportation and storage, accommodation and food services predetermined about half (0.77 percentage points) of the GDP growth rate in 2015. Manufacturing, although affected by negative external environment factors, generated about 0.5 percentage points of the GDP growth rate. Construction activities that has seen fast growth for several consecutive years and which in 2014 predetermined about 1 percentage point of the GDP growth rate, in 2015 did not contribute to the GDP growth rate. Although in the first half of 2015 the value added created in construction sector increased by 8.1%, as compared to the first half of 2014, after completion of the projects financed from the EU 2007-2013 EU Structural Funds assistance period, in the second half of the year activeness of construction activities slowed down, while throughout the year 2015 the value added generated from construction activities was by 0.3% lower. The negative trends formed were predetermined by the results of construction activities of the second half of the year – the value added generated in construction activities, as compared to the second half of 2014, went down by 6% (largely due to decrease of about 12% in civil engineering).

Trends in construction activities that changed in the second half of 2015 and the decreasing construction confidence indicator (based on business survey data by Statistics Lithuania, this indicator in February 2016 was by 11 percentage points lower than in the same period of the previous year) led to that investments for gross fixed capital formation (most of such investments in recent years were created by construction activities) for 2016 are projected to be lower than the ones projected in autumn 2015.

In 2016 investment growth will be reduced also by the effect of the change in the EU financial assistance periods – lower EU structural assistance due to doubling of the 2007–2013 and the 2014–2020 financial periods in 2015 – in 2015 the funds from both financial periods were invested, while in 2016 – just the funds of the new 2014–2020 period.

The volumes of the projects implemented from the EU funds will increase from 2017. In the 2014–2020 financial period investments into infrastructure projects in the areas of transport, environment, energy, research and experimental development, and regional development are planned, also works of modernisation and renovation of multi-apartment houses and public buildings are to be financed.

In the medium term the projects on modernisation of multi-apartment buildings will remain important for investment growth; however, not to the same extent as in 2015 when there was a huge leap in the area of renovation, and within one year almost 4 times more projects were completed than in earlier years. According to the data by the Ministry of Finance, by using the funds of the EU operational programmes under the 2007–2013 financial period, by 31 December 2015, in total 667 multi-apartment renovation projects were completed, still 388 houses were under renovation. Moreover, by mid-February 2016, 511 loan agreements for renovation of multi-apartment buildings for 145.5 MEUR were signed. The EU funds of the 2014-2020 financial period are earmarked for the implementation of these projects. The projects on construction of commercial buildings, which become an object of active interest by foreign investors, and infrastructure projects will be also important for the investment process.

The obligation each year to renovate 3% of buildings owned by central government in the medium term provided for in the EU Energy Efficiency Directive will also contribute to the flow of investments earmarked for financing construction (in case of non-compliance with this objective set in the EU Energy Efficiency Directive, Lithuania is subject to penalties). Currently renovation of buildings owned by the State and modernisation of street lighting in order to increase energy efficiency are financed using the funds of the Energy Efficiency Fund established on 18 February 2015 (value of the Fund is 79.6 MEUR, 19 MEUR were already transferred to the Fund). It is planned to establish a fund, the funds of which will be used for renovation of municipal public buildings. 50 MEUR of EU structural assistance are planned to be allocated to this fund.

The investment process in the medium term will be supported also by the implementation of the provisions on ensuring complementarity of the Partnership Agreement of the Republic of Lithuania approved by European Commission Decision of 20 June 2014 (share of general government expenditure of the GDP for gross fixed capital formation in the 2014–2020 financing period on average per year should remain at least 3.2%).

Taking into consideration that unused labour resources in the country significantly decrease, in the medium term enterprises risk facing the lack of not only qualified labour force but also of the unqualified one. Therefore, as labour force decreases and its price increases, the need to increase labour productivity and to invest into less labour requiring production (production facilities) will remain throughout the medium term.

In the last four years the number of the employed persons being rapidly increasing and the number of working-age population decreasing led to that in 2015 the rates of employment and labour participation became the highest ones since the start of the Labour Force Survey in 1998 – they represented 67.2% and 74.1%, accordingly (in the age group 15–64), and partially mitigated the problem of labour supply formed in the market. The number of the employed persons was increasing in many economic activities, and in total it increased by 1.2% in 2015. The greatest increase in the number of the employed persons was in the activities of construction, human health and social work, manufacturing, information and communications. The number of the employed in wholesale and retail trade activities decreased by 3.5% despite a 55.9% increase in the number of job vacancies in this activities. The number of the employed persons in private sector increased by 4.1%, and in public sector – by 0.1%.

As the unemployment and the number of working-age population rapidly decrease and the labour demand increases, tension in the labour market will strengthen in the medium term, while depleting unused labour force resources in the country will determine slowing employment growth rates.

A low unemployment rate (in 2015 it fell by 1.6 percentage points – down to 9.1%) together with tension in the labour market over the lack of qualified labour force and Government decisions on the increase in the minimum monthly wage (hereinafter referred to as the MMW) in 2015 stimulated the increase in wages. According to preliminary data, in 2015 the average gross monthly wage (including individual enterprises) in Lithuania increased by 5.1% (in private sector – by 6%, in public sector – by 3.8%). Wages were increasing in the enterprises of all types of economic activities, in particular in information and communication activities (8.3%), accommodation and food services (8.2%), arts, entertainment and recreation activities (7.5%), and the lowest increase was in public administration and defence activities, compulsory social security activities (2.4%), and education activities (3%).

Due to increasing labour demand the rate of increase in salaries will remain accelerated in the medium term. The greatest increase in wages will be in private sector – of those activities, which are characteristic of high labour productivity, great labour demand and wages of which were the lowest ones. A significant impact will be made by the increase in the MMW (from January 2016 the MMW was increased by EUR 25 up to EUR 350). As a result of increasing wages, income of residents will also steadily increase in the medium term. Like in recent years, the Lithuanian residents will allocate most of their income to acquisition of goods and services; however, the increasing inflation will reduce the purchasing power of the population; therefore, household consumption expenditure (at constant prices) will increase at a slower pace in the medium term than in 2015.

Due to a low comparable base the impact of low oil prices (the European Commission Winter 2016 Forecast foresees that in 2016 oil prices expressed in euro per barrel will drop by 31.4%) on consumer goods in 2016 will be weaker than in the previous year when due to decreased oil prices the average annual deflation made up 0.7% in Lithuania (calculated on the basis of the Harmonised Index of Consumer Prices (hereinafter referred to as the HICP)). Lower weight of energy products in the consumer’s basket of goods and services than in the previous year will lead to less negative impact on the HICP in 2016, thus, in 2016 low inflation (0.7%) is projected, and from 2017, as the negative impact of external factors disappears (after recovery of global oil prices), acceleration of inflation is projected. Stable increase in excise duties on alcoholic beverages and tobacco planned for 2016–2018 (at the moment it is planned on tabacco just for 2016) will have a slight accelerating impact on inflation. It is likely that in the medium term global food prices will remain stable; therefore, food prices in the country will be mostly affected by the relation between domestic demand and supply. On the one hand, increasing income of consumers will enhance pressure on prices, on the other hand, a decreasing number of consumers and expected growth of competition in retail trade market will reduce this pressure. Taking this into consideration, a moderate gradual increase in food prices is projected in the medium term.

Core inflation (calculated based on the HICP excluding energy and unprocessed food), in recent two years featured by stability and in 2014–2015 on average representing 1.2%, in the medium term, as domestic demand increases, will gradually accelerate and approach the multiannual average (2.5%).

It is planned that as wages increase rapidly, rise in prices for services, which became distinguished in 2015, will continue throughout the medium term.

Risk for the Economic Development Scenario Fulfilment

Negative risk for the Economic Development Scenario remains and in essence arises due to uncertainty of the external economic environment. Geopolitical tension still persists; mutual Russian and EU sanctions extended till 2016 may be not lifted for a longer period. Negative risk arises also due to possible further deceleration of Chinese and other developing markets and possible deeper Russian recession.

From autumn 2015 some additional negative factors occurred regarding fluctuations on global financial markets, problems of refugees that invaded Europe and of the European Union stability are still unsolved. If after the referendum of 23 June 2016 the United Kingdom withdrew from the European Union, this would lead to introduction of protectionist measures and depreciation of the pound. This would limit exports of goods from Lithuania to this country, where in recent years the exports represent more than 4% of total Lithuanian exports.

There is a risk that due to a problem of refugees, which recently became more complicated, the Schengen Agreement may be repealed. This would mean introduction of border control and would aggravate foreign trade, reduce foreign investments, have a negative effect on transport and logistics activities, tourism sector.

The prolonged period of deflation or oil prices increasing significantly faster than projected in the preparation of the Economic Development Scenario would also affect economic development perspectives.

The change in the development trend of the number of working-age population would affect labour market indicators. Poorer demographic trends would lead to a lower amount of labour, form the conditions for decrease in the number of the employed persons. More positive demographic trends would form the conditions for a faster increase in the number of employed persons; however, due to a greater amount of labour force the unemployment rate would decrease more slowly. The changes in the labour market would have an impact also on projections of wages and wage fund.

Positive risk factors also exist, in case of their fulfilment the economic indicators projected in the Economic Development Scenario would improve.

If the euro value depreciated more than it was projected in the preparation of the scenario, the Lithuanian exporters might make use of it when trading with non-euro area member states and accelerate the development of exports more than it is provided for in the scenario. Higher economic activity in the EU and the euro area would also be a factor of positive risk.

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