Lithuanian Economic Development Scenario for 2017–2020

Lithuania’s Economic Outlook for 2017–2020

Lithuania’s Economic Outlook for 2017–2020

The Economic Development Scenario (hereinafter referred to as the Scenario) was developed on the basis of the statistical data published by 1 September 2017 and the information obtained, which, following Government of the Republic of Lithuania Resolution No 369 On the Approval of the Description of the Procedure for Development and Publishing of the Economic Development Scenario of 13 April 2016, was presented by the Ministries of the Republic of Lithuania (of Environment, Energy, Social Security and Labour, Transport and Communications, Economy, Foreign Affairs, Agriculture). The appropriate technical assumptions of the external environment (development of trading partners, oil prices, EUR / USD exchange rate) published by the European Commission and the European Central Bank were also used.

In the first half of 2017 Lithuania’s gross domestic product (GDP) growth was 4.1% – twice faster than the euro area average (stood at about 2%). Such relatively accelerated, not seen for several years economic growth was predetermined by the results of the economic activities oriented both towards the domestic market and the export. In the first half of 2017 the investment process was also active: gross fixed capital formation expenditure increased by 6.9%, the greatest impact on the increase in this expenditure was made by productive investment in capital goods, information and communication technology equipment, and intellectual property products. Recovery of the global economy had a positive impact on the Lithuanian export development: in the first half-year the exports of goods and services (at current prices) grew by two-digit numbers (17.6% and 17.2%, respectively) – such scale of the development of exports of goods and services has not been seen for the past four years.

After evaluation of the economic development results of the first half of 2017 and the changed (more favourable) assumptions regarding foreign demand on the main Lithuanian foreign trading markets, we increase a projection of the annual change in GDP for 2017 by 0.9 percentage point (from the projection of 2.7% made in March this year to 3.6%), and for 2018 – by 0.3 percentage point (from 2.6% to 2.9%). It is projected that in 2019 and 2020 GDP will grow by 2.5% and 2.4%, accordingly. The possibilities of more accelerated GDP growth in the medium term will be limited by decreasing labour force resources, insufficient levels of investment. In order to achieve higher economic growth, in the medium term it is necessary to strengthen the economy’s long-term growth potential. The most effective method for that – to pursue structural reforms; however, their positive impact on the economy is felt only after several years, and longstanding demographic problems are not solved so quickly either. Therefore, in the medium term innovations, intellectual property products should become priority investment areas. This type of investments is the fastest way to increase labour productivity, growth of which has been low in recent years, and also to accelerate economic growth.

Despite the economic upturn, in the first half of 2017 demographic trends did not improve – the resident population of Lithuania kept further decreasing – on 1 July it was by 48.7 thousand smaller than a year ago. Labour force decreased by 1.1% or by 16.1 thousand persons in the first half of 2017. Unfavourable demographic trends had a negative impact on the employment indicators – in the first half of 2017 the number of the employed in the country decreased by 0.4%. Although in the second half of 2017 (and in later years of the medium term) a positive impact on the labour market indicators will be made by the amendments to the Labour Code that entered into force from 1 July 2017, the medium term employment indicators due to slower increase in the 2 labour force participation, as compared to the ones projected in spring of 2017, will be worse. It is projected that the number of the employed will consistently decrease during the whole medium term: –0.2% in 2017, –0.3% in 2018, –0.4% each in 2019 and 2020.

As tension on the labour market increases, in the first half of 2017 the pace of growth of the average monthly gross wages reached the amount unseen since 2009 – it exceeded 9% (in I and II quarters it made up 9.7% and about 9.1% 1 , accordingly). As the labour force decreased, pressure to increase wages of not only private but also of public sectors strengthened. Having assessed the results of the first half of 2017, we have increased the projection of the average monthly gross wages for 2017 by 1.6 percentage points (as compared to the estimate projected in spring) up to 8.3%. Due to the gap between the lack of labour force and high payment of labour, as compared to the developed euro area countries, pressure to increase wages will remain during the whole medium term. Therefore, wages in private sector should grow on average by about 6–8% per year in the medium term, and in 2018–2020 growth of the average monthly wages in the country should stabilise at 5-7% per year. The same development of the wages was projected also in spring of 2017.

In the first half of 2017 the price evolution in essence corresponded with the projection in the Scenario published in spring of 2017. However, after assessment of the acceleration in the rise in the prices for services observed since April 2017, we increase the average annual inflation rate (calculated in accordance with the consumer price index methodologically harmonised with other European Union (EU) Member States) by 0.1 percentage point for 2017 (as compared to the projection in March 2017) up to 3.5%. The inflation estimates for the remaining years of the medium term are not changed. After disappearance of one-off factors, which accelerated the rise in prices in 2017 (in essence, these include a significant increase in the excise duty rates on alcoholic beverages, higher international oil prices) and having restrained aggregate demand, the prices should go up at a more moderate pace in 2018–2020. It is projected that in 2018 the average annual inflation will represent 2.7%, and in 2019 and 2020 it will be close to the average multi-annual net inflation and will constitute 2.5 % each year.

A 3.6% GDP growth rate projected for 2017 in this Scenario warns that the economy grows at a more accelerated pace than it would be potentially possible with the available production capacities and labour force resources. Tension on the labour market strengthening for several years, increasing activity on the real estate market as well as the rise in prices that has gained momentum this year are the signs that it is necessary to manage excess aggregate demand having formed at the time of cyclical upswing by fiscal policy measures, i.e. to implement the plan of tasks for the general government balance indicator in the medium term established in Lithuania’s Stability Programme for 2017 approved by Government of the Republic of Lithuania Resolution No 315 of 26 April 2017 – to form general government surpluses thus creating fiscal space forming the conditions to prevent pro-cyclical consolidation. The Scenario was developed assuming that this plan will be implemented.

Investment

The year 2017 may be called a year of investment breakthrough. In the first half-year the investment process was active – expenditure of gross fixed capital formation increased by 6.9% in the first half of 2017. Increasing demand and decreasing labour force resources encouraged business investment in the measures enhancing labour productivity and efficiency – in the first half of 2017 there was a significant increase in productive investments in information and communication technology (27.3%), intellectual property products (25.5%). Increase in foreign demand resulted in growth of manufacturing investment expenditure for tangible assets. In the first half of 2017 the share of private sector investments in tangible assets of total material investments in tangible assets went up to 78.7% (in the same period in 2016 it accounted for 77%).

In II quarter of 2017 investments of public sector in tangible assets recovered. Such growth trend encouraged by more active implementation of projects funded by the EU funds should remain also in other quarters of 2017. As spurt of private investments continues, expenditure of gross fixed capital formation should increase by 6.3% during the whole year 2017 – that is by 0.4 percentage point more than projected in spring of 2017.

In the medium term a positive impact on investment evolution in the country will be made by the use of alternative funding sources for investment projects. By using the Investment Plan for Europe in Lithuania it is planned to implement 6 projects that would be partially funded from the European Strategic Investment Fund. The Investment Plan will also create a possibility for small and medium-sized business to attract funds for investments.

Despite a relatively active investment process envisaged in the medium term, the share of gross fixed capital formation expenditure of GDP at the end of the medium term will have still not reached the pre-crisis level – in 2020 it will account for 20.2% of GDP (in 2007 this indicator represented 28.6% of GDP). Such level of investments is too low for achieving rapid convergence with the developed countries of the euro area.

The need to take decisions reducing production costs, increasing activity efficiency and production volumes will remain for the whole medium term, the implementation of projects funded by the EU funds will also accelerate. A decreased stimulus of new business centres construction for investment will be replaced by an active development of hotels that has already started. Considering the information available at the time of the Scenario development on business and public sector investment projects being implemented or planned to be implemented, in 2018-2020 the gross fixed capital formation expenditure should increase at a relatively accelerated pace – on average by about 5.2% per year.

Inflation

In July 2017 the annual inflation (calculated in accordance with the consumer price index methodologically harmonised with other EU Member States – HICP) reached 4.1%, and the annual core inflation (calculated in accordance with the HICP, excluding energy and unprocessed food) – 4.5%. Accelerating inflation warns about the strengthening impact of domestic factors on the prices, in particular regarding the increasing labour costs. The tendency in business enterprises’ behaviour to shift a larger and larger part of labour costs to the prices for goods and services, in view of more accelerated increase in wages, is strengthening.

The annual increase in the prices for foodstuffs and non-alcoholic beverages accelerated up to 2.8% in July this year. The increase in food prices is stimulated by the rising prices of dairy products, oils and fats, meat, fish, and confectionery. For the past 4 months the prices for vegetables, as compared to the corresponding period a year ago, decreased by 10%, as the buying-in prices for vegetables have declined. However, in June the buying-prices for agriculture products in Lithuania increased by 3.7%. The risk that the impact on the prices for fruit in III-IV quarters of the current year may be made by the frosts that hit the European farms this spring is not excluded. In July the annual increase in the prices for oils and fats accelerated up to 10.2%. A great impact on that is made by butter, the price of which is increasing due to the increasing demand for butter on the international market and decreasing stocks of producers. Currently the prices for butter on the international market are at record highs. As the global food price index is increasing, wages further rising, no stabilization of food prices is expected in the near future.

As the prices for international flights increased by one-fourth, rise in the prices for services in July 2017, as compared to the corresponding period a year ago, accelerated up to 6.5%. The prices for the services of many types, not only transportation, except for communication services, are going up. The increase in the prices for services is predetermined by both rapidly increasing wages of the employees working in service sector and increasing household disposable income.

Energy goods still remain more expensive than a year ago. In January-July 2017 average prices of fuel for motor vehicles, as compared to the corresponding period of the previous year, increased by 10.9%, and are to be related to higher oil prices. Although in recent months Brent oil price remains rather stable, in the first half of 2017, as compared to the corresponding period in 2016, the average price (in EUR) was by 29% higher. With the statistical base effect coming to an end, in the second half of the current year a lower annual increase in fuel prices is expected, which at the end of the year in case of favourable oil prices may disappear completely. Based on technical assumptions of the external environment of the Scenario, in 2018 Brent oil price (in EUR) should remain almost stable, thus next year quite stable fuel prices are expected.

The rise in the prices for alcoholic beverages and tobacco products are predetermined by the increased excise duties on these goods; however, their impact on the annual inflation remains stable. Starting from 1 March this year the excise duty rate on anhydrous ethyl alcohol was increased by almost one fourth and the excise duty rates on alcoholic beverages were almost doubled, also the excise duty rates on tobacco products were increased by about one tenth, which have a 1 percentage point increasing impact on the annual inflation. This impact should come to an end in March next 5 year. In the development of the Scenario there were no decisions made concerning the changes in the excise duty rates for 2018 that will have a significant impact on inflation.

Having assessed the acceleration in the growth of prices for services strengthening from April 2017, we increase the average annual inflation projection for 2017 by 0.1 percentage point (as compared to the estimate projected in March 2017) up to 3.5%. The estimates of inflation for the remaining years of the medium term are not changed. It is projected that after disappearance of one-off factors, which predetermined growth in 2017, in 2018 the average annual inflation will decrease down to 2.7%, and in 2019 and 2020 the average annual inflation will be close to the average multi-annual core inflation and will constitute 2.5 %.

Employment and Unemployment

Tension in the labour market keeps further increasing. Although labour participation, partially compensating demographic losses, remains at a record high rate and further increases, statistical data of the first half of 2017 shows that its growth resources are decreasing. In the medium term business enterprises will find it more and more difficult to find specialists to the created new vacancies for the occurrence of which the economic conditions in the medium term will remain favourable.

In the first half of 2017 labour force supply diminished by 1.1% or 16.1 thousand persons due to persistent negative demographic trends and decelerated growth of labour force participation. Rapidly growing real wages and supply of job vacancies, which kept increasing in the majority of economic activities, encouraged the passive population to enter the labour market and to become active labour market participants – labour force participation rate in the 15–74 age group on average constituted 68.1 % and was by 0.7 percentage point higher than in the corresponding period of the previous year. Slower growth of the participation rate in the economy was mostly predetermined by the participation of the 55 and older age group of the population that kept growing at a slower pace than in the first half of 2016. Greater labour force participation compensated a part of labour force lost due to the negative impact of demographic factors; however, not so much as it was expected in the development of the Scenario in March 2017.

Despite further rapidly increasing labour demand (in the first half of 2017 the number of job vacancies increased by 22.4% during the year) and a higher labour force participation rate, the number of the employed population in the first half of 2017, as compared to the corresponding period in the previous year, decreased by 5.2 thousand persons or 0.4% during the year. The number of the employed in particular decreased – by 2.3%, or 21.8 thousand persons, – in the main 25–54 age group, which accounts for 70% of the employed population of the country. The number of elderly people (55 years of age and older, i.e. the persons whose reserve for employment growth is the greatest one) was still increasing but at a slower pace (by 6.6% or 19.2 thousand persons). The employed population in the youth (15–29 years old) age group increased slightly – by 0.9%, or 2.1 thousand persons.

A positive impact on the labour market will be made by the amendments to the Labour Code that entered into force on 1 July 2017, which will form better conditions for the new participants to enter the labour market, for example, young students or parents with young children. It is expected that it will encourage labour force participation (in particular of youth and retirement age groups) and will mitigate a negative impact of demographic trends on the employment of the country; however, it will not eliminate it completely. After evaluation of the recently formed tendencies, we project that the employment indicators of the medium term, as compared to the ones projected in spring 2017, will be lower. It is projected that the number of the employed will consistently decrease during the whole medium term: –0.2% in 2017, –0.3% in 2018, –0.4% each in 2019 and 2020.

In the first half of 2017 the unemployment rate on average made up 7.5% and was by 0.7 percentage point lower than in the corresponding period of the previous year. The long-term unemployment rate during the year decreased by 0.4 percentage point down to 2.8%. The unemployment rate was reduced by a lower number of the unemployed, although the number of the employed population was also decreasing. Likewise in spring 2017, we project that the number of the unemployed, as the unemployment keeps decreasing, will further decline and in 2017 it will make up 7%, 2018 – 6.4%, 2019 – 5.9%, 2020 – 5.4%.

Wages

A persistent situation in the labour market favourable for employees – labour demand exceeding supply and diminishing unemployment – as well as strengthening negotiating powers of employees further stimulate growth of wages in 2017. In I quarter of 2017 the average monthly gross wages in the country (including individual enterprises) increased by 9.7 % (in private sector – 11%, public sector – 7.2 %) – this has been the most accelerated growth of wages since 2009. Wages kept increasing in enterprises of all types of economic activities, in particular in those where wages were the lowest, and the nature of activity is related to provision of services as well as in those where labour demand significantly exceeded supply: accommodation and catering services, construction, trade, and manufacturing. The rise in wages was also predetermined by the increased minimum monthly wages up to EUR 380 from 1 July 2016.

In the medium term labour demand will further exceed supply, therefore pressure to increase wages will remain. In 2017 growth of wages in the country will be accelerated also by the Republic of Lithuania Law on Payments for the Employees of State and Municipal Institutions which came into force on 1 February 2017 and the application of the provisions of which will increase wages of the lowest-paid professionals. Having regard to the development of wages in the country in the first half-year and having assessed the changed information concerning the wages fund of budgetary institutions financed from the State and municipal budgets, in the national economy a growth rate of wages close to that in 2016 is expected. In 2018 due to the projected low growth of wages in public sector, growth of wages in the economy should slow down. For these reasons in 2017 the projection of the average monthly gross wages is increased up to 8.3%, in 2018 – up to 6.2%. In 2019–2020 the changes in the average monthly gross wages will depend on the 7 development of economic factors – labour supply and demand, labour productivity, inflation, profitability of enterprises – and decisions of the Government of the Republic of Lithuania on the increase in wages for public sector employees. It is projected that wages will grow at the most accelerated pace in private sector – of the activities where the labour demand is buoyant and wages remain to be the lowest. The projected growth of wages at a more accelerated pace than labour productivity reflects strengthening negotiating powers of employees and wage convergence towards the wage rates in the single EU labour market.

Consumption

Under favourable conditions of both labour market and crediting, in the first half of 2017 household consumption expenditure was rapidly increasing (by 4%) and remained one of the most important sources of economic growth (contributed by 2.7 percentage points to GDP growth). Increasing labour and other income enabled the increase in household disposable income. The purchasing power of the population was reduced by the spurt in prices, but it remained strong due to higher increase in disposable income than in the prices.

The trends of the first half of 2017 show that it is possible to expect a more accelerated increase in household consumption expenditure in 2017 than it was projected in March 2017. It is projected that household consumption will increase by 4.2% (by 0.3 percentage point more rapidly than it was projected in March).

As consumer expectations remain quite stable, it is possible to expect consumer behaviour not to change too much. In the medium term household consumption will further significantly contribute to GDP growth. Changes in household consumption expenditure in the medium term, as compared to those projected in March, essentially should not change – in 2018 expenditure might grow by 3.7%, in 2019–2020 – by 3.5% each year.

Exports

After strengthening of the export demand in the EU and more rapid recovery of the Russian economy, exports of goods increase at a more accelerated pace than it was expected in March this year. Based on provisional data of customs declarations, Intrastat reports and VAT returns in the first half of 2017 the exports of the Lithuanian goods at current prices increased by 17.7 % (excluding mineral products – by 16%). As the prices for export goods increased by 6.7%, a real growth rate of export goods accounted for 10.2%. Exports of almost all groups of goods to the main export blocks increased.

Exports of goods of the Lithuanian origin at current prices increased by 16.1% (excluding mineral products – by 11.1%). Re-exports of goods increased by 20.5% (excluding mineral products – by 22.9%). The export results of June were the best ones this year (a 22.7% annual growth of total exports, 17.6% – only of the goods of the Lithuanian origin).

The rise in the exports of goods was predetermined by the increased exports of oil products (28.2%) (quantity in tonnes decreased by 7.4%), machinery and mechanical appliances, and parts thereof (28.2%), electrical machines and equipment, and parts thereof (26.5%).

A jump in the prices for export goods (a 6.7% growth) in the first half of 2017 was in essence predetermined by the prices for energy goods that increased by one third. Rapid growth of the prices for energy goods took place mostly due to the statistical base effect coming to an end related to the annual changes in oil prices. With the increase in the demand from February the prices for intermediate consumption goods started increasing, the rise in the prices for non-durable goods accelerated. Having regard to that, the prices for export goods should increase at a slower pace in the second half of 2017.

Despite good results of this year, in the medium term the Lithuanian exporters will have further to adapt to changing economic circumstances, manage currency risk, continue making investments to promote competitiveness and to make decisions on decrease of production costs, enhancement of operational efficiency and manufacturing capacities. A strong sustaining diversification of exports of goods creates certain optimism about export perspectives. Stable growth of exports of services, material investments increasing in manufacturing in the second half of 2016 create conditions for continuous development of exports in the medium term. In the medium term we project that in 2017 real exports of goods and services will increase by 9.3%, in 2018 – by 6.6%, 2019 – 6.5%, 2020 – 6.3%.

Risk for the Economic Development Scenario Fulfillment

Negative factors of the external environment that caused risk for the Scenario fulfillment in March 2017 have weakened but still remain. Geopolitical tension, challenges oppressing the EU – debt problems of some EU countries, problem of refugees invading Europe, terrorism threat – still exist. Low profitability and the burden of non-performing loans still cause difficulties for the European banks. The risk of political tension in the EU has decreased but not disappeared. Still unknown results of Brexit negotiations create economic and political uncertainty, due to which currently existing trends in the Lithuanian economy and the perspectives of the basic economic indicators laid down in this Scenario may change.

Domestic negative factors have not disappeared either. With accelerated increase in wages the risk that a great share of the increased labour force price will be shifted to the prices for services has realized. Therefore, the risk of a wage-price spiral has strengthened. A number of signs of heating of the economy have increased, in case of failure of managing which through macro-prudential and fiscal policy measures economic development would be different than projected in this Scenario, a risk of hard landing would arise.

The evidence that in the medium term Lithuania risks to fall into low growth trap is further strengthening: in the medium term the potential national GDP growth will remain significantly lower than during the period before the economic crisis; the GDP per capita (following the Purchasing Power Standard) has not increased for a number of years in turn (in 2014–2016 stood at 9 75% of the EU level). Some positive risk factors also exist, due to which the economic development may be more accelerated than projected in this Scenario: more accelerated than projected in the assumptions of this Scenario growth of both the EU and global economy, tax incentives for investments, cheaper energy goods, new Labour Code provisions, better financial situation of the Lithuanian population may enhance economic activity more than projected in this Scenario.

In case the essential assumptions did not fulfill based on which this Scenario was developed, the estimates of many indicators projected in this Scenario would also change.

The Source: Ministry of Finance of the Republic of Lithuania