Developments Since Transition Lithuania has recorded impressive economic growth in recent years, which helped improve living standards. Rapid growth has helped Lithuania to catch-up to EU average income levels, with GDP per capita (in PPS terms) reaching almost 61.6 percent of EU25 average in 2008 – significantly up from 47 percent in 2003. Growth was driven almost entirely by domestic demand, encouraged by large real wage increases, rapid credit growth, and stimulus from EU grants. High growth also helped to significantly improve labor market outcomes with unemployment reduced to 4.4 percent in 2007 from over 13 percent in 2003. Recent Economic Performance The economic growth that Lithuania enjoyed since the EU accession was driven almost entirely by domestic demand as households benefited from strong real wage growth and credit expansion, and investment was supported by large inflows of EU funds. The labor market tightened significantly with the unemployment rate declining steadily to 4.3 percent in 2007, one third of the 2003 level. Moreover, since Lithuania's accession to the EU, emigration has increased considerably adding to labor shortages and pushing up wages. As the economy expanded above its growth potential, overheating pressures mounted and significant external and internal imbalances developed. Both the current account deficit and inflation reached high levels, the latter complicating Lithuania’s Euro adoption plans (in May 2006 the EU rejected Lithuania’s application to join the Euro zone from January 2007, as inflation was marginally (0.1 percent) above the reference value). Furthermore, much of the rapid credit expansion was in foreign exchange and banks were taking on increasing exposures to real estate, which brought substantial risks to the banks' assets quality and financial sector stability. The policy response to these imbalances was insufficient. Given Lithuania’s currency board arrangement, the focus was on fiscal policy which tended to be pro-cyclical and expansionary despite robust economic growth translating into good revenue performance. The fiscal balance remained in deficit in most years (reaching 1.2 percent of GDP in 2007). After a period of overheating, economic growth started to slow down rapidly, which, together with the impact of the global financial crisis, has caused some concerns about Lithuania’s macroeconomic stability. As a result of economic overheating, 2008 saw a major economic slowdown and output growth turned negative (-2.2 percent year-on-year) in the fourth quarter. Risks to financial sector stability have further increased as a result of the recent global financial turmoil and related liquidity pressures. Furthermore, concerns have been raised about contagion risks from neighboring countries. The government is taking fiscal tightening measures in an attempt to keep fiscal deficit within the Maastricht limit of 3 percent of GDP. Nevertheless, Lithuania’s path of economic adjustment poses some risks for macroeconomic stability. As the expected slowdown in Lithuania’s main trading partners undermines the outlook for exports, prospects of economic recovery remain bleak, with the economy set to contract 10 percent or more in 2009. Challenges Ahead In the short term, mitigating the impacts of economic recession and the global financial crisis is the main challenge ahead. Strong domestic adjustment policies, including measures to stabilize public finances, will need to be implemented in order to unwind the accumulated imbalances. At the same time, one of the major challenges will be protecting the most vulnerable social groups from the impact of the ongoing economic crisis. In the medium term, Euro adoption and sustainable convergence with the EU are the key goals, to be supported with further structural reforms and efforts to foster the creation of a knowledge economy as a way of increasing Lithuania’s global competitiveness.
| 
RSS