Lithuanian Economic Review

2013 2013 REVIEW ECONOMIC LITHUANIAN MAY ISSN 2029-8471 (online)

Lithuanian Economic Review analyses the developments of the real sector, prices, public finance and credit in Lithuania, as well as the projected development of the domestic economy. The material presented in the Review is the result of statistical data analysis, modelling and expert assessment. The Review is prepared by the Bank of Lithuania.

During the preparation of the Lithuanian Economic Review, the data of the Bank of Lithuania, Statistics Lithuania, the European Central Bank, Eurostat, the International Monetary Fund, Bloomberg and other data published up to 30 April 2013 were used.

Reprinting is allowed only for education and non-commercial purposes, if the source is indicated.

ECONOMIC OUTLOOK ...... 3

I. INTERNATIONAL ENVIRONMENT...... 5

II. REAL SECTOR ...... 7

III. LABOUR MARKET...... 11

IV. EXTERNAL SECTOR ...... 12

V. PRICES AND COSTS ...... 16

VI. CREDIT AND DEPOSITS ...... 18

VII. GENERAL GOVERNMENT FINANCE ...... 19

Boxes

Box 1. Lithuanian export concentration ...... 8 Box 2. Factors for the Lithuanian export market share development in 2000–2011 ...... 13

2 List of tables Table 1. Macroeconomic indicators of the US, euro area, Japan and Russia ...... 5

List of charts Chart 1. Purchasing managers’ indices (PMI) ...... 5 Chart 2. GDP developments in Lithuania's main export partners ...... 5 Chart 3. Asset side of the main central bank balance sheets ...... 6 Chart 4. Contributions to growth of real GDP by expenditure approach ...... 7 Chart 5. Contributions to investment growth ...... 7 Chart 6. Household wage bill and consumption ...... 7 Chart 7. Unemployment rate ...... 11 Chart 8. Number of employed by economic activity ...... 11 Chart 9. Wages in the tradable and non-tradable sectors ...... 11 Chart 10. Annual changes of export of Lithuanian origin products and re-exports ...... 12 Chart 11. Contributions to the growth of export of Lithuanian origin products ...... 12 Chart 12. Components of the current account balance ...... 12 Chart 13. Contributions to annual inflation ...... 16 Chart 14. Unit labour costs and non-energy consumer prices ...... 16 Chart 15. Global food commodity prices ...... 16 Chart 16. Contributions of administered prices to annual inflation ...... 17 Chart 17. Crude oil price and fuel prices in Lithuania ...... 17 Chart 18. Contributions to annual changes in banking sector’s loan portfolio ...... 18 Chart 19. Contributions to changes in weighted average interest rate on new loans to the private sector ...... 18 Chart 20. The development of the structure of bank deposits and the difference of interest rate ...... 18 Chart 21. Contributions to general government revenue growth ...... 19 Chart 22. Contributions to general government expenditure growth ...... 19 Chart 23. General government debt ...... 19

Abbreviations

% per cent CIS Commonwealth of Independent States EC European Commission ECB European Central Bank EU European Union Eurostat statistical office of the European Union excl. excluding GDP gross domestic product HICP harmonised index of consumer prices IMF International Monetary Fund incl. including p.p. percentage point rh scale right-hand scale US United States of America USD United States dollar

VAT value-added tax LIETUVOS EKONOMIKOS APŽVALGA / 2012 m. lapkritis

ECONOMIC OUTLOOK 3

The economy of Lithuania still exhibits strong growth, but it has slowed down slightly. In the second half of last year exports had risen exceptionally strongly, especially due to a good agricultural harvest and intensive re- export, but currently export growth has decelerated. As expected, with the decrease in reserves, the export of agricultural and food products is not rising as much as before; foreign trade in other products is also noticeably decelerating, because foreign demand is growing less. The development of these indicators had an impact on the development of manufacturing — production by its main groupings is growing much less. Such changes were expected in the tradable sector. It was projected that export in 2013 will grow less than in 2012. This outlook does not change: it is expected that in the upcoming quarters the development of export will be slower and more in line with the development of external demand. Nevertheless, economic growth is lower than expected. This is, first of all, related to the further decrease in investment. Compared to other EU countries, Lithuania’s share of investment in non-residential buildings and structures, compared with GDP, remains rather large; however, in Lithuania a decline in this type of spending mainly contributes to lower general investment. Among the most rapidly decreasing — government financed investment in infrastructure objects. A lot less investment is made in machinery and other equipment. It should be noted that only about a fourth of investment spending on machinery and equipment is made by manufacturing. A rather large part of spending on this investment category is made by retail and wholesale trade and construction, i.e. economic activities, the future prospects of which were assessed particularly cautiously last year. This negatively affected the decisions of these economic activity enterprises on development. This year investment in machinery and other equipment should also not increase by much. Such an assumption is the result of foreign trade partner prospects being worse despite presently better confidence indicators of Lithuania’s enterprises. The development of investment in the nearest quarters will be significantly affected by government expenditure on infrastructure objects. As these expenditures increase to the level planned in the state investment programme, general domestic investment should stabilise. Slower economic growth has an effect on the labour market. The increase in the number of employed in the second half of last year was due to an increase in activity in the tradable sector. There was particularly an increase in the number of employed in agriculture. In the non-tradable sector employment rose less, while in some kinds of economic activities it dropped. Since development of the tradable sector is gradually slowing down, employment in the country’s economy should grow less, too. This insight is confirmed by the most recent unemployment data — the number of newly unemployed persons is no longer decreasing. The change in economic activity will affect wage developments as well. Unemployment is still only approaching the natural unemployment rate; therefore pressure on wages should remain moderate. As was recently, due to a lack of qualified employees, wages should increase only in some economic activities. However, this year, average wages should grow due to the minimum wage that was increased in the beginning of the year, and which will be the driving force behind the larger than last year rise in unit labour costs. It is expected that in the further forecasting horizon, when the effect of the minimum wage increase will disappear, these costs will again rise less. Changes in the labour market lead to a lower increase of household income. The growth in private consumption, as was projected, is stabilising. Nevertheless, it has been rising substantially — it is supported by household income other than wages, for example, property income, as well as prices increasing less than before. It is projected that in the nearest quarters the development of private consumption will not change significantly. Although average wages will rise due to the increased minimum wage, this will, in turn, limit the growth of employment. Disposable income of households will depend largely on the development of the tradable sector, which is expected to be more moderate than in several previous years. This will affect the ability of households to consume. Domestic demand, covering consumption and investment, will nevertheless be the key factor in real GDP growth in the entire forecasting horizon. As long

as cautious assessment of the outlook dominates in Lithuania and foreign countries, this demand will rise less, while in 3 further projected years it should grow more. It is projected that real GDP, which last year grew 3.7 per cent, this year

will rise by 2.8 per cent, and in 2014 — by 3.5 per cent. 201 M a y

Changes in economic activity in Lithuania and globally have a dampening effect on consumer prices too. / Compared to the end of last year, overall inflation was mostly reduced by the trends of prices, more favourable to consumers, related to external factors: there was a significant slowdown in the annual growth of food and administered prices, while fuel prices now are lower than a year ago. This is related to global commodity prices: food commodity and oil prices are lower than a year ago; imported natural gas became cheaper, while due to the latter, prices of heating and natural gas for Lithuanian consumers decreased. Although inflation was reduced most by developments in prices related to external factors, the prices of industrial goods and market services, depending more on the domestic situation, also rose slower. Overall, in the beginning of the year, inflation decreased more than was expected. If global price trends continue to be favourable, it can be expected that inflation will be much lower than in several previous years. In 2013 inflation is projected to be 2.0 per cent, while in 2014 — 2.4 per cent. Regardless, the risk related to global

commodity prices remains relevant: the stocks of some agricultural raw materials are very small, while for the oil market LITHUANIAN ECONOMIC REVIEW

geopolitical risk is still significant. In addition, inflation can be affected by increased minimum wage, having an effect on the 4 development of unit labour costs.

Outlook of Lithuania’s economy in 2013–2014

May 2013 projection February 2013 projection 2012 2013* 2014* 2012* 2013* 2014* Price and cost developments (annual percentage changes) Average annual inflation (based on HICP) 3.2 2.0 2.4 3.2 2.4 3.0 GDP deflator 2.8 2.2 2.9 2.0 2.6 3.6 Wages (compensation per employee) 3.2 4.1 3.3 3.0 4.4 3.7 Import deflator 4.2 2.0 1.7 4.4 3.0 1.9 Export deflator 3.5 1.8 1.5 3.6 3.0 1.6 Economic activity (constant prices; annual percentage changes) Gross domestic product** 3.7 2.8 3.5 3.6 3.1 3.8 Private consumption expenditure 4.3 2.5 3.2 4.6 2.5 3.3 General government consumption expenditure 0.4 1.2 2.4 1.3 1.3 2.4 Gross fixed capital formation –2.5 2.6 6.2 –0.9 4.6 7.4 Exports of goods and services 11.9 5.8 5.9 10.5 5.8 6.0 Imports of goods and services 6.6 5.9 6.3 6.0 6.1 6.5

Labour market Unemployment rate (annual average as a percentage of labour 13.2 11.6 10.1 13.2 11.6 10.0 force) Employment (annual percentage change) 1.8 1.4 1.7 1.8 1.4 1.8

External sector (as a percentage of GDP) Balance of goods and services 0.7 0.1 –0.3 0.0 –0.3 –0.9 Current account balance –0.4 –1.8 –2.1 –1.8 –2.0 –2.6 Current and capital account balance 1.8 –0.1 –0.5 0.3 –0.3 –1.1 * Projection. ** Changes in inventories are not included in GDP components.

LITHUANIAN ECONOMIC REVIEW / May 2013

I. INTERNATIONAL ENVIRONMENT 5

In the first quarter of 2013, uncertainty increased due to unfa- Improving expectations of the global economic outlook in the end of 2012 was dampened by the vourable economic developments in the euro area and the events in events in Cyprus and rather poor economic Cyprus, while improved sentiment on global economic prospects development in the euro area. receded. Currently it is anticipated that in 2013 world GDP will grow similar to 2012, and growth will accelerate only in 2014. The most difficult Chart 1. Purchasing managers’ indices (PMI) situation, as before, will be in the euro area since the recession that began 60 in the third quarter of 2012 is strengthening and should persist for longer 55 than previously expected. 50

The economic situation in the US is reasonably good. In the fourth 45 quarter of 2012, quarterly GDP growth in the US declined to 0.1 per cent, 40 but the slowdown was due to one-off factors, and in the first quarter 35 of 2013 the economy was growing faster (0.6% quarter-on-quarter). The 30 labour market situation is also gradually improving — in March the US 2008 2009 2010 2011 2012 2013 unemployment rate dropped to 7.6 per cent, i.e. to its lowest level in four Global composite PMI Global manufacturing PMI years. In addition, the real estate market of the country is recovering: the Global services PMI number of housing sale transactions has been growing for almost two Source: Markit. years, and the housing prices have been on the rise for about a year. However, the country’s economic growth is revised slightly downwards, Currently it is anticipated that the recession in the euro area will be slightly stronger and more since somewhat stronger than expected fiscal consolidation became prolonged than previously expected. The situation effective in the first quarter of 2013. Since January, some taxes in the US in the US economy is much more favourable. have risen, and in March the decision to slightly reduce government Table 1. Macroeconomic indicators of the US, euro spending became effective because the US Congress did not agree on area, Japan and Russia measures that would have allowed postponing the reduction. With such (percentage changes, unless otherwise indicated) consolidation, the US government deficit will decline. However, the US 2012 2013* 2014* Congressional Budget Office, which presents long-term federal budget Real GDP change deficit projections, estimates that over the next decade, it will average US 2.2 1.9 3.0 about 3.3 per cent of the GDP annually. Such developments of the gov- Euro area –0.6 –0.4 1.2 ernment finances remain a concern. Therefore, it is likely that decisions Japan 2.0 1.6 1.4 aimed at reducing the general government deficit will be one of the major Russia 3.4 3.4 3.8 topics of US domestic policy discussions and negotiations. Average annual inflation Due to the disorderly process on the agreement of international US 2.1 1.8 1.7 assistance for Cyprus, confidence in the euro area prospects has Euro area 2.5 1.6 1.5 Japan 0.0 0.1 3.0 been undermined from strengthening only a few months ago. Since Russia 5.1 6.9 6.2 the negotiations were very difficult and prolonged, there are concerns that General government balance, per cent GDP the reluctance of strong euro area members to provide assistance for US –8.5 –6.5 –5.4 another state with financial problems may continue to increase. In addition, Euro area –3.7 –2.9 –2.8 the fact that Cyprus has almost implemented a decision to write off part of Japan –10.2 –9.8 –7.0 all deposits has created a negatively assessed precedent in the euro area, Russia 0.4 –0.3 –1.0 and it can have an impact on the development of the banking sector in Sources: IMF and EC. weaker countries of the region. Finally, Cyprus introduced capital re- * Forecasts. strictions, which can be applied in emergency situations, but they in The international environment is becoming less general do not meet the principles of operation of the monetary union. favourable — the economic developments of most

Expected significant GDP decline of the Cypriot economy, due to the of the main export partners of Lithuania are slowing relatively small size of it, will have only a very negligent effect on the euro down. area economy. However, the events in Cyprus have increased concerns Chart 2. GDP developments in Lithuania’s main on the absence of adequate decisions that enable management of the export partners prolonged crisis in the region. Percent, annual change The development of the Russian economy is slowing down more 10 than was expected, and lower economic growth is projected in 2013. 5 Compared to the first two quarters of 2012, in the fourth quarter of 2012 0 the country’s GDP was rising at a twice slower rate (2.1% per year) and in –5 the first quarter of 2013 growth declined even more (according to prelimi- –10 –15 nary estimates — up to 1.5% per year). The country’s Minister of Econom- –20 ic Development said that such trends, particularly slower export and 2008 2009 2010 2011 2012 investment growth, are largely attributed to the euro area’s economic Russia Euro area downturn. Less favourable economic developments in Russia might Germany Latvia encourage the central bank to implement the monetary policy, which would Estonia Poland stimulate economic growth. So far, the monetary policy has been con- Sources: Eurostat, Federal State Statistics Service of the Russian Federation LITHUANIAN ECONOMIC REVIEW / May 2013 servative, as the central bank paid more attention to the larger than and Bank of Lithuania calculations. targeted inflation.

Major central banks continue to implement non- The world’s major central banks are not expected to change the 6 standard monetary policy measures. direction of monetary policy in the coming months; it will remain expansionary. Over the first four months of 2013, the central banks of the Chart 3. Asset side of the main central bank balance sheets US, euro area and UK made no new monetary policy decisions, but the statements of ECB representatives reinforced the expectations that such USD trillions USD trillions decisions can be made in the nearest future. The international markets 4,5 0,9 4,0 0,8 were mostly surprised by the Bank of Japan, which is headed by a new 3,5 0,7 chairman since March 19. Already in January the Bank of Japan an- 3,0 0,6 nounced that it will double the inflation target from 1 to 2 per cent. Such 2,5 0,5 2,0 0,4 change is substantial in the country in which the inflation rate during the 1,5 0,3 past fifteen years has been largely negative, and stood at 0 per cent 1,0 0,2 in 2012. On April 4 the Bank of Japan announced that it changed the main 0,5 0,1 monetary policy operating target — the indicator directly targeted through 0,0 0,0 2007 2008 2009 2010 2011 2012 2013 money market operations. It will focus not on the overnight interest rate,

Federal Reserve System but rather on the monetary base. To ensure that inflation would increase to Eurosystem Bank of Japan 2 per cent in two years, the Bank of Japan plans to double the monetary Bank of England (rh scale) base and the outstanding amount of Japanese government securities. It is Sources: Bloomberg, Federal Reserve System and Bank of Lithuania calculations. expected that this new stimulus plan will weaken the Japanese yen, increase the country’s exports and GDP growth.

LITHUANIAN ECONOMIC REVIEW / May 2013

II. REAL SECTOR 7

Lithuania’s economy continues to grow at one of the fastest rates With decelerating growth in domestic demand, net exports remain the key contributor to economic in the EU, and net exports are an important growth factor. The extreme- development. ly favourable impact of net exports was determined by subdued growth of domestic demand and one-off factors. Lower growth in domestic demand Chart 4. Contributions to growth of real GDP by expenditure approach had an impact on imports, especially on import of capital goods, and one-off factors — a record agricultural harvest in Lithuania and poor harvests abroad — significantly increased exports. Exports grew due to external Percentage points Per cent, annual change demand for other goods as well; however, it increased less than previously. 30 30 20 20 Contribution of net exports to GDP growth was partially offset by changes in 10 10 inventories: as previously accumulated inventories of agricultural products 0 0 1 are exported, total inventories in the country go down. –10 –10 –20 –20 The outstanding public investment programme is an important de- –30 –30 terminant of investment decline. The public investment programme is –40 –40 mostly focused on the infrastructure development in Lithuania. The con- 2005 2006 2007 2008 2009 2010 2011 2012 2013 struction of this particular type of buildings, i.e. engineering structures, in the Final consumption expenditure Domestic investment (excluding inventory changes) second half of 2012 declined the most. However, investment in civil engi- Net exports Changes in inventories neering structures is likely to recover in the coming quarters, as the new GDP (rh scale) public investment programme envisages greater investment in 2013. In- Sources: Statistics Lithuania and Bank of Lithuania calculations. vestment in machinery and equipment, including transport equipment, is on Outstanding public investment programme is an a similar level as the year before. They are especially supported by the important determinant of investment decline. increased business expenditure for vehicle fleet renewal. However, the growth of the main trading partners is projected to be lower, so the trends of Chart 5. Contributions to investment growth investment in transport equipment in the short term might be less favoura- Percentage points Per cent, annual change ble. So far there is no recovery of investment in other machinery and 60 60 equipment. It should be noted that manufacturing composes about a quarter 40 40 of this investment. A significant part of investment in these capital goods 20 20 was made by retail and wholesale trade, construction, namely in economic 0 0 activities where future outlook throughout the last year was extremely –20 –20 –40 –40 cautious. Such caution adversely affected the development decisions of the –60 –60 enterprises of these economic activities. In the context of uncertainty over 2005 2006 2007 2008 2009 2010 2011 2012 the prospects of the economy, investments in machinery and equipment in Housing Other buildings and structures the near future are not expected to change much. Transport equipment Machinery and other equipment Although the real wage bill decreased, improving household senti- Other investment and statistical discrepancies Gross fixed capital formation (rh scale) ment and smaller than a year ago decrease in liabilities to the banks Sources: Statistics Lithuania and Bank of Lithuania calculations. generate quite rapid growth of private consumption. Better household sentiment is probably related to the higher disposable income expectations Improvement in household sentiment and smaller than a year ago decrease in liabilities to banks lead attributable to the minimum monthly wage increase. The favourable impact to a quite rapid growth of private consumption. of credit is partly related to the base effect, since household financial liabilities to the banks decreased more than ever in the fourth quarter of 2011. At Chart 6. Household wage bill and consumption the end of 2012 they did not drop as much and therefore households could Per cent, annual change Per cent, annual change use a bigger share of disposable income for consumption. It is worth noting 30 30 that the consumption could also be promoted by irregular household income 20 20

from assets, the greater part of which is comprised of dividends. Assessing 10 10 the short-term perspective, private consumption is expected to grow at a 0 0 similar pace as the second half of last year. An on-going improvement of –10 –10 household sentiment, increased minimum wage and lower price growth will –20 –20 –30 –30 be the key factors that will promote private consumption, but their effects will 2008 2009 2010 2011 2012 be inhibited by slower employment growth. Real private consumption (rh scale) Adjusted real wage bill* Real wage bill Nominal wage bill

Sources: Statistics Lithuania and Bank of Lithuania calculations. * Wage bill is increased by consumer credit and other loans and decreased by debt servicing cost.

______1 In national accounts, inventories include materials and supplies (for intermediate use in production), products and services in progress, finished products no longer intended to be processed by manufacturers, and products for resale. Agricultural production is included in GDP when it is harvested, but because of the price trends in the market, the terms and conditions of transactions or logistical constraints usually reach consumers later. Harvest that does not reach LITHUANIAN ECONOMIC REVIEW / May 2013 consumers is seen as inventory, which initially has a favourable impact on economic growth, and later, when harvest reaches consumers and inventories dwindle — a negative effect. If harvest consumers are abroad, inventory reduction is offset by higher exports.

8 Box 1. Lithuanian export concentration

In 2012, exports again became the main driver of economic growth. For export growth to be sustainable, it is important that the export growth withstand a variety of demand and supply shocks. One of the ways to reduce their impact is to diversify exported products by products or markets. Various concentration indices are calculated to assess the level of export diversification, one of the most popular being the Herfindahl-Hirschman Index (HHI)1:

here: — product exports (or exports to the country ), — number of product groups (or countries), — total exports. The index value can range from 0 to 1. However, the lowest HHI value varies depending on the number of product groups or countries used in the calculation — the higher it is, the smaller the potential lowest value of the index. HHI would be the smallest when the share of export of all product groups or countries is the same. When the entire export consists of only one group of products, or products are exported to only one trading partner, the index acquires its highest value. To avoid extremely large fluctuations of the index, further analysis is made based on the export data excluding the export of mineral fuels, lubricants and related materials, since the latter is highly dependent on price fluctuations. These products are classified as category 3 in the Standard International Trade Classification (SITC).

Chart A. Values of HHI of the exports to EU countries and Croatia in 2011 (estimated by breaking down the exports into the groups of products)

HHI

0,520

0,470

0,420

0,370

0,320

0,270

0,220

0,170

Malta Ireland Slovakia Cyprus Hungary Luxembourg Republic Czech Slovenia Finland Germany Spain Romania Bulgaria Sweden United Kingdom Belgium Poland Estonia Croatia Portugal Latvia Austria Greece France Italy Denmark Lithuania the Netherlands

Sources: Comtrade (UN) and Bank of Lithuania calculations.

In assessing the export concentration by commodities, the two-digit level of SITC Revision 3 classification is used. In 2011, the Lithuanian export HHI value was 0.186 (see Chart A). It is the lowest HHI value among the Baltic states (in Latvia, the value is 0.207, in Estonia – 0.211), and one of the lowest in the EU (Croatia is included in the calculations, as this country will soon become a member of the EU). Latvia and Estonia are also among the 10 countries with the highest export diversification in the EU. Large export diversification by product means that the economy of Lithuania (and other Baltic states) should be relatively less affected by the shocks in demand for the most important export products than most other EU economies. Chart B. HHI changes in 2000–2011 (estimated by breaking down the Lithuanian export diversification by products grew export into the groups of products) throughout the whole period of 2000–2011 (see Chart B).

A similar trend prevailed in Estonia and Latvia. Compared HHI to the other Baltic states, in Lithuania export concentration 0,360 was decreasing significantly slower. Such changes in 0,340 export concentration are explained by significantly lower 0,320 concentration of Lithuanian exports at the beginning of the 0,300 0,280 analysed period. 0,260 Calculations of the concentration index can also esti- 0,240 mate the reasons for export growth in the product groups 0,220 that contributed most to the expansion of total exports. If 0,200 export diversification of a certain group of products 0,180 0,160 increases, this suggests that export of less important 2000 2002 2004 2006 2008 2010 products in that group (making up a smaller share in the total exports of the group) in the analysed period grew Lithuania faster than export of its more important products, i.e. the Latvia structure of exports in the certain product group becomes Estonia more gradual. When the trend is the opposite — more Sources: Comtrade (UN) and Bank of Lithuania calculations. LITHUANIAN ECONOMIC importantREVIEW / May 2013 product exports grow faster than less important . product exports — export diversification of the certain product groups decreases, i.e. increasing specialization in export of more important products. The analysis is carried out

by analysing the effect of changes of export concentration in individual product groups, using more detailed exports data. 9 Analysis of the HHI development of the main exported product groups shows that exports of product groups contrib- uting the most to Lithuanian export expansion — food, beverages and tobacco group, chemical, rubber, plastics and non- metallic mineral product group — grew due to the relatively robust growth of export of less important products, i.e. the export concentration of these groups decreased. Concentration in the food, beverages and tobacco product group decreased in 1999–2006, and later remained essentially unchanged. For the export of chemical, rubber, plastics and non-metallic mineral products, the year 2006 was essential. At that time, larger factories of primary plastics were launched in Lithuania, which reduced the export concentration in that product group. The development of export of other less important product groups — vehicle groups and wood and wood products, including furniture, paper and cardboard — was led by the faster growth of the key product exports: in the group of vehicles — cars and other motor vehicles, and in the group of wood and wood products, including furniture, paper and cardboard — furniture. Textile products were probably the only one of the most important export product groups, which reached higher diversification by products due to the declining traditional textile industry. At the end of the analysed period, the share of textile products in total exports was 3 times lower than at the beginning and niche products accounted for an important part of textile exports. Export concentration of other groups of products over the analysed period did not change much, which indicates that the structure of products comprising these product groups did not change significantly. During the analysed period, basically in all product groups that determined the development of Latvia’s exports — metals and metal products, chemical products, non-food raw materials — the exports of less important products was growing faster compared to the more important product exports, i.e. export diversification in these product groups increased. Only the diversification of exported products from the agricultural and industrial machinery and equipment group declined, while concentration changes in the food, beverages and tobacco group were minor. Somewhat less than one-third of the total exports in Estonia are agricultural and industrial machinery and equipment. At the beginning of the analysed period exports of this group of products were highly concentrated, the main product — telecommunication equipment — accounted for three-quarters of this group’s exports. However, Estonia started to export more construction engineering equipment, electrical equipment and other similar equipment, decreasing the share of telecommunication equipment to 40 per cent at the end of the period, thus agricultural and industrial machinery and equipment export diversification increased. Export diversification of other major product groups — food, beverages and tobacco, non-food raw materials — also increased over the period in question. The analysis of export concentration by geographical markets shows that the concentration of Lithuanian exports among the EU member states is average (see Chart C). However, in terms of the Baltic States, it is the smallest (in 2011 the Lithuanian HHI was 0.085, Latvian — 0.086, Estonian — 0.101). Therefore, if compared to other EU countries, the demand shock associated with the major trading partners might have a relatively greater impact than the demand shock associated with the main exported products groups. Thus, in terms of the geographic markets Lithuanian exports are not distributed as well as by products. Significant market concentration of Lithuanian exports is in part associated with very high export to Russia. At the end of the analysed period, one-fifth of the exported products were delivered to that country. Therefore, in the event of demand shock in Russia, Lithuania’s economy might be affected rather heavily.

Chart C. Value of HHI of the exports of EU countries and Croatia in 2011 (estimated by breaking down the export into countries)

HHI

0,150

0,130

0,110

0,090

0,070

0,050

0,030

Estonia Slovenia Czech Republic Czech Luxembourg Portugal Austria Ireland Cyprus Poland the Netherlands Hungary Slovakia Belgium Latvia Lithuania Romania Malta Spain Croatia Bulgaria France Denmark United Kingdom Italy Greece Finland Sweden Germany

Sources: Comtrade (UN) and Bank of Lithuania calculations.

In the context of the current sovereign debt crisis in the EU, it was decided to evaluate the concentration of Lithuanian exports only to EU member states. Assessing it gave much better results than evaluating the concentration of Lithuanian exports to all global markets. In 2011, among the EU member states, the index of the Lithuanian export concentration to the EU is one of the lowest, only the corresponding indicators of Germany and Sweden being less. This suggests that in Lithuania exports to EU member states is divided relatively better than in other EU countries and in the event of demand shock in one of the major trading partners, the Lithuania’s foreign trade would suffer less. The situation is somewhat different in other Baltic countries. The diversification of Latvia’s exports to EU countries is higher than the exports to the world markets, and the diversification of Estonia’s exports to EU countries is similar to the diversification of its exports to LITHUANIAN ECONOMIC REVIEW / May 2013 the world markets.

Chart D. HHI changes in 2000–2011 (estimated by breaking down the 10 Unlike export concentration by product, concentration of Lithuanian exports to the rest of the world in the ana- export into countries) lysed period rose (see Chart D). Although initially the latter declined, however, since 2004 it began to grow, with HHI a brief pause only in 2009. Among the Baltic countries, 0,140 export concentration by markets was increasing only in 0,130 Lithuania. In Latvia in the analysed period it remained 0,120

broadly unchanged. In Estonia significant export concen- 0,110 tration by markets was in 2000–2002, after which it fluctuated around a certain long-term average. In as- 0,100 sessment of changes of concentration of export only to 0,090 EU countries, no major changes have been observed over 0,080 the entire analysed period. 0,070 In summarizing the results, it can be concluded that 0,060 the Lithuanian export structure is well diversified. Increas- 0,050 2000 2002 2004 2006 2008 2010 ing diversification by products resulted in the development of export of the product groups, which contributed the most to expansion of total exports. However, export of Lithuania some of the less important groups of products grew due to Latvia increasing specialization. Furthermore, there are some Estonia concerns about the weakening export diversification by Sources: Comtrade (UN) and Bank of Lithuania calculations. markets and increasing export dependence on the economic situation in Russia. Diversification of exports in other Baltic countries is much lower than the Lithuanian exports, but higher than the EU average.

1 In order to highlight the difference between the countries, modified HHI is used. Classical formula for the index is .

LITHUANIAN ECONOMIC REVIEW / May 2013

III. LABOUR MARKET 11

Moderately improving in the earlier quarters of 2012, at the end of Despite the increasing general level of unemployment, long-term and youth unemployment has the year the situation in the labour market slightly worsened. In the declined. fourth quarter, unemployment rose to 13.0 per cent (in the third quarter it amounted to 12.3%), but was 0.7 percentage points lower than a year ago. Chart 7. Unemployment rate Typically, at the end of the year the number of unemployed grows due to the seasonality in certain economic activities. However, the increase in the Per cent 40 unemployment rate cannot be entirely explained by seasonality — increase 35 in unemployment was recorded in the fourth quarter even after eliminating 30 2 seasonality. It is likely to be mainly associated with the service sector, as 25 the number of unemployed that had been previously employed in this sector 20 grew the most at the end of the year. On the other hand, labour market 15 10 developments are mixed. The number of long-term unemployed, i.e. per- 5 sons who are unemployed for more than a year, declined in the last two 0 years. However, the number of people unemployed for less than a year, 2005 2006 2007 2008 2009 2010 2011 2012 which decreased in 2011, stopped declining in 2012 and even slightly Unemployment rate increased at the end of it. Long-term unemployment rate Youth unemployment rate

Although employment was positively affected by one-off factors Sources: Statistics Lithuania and Bank of Lithuania calculations. related to agricultural harvest, they were not sufficient to maintain Note: data until the first quarter of 2011 are recalculated based on the 2011 Population and Housing Census data. strong annual growth in the number of employed recorded in the middle of the year. In the fourth quarter employment was 0.8 per cent The contribution of agriculture to employment was higher than a year ago. Mostly it was because of the growing number of positive, while that of services sector – negative. self-employed. The growth in the number of employees was the slowest since the beginning of the recovery in the labour market. The number of Chart 8. Number of employed by economic activity employed in the public sector remains nearly unchanged for more than a year, which means that employment is growing mainly due to the increasing Percentage points Per cent, annual change 6 6 number of the employed in the private sector. From the middle of the year 4 4 agriculture significantly contributes to employment growth — at the end of 2 2 the year the number of persons employed in the sector has been higher by 0 0 –2 –2 a tenth compared to a year ago. It is likely to be still affected by bountiful –4 –4 harvest, but its impact is likely to be temporary. The impact of the service –6 –6 sector, which has significantly contributed to the growth of employment in –8 –8 –10 –10 the first half of the year, decreased thereafter, and at the end of the year the 2005 2006 2007 2008 2009 2010 2011 2012 number of employed in the sector has been even less than in the same Agriculture period in 2011. Industry Construction Services sector Wages grew moderately. In the fourth quarter the nominal gross earn- Overall economy (rh scale) ings increased by 2.6 per cent over the year — at a similar rate as in the Sources: Statistics Lithuania and Bank of Lithuania calculations. previous four quarters. Both in the public and private sectors wages rose at Note: data until the first quarter of 2011 are recalculated based on the 2011 Population and Housing Census data. a similar rate. In the tradable sector — manufacturing and agriculture — it has been growing twice as fast as in the non-tradable sector for almost a year. The impact of irregular payments, which contributed significantly to Wages grew moderately, noticeably faster in the earnings growth in the beginning of 2012, was minor over the last two tradable sector than in the non-tradable. quarters of 2012. Chart 9. Wages in the tradable and non-tradable

As the outlook of economic growth is quite uncertain, significant sectors improvement in the labour market situation in the near future is unlike- Per cent, annual change ly. In January–March, compared to the same period a year ago, the number 25 of registered unemployed was lower, but the rate of decline became notice- 20 ably slower from the middle of last year. Business surveys also do not allow 15 expectations of retail and other service sector’s employment growing 10 strongly in the near future. The retail trade sector’s expectations were well 5 below levels seen in the years before the recession, while those of other 0 service companies deteriorated quite noticeably during the second half of –5 –10 the year. However, employment expectations in industry were relatively 2006 2007 2008 2009 2010 2011 2012 optimistic, similar to these before the economic downturn. The construction Overall economy Non-tradable sector sector, which was pessimistic about their number of workers in the future Tradable sector

during the whole of 2012, became more upbeat recently. Sources: Statistics Lithuania and Bank of Lithuania calculations. LITHUANIAN ECONOMIC REVIEW / May 2013

______2 According to the seasonally adjusted Eurostat data, in the fourth quarter the unemployment rate increased by 0.2 percentage points (to 13.2%).

12 IV. EXTERNAL SECTOR Continued decline in the euro area and weakening domestic demand in Russia leads to deterioration of Due to the impact of foreign demand, export is growing slower, but Lithuanian export development. the growth is still relatively rapid, as exports of agricultural products continue to be high.3 Development of exports of Lithuanian origin and re- Chart 10. Annual changes of export of Lithuanian origin products and re-exports exports is similar: after a very dashing second half of 2012, annual growth is (three-month moving sums) fading. Re-exports are growing slower due to the slowdown of domestic demand growth in Russia, where the largest re-export part of Lithuania is Per cent, annual change 80 directed. This factor and continued downturn in the euro area also affect the

60 export of products of Lithuanian origin. Data of January–February 2013 show that the trends in most groups of Lithuanian origin products deteriorat- 40 ed — growth of export in furniture, machinery and equipment slowed down, 20 and exports of metals were significantly lower than a year ago. However, 0 such development of foreign demand is outweighed by still rapid growth of –20 petroleum product exports and particularly improved Lithuanian agricultural –40 exports. From September 2012 to February 2013 more than 2.5 times more 2008 2009 2010 2011 2012 2013 Total exports grain was sold than in the corresponding period of the previous year, and Exports of goods produced in Lithuania Re-exports the nominal value of their exports, due to high global food prices, exceeded Sources: Statistics Lithuania and Bank of Lithuania calculations. 1.8 billion litas and was more than three times higher. Thus, agricultural and oil product export indicators are the key factors accounting for more than

The development of exports of Lithuanian origin 90 per cent of annual export growth in January–February. products is particularly driven by agricultural exports, but such effect would wither away in the The expansion of export is likely to decline in the near future. It coming months after exhaustion of the previous seems that in the first quarter of 2013 export will grow more slowly than in year’s harvest inventories. the previous several quarters, especially because of the depletion of Lithua-

Chart 11. Contributions to the growth of export of nian harvest inventories. However, export growth should be sustained by Lithuanian origin products long-term supply agreements of the sectors, important for export, and by the (three-month moving sums competitiveness of the Lithuanian producers, which allows many Lithuanian exporters to increase their foreign market share even with weak external Percentage points Percent, annual change 45 45 demand. The activity of the country’s largest exporter, AB ORLEN Lietuva, 30 30 which should be more stable than in 2012, will also contribute to the devel- 15 15 opment of export. A longer-term perspective of Lithuanian export will be 0 0 driven mainly by developments in the euro area crisis and the ability to –15 –15 preserve industry competitiveness. –30 –30 In the fourth quarter of 2012 there was a current account surplus –45 –45 2008 2009 2010 2011 2012 2013 (3.4% of GDP). It was mainly due to favourable foreign trade effects, i.e. Agricultural products and food Chemical products and plastics intense export and relatively lower import growth. The quarterly surplus of Wood and articles of wood Metals goods balance was one of the largest since the beginning of data collection. Machinery and appliances Vehicles Lithuanian origin agricultural exports was particularly favourable to the Other Exports of goods (rh scale) foreign trade balance, since, unlike in manufacturing (excluding the food Exports of goods, excl. mineral products (rh scale) industry), the demand for foreign raw materials is very low in the agricultural Sources: Statistics Lithuania and Bank of Lithuania calculations. economic activity. Therefore, this activity did not create preconditions for faster import growth, and, without accelerating domestic demand, imports In the fourth quarter of 2012 the current account developments have been favourable due to the grew less than exports since the second half of 2012. Other components of foreign trade surplus. the current account have changed relatively little: surplus of current transfers was lower than previously, mostly because of smaller EU funds transfers, Chart 12. Components of the current account balance

and the income deficit decreased due to lower profits of foreign capital Percentage of GDP companies. In the short term the balance of foreign trade is likely to become 15 less favourable, but the current account will remain close to balance. 10 5 The current account surplus implies that the capital and financial ac- 0 counts are in deficit. In the fourth quarter of 2012, this was partially due to –5 lower capital account inflows (mainly EU support) and reduction of non- –10 –15 financial corporate liabilities. In addition, the Government’s net external –20 borrowing was negative — it reduced its external obligations. Changes in –25 other financial account components are less important. It is likely that in the 2005 2006 2007 2008 2009 2010 2011 2012 coming quarters the capital account will be mostly affected by the decisions Goods balance Services balance of the donors for the programme on decommissioning of the Ignalina nuclear Income balance Current transfers balance power plant to suspend payments for this program, and the portfolio invest- Current account balance ment flows will be affected by the Government’s active borrowing on the Sources: Statistics Lithuania, Bank of Lithuania and Bank of Lithuania calculations. domestic market. The Government borrowing program of 2013 envisages a

decrease in foreign liabilities that will increase portfolio investment outflows. LITHUANIAN ECONOMIC REVIEW / May 2013

______3 This section reviews nominal data of foreign trade in goods.

Box 2. Factors for the Lithuanian export market share development in 2000–20111 13 Since 2000 the market share of the Lithuanian exports in key export partners was increasing almost constantly. Such an increase can be considered as a sign of improving trade competitiveness, but the changes of general market share may also be determined by the export structure. The nominal export market share is calculated as the ratio of export from Lithuania and overall export to the main export partners. The market share could increase due to the exporters’ ability to compete on price or other properties of products and so to win a larger share of the market for a given product in a given country. However, the aggregate export market share might increase also if the Lithuanian exports are more focused to the rapidly growing market for a certain product or country. In this case, it would increase as Lithuanian exports to the main trading partners might grow faster than total exports directed to the same markets. But the increase of this market share might not indicate better Lithuanian export competitiveness, but would simply be a result of greater demand for certain products or in a certain market. One of the most widespread empirical methods used to distinguish between the effects of competitiveness and the export structure is the Constant Market Share Analysis (CMSA). It estimates how much exports are growing faster (slower) than required to preserve a stable share of export market. In this box the market share analysis is performed by applying the fixed market share calculation modification presented in the ECB (2005) working paper. It allows to assess the competitiveness and export structure factors that are the determinants of changes in the Lithuanian market share, when the market share is expressed as a difference between the Lithuanian export growth rate and the growth rate of world exports2, i.e.:

∑i ∑j( ) ∑i ∑j ( ,

Structure effect Competitiveness effect here: — change of the Lithuanian ( — global) exports to its main trading partners in the current period, — change of the product exports from Lithuania ( — global) to the country during the current period, — share of the product exports to the country in the entire exports of Lithuania ( — global) during the previous period. Structure effect can be further broken down into the product, market and mixed structural effects:

∑i ( ) ∑j ( ) ∑i ∑j [( ) – ( ) ( ) ] ,

Product effect Market effect Mixed structure effect where — change of the world’s product exports in the current period, — change of the world’s export to the market in the current period, — product export share in the entire exports of Lithuania ( — global) during the previous period, — the export market share in the entire exports of Lithuania ( — global) during the previous period.

The competitiveness effect indicates the increase (dec- Chart A. Factors for the market share development rease) in market shares for individual groups of products in Procentage points export markets due to the fact that the export growth of the 25 Lithuanian group of those products was higher (lower) than 20 the export development in rest of the world in this group. Structural effects are divided to the product, market and 15 mixed structure effects. The first one shows the extent to 10

which the market share change is affected by the focus on 5 the product groups, where exports are growing rapidly, the 0 second — how it is affected by a certain rapidly growing –5 market (or how it is determined by the focus on the product –10 group of market experiencing the decline). Mixed structural 2000 2002 2004 2006 2008 2010 effect is a residual item which shows the extent to which the Competitiveness effect change in the market share is determined by the product Market effect Product effect and market impact. As this effect is a combined estimate, Mixed structure effect the interpretation of this structural impact is more difficult. Residual Total effect Below is the analysis of constant market shares in Lithuania in 2000–2011 and evaluation of its results.3 Sources: Comtrade (UN) and Bank of Lithuania calculations. Analysis of factors of the constant export market shares, carried out by the Bank of Lithuania4 (see Chart A), shows that the competitiveness and export structure effects had an impact on changes of the Lithuanian export market share. Competitiveness has been the main factor of the growth of Lithuania’s export market share. The market effect was relatively strong, the product effect has been weaker, and only in some years it has led to significant changes in the market share, while the mixed structural effect over the analysed period was extremely low. Below is the analysis of the LITHUANIAN ECONOMIC REVIEW / May 2013 changes of each market share effect separately, with comparison of the effects of the Lithuanian export market shares over different periods.

14 Market effect Market effect (see Chart B) shows the extent to which the increase (decrease) of the Lithuanian export market share was determined by higher (lower) export orientation to certain countries, compared to the orientation of all world countries exports to them. This effect is analysed upon breaking down the Lithuanian export partners into the four main groups: the Baltic States, the EU (excluding the Baltic States), CIS countries and other states.5 In 2001–2008, as well as in 2010– 2011 the Lithuanian export market structure had a very positive impact on the change of the export market shares. Chart B. Breakdown of market effect by country groups

This was especially due to a great focus of Lithuanian Procentage points exporters to the markets of the Baltic countries and the CIS 15 markets that were experiencing rapid growth during given 10 periods. However, relatively little focus on other markets (non-EU and non-CIS countries) was negative and subsided 5

the overall market effect. The share of Lithuanian exports to 0 the EU (excluding the Baltic States) was more akin to the world’s exports share to this group of countries, and so the –5

market impact resulting from the relative orientation to that –10 market in the analysed period was relatively small. It should –15 be noted that, depending on the domestic demand deve- 2000 2002 2004 2006 2008 2010 lopments in individual markets, the effects of the relative Baltic states focus of Lithuanian export to the market share has changed EU (excluding Baltic States) significantly. For example, in 2001 the Lithuania’s market CIS Other share increased mainly due to the fact that the country had Total market effect a little focus on the markets where domestic demand was decreasing (in the US etc.) and in 2009 similar effect did not Sources: Comtrade (UN) and Bank of Lithuania calculations. offset the negative impact on domestic demand in those markets in which Lithuania exports relatively more (in particular in the Baltic countries and the CIS). However, the analysis shows that it is the market orientation that was one of the most important factors that led to the growth of the Lithua- nian market share in 2000–2011.

Product effect Chart C. Breakdown of product effect by technological intensity Product effect on the export market share occurs because of the differences in the structure of products exported by Procentage points Lithuania, compared with the general world export structure. 6 Unlike the market effect, the product effect has not been so 4 constant (see Chart C). During the greater part of the analysed period the product impact was negative. In 2000, 2 as well as in 2004–2006 and in 2010–2011 this resulted 0

from a small Lithuanian focus to high- and medium- techno- –2 logy products the demand for which in export markets was increasing. In other periods the product has positively –4 affected the growth of the export market share precisely –6 2000 2002 2004 2006 2008 2010 because Lithuanian exporters had relatively low focus to the mentioned product groups, and their demand in export Low-tech Medium-tech markets declined. Effects of high and medium technology High-tech Other product groups were offsetting low-technology product Total product effect effect, as Lithuania exports the latter relatively more than Sources: Comtrade (UN) and Bank of Lithuania calculations. other countries.

Competitiveness effect

Competitiveness effect shows how the export of certain products to the relative export market is growing more (less) than the world’s export of these products to that market, i.e. the Lithuanian export growth is compared with the growth of demand for the relevant product in a certain country. CMSA estimation suggests that Lithuanian export market share grew mainly because of competitiveness, as it has led to more than half of the total market share gains in 2000–2011. By breaking down the competitiveness effect by product groups (see Chart D) it is noticeable that the increase in competitiveness in 2000–2003 was mainly due to low-technology products. This was influenced by the exports of foods, textiles and timber. It resulted in the highest effect of competitiveness on the export market share also in other periods. Improvement of the Lithuanian export competitiveness in the exports of low value-added products is likely to be associated with improving agricultural technology, renewed with the support of the EU funds, as well as with technological LITHUANIAN ECONOMIC improvementREVIEW / May 2013 of food processing activities, and its growth of labour productivity. However, in these areas Lithuanian farmers and producers are just catching up with more advanced countries. Similarly important for competitiveness is the

exports of medium-technologies. Almost during the entire analysed period (except in 2001 and 2009) it had a positive impact on the overall competitiveness. The effect was particularly strong in 2007 and 2008, when new plants of chemi- 15 cals and plastics were launched in Lithuania and gained significant market share in the main export markets. The chemical and plastics industries were the main contributors to the Lithuanian export competitiveness and growth during other periods as well. As mentioned above, high-technology products are not the strength of the Lithuanian exports. Therefore, their impact on the competitiveness over the whole analysed period were relatively low and even negative in 2008–2009. After disaggregating the effect to the groups of countries (see Chart E), it is obvious that during the analysed period most of the market share was reclaimed in EU countries (excluding the Baltic States) mainly due to competitiveness. This is especially apparent during the analysed period immediately after the Russian crisis (2000–2003), when the Lithuanian producers intensely sought to acquire a foothold in Western markets. At a later period, the size of the market share in the EU fluctuated more, but determined the largest share of the competitiveness effect. Changes in the market share in the Baltic and CIS countries had much smaller effect.

Chart D. Breakdown of competitiveness effect by technological intensity Chart E. Breakdown of competitiveness effect by country groups

Procentage points Procentage points 20 20

15 15

10 10

5 5

0 0

–5 –5

–10 –10 2000 2002 2004 2006 2008 2010 2000 2002 2004 2006 2008 2010

Low-tech Baltic states Medium-tech EU (excluding Baltic States) High-tech CIS Other Other Total competiveness effect Total competitiveness effect

Sources: Comtrade (UN) and Bank of Lithuania calculations. Sources: Comtrade (UN) and Bank of Lithuania calculations.

The CMSA results indicate that the orientation of Lithuanian exports to the export markets promotes more rapid export market share growth, and structure by products is almost discouraging it. Targeting the more volatile economies had a positive impact to export market shares during the period of economic boom in export markets, but was negative during the recession. Generally Lithuanian export orientation is seen as favourable, as it is likely that in the medium term, the economy in the countries to which Lithuanian export is mainly focused, is expected to grow faster than the average for all export markets. The Lithuanian export structure by product is still more focused on low-technology products, which means that Lithuania has not yet employed its potential for producing higher technology products.

References Task Force of the Monetary Policy Committee of the European System of Central Banks 2005: Competitiveness and the Export Performance of the

Euro Area. ECB Occasional Paper Series No. 30.

1 Here is analysed the trade data (excluding mineral products) of 30 major export foreign partners of Lithuania. As Eurostat data suggest, no less than 95 per cent of Lithuania's total exports of products (excluding mineral products) were directed to these countries in 1999–2011. The sample includes (listed in the descending order of the country’s significance to the exports of Lithuania): Russia, Germany, Latvia, Belarus, Poland, United Kingdom, Sweden, Denmark, France, Estonia, Netherlands, Norway, Italy, USA, Belgium, Ukraine, Kazakhstan, Finland, Spain, Turkey, Czech Republic, India, Hungary, Switzerland, Ireland, Portugal, Canada, Romania and Saudi Arabia. 2 For data integrity purposes, Lithuanian trade partner import data were used in all calculations conducted herein. 3 The ECB working paper (2005) and other sources indicate a number of limitations of CMSA, mainly related to the selected data clustering effect. Therefore, the results of this CMSA, as well as of other CMSA, should be interpreted with caution, taking into consideration the methodological limitations. 4 Nominal import data of main export partners of Lithuania from the United Nations Statistics Division Comtrade database are used for calculations. The dataset contains data from the period 1999–2011 (results are presented since 2000, as annual changes are used in the analysis). According to ECB (2005) methodolo- gy, the calculations herein do not include mineral products. All other SITC3 (three-digit level) products are grouped into twelve categories according to the breakdown indicated in the same source. For analytical purposes, these categories are grouped according to technological intensity: low, medium and high. It should be noted that due to such grouping we should interpret the results with some caution as certain categories of products can be attributed to a different technological intensity in a lower aggregation level. 5 The categories ―EU (excluding the Baltic States)‖ and ―CIS countries‖ include not all countries assigned to these groups, but only those that satisfy the

requirement of the study sample. LITHUANIAN ECONOMIC REVIEW / May 2013

16 V. PRICES AND COSTS

In the beginning of 2013 the annual inflation rate Annual inflation was decreasing significantly in the beginning of was declining rapidly. 2013: compared to December 2012 (2.9%), its rate in March almost

Chart 13. Contributions to annual inflation halved (1.6%). Inflation was reduced by more favourable changes in prices in all main consumer basket groups, but among them, food, fuel and admin-

Percentage points Per cent istered prices had a greater impact, while the core inflation had a lesser 14 14 impact. 12 12 10 10 The consumer price data of 2013 confirmed the earlier assumption that 8 8 6 6 VAT reliefs that came into force this year (9% rate for passenger transporta- 4 4 tion for regular routes and for press) will have no major impact on inflation, 2 2 because sellers may not pass all the VAT reduction to consumers. Prices of 0 0 –2 –2 newspapers and periodicals remain unchanged from the middle of 2012 and –4 –4 prices of passenger transport by road in January 2013 fell slightly (1.3%). At 2008 2009 2010 2011 2012 2013 the beginning of the year, with an increase in excise duty on diesel, this type Administered prices Prices of food incl. beverages and tobacco of fuel became more expensive. Excise duty on cigarettes was increased in Prices of fuels and lubricants March 2013, but its impact on the tobacco group consumer prices, as usual, Prices of services Prices of industrial goods should occur in more than a single month. In March, i.e. in the first higher Annual core inflation* (rh scale) Annual inflation (rh scale) excise month, prices rose just 0.3 per cent. Sources: Statistics Lithuania and Bank of Lithuania calculations. Trends of indicators associated with consumer prices remain fa- * Change in HICP excl. food, fuels and lubricants, and administered prices. vourable for low inflation. The annual rise in producer prices on the

Unit labour costs decrease and non-energy domestic market is still declining (in December 2012 it amounted to 2.9%, in consumer prices rise slowly. March 2013 — 1.1%). Producer prices for non-durable and durable consumer goods, i.e. producer price components, most associated with con- Chart 14. Unit labour costs and non-energy consumer sumer prices, had a negligent effect on the growth of producer prices. The prices rise of import prices has slowed down further, and in February 2013 they Per cent, annual change were lower than in the same period of 2012. The annual change of unit

20 labour costs in the fourth quarter of 2012, after several quarters break, again 15 was negative (because gross earnings increased less than labour productiv- 10 ity). Thus, labour costs did not cause pressure on inflation. 5 0 Annual core inflation remained low (in March — 1.3%). It shows the –5 developments of HICP, excluding food, fuel and administered prices, or the –10 –15 inflation dependent on internal factors (unit labour costs, etc.). In 2013 the 2007 2008 2009 2010 2011 2012 2013 economy is expected to grow more slowly than in 2011 or 2012, and unit Unit labour costs labour costs, which are expected to increase due to the increase of the Non-energy consumer prices minimum monthly wage, nevertheless will grow rather slowly, therefore the

Sources: Statistics Lithuania and Bank of Lithuania calculations. pressure on core inflation will not be strong. Note: data until the first quarter of 2011 are recalculated based on the 2011 Population and Housing Census data. Annual growth in the prices of food, including beverages and to-

bacco, in Lithuania in the first quarter of 2013 was 2.9 per cent and was In March, among food commodities, only the prices of cereals and dairy products in the world were lower than in the previous quarter (3.4%). In particular, it fell due to the higher than a year ago. lower growth in prices of dairy products, meat and fish. Global price trends remain favourable: food commodity prices on world markets in recent Chart 15. Global food commodity prices months have changed slightly and were still lower than a year ago. Accord- ing to data of the Food and Agriculture Organization of the United Nations, Per cent, annual change 120 from November 2012, the global food price index observed by this organiza- 90 tion was similar in size — the effects of growing prices of dairy products and 60 fats were significantly offset by the drop of sugar and grain prices. Grain 30 prices, which went up sharply in the middle of 2012 with significantly wors- 0 ening harvest forecasts in some major grain growing regions, later, with –30 improving supply assessment, decreased. Prices of dairy products in- –60 creased earlier, too, while in March their prices went up by more than a 2008 2009 2010 2011 2012 2013 Food prices tenth. This is related to the continued heat in Oceania — such weather Prices of meat products conditions have markedly reduced the amount of milk and milk production. Prices of dairy products Cereal prices According to preliminary data, the annual drop of food commodity prices in Oil and fat prices Sugar prices March accounted for about 2 per cent (in December 2012 — 0%). Com- Sources: Food and Agriculture Organization of the United Nations and Bank pared to the corresponding period in 2012, in March the prices for sugar of Lithuania calculations. (23%) and fats (18%) dropped the most. The price of meat was just a little lower than a year ago. Higher than a year ago were prices for grain (7%)

LITHUANIAN ECONOMIC REVIEW / May 2013 and dairy products (14%). It is expected that this year’s food commodity harvests will be better, but nevertheless there is a risk that prices will rise:

at low stock of various agricultural products, any disruption of supply from The contribution of administered prices to inflation important producers might lead to higher prices. decreased, although electricity became much more 17 expensive at the beginning of 2013. In the beginning of 2013 the impact of administered prices on annual inflation continued to decline, mostly because of heat energy. Chart 16. Contributions of administered prices to annual inflation However, in January the mitigating factors were outweighed by the rise in the price of electricity: electricity for household consumers went up by Percentage points almost a tenth (9.4%), which will have a 0.3 p.p. impact on average annual 3,0 inflation in 2013. Previously, the annual growth of heat price slowed down, 2,4 however, remained positive. At the beginning of 2013 it was already nega- 1,8 tive: in February the price of heat was 4.3 per cent, and in March — as 1,2 much as 6.3 per cent lower than a year ago. From October, i.e. for the six 0,6 consecutive months, the heat has become cheaper: in October alone its 0,0 price went down by about 4 per cent, and in March 2013 compared to –0,6 September, it went down by more than 7 per cent. According to information –1,2 2008 2009 2010 2011 2012 2013 from the National Control Commission for Prices and Energy, in April the Electricity average price of heat in Lithuania decreased slightly, but changes were not Gas Heat energy the same in all cities: in the major cities the heat price went down only in Passenger transport by railway Vilnius; in Klaipeda its price did not change, and in other major cities it Passenger transport by road Other increased. The rising heat prices in some cities are related to the fact that in Sources: Statistics Lithuania and Bank of Lithuania calculations. February the price of the main fuel for heat production — imported natural gas went up; before that, it had been going down for half a year. Prices of In the first quarter the price of oil was lower than a natural gas for household consumers, which are recalculated every six year ago. months, in January went down by 3.3 per cent. Chart 17. Crude oil price and fuel prices in Lithuania Annual growth of fuel prices slowed significantly in the end of

2012, then in the beginning of 2013 continued to decline, and in March Per cent, annual change USD was already negative (–1.0%). Such fuel price trends are related to the oil 90 150 price drop in the global markets: in December 2012 the annual change of oil 60 120 prices in litas was positive (1.7%), while in early 2013 it was already negative (in March, the price of oil fell by almost 11% per year). Changes in oil 30 90 prices are affected, favourably to consumers, by anxiety over the weak euro area economy, threat of potential disagreement over the US fiscal policy, 0 60 and the uncertainty about China’s economic growth. However, the price of –30 30 oil may increase substantially because of the still relevant geopolitical risk.

There are tensions between the Western countries and Iran; after the –60 0 President’s death prospects of political stability in Venezuela are uncertain, 2008 2009 2010 2011 2012 2013 disruption of oil supplies is possible in Libya and Egypt (due to political Average monthly oil price (rh scale) instability), as well as in Syria (because of the internal unrest). Internal Oil price, LTL unrest in Syria might spill over into Turkey and Lebanon, but most important Fuel price to the oil market would be their spread to Iraq. Sources: Bloomberg, Statistics Lithuania and Bank of Lithuania calculations.

LITHUANIAN ECONOMIC REVIEW / May 2013

4 18 VI. CREDIT AND DEPOSITS

The banking sector’s loan portfolio expanded in the The banking sector’s loan portfolio expanded further in the begin- beginning of 2013. ning of 2013. In February it was the highest in two years, with an annual Chart 18. Contributions to annual changes in banking sector’s loan portfolio growth rate of 3.0 per cent. However, unusual growth for the beginning of the year needs to be interpreted with caution, since it was mainly due to a Percentage points Percentages bank loan granted to the central government. However, with the strengthen- 20 20 ing financial position of the private sector, consumption and investment 15 15 financing from borrowed funds has become more acceptable, likely due to 10 10 still low interest rates on loans and less tight credit conditions. The private

5 5 sector’s expectations on the future recovered slightly at the beginning of the year, enabling to expect the increase in demand for credit; commercial 0 0 banks expect about 3 per cent growth in the loan portfolio in 2013.5 –5 –5 The financial position of the banks’ major borrowers — non- –10 –10 2009 2010 2011 2012 2013 financial corporations and residents — kept strengthening. With in- Government Financial intermediaries creasing economic activity, sales of non-financial companies in 2012 were Non-financial corporations the highest since the beginning of the data, and profits earned over the year Households Total (rh scale) were growing. This has contributed to an improving assessment of future by Source: Bank of Lithuania calculations. non-financial companies and in March 2013 the economic sentiment indica- New loan interest rates remain low as never before. tor again became positive after a year and a half. With high production capacity utilisation, some of the businesses (more open to foreign trade) Chart 19. Contributions to changes in weighted average interest rate on new loans to the private sector increased investment in tangible fixed assets, in part financed by bank (twelve-month moving average) loans. In the first two months of 2013 the portfolio of banking sector loans to Percentage points Percentages non-financial corporations increased by 67.8 million litas (for example, 0,3 7,5 during all of 2012 the growth was 88.3 million litas). Because of increasing 0,2 7,0 economic activity of non-financial corporations, some of the enterprises 0,1 6,5 began lacking adequately skilled labour. This contributed to the fact that in 0,0 6,0 2012 the number of unemployed decreased (7.4%), average gross monthly –0,1 5,5 wages and salaries increased (2.6%), and the consumer confidence index –0,2 5,0 rebounded faster. Nevertheless, during the first two months of 2013 house- –0,3 4,5 holds continued to reduce financial liabilities to banks, although slightly less –0,4 4,0 than in the corresponding period a year ago.

–0,5 3,5 2008 2009 2010 2011 2012 2013 Interest rates for new bank loans to the private sector remain low. Dynamics of average weighted interbank interest rate (6 months) This is essentially affected by low interest rates on inter-bank loans in litas Dynamics of the margin Average weighted interest rate (rh scale) and euro, since the majority of interest rates on new loans is fixed for less Sources: www.euribor-ebf.eu and Bank of Lithuania calculations. than one year. In the beginning of 2013 the interest rates on interbank loans Structure of deposits in banks is changed by still in euro rose, but the overall cost of the loan was almost unaffected because extremely low interest rates. in the light of the improving financial position of borrowers, banks slightly

Chart 20. The development of the structure of bank reduced their margins. In February of 2013 interest rates on new loans to deposits and the difference of interest rate the private sector were 3.6 per cent and fell by a third during the year. Percentages Percentage points After the usual decrease in January, deposits in the banking sector 65 7 grew in February. Households were the main factor behind the decrease in 60 6 deposits at the beginning of the year as they withdrew 0.8 billion litas

55 5 (because of the demand for money during the post-holiday period and

50 4 growing heating bills). At the beginning of the year, bank deposits (by 0.5 billion litas) were reduced by non-financial corporations, although the 45 3 largest monthly withdrawal of funds since the start of the recession should 40 2 be interpreted with caution, as it was due to the withdrawal by a single 35 1 company. In February deposits were rising, despite historically low interest

30 0 rates. With banks’ lending not growing rapidly, the need to attract more 2005 2006 2007 2008 2009 2010 2011 2012 2013 funding was low, so the interest rate was at its lowest level in the last eight Share of overnight deposits (left-hand scale) years. In February 2013 it amounted to 0.7 per cent and was almost twice Difference between term and overnight deposits' interest rates as low as in the previous year. The still low interest rates altered the struc- Source: Bank of Lithuania calculations. ture of the private sector’s deposits: deposits with longer maturity were decreasing, and priority given to cash and funds in bank accounts.

______4 In this part, for the evaluation of loans and deposits, the data used is from statistics of monetary financial institutions, presented by the Department of Statistics of the Economics and Financial

LITHUANIAN ECONOMIC REVIEW / May 2013 Stability Service at the Bank of Lithuania. 5 Bank survey on lending terms and conditions, April 2013.

VII. GENERAL GOVERNMENT FINANCE 19

At the end of 2012 the situation of government finances continued to Government revenues increased mostly due to the increase in direct tax revenues related to a higher improve rapidly. In the fourth quarter of 2012, the ratio of four-quarter number of people covered by social insurance and general government deficit to GDP has shrunk by more than one third com- improved corporate profitability prospects. pared with the corresponding period of the previous year and totalled 3.3 per Chart 21. Contributions to general government revenue cent. From an economic point of view, the deficit was mostly reduced by the growth declining ratio between general government expenditure and GDP, the decrease of which was due to declining expenditure and rapid growth of Percentage points Per cent, annual change economic activity. From the institutional sector point of view, the lower deficit 30 30 was mostly driven by a decrease of the state budget deficit over the year, and 20 20 the main reason for the general government deficit was still a negative 10 10 balance of the social security funds. The better labour market situation 0 0 improved the social security fund balance; however, this effect was offset by –10 –10 the restoration of retirement benefits after the cuts. Breaking down the –20 –20 general government balance into structural and cyclical components, about –30 –30 2005 2006 2007 2008 2009 2010 2011 2012 four-fifths of the deficit reduction in 2012, compared to 2011, resulted from Indirect taxes the reduction of the structural deficit. Cyclical deficit also declined, but not Social contributions Taxes on income, wealth, etc. much, therefore the impact of the business cycle on the development of the Non-tax revenue deficit was negligible. Total revenue (rh scale) Conditions for government revenue increase was a higher wage bill Sources: Statistics Lithuania and Bank of Lithuania calculations. and changed behaviour of the advance corporate income tax payers, but the revenue to GDP four-quarter sum ratio decreased. In the fourth Due to the on-going restrictive fiscal policy the quarter, with the growing employment and the rise in average earnings, the government expenditure continued to decline. government revenue from personal income tax and social security contribu- Chart 22. Contributions to general government tions grew the fastest in 2012. A larger wage bill than a year ago created expenditure growth preconditions for increased domestic consumption, but its impact on indirect tax revenue in the fourth quarter was small. Prerequisites to suggest that the Percentage points Per cent, annual change situation of general government finances is improving at a slower pace due to 40 40 the revenue growth are the data of the national budget in January–March 30 30 2013, showing that the revenue collection from indirect taxes decreased. 20 20 In the fourth quarter of 2012, government expenditure-to-GDP ratio 10 10 continued to decline not only because of the increased GDP but also 0 0 because the expenditure was lower than a year ago. Government ex- –10 –10 penditure levels were reduced the most by the capital and current transfers –20 –20 2005 2006 2007 2008 2009 2010 2011 2012 that declined over the year, as well as lower investment and compensation of Social payments Interest employees. Capital transfers fell mainly due to the base effect resulting from Compensation of employees Intermediate consumption the decisions made in the fourth quarter of 2011. Smaller than a year ago EU Total capital expenditure Other consumpion funds for investment, as well as the lower amount of co-financing, led to the Total expenditure (rh scale) government investment decline. Government expenditure did not decline Sources: Statistics Lithuania and Bank of Lithuania calculations. faster because of social benefits, which increased due to the retirement benefit restoration to the pre-crisis level and higher unemployment insurance Due to the rapid growth of economic activity the favourable "snowball" effect hindered the growth benefits. The latter for the second quarter in a row were higher than a year of the debt-to-GDP ratio. ago. It could be affected by the number of short-term unemployed that rose slightly during the year. Expenditure for property repairs and heating, which Chart 23. General government debt increased in the fourth quarter over the year, led to higher intermediate consumption. One should not expect a faster decline of government expendi- Percentage of GDP ture at the beginning of 2013: the central government expenditure in Janu- 40 ary–March declined very slightly over the year. 30 Government debt in the fourth quarter increased by almost 20 1 billion litas, but the ratio of this debt and the four-quarter GDP sum remained broadly unchanged due to the large increase in GDP. As in 10 previous quarters, the debt was mainly increased by the issue of long-term 0 government securities, but the funds generated by the distribution of saving 2005 2006 2007 2008 2009 2010 2011 2012 Deposits (including saving notes) notes increased significantly in the fourth quarter. In general, in 2012 saving Loans note borrowing increased markedly. It is likely that such popularity of saving Securities General government debt notes is related to their popularity as an investment instrument because of Sources: Ministry of Finance and Bank of Lithuania calculations. slightly higher interest rates, as compared to the offered for similar maturity deposits in commercial banks. The data of January–February shows that in

the first quarter of 2013 government debt, due to active borrowing, should LITHUANIAN ECONOMIC REVIEW / May 2013 increase by about 0.4 billion litas (0.3% of GDP).