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Lithuania's Economic Development Scenario 2018–2021

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Lithuania's Economic Development Scenario 2018–2021 Lithuania’s Economic Development Scenario 2018–2021 September 2018 1 The Economic Development Scenario (hereinafter – the scenario) has been developed on the basis of the statistical data published by 31 August 2018 and the information presented by the institutions 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. Respective publicly available technical assumptions about the external environment (development of trading partners, oil prices, EUR / USD exchange rate) made by the European Commission and the International Monetary Fund were also taken into consideration. Taking into consideration Lithuania’s economic development results in the first half of 2018, changes in the external environment and favourable conditions for domestic demand acceleration, we project that Lithuania’s gross domestic product (GDP) in 2018 could grow 3.4 %. This is by 0.2 percentage point higher than it was projected in spring this year. In subsequent medium-term years GDP should grow at the same pace as it was projected in spring this year – 2.8 % in 2019 and 2.5 % both in 2020 and 2021. International institutions did not change the world economic outlook in summer 2018 – a stable GDP growth of almost 4 % is still expected within next two years, however, it will not be synchronised as in 2017. Economies of some foreign trading partners important to Lithuania will grow at less accelerated pace as it was projected at the beginning of the current year, and a negative risk, as a result of the increased tension in international trade, as compared to spring this year, increased. Due to these circumstances, the development of exports of the Lithuanian goods and services will be more moderate compared to the development projected in spring this year. Domestic demand in medium-term will be a key driver of Lithuania’s economic activity. It will be stimulated by the Government decisions related to personal income increase and enhanced incentives to invest, direct foreign investments and the implementation of investment projects financed from the European Union (EU) financial assistance as well as the need encouraged by tight labour market for business to invest to operational automation, technological renewal, innovations and other measures enhancing operational efficiency and productivity. The situation on the labour market will remain favourable during the entire medium term, and the competition between the employers for employees will not decrease. Taking into consideration current trends and administrative solutions increasing wages, we project that the average monthly gross wages in the country in medium-term will grow at an average about 7.2 % per year – this is by 1 percentage point higher than projected in spring this year. As the effect of one-off factors which led to the average annual inflation jump faded out in 2017, price developments in first 7 months this year were more moderate. Taking into consideration the information disposed during the development of the scenario, we project that the change in inflation estimated on the basis of the harmonised consumer price index will reach 2.7 % − this is by 0.2 percentage point lower than projected in spring 2018. In subsequent years of the medium term price developments should settle at 2.5 % per year. 2 The scenario has been developed assuming that it will not be deviated from the fiscal policy laid down in the Stability Programme of Lithuania, i.e. general government financial surpluses will be formed in medium term. General government sector surplus along with the Government measures increasing domestic demand and enhancing public expenditure effectiveness under increased uncertainty in the external environment will play the role in stabilising the economy. Investments We project that in 2018 gross fixed capital formation expenditure in the country will grow at a more accelerated pace than it grew during last several years – 9 % – this is by 1.4 percentage point higher than projected in spring 2018. We also upgraded medium-term perspectives: in 2018-2021 expenditure on gross fixed capital formation should grow by an average of 5.8 % each year (in spring 2018 it was projected to grow by 5.4 %). The need to maintain a competitive advantage both in domestic and foreign markets under limited labour supply conditions encourages the Lithuanian enterprises to search for ways to increase labour productivity through modernisation, automation and making work processes more effective, and provides a strong stimulus for increase of productive investments. Rapidly growing productive investments in 2017 enabled the increase in national labour productivity level by 3 percentage points, as compared to the EU average, − from 72 % in 2016 to 74.9 % in 2017. In the first half of 2018 such investments were further increasing: to machinery, equipment and weapon systems – 10.7 %, intellectual property products – 6.6 %, information and communications technologies equipment – 6.5 %, transport equipment – 2.1 %. Demographic changes taking place in the country dictate that the investments to technological renewal, automation of processes and operational modernisation are necessary to maintain profitability of companies and to attract suitably qualified staff; therefore, the development of this type of investments should not stop through the entire medium term. The importance of innovations, technological innovations is perceived in the country and the attention paid to this area is evinced. Currently more and more investments are made to intellectual property products: this type of investments in 2017 grew by 16.3 %, in the first half of 2018 – 6.6 %. Tax incentives and one of 6 reforms implemented by the Government of the Republic of Lithuania directed towards the promotion of innovations in medium term should support the development of innovations. Under improving financial situation of the population in medium term, housing will remain an attractive investment instrument, however, due to prevailing demographic trends, we do not expect a significant growth of residential construction in medium term. The development of construction of infrastructure stimulated by the EU financial assistance should continue. Constantly growing flows of tourists, improved transport infrastructure will foster the enlarged construction of new hotels. For Lithuania becoming more attractive to foreign investors, the international companies that settled down in the country will foster the construction of commercial premises which meets the latest standards. 3 The endeavour to meet the EU quality standards and to remain competitive fosters the renewal and development of the transport fleet – the fastest growth pace of acquisition of new heavy goods vehicles (26 %) in the EU was recorded in Lithuania in the first half of 2018. The investments to acquisition of new transport vehicles in short term will remain to be a significant factor of the investment growth in the country. Under a persistent need to make operational processes more effective, further investments should be made to expand production capacity. Historically high industrial production capacity utilization level recorded in the last several years demonstrates that a part of enterprises are currently operating without having the possibility of expanding production without additional investments, therefore, they are restricted from rapid business expansion. The impact of the implementation of the Investment Plan for Europe (ESIF) will be also felt in medium term – according to the data for July 2018, the financing volume of transactions approved in Lithuania under ESIF makes up EUR 409 million. It is expected that this will promote investments in the amount of EUR 1.5 billion. Inflation Increased economic activity and natural convergence processes to the EU average in medium term will foster price increase in Lithuania, however it will not be as rapid as the one observed in 2017. The development of productive investments projected in medium term will create conditions for narrowing the recent gap between labour productivity and wage growth, and thereby reducing the pressure on price increase. The scenario is based on technical assumptions that starting from the year 2020 global oil prices and EUR / USD exchange rate will stabilise. Taking into consideration the information disposed of during the development of the scenario, we project that the change in inflation estimated on the basis of the harmonised consumer price index (HICP) will reach 2.7 % − this is by 0.2 percentage point lower than projected in spring 2018. In subsequent years of the medium term price developments should settle at 2.5 % per year. Since October 2017 annual inflation in Lithuania keeps decreasing and at present is twofold lower than last year. In July 2018 annual inflation estimated on the basis of the HICP represented 2.3 %, average annual inflation – 3.4 %. Annual inflation significantly shrank in March 2018 when the impact of excise duties on alcoholic beverages increased last year faded out. More favourable food commodity prices that reduced prices of dairy products, fruit, vegetables, stable prices of non- energy industrial goods make conditions for falling inflation. In the current year the growth of prices of consumption goods and services will be fostered by higher oil prices and persistent (though more benign) growth of service prices. Recently
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