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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 18 mThe Economic Development Scenario (hereinafter – the scenario) was developed on the basis of the statistical data published by 1 March 2018 and the information obtained, which, following Government of the Republic of Lithuania Resolution No 369 On the Approval of the Description of the Procedure for Development and Publishing of the Economic Development Scenario of 13 April 2016, was presented by the Ministries of the Republic of Lithuania (of Environment, Energy, Social Security and Labour, Transport and Communications, Economy, Foreign Affairs, Agriculture). Respective assumptions of the external environment (development of trading partners, oil prices, EUR / USD exchange rate) by the European Commission and the International Monetary Fund were also taken into consideration. The year 2017 was extremely successful for Lithuania’s economy, it enhanced national macroeconomic stability and laid the foundations for further economic development in short term. Currently observed synchronic economic recovery of the main Lithuania’s foreign trading partners, based on the forecasts of international experts, should continue for at least another two years, and this will create favourable conditions for increasing demand of exports of goods and services from Lithuania. The endeavour to satisfy the robust external demand and not to lose international competitiveness will further encourage exporters to make decisions reducing production costs and enhancing operational efficiency. All this and foreseen implementation of investment projects financed from foreign direct investments and the European Union (EU) financial assistance will accelerate the investment process in the country. The productive investment breakthrough observed in 2017 (grew faster by 10.4 % than in 2016 and by 11.9 % than in 2007) may be seen as the start of change in the thus far dominant business model – from now on the economic growth in the country will be more fostered by new technologies, innovations, automated and more effective processes than hiring a higher number of workers. Under country-wide shrinking labour force resources, the competition for workers between enterprises will increase. In this scenario it was assumed that under the external environment remaining stable, the economy will smoothly adapt to labour supply shortages: enterprises seeking a competitive advantage will make investments to productivity enhancing measures and, therefore, will be able to offer market attractive wages to workers, while the workers will have the opportunity to move to enterprises with a higher added value. Thus, a limited labour supply in medium term may become a growth stimulating factor. The tax measures promoting the investment process and increasing income of the lowest wage earners that came into force from the year 2018 should help enterprises cope with competitive pressure and adapt to changing economic conditions. Good labour market indicators – the employment rate in the country in 2017 reached 70.4 % and was the highest in the last ten years; the unemployment rate fell down to 7.1 % and was by 2 percentage points lower than the euro area average; the average wages grew by more than 8 % for two years in row. The prospective stable external environment demonstrates that there is no need for additional stimulation of economy through fiscal policy tools, therefore, in medium term a prudent fiscal policy should be further pursued, and public finances should remain in surplus. Taking into consideration the formed economic development trends and more favourable conditions for the external environment, it is forecasted that the national gross domestic product (GDP) in 2018 will grow 3.2 % , and in 2019 – 2.8 % – this is by 0.3 percentage point and 0.2 percentage point, accordingly, faster than it was forecasted in autumn 2017. In subsequent years of the medium term, based on technical assumption about a stable external environment, the GDP should grow at an average of about 2.5 % per year. The situation in the labour market will remain favourable for the workers during the entire medium term, therefore, we project that the wages will grow at an average about 6.2 % per year, and the unemployment rate at the end of the medium term may fall down to 5.9 %. As the effect of one-off factors which led to the average annual inflation jump faded out in 2017, in medium term we expect more moderate price developments. After evaluation of the revised assumptions for oil prices, we project that the change in average annual inflation in 2018 will reach 2.9 % – this is higher by 0.2 percentage point than it was projected in autumn 2017, and in 2019 – 2.4 % , i.e. lower by 0.1 percentage point than it was projected in autumn 2017. In subsequent years of the medium term price developments should settle at an average of 2.5 % per year. Investments The need to maintain a competitive advantage both in domestic and foreign markets under limited labour supply conditions in medium term will encourage the Lithuanian enterprises to search for ways to increase labour productivity through modernisation, automation and making work processes more effective, and will provide a strong stimulus for increase of productive investments. 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 meeting the latest standards. The interest in high technology currently evinced in the country, the observed development of Fin Tech firms should continue throughout the medium term. We project that in 2018 gross fixed capital formation expenditure in the country will grow at more accelerated pace than it grew during last several years – 7.6 % – this is by 1.6 percentage point higher than it was projected in autumn 2017. In medium term gross fixed capital formation expenditure should grow by an average of 5.4 % each year. Growing foreign demand will stimulate the need for modernisation and more effective operational processes of enterprises, it will also promote the continuous investment in transport equipment, contribute to the construction growth as a result of the increased demand for logistics, warehouse buildings and construction of new plants. Further development of business centres in Vilnius is projected in 2018, while the construction of business centres launched in 2017 will continue in Kaunas. A considerable momentum for investment development will be a breakthrough of implemented investment projects financed from the EU Funds’ – it is projected that their scope in 2018 will be twofold as compared to 2017. In medium term, the investment projects of national importance will be implemented in transport infrastructure and energy field. Recent trends in housing market should not change too much in medium term. Housing construction should remain at a similar level after a restraint in 2017. Improving financial position of the population will sustain the demand for housing, however, due to prevailing demographic trends, its significant growth in medium term is not projected. As a result of rapid growth of housing construction until now, there is the need for new schools in certain districts of Vilnius, which will be taken into consideration and the construction of new schools is planned in medium term. The impact of the implementation of the Investment Plan for Europe (ESIF) will be also felt in medium term – according to the data for February 2018, the financing volume of transactions approved in Lithuania under ESIF makes up EUR 324 million. It is expected that this will promote investments in the amount of EUR 934 million. 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 (in 2017 average prices of consumer goods and services grew by 3.7 % – the fastest increase in the last 6 years). The development of productive investment 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 2019 global oil prices will stabilise and no significant changes in tax rates will occur in medium term. The scenario projects that in 2018 the average annual inflation measured by the Harmonised Index of Consumer Prices (HICP) methodologically harmonised with other EU Member States will constitute 2.9 % , in 2019 – 2.4 % , in 2020 and 2021 – 2.5 %, accordingly. The inflation at the beginning of 2018, as in 2017, will be stimulated by higher oil prices and increasing prices of consumer services, however in spring, after the effect of excise duties on alcoholic beverages and tobacco products increased a year ago fades, the annual inflation should decrease. Excise duties on alcoholic beverages and tobacco products increased from March 2017 had the 0.9 percentage point contribution on the average annual inflation in 2017. The increased prices of beer had the largest effect, while higher prices of spirituous beverages, wine and tobacco products – a slightly lower effect. A moderate increase in excise duty rates on diesel (from 1 January) and on tobacco products (from 1 March) in 2018 will have a modest contribution (0.1 percentage point) on the average annual inflation in 2018. Recently observed rising prices of services are mainly due to rapidly growing wages in the service sector, where labour costs, other than in case of goods, are mainly passed on to the final price, as well as to growing income of households which prompted the consumption of services. Therefore, the prices of the majority of services were rapidly growing (at an average by 5 %) in 2017. The growth of prices of services of restaurants and cafés (9 %), cinema theatres, concerts, theatres (11.9 %) and air transport (12.1 %) has been particularly dynamic.
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