2012 2012 REVIEW ECONOMIC LITHUANIAN FEBRUARY ISSN 2029-8471 (online)

Lithuanian Economic Review analyses the developments of the real sector, prices, public finance and credit in , 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 .

During the preparation of the Lithuanian Economic Review, the data of the Bank of Lithuania, Statistics Lithuania, the , , the International Monetary Fund, Bloomberg and other data published up to 30 January 2012 were used.

Coordinator of the publication: Mr Leika, Director of Economics Department, phone No.: +370 5 268 0138, e-mail: [email protected]

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

© Lietuvos bankas, 2012 Contents

ECONOMIC OUTLOOK ...... 3

I. INTERNATIONAL ENVIRONMENT ...... 5

II. REAL SECTOR ...... 7

III. LABOUR MARKET ...... 10

IV. EXTERNAL SECTOR ...... 12 Current account and its financing ...... 12 Foreign trade and competitiveness ...... 13

V. PRICES AND COSTS ...... 14 Core ...... 14 Food prices ...... 14 Administered prices ...... 15 Fuel prices ...... 15

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

VII. GENERAL GOVERNMENT FINANCE ...... 20

ANNEX ...... 22 Introduction to Social Accounting Matrices ...... 22

Boxes

Box 1. Effects of AB bankas SNORAS bankruptcy on key economic indicators of Lithuania ...... 4 Box 2. Carry-over effect and its impact on the growth of GDP ...... 9 Box 3. About the minimum monthly wage ...... 11 Box 4. An overview of forecasts of global food prices...... 16

List of tables 2 Table 1. Macroeconomic indicators of and ...... 6

List of charts Chart 1. Global purchasing managers’ index (PMI) ...... 5 Chart 2.Key interest rates of central banks ...... 5 Chart 3. World commodity prices ...... 5 Chart 4. Annual change of real GDP, estimated by expenditure approach, in the US...... 6 Chart 5. Price of five-year credit default swaps in the area countries ...... 6 Chart 6. Real GDP growth and contributions ...... 7 Chart 7. Development of private consumption and retail trade ...... 7 Chart 8. Gross fixed capital formation growth and contributions ...... 7 Chart 9. Contribution of real net exports to annual GDP growth ...... 8 Chart 10. Real GDP growth and contributions ...... 8 Chart 11. The number of the employed and the unemployment rate ...... 10 Chart 12. Average gross wage ...... 10 Chart 13. Components of the current account balance ...... 12 Chart 14. Current transfers to Lithuania ...... 12 Chart 15. Current account deficit and its financing ...... 12 Chart 16. Contributions to exports growth ...... 13 Chart 17. Value of exports of goods ...... 13 Chart 18. Contributions to imports growth ...... 13 Chart 19. Contributions to annual inflation ...... 14 Chart 20. Global food prices ...... 14 Chart 21. Contributions of administered prices to annual inflation ...... 15 Chart 22. Crude oil price and fuel prices in Lithuania ...... 15 Chart 23. Contribution to changes in banking loan portfolio in January-November ...... 18 Chart 24. Changes in loan portfolio to corporate sector per quarter ...... 18 Chart 25. Changes in loan portfolio to households per month ...... 18 Chart 26. Contribution to changes in weighted average interest rate on new loans to private sector ...... 19 Chart 27. Contribution to changes in deposits in banking system per month ...... 19 Chart 28. General government revenue growth and contributions ...... 20 Chart 29. General government spending growth and contributions ...... 20 Chart 30. Government consumption expenditure growth and contributions ...... 20 Chart 31. General government revenue, spending and balance...... 21 Chart 32. Breakdown of general government balance ...... 21 Chart 33. Breakdown of general government debt ...... 21

Abbreviations and other explanations CIS Commonwealth of Independent States CPI consumer price index EBF European Banking Federation ECB European Central Bank EU EURIBOR euro inter-bank offered rate, the rate at which a prime bank is willing to lend funds in euro to another prime bank Eurostat statistical office of the European Union FDI foreign direct investment GDP HICP harmonised index of consumer prices IMF International Monetary Fund LTL February 2012 MFI monetary financial institution OPEC Organization of Petroleum Exporting Countries OTC over the counter p.p. percentage point rh scale right-hand scale SAM social accounting matrices US of America USD US dollar VAT value-added tax VILIBOR inter-bank offered rate, average interbank interest rates at which banks are willing (ready) to lend funds in litas to other banks LITHUANIAN ECONOMIC REVIEW /

ECONOMIC OUTLOOK 3

The economy of Lithuania is entering the stage of a slower growth. Up to now, the domestic economy grew very rapidly, however, there are increasing signs of less favourable prospects. Owing to a slower global economic development, lower economic growth is projected in the main trade partners of Lithuania, whereas confidence indicators in Lithuania and foreign countries are also deteriorating in the context of uncertainty related to indebtedness problems in some euro area countries. Such situation dampens the expectations of the Lithuanian households and enterprises, limits investment plans of enterprises, constrains employment growth and strengthens household saving. These factors contribute to the assessment that the real sector of Lithuania will grow slower in the near term. The suspended activity of AB bankas SNORAS will also have a negative impact on the development of Lithuania’s economy. Although the direct impact of this bankruptcy on the economic development will be low due to relatively small amount of uninsured deposits, the indirect impact is still projected. It is forecasted that the real GDP of Lithuania, which grew by 5.8 per cent in 2011, will increase by 2.2 per cent in 2012 and by 3.3 per cent in 2013. An important factor of the real GDP growth is private consumption. It is pushed up by the household income that grew for some time both due to wage rise and employment growth. As indicated by the data of retail trade enterprises, households spend much more money for house equipment, car fuel and food. Still, owing to rising prices and declining confidence, the private consumption expenditure should not grow as fast in the short run. As enterprises undertake new investments more cautiously, the number of new jobs created will be lower and wages will be raised more moderately, and this will limit the increase in household income and thus private consumption. After a rapid growth in 2011 (5.6 per cent), private consumption should grow slower in 2012 and 2013 – by 2.5 per cent and 2.6 per cent, respectively. Another domestic demand component – gross fixed capital formation – is growing noticeably less than earlier. Decisions of enterprises regarding investment are affected by the unclear further domestic and global economic development. Investments in non-residential buildings and constructions are larger, whereas investments in residential buildings, vehicles, machinery and equipment are lower than a year ago. Enterprises are investing less into production capacity expansion than in several previous quarters, and this fact will affect the domestic economic development during the projection period. Owing to less favourable economic development prospects, investments in gross fixed capital should grow less in 2012 than they grew on average up to now (it is projected that they will increase by 5.0%), while in 2013 they should grow more – by 7.9 per cent. The situation in the labour market is still improving, albeit slower. The assessment of the changes over the year shows that the unemployment is declining in the country and more people are employed. Over the year, especially large growth of the number of the employed was observed in the largest sector in terms of employment – the services sector, particularly in trade, transport and storage activities. The number of the employed also increased in construction and industry. However, it should be noted that, according to seasonally adjusted data, the number of the employed has not been growing recently. According to this data, the number of those employed on a part-time basis is slightly higher than earlier, whereas the number of those employed on a full-time basis is lower. Owing to a cautious assessment of economic prospects by enterprises, it is likely that the employment will grow only slightly during the projection period. Lithuania’s foreign trade is becoming less buoyant. According to seasonally adjusted data, only the export of oil products has been growing recently, while the export of the majority of other products is stabilising. The trade in passenger cars in the markets of the CIS countries is contributing to export developments less favourably, therefore, according to seasonally adjusted data, re-export is not growing. Still, when assessing longer-term data, it is noticeable that our country’s export is growing more than the import of the main foreign trade partners – EU states and , while Lithuania’s exporters gain a larger market share in these countries. It is projected that the import demand in the mentioned countries will weaken further gradually, therefore, Lithuania’s export will grow slower. After growing by 13.6 per cent in 2011, the real export of goods and services should increase by 3.9 per cent in 2012 and 5.8 per cent in 2013. Partially owing to a more favourable trade in oil products, the foreign trade balance is improving. The overall surplus of the trade in goods and services, compared to the GDP, has recently been one of the largest since the beginning of data collection. Jointly with lower profitability of foreign capital enterprises, this determines a surplus in the current account. Current transfers, other important component, exert further positive influence on the current account due to both higher inflows from the EU funds and strong remittances of emigrants. Foreign trade and current account balances should be less favourable in the nearest time, however, assuming that domestic demand will rise moderately, these balances should not deteriorate strongly. Annual inflation is declining gradually. This is mostly determined by food price changes, which have been influenced by the trends in the global food commodity markets with a delay. In the beginning of the year, global food prices were record high and significantly higher than a year ago; later they declined and became lower than a year ago at the end of the year. With a slower rise of global food prices, food price growth decelerates in Lithuania too, and this reduces inflation noticeably. Nevertheless, the rise of food prices at the end of the year remained the main factor of inflation. Quite

significant contribution was made by administered prices. Due to a continued growth of heat energy prices, administered THUANIAN ECONOMIC REVIEW / February 2012

prices were significantly higher than a year ago. Fuel prices grew significantly slower at the end of the year, owing to a LI lower increase in the oil price over the year. With the deterioration of the situation of the global economy, it is not

expected that food and energy commodity prices will grow, therefore, there should be no external pressure on prices in 4 Lithuania. Several administrative decisions, which will increase prices, were made: price was increased and excise duties for cigarettes will be increased, however, their impact on inflation will not be large. Annual core inflation, which is mostly related to domestic consumption, remains low, whereas domestic consumption should not stimulate price growth, as the growth of wages and employment will be sluggish in the nearest time. Owing to slower economic development and lower external pressure on prices, lower inflation is expected in 2012 (2.1%). In 2013, when the economic growth will start strengthening again, the prices should also increase faster (2.4%).

Outlook of Lithuania’s Economy in 2011–2013

February 2012 November 2011 2011* 2012* 2013* 2011* 2012* 2013* Price and Cost Developments (annual percentage changes) Average annual inflation (based on HICP) 4.1 2.1 2.4 4.2 3.0 - GDP deflator 5.1 2.5 2.6 4.6 3.2 - Wages (compensation per employee) 3.9 1.6 2.5 4.0 3.0 - Import deflator 12.8 2.5 2.3 12.6 2.4 - Export deflator 11.9 2.6 2.2 11.3 2.4 - Economic Activity (constant prices; annual percentage changes) Gross domestic product** 5.8 2.2 3.3 6.2 3.5 - Private consumption expenditure 5.6 2.5 2.6 6.3 3.5 - General government consumption expenditure 1.2 0.6 1.9 0.3 0.2 - Gross fixed capital formation 15.9 5.0 7.9 17.7 9.1 - Exports of goods and services 13.6 3.9 5.8 13.2 5.3 - Imports of goods and services 13.3 4.1 6.1 14.0 5.6 - Labour Market Unemployment rate (annual average as a percentage of labour 15.4 14.2 12.9 15.4 13.6 - force Employment (annual percentage changes) 2.0 0.7 1.2 3.1 1.6 - External Sector (as a percentage of GDP) Balance of goods and services –1.5 –2.1 –2.4 –2.7 –3.3 - Current account balance –0.3 –1.2 –1.6 –1.3 –2.0 - Current and capital account balance 2.1 0.9 0.1 1.1 0.2 - * Projection. ** Changes in inventories are not included in GDP components.

Box 1. Effects of AB bankas SNORAS bankruptcy on key economic indicators of Lithuania Bankruptcy proceedings initiated against AB bankas SNORAS on 7 December 2011 was an important event for the Lithuanian financial system and economy, thus it will influence economic development in the coming quarters. On the scale of the entire economy, the amount of uninsured deposits held with AB bankas SNORAS is not large, thus the direct impact of this bank’s bankruptcy on private consumption and investment will be insignificant. In order to assess the maximum likely effects of this bankruptcy, one should also take into account the indirect influence related to weakened confidence. A deterioration in household expectations is likely to increase saving and decrease consumption. As a result of loss of confidence and poorer expectations, enterprises are likely to reduce investment or postpone it, review recruitment plans, suspend wage revisions, etc. Assessing the highest direct and indirect effects of AB bankas SNORAS February 2012 bankruptcy on the Lithuanian economy, in 2012 the growth of private consumption may be smaller by about 1 p.p., that of investment – by 2 p.p., and the impact on GDP growth may amount to 0.5 p.p. AB bankas SNORAS bankruptcy is likely to have an impact on Lithuania's labour market too. Unemployment may rise both on account of dismissal of the employees of the bank under bankruptcy and the possible bankruptcy or lower activity of enterprises that suffered because of the termination of the bank’s operations. Nevertheless, the impact on the scale of the entire economy is insignificant, thus the unemployment rate in Lithuania because of this event may rise by approximately 0.2 p.p. Weaker economic growth and higher unemployment level will affect wages: due to AB bankas SNORAS bankruptcy compensation per employee is estimated to grow by 0.3 p.p. less.

LITHUANIAN ECONOMIC REVIEW /

I. INTERNATIONAL ENVIRONMENT 5

The global economy is growing at slower pace. Economic growth in a Deteriorating global sentiment indices warn number of advanced economies has nearly come to a halt. about increased downside risks to the outlook.

Prevailing tensions in international financial markets suppressed global Chart 1. Global purchasing managers’ index (PMI) economic expansion in the second half of 2011. Growth slowed both in 65 advanced and emerging economies. Many economies were negatively 60 affected by deteriorating business and consumer expectations, the need to 55 reduce fiscal imbalances, high unemployment, and slack in the real estate 50 market. At the end of the year, advanced economies whose real GDP began 45 shrinking increased in number. 40 Economic outlook remains particularly uncertain, and the risk that 35 growth will decelerate further is high. 30 Confidence indicators reflecting developments in the world economy 2007 2008 2009 2010 2011 fluctuated close to the neutral threshold (50), suggesting the modest growth Global composite PMI in the services sector, however the industrial output shrank for three Global manufacturing PMI Global services PMI consecutive months. Estimating the outlook for individual economies, the US economy has shown some signs of optimism, whereas in Europe downturn Source: Markit. trends strengthened, mainly due to negative sentiments related to the economic developments in the euro area countries.

The protracted and outspread euro area sovereign debt crisis poses a great threat to the global economy. Key interest rates remain historically low. In the second half of 2011, the euro area sovereign debt crisis deepened and became a confidence crisis. In order to stabilize the situation, a wide range of Chart 2.Key interest rates of central banks measures is undertaken: the European Financial Stability Facility is Per cent increased, a Stability Mechanism for the euro area member states is under 6 development, fiscal consolidation and supervision of the financial sector are 5 tightened, efforts are made to restructure Greek government debts. 4 Persisting international financial market tensions, however, suggest that doubts as to whether these measures will be implemented smoothly and 3 whether they will be sufficient to address the crisis, remain considerable. 2 1 Seeking to ease financial sector tensions, central banks increased financial sector liquidity and continued implementing accommodative 0 2007 2008 2009 2010 2011 2012 monetary policy instruments. ECB The ECB reduced the key interest rate on refinancing operations for two US Federal Reserve System consecutive times in the fourth quarter (by 0.25 p.p. – to 1%) and approved Bank of Japan

additional special monetary instruments: announced about three-year Source: Bloomberg. refinancing operations, reduced the reserve requirement (from 2% to 1%),

introduced softer criteria for pledging debts and asset-backed securities. In the fourth quarter of 2011, the US Federal Reserve System, jointly with other five major central banks, undertook coordinated action to ease stress in

money markets. On 30 November, a decision was adopted to halve (to 50 Since the middle of 2011, growth of commodity basis points) the price for USD swaps among central banks, and to extend prices has decelerated.

validity of this instrument until 2013. Chart 3. World commodity prices Global commodity prices fluctuated but changed just slightly despite Per cent, annual change the tensions in the financial sector. 100 80 Price index for commodities was approximately 5 per cent higher in the fourth 60 quarter of 2011 year on year, remaining almost unchanged, however, quarter 40 on quarter. Food and other agricultural raw material prices have declined 20 since mid-year, driven by good harvest and weak recovery in demand in 0 advanced economies. Energy commodity prices were on a rise, but changes –20 were insignificant. The average price of Brent crude oil fluctuated at around –40 USD 110 per barrel in the fourth quarter. Oil prices were influenced by an –60 increase in oil supply on account of recovering oil production in Libya. In the 2007 2008 2009 2010 2011 context of the slowing global economic recovery, oil exporting countries do Commodity Index Agriculture Index not intend increasing oil supply. Crude oil Index The growth of the US economy has remained weak; however, the Source: Standard & Poor's. situation in labour market slightly improved and other signs of THUANIAN ECONOMIC REVIEW / February 2012 economic recovery emerged towards the end of 2011. LI

Recovery in many world economies depends on In the US, real GDP rose by 1.6 per cent in the fourth quarter of 2011 year on 6 the growth rate of the US economy. year. Economic expansion strengthened slightly in the fourth quarter. The Chart 4. Annual change of real GDP, estimated by economy was fuelled by growth in household consumption, investments, and expenditure approach, in the US a positive contribution from change in private inventories and net exports. Per cent 20 Accomplishment of the economic stimulus programmes and a decline in government expenditure had a negative impact on the GDP. Towards the end 15 of the year, some positive patterns began surfacing in the US economy: the

10 unemployment rate declined, the activity of services and industrial sectors increased, and some signs of recovery in the construction sector emerged. 5 The economic expansion of the EU Member States slowed down in the 0 second half of 2011, a probability of recession in 2012 is not to be rejected. –5 2010 Q4 2011 Q1 2011 Q2 2011 Q3 2011 Q4 In the EU, real GDP growth moderated to 1.4 per cent in the third quarter of Private consumption Government expenditure 2011 year on year (2.4% and 1.7% respectively in the first and second Fixed capital formation quarters). The construction sector contracted, expansion in the manufacturing Exports Imports came to a halt, growth in investment and household consumption lost Real GDP momentum. Economic activity was held back by financial market tensions and Source: US Bureau of Economic Analysis. fiscal consolidation in a number of countries. The downturn continued in Greece and , real GDP also declined in , Cyprus, and

Slovenia. In the Baltic States, and economic expansion Record high cost of insuring against default on remained strong but started weakening as well. A decline in confidence Greek debt signals distrust in the country’s ability to repay its debts. indicators at the end of the year suggests that the expansion of the EU economy is likely to weaken further in the years ahead. The IMF projects that Chart 5. Price of five-year credit default swaps in the euro area countries in 2012 the euro area economy will shrink by 0.5 per cent; the European Basis points Basis points Commission also warns about the risk of recession in the region. 4.000 16.000 3.500 14.000 The Baltic States recorded the strongest economic growth in the EU in 3.000 12.000 the third quarter of 2011; however, a slower pace of recovery in the main 2.500 10.000 trade partners, particularly the euro area countries, exerts negative 2.000 8.000 influence on their further expansion. 1.500 6.000 The Latvian and Estonian economies were supported by growth in investment 1.000 4.000 and household consumption. In the context of increasing domestic demand, 500 2.000 import growth outpaced export growth, resulting in negative contribution of net 0 0 exports to GDP. In both countries nearly all sectors of the economy recorded 2011 01 2011 04 2011 07 2011 10 2012 01 growth, except the real estate sector. In the Baltic States, patterns of moderation in industry expansion began surfacing in the fourth quarter, more Portugal Greece (right scale) distinct in Estonia. The European Commission projects that in 2012 both Source: Bloomberg. countries will face a sharp deceleration in growth. According to the European Commission’s preliminary estimates, fiscal deficit in Latvia, after being above 4 per cent of GDP in 2011, will narrow to 2.5 per cent in 2012, whereas the deficit of Estonia’s budget, which was close to balanced, will widen to 2.1 per Economic growth in the Baltic States is projected to slow down markedly in 2012. cent of GDP on account of increase in public expenditure.

Table 1. Macroeconomic indicators of Estonia and In Russia and other oil exporting CIS countries, economic growth Latvia remained strong. The region is expected to enjoy benefits of Russia’s Estonia Latvia membership in the and other adopted Annual percentage change in real GDP decisions on trade liberalisation. 2011 Q1 9.5 3.5 In Russia, real GDP rose by 4.5 per cent in the third quarter of 2011 year on 2011 Q2 8.4 5.6 2011 Q3 8.5 6.6 year, driven by a recovery in domestic consumption. In other CIS countries, February 2012 2011* 7.9 4.5 economic expansion was quite strong, except Belarus, where the situation

2012* 1.9 1.3 remained tight. An important move towards strengthening economic Average annual percentage change in HICP relationship among the CIS countries was made through eight countries in the 2011 5.1 4.2 region – Russia, Ukraine, Belarus, Kazakhstan, , Kirghizia, Moldova

2012* 3.3 2.4 and Tajikistan – signing a free trade agreement in October; also, agreements Sources: Bank of Estonia, Bank of Latvia, ECB, IMF. on the main principles for the regulation policy and control of currencies in the * Forecasts CIS countries were approved. The creation of a free trade area in the CIS was

not in contradiction to liberalisation requirements and in December 2011, after 18 years of negotiation, the World Trade Organization approved Russia’s membership. After ratifying the accession agreement by the country, it is to come into effect in mid-2012.

LITHUANIAN ECONOMIC REVIEW /

II. REAL SECTOR 7

As has been expected in a previous review, Lithuania’s economic Growth of Lithuania’s economy is slowing down. development is slowing down. Such shifts were the result of a Chart 6. Real GDP growth and contributions deteriorating situation in international markets and worsening (expenditure approach) expectations of enterprises and households. Percentage points Per cent, annual change After a particularly good third quarter when the GDP increased by 6.7 per 30 30 cent, in the fourth quarter it grew by 4.3 per cent. In the third quarter, the 20 20 GDP increased mainly due to domestic demand, especially private 10 10 consumption. The impact of another domestic demand contributor – 0 0 domestic investment – on the GDP development weakened due to an –10 –10 increasing uncertainty surrounding the outlook of the global and Lithuanian –20 –20 economic growth. Because of a slower growth of investment and more –30 –30 moderate development of real exports of goods and services, real imports of –40 –40 2005 2006 2007 2008 2009 2010 2011 goods and services were also increasing at a slower rate. After a break of Final consumption expenditure more than a year, in the third quarter it grew slower than exports, therefore Domestic investment (excluding inventory changes) real net exports pushed GDP up. Net exports Changes in inventories In the third quarter, private consumption remained one of the main GDP (rh scale) contributors to GDP growth. However, its impact on GDP growth was Sources: Statistics Lithuania and Bank of Lithuania calculations. weaker than in previous quarter due to rising prices restricting the Private consumption was one of the main purchasing power of households. contributors to GDP growth.

In the third quarter, private consumption increased by 4.1 per cent per Chart 7. Development of private consumption and retail trade annum. Similar to the second quarter, it grew mainly due to, at that time, still Per cent, annual change improving household expectations and a more favourable situation in the 20 labour market – the unemployment rate continued to decrease, employment and wages were growing. Due to more favourable economic situation 10 households saved less, while spending more also on goods other than necessities. Expenditure on furniture and interior elements and automotive 0 fuel rose the most. Notwithstanding this, private consumption grew at a –10 slower rate compared to the second quarter. Such development of private

consumption was influenced by rising prices. They restricted the household –20 purchasing power. –30 The development of another domestic demand component – gross 2005 2006 2007 2008 2009 2010 2011 fixed capital formation – slackened significantly. Due to an unclear Private consumption further development of the global economy, enterprises were not Retail trade, excl. trade of motor vehicles inclined to expand production capacity. Sources: Statistics Lithuania and Bank of Lithuania calculations.

Investment in the third quarter grew more than two times slower than in Uncertainty surrounding the outlook of world’s previous quarter. This indicator was pushed up only by expenses on non- economy encouraged enterprises to postpone investment. residential construction, largely due to finished engineering constructions and buildings for cultural and sports arrangements. This allowed the activity Chart 8. Gross fixed capital formation growth and contributions of construction to grow the most among all economic activities even taken Percentage points Per cent, annual change into account shrinking investment into residential construction. The drop in 60 60 this investment was the result of not yet recovering real estate market. It is 40 40 likely that in the first half of 2011 this investment increased due to finished projects that had been begun before the downturn. Shrunk investment into 20 20

capital goods and vehicles was influenced by a slowing down global 0 0 economy and worsening enterprise expectations that forced enterprises to –20 –20 be more cautious in assessing new investment projects. –40 –40 Declining investment into capital goods and vehicles contributed to a –60 –60 smaller real growth of imports of goods and services. For the first time 2005 2006 2007 2008 2009 2010 2011 in a recent year this indicator was growing slower than real exports of Housing goods and services. These changes allowed real net exports to push Other buildings and structures

GDP up. Transport equipment Slowing down economies of the main trade partners of Lithuania also Machinery and other equipment Other investment and statistical discrepancies reduced the growth of Lithuania’s real exports of goods and services. Under Gross fixed capital formation (rh scale) the background of not so intensive growth of orders for the exported Sources: Statistics Lithuania and Bank of Lithuania calculations. production, the volume of imported raw materials and intermediate goods THUANIAN ECONOMIC REVIEW / February 2012 LI was growing at a slower pace as well. Also, weaker incentives of the

Decelerating growth of imports of goods and Lithuanian enterprises to invest into the production growth supported a 8 services led to positive contribution of net exports to GDP growth. slower growth of real imports of goods and services. Regardless a buoyant development of private consumption, an unclear global economic outlook Chart 9. Contribution of real net exports to annual GDP growth forced enterprises to optimize inventories. This suppressed the growth of imported durable and non-durable consumer goods. For the first time since Percentage points 30 30 the start of 2010, real net exports of services had a negative effect on GDP. 25 25 Substantially decelerating growth of exports of services was the main factor 20 20 behind these developments. Exports of services slumped due to decreasing 15 15 10 10 demand for transportation services as global economy slowed down. 5 5 0 0 Because of growing demand in foreign markets and a sufficiently –5 –5 competitive position of Lithuania’s enterprises in these markets, the –10 –10 tradable sector remained the key driver of the GDP growth. Also due to –15 –15 –20 –20 increasing private consumption, the activity of the non-tradable sector 2007 2008 2009 2010 2011 was also growing. Exports of goods Exports of services While transportation and storage economic activity was slackening, value Imports of goods added of the tradable sector was increased mostly by still sufficiently Imports of services Net exports growing manufacturing activity. It was mostly pushed up by growing sales in

Sources: Eurostat and Bank of Lithuania calculations. foreign markets, while domestic demand was more sluggish. As projected in the previous review, the largest growth of sales was registered in low value added manufacturing branches – furniture and textile industries. The activity in higher value added branches was also increasing but materially slower

Tradable sector activities increased GDP the most. compared to other quarters of 2011. An increasing activity of manufacturing encouraged other business servicing economic activities but the growth of Chart 10. Real GDP growth and contributions (production approach) the value added of these activities was feeble. The highest increase of the value added of the non-tradable sector was generated by construction and Percentage points Per cent, annual change 15 15 trade economic activities. A larger growth of the former, as has been 10 10 mentioned above, was driven by investment into non-residential 5 5 constructions, while of the latter – by growing private consumption. 0 0 Looking at a short-term prospect of Lithuania’s economy, Lithuania’s –5 –5 GDP is expected to grow at a slower rate. These shifts will be –10 –10 influenced mostly by a slowing down global economy. It will reduce –15 –15 the demand of Lithuania’s exports as well as enterprise investment –20 –20 2005 2006 2007 2008 2009 2010 2011 into the expansion of production volume and updating of equipment. A

Agriculture, forestry and fishing slower improvement in the labour market will have an impact on the Industry household sentiment, hence slackening private consumption. Construction Trade, transportation, accommodation and food service activities Financial and administrative activities, real estate In the short run, due to further slowdown of the economies of the main trade Other services partners of Lithuania, exports growth rate should slacken, but its decrease is Taxes, subsidies and statistical error GDP (rh scale) not expected so far. Industrial enterprises also expect the same exports Sources: Statistics Lithuania and Bank of Lithuania calculations. dynamics. Business tendency survey in manufacturing demonstrates the intention of enterprises to increase the volume of output in the nearest

quarter, and furniture industry should remain one of the main economic activities that will increase the industrial value added. In 2011 tangible investment of this activity was two times larger than a year ago. Also, the number of hired employees is intended to be increased in order to expand production. The production of rubber and plastic products and wearing apparel industry should also contribute materially to a larger value added of manufacturing. The development of other manufacturing branches will, most

February 2012 probably, be less favourable. One more indicator evidencing the slowdown of the manufacturing activity is orders for the production. In the last quarter of 2011, these orders remained basically at the same level as a year ago. This trend is observed in both external and internal markets. The mentioned changes in demand will not encourage enterprises to invest into the expansion of production, therefore, investment will also grow sluggishly. Suspended activity of the AB bankas SNORAS may also have a negative effect on slower investment growth. This factor will have a negative impact on private consumption as well, although the assessment of the financial state of households in the last quarter of 2011 was the best since the beginning of time series. Household sentiment may be worsened by a slower decrease of unemployment and less intensive growth of wages. This LITHUANIAN ECONOMIC REVIEW / would suppress household incentives to consume.

Box 2. Carry-over effect and its impact on the growth of GDP 9 The annual growth rate of GDP depends on two factors – GDP growth in the current year and its development in the previous year. The latter contributor is also called the carry-over effect and is calculated using seasonally and working day adjusted data. It shows the level of the GDP growth in the current year if the GDP growth within all quarters of the year was equal to 0 per cent. In other words, the volume of GDP of all quarters of a respective year should be equal to the level attained in the last quarter of the previous year. In such a case the actual GDP growth rate would be treated as the difference between the GDP growth rate and carry-over effect. As an example could be used quarterly volumes of Lithuania’s

GDP in 2006–2007 shown in Chart A. Lines A and C show average volumes of the quarterly GDP in 2006 and 2007 Chart A. 2006–2007 Lithuania‘s quarterly GDP in volumes respectively. Line B shows the average GDP volume in 2007 if the GDP volume in all quarters of 2007 did not change (would LTL billions remain at the level of the fourth quarter of 2006). The 21,0 percentage difference between A and C values corresponds to 20,5 the GDP growth rate in 2007 (9.8%), the percentage difference 20,0 between A and B shows the carry-over effect (3.5%), while the C percentage difference between B and C reflects the actual 19,5 19,0 GDP growth rate within 2007 (6.3%). The ratio of the carry- B over effect and actual GDP growth rate in 2007 complied with 18,5 the historical average of 1996–2008. A positive impact of the A 18,0 carry-over effect on GDP is explained by the fact that GDP historically was constantly increasing. During the mentioned 17,5 period, the carry-over effect itself made up on average about 17,0 one third of Lithuania’s GDP development and complied with 2006 2007 the euro area data. Sources: Statistics Lithuania and Bank of Lithuania calculations. Note: data is seasonally and working day adjusted. Chart B shows the breakdown of the annual change of Lithuania’s GDP in 2001–2011 into the carry-over effect and actual GDP growth rate in a respective year. The chart also shows the carry-over effect in 2012. Looking into the GDP contributors of several recent years, it is evident that in 2008 the actual GDP growth rate was negative (–0.3%), however, due to the carry-over effect in that year GDP grew by 2.9 per cent. An immensely large 14.7 per cent GDP drop was registered in 2009. In that year the drop was seen in the actual GDP growth rate (–13.8%), the carry-over effect also reduced it (–1.0%). This occurred due to the fact that the GDP volume declined from the mid- 2008 and started to grow again only at the beginning of 2010.

The latter contribution entailed a negative impact (–1.2%) of the Chart B. Growth rate of Lithuania‘s GDP carry-over effect on the GDP growth in 2010, while the GDP itself Percentage points Per cent, annual change grew throughout 2010 (by 2.6%). GDP also grew in 2011 (5.8%), 15 15 however the actual GDP growth rate was smaller (4.0%) 10 10 because the carry-over effect after a break of two years

5 5 increased GDP again (1.8%).

0 0 In 2012 the carry-over effect will have a minor impact on GDP growth (0.3%). However, it is not expected that actual GDP –5 –5 growth rate will be negative. The latest forecasts of international –10 –10 organisations and Lithuanian commercial banks suggest that in

–15 –15 2012 GDP should grow in the range of 2.0–3.5 per cent. This shows that in 2012 the actual GDP growth rate will be in the 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 range of 1.7 and 3.2 per cent. Such growth of GDP is smaller Actual GDP growth rate The carry-over effect than its long-term average. These estimations comply with the GDP growth rate (rh scale) latest Bank of Lithuania forecast suggesting that Lithuania’s GDP

Sources: Statistics Lithuania and Bank of Lithuania calculations. will grow in 2012 by 2.2 per cent.

THUANIAN ECONOMIC REVIEW / February 2012 LI

10 III. LABOUR MARKET

In the second half of 2011, the situation in labour market continued to improve. The situation in the labour market continued to improve: unemployment rate dropped, the number Unemployment rate in Lithuania was 14.8 per cent in the third quarter of employed increased; however, the growth in employment decelerated. (15.6% in the second quarter). According to preliminary data it was further dropping to 13.9 per cent in the fourth quarter of 2011. Although this Chart 11. The number of the employed and the unemployment rate indicator in the third quarter was sufficiently (3 p.p.) smaller than a year ago, Per cent, annual change Per cent it remained one of the largest in the EU and the highest in the Baltic States. 5 20 An improving situation in the labour market was also suggested by a 1 0 15 decreasing level of youth unemployment . This level in several recent years was persistently increasing. The level of long-term unemployment2 in –5 10 Lithuania stabilised (8.0%) in the third quarter, however, remained very high compared to the EU average. –10 5 For already several quarters employment was larger than a year ago. In the –15 0 third quarter, the number of the employed increased 2.1 per cent per 2005 2006 2007 2008 2009 2010 2011 annum. According to preliminary data, it increased by 0.9 per cent in the Unemployment rate (rh scale) fourth quarter of 2011. The growth in the third quarter was influenced mainly Employed by the largest by employment sector – the services sector, particularly trade, Sources: Statistics Lithuania and Bank of Lithuania calculations. transport and storage activities. Over a year the number of the employed increased somewhat also in the construction sector and industry, whereas Wages were higher than a year ago; however, they were also increasing at a slower rate. in agriculture it curtailed. In the private sector the employment was increasing for a year already, while in the public sector after increasing in Chart 12. Average gross wage the first half-year it shrank in the third quarter. Per cent, annual change 30 A more rapidly growing national economy determined increasing wages as well. The average gross wages in the third quarter of 2011 stepped up 1.6 20 per cent per annum mainly due to higher wages in the services sector,

10 though construction, industry and agriculture also contributed to this. The wage growth in the public sector was more intensive than in the private one. 0 Declared emigration decreased in 2011. –10 Monthly data of the declared emigration from Lithuania suggest that in 2011, –20 compared to 2010, the number of emigrants decreased (from 83 thousand 2005 2006 2007 2008 2009 2010 2011 to 54 thousand of persons or by one third). To be true, data of the declared Overall economy emigration in 2010 and possibly in 2011 were distorted by earlier emigrants Private sector Public sector who declared their departure after the spread of information that in case of

Source: Statistics Lithuania. non-declaration of their departure they would be required to pay mandatory health insurance contributions on their own.

In 2011, the total outflow from Lithuania to five European countries (United Kingdom, , Ireland, Spain and Germany3) mostly favoured by the Lithuanian emigrants does not seem to increase compared to 2010. Data of the United Kingdom of the first half-year suggest that this state remained to be the main target country for emigrating – the number of those who left Lithuania for United Kingdom was larger than at the same time last year. However, a complicated economic situation in Ireland was behind a

decrease of the flow of emigrants in January–November from Lithuania year

February 2012 on year. Interest in the labour market of Spain earlier favoured by the Lithuanians subsided already at the beginning of 2011 and an increase of the emigrants flow to the German labour market that opened in May 2011 is not observed. According to the data of three quarters, the number of new arrivals from Lithuania to Norway decreased somewhat on an annual basis.

______1 The youth unemployment is expressed by the ratio of the unemployed and labour force in the age group of 15–24. 2 The rate of long-term unemployment is expressed by the ratio of long-term unemployed (looking for a job for one year or more) and labour force. 3 Data used by the United Kingdom and Ireland is the number of state social insurance numbers newly issued for the Lithuanians. After the registration in the national social security system, a person is obliged to pay taxes on labour related income earned in this country. The Norwegian LITHUANIAN ECONOMIC REVIEW / data reflect the number of work permissions newly issued to Lithuania‘s citizens. Data of Germany reflect the number of new arrivals of the Lithuanian citizens, and of Spain – the balance of new arrivals and departures from the country.

However, to compare with the second quarter, the situation in the labour market was improving at a slower rate, while future expectations deteriorated. 11 In the third and the fourth quarters, unemployment was decreasing, but the number of the employed was increasing slower than in the second quarter. In the third quarter, a small increase was registered in the average gross wages in Lithuania’s economy, and in the private sector its growth slackened in particular. This might be associated with worsening private sector expectations because of a further outlook of Lithuania’s economic development. Expectations of the population about changes in the number of unemployed were deteriorating in the course of all months of the third quarter. This trend was also observed in the fourth quarter. In the context of worsening prospects of the development of Lithuanian economy, the situation in labour market is also envisaged to be worse (employment will step up and unemployment will shrink at a slower rate), also risk of an increase of the emigration flow is strengthening.

Box 3. About the minimum monthly wage

As from 1 January 2008, the minimum monthly wage in Lithuania amounts to LTL 800. In order to compare this Chart A. Ratio of the minimum monthly wage and average gross earnings in 2010 indicator with those applied in the EU, it is worthwhile to use the ratio of the minimum monthly wage to average gross earnings. Eurostat announces that in 2010 this ratio Per cent 50 in Lithuania made up 42.0 per cent. It was the largest in 45 France, , and (47.6%, 47.5%, 40 46.2% and 45.9% respectively, and the smallest – in the 35 30 Czech Republic and Romania (33.4% and 32.3% 25 respectively). 20 15 To be true, the indicator announced by Eurostat is the ratio 10 5 of the minimum monthly wage and average gross earnings 0 in industrial, construction and services sectors but not in USA Malta Spain the whole economy. In addition, in some EU states Latvia Ireland Greece Estonia France* Poland* Bulgaria Portugal Slovakia Slovenia Romania (Sweden, Denmark, Austria, and others) the minimum Lithuania wage is not set for the economy-wide, therefore, they are Luxembourg Czech Republic Czech United Kingdom United not included into the analysed statistics. * Year 2009. Source: Eurostat. In some EU states (France, Czech Republic, Malta, and others), the minimum monthly wage is differentiated by age groups, i.e. laws permit to pay a smaller than minimum wage to young and having no work experience persons. For example, in 2010 in Poland the wage of persons participating in the labour market for the first year had to make up no less than 80 per cent of the main amount of the minimum monthly wage. In other states, e.g., France, Czech Republic and Netherlands it was allowed to pay a smaller amount than the minimum monthly wage for persons up to a certain age (younger than 19 years of age in France, 22 – in 4 Czech Republic, 23 – in Netherlands) . On the basis of the data of Statistics Lithuania, the ratio of the minimum monthly wage to the average gross earnings in the whole economy in 2010 would amount to 40.2 per cent in Lithuania. According to preliminary data it dropped to 39.2 per cent in 2011. Taking into account the fact that a part of wages in Lithuania might be paid illegally, this ratio could be somewhat lower. According to the wage growth forecast of the Bank of Lithuania made in February 2012, the ratio should decrease further to 38.6 per cent in 2012 if the minimum monthly wage did not increase. In case of an increase of the minimum monthly wage to e.g. LTL 850 as from 1 July 2012, the mentioned ratio would slightly increase compared to 2011, while a larger increase of the minimum monthly wage would result in a larger ratio.

THUANIAN ECONOMIC REVIEW / February 2012

______LI 4 European Foundation for the Improvement of Living and Working Conditions (Eurofound) „Pay developments – 2010“, 15th January 2012 (http://www.eurofound.europa.eu/eiro/studies/tn1109060s/tn1109060s.htm).

12 IV. EXTERNAL SECTOR

CURRENT ACCOUNT AND ITS FINANCING In the third quarter, the current account was in surplus. In the third quarter of 2011, Lithuania’s current account recorded a Chart 13. Components of the current account balance surplus, which stood at 2.2 per cent of GDP. Per cent, compared to GDP 20 Unlike in the first two quarters, the current account recorded a surplus in the

10 third quarter. This was mainly driven by halving of the trade in goods deficit, while the overall balance of exports of goods and services recorded a 0 surplus for the first time in over a year. Significant contribution to the –10 dynamics of the current account balance also came from the income –20 balance, whose smaller deficit mainly reflects foreign investors’ profitability

–30 volatilities. At the same time it should be noted that profits of foreign capital 2005 2006 2007 2008 2009 2010 2011 enterprises accumulated over the first three quarters of 2011 are nearly Goods three times as high as those accumulated during the respective period a Services Income balance year ago. Current transfers Current account balance Current transfers increased slightly in the third quarter on account of Sources: Statistics Lithuania and Bank of Lithuania calculations. an increase in EU payment flows and significant emigrants’ transfers.

In line with previous review, EU transfers increased in the third quarter The flows of current transfers were supported by increased EU support payments (see “transfers to compared against the second quarter. The amounts of EU support and general government” in the chart). other payments (including the Ignalina Plant closure

Chart 14. Current transfers to Lithuania programme) vary depending on the schedule for project implementation and Per cent, compared to GDP other circumstances, but average yearly amounts do not change 12 significantly. Thus, if the projects of the EU structural support programme for 10 2007–2013 were further successfully implemented, these flows would 8 remain stable. While emigrants’ transfers, another important component of 6 current transfers, stopped increasing, they have been supporting significant 4 flows of current transfers. In the last quarter of 2011, the dynamics of 2 current transfers is likely to be similar. 0 2006 2007 2008 2009 2010 2011 In the third quarter of 2011, the overall balance of the capital and Transfers to general government financial accounts was negative. Growth in official reserve assets and 5 Workers' remittances larger negative flows of the other investment category were the main Other transfers Current transfers drivers behind the overall deficit of these accounts.

Sources: Statistics Lithuania and Bank of Lithuania calculations. Changes in the current account were also reflected in the overall capital and

financial accounts balance. It was negative mainly due to financial account With a surplus in the current account, Lithuania’s changes – primarily an increase in official reserve assets and foreign assets official reserve assets and banks’ foreign assets (see “other investment” in the chart) recorded an of domestic banks, as well as overall decrease of foreign obligations by all increase. subjects of the economy. All the above mentioned factors are recorded in

Chart 15. Current account deficit and its financing the financial account as negative flows and heavily outweighed positive Per cent, compared to GDP values in other parts of the financial account. The most significant of them, 30 the FDI flow in the third quarter of 2011 was mainly formed by reinvestment 20 and new share capital contributions, while the net positive flow of 10 investment portfolio was determined by the smaller exposure of domestic

0 banks to foreign equity securities. Meanwhile, the capital account surplus,

–10 which shows EU support funds payments for investment projects under implementation in the country, increased nearly four times over the period –20 giving one of the highest quarterly values since the start of compilation of –30 February 2012 2005 2006 2007 2008 2009 2010 2011 the . These exclusive flows resulted from payments for Capital account the projects administered by the Transport Investment Directorate restored FDI 6 Portfolio investment by the European Commission late in the summer , thus they are likely not to Other investment be that significant in other periods. Official reserve assets Errors and omissions Current account deficit Sources: Statistics Lithuania and Bank of Lithuania calculations.

______5 Other investment covers debts for goods and services, deposits, loans, cash and current accounts as well as other foreign assets (liabilities). 6 As mentioned in the previous review, Lithuanian authorities have resolved the issues related to LITHUANIAN ECONOMIC REVIEW / the State Control report concerning the misuse of EU funds in the projects administered by Transport Investment Directorate in 2009, therefore the EC resumed payment of funds in August 2011; in addition, payments temporarily covered with national resources were compensated.

Annual export growth decelerated mainly driven FOREIGN TRADE AND COMPETITIVENESS by negative trends in the export of vehicles. 13 7 In the third quarter of 2011, foreign trade deficit at nominal value Chart 16. Contributions to exports growth (three-month moving sums) narrowed by one-third, the lowest quarterly deficit during the last one Percentage points Per cent, annual change and a half years. 60 60 In particular, positive change in trade balance in the third quarter of 2011 45 45 was affected by weaker annual import growth, while imports, according to 30 30 seasonally adjusted data, even declined during the quarter. Export 15 15 development was not as strong as in the first half of 2011 either; 0 0 nevertheless, still its dynamics was better than import dynamics. It should –15 –15 be noted that export growth has rather been maintained by exports of goods –30 –30 of Lithuanian origin, whereas re-exports have lost much of their significance. –45 –45 No significant change in foreign trade deficit can be expected for the last 2007 2008 2009 2010 2011 Agricultural products and food quarter of 2011, because, as the data for October–November suggests that Chemical products and plastics the rate of expansion of nominal exports will be similar (especially on Wood and articles of wood Metals account of the performance of trade in oil and food products), while imports Machinery and appliances Vehicles will be affected by seasonal factors of domestic demand. Other Exports of goods (rh scale) Annual export growth remained substantial in the third quarter of 2011, Exports of goods, excl. mineral products (rh scale) though it noticeably decelerated. Sources: Statistics Lithuania and Bank of Lithuania calculations. Annual export growth has been losing momentum. However, positive annual Recently, growth of both exports of Lithuanian origin and re-exports was less pronounced. changes were maintained in all groups of export goods in the third quarter; as a matter of fact, the growth rate of exports of oil products only was Chart 17. Value of exports of goods (seasonally adjusted data) stronger, while expansion in all other sectors weakened. Lower growth resulted from decreased re-exports, which, seasonally adjusted, declined by LTL billions 12 per cent over the quarter. As was mentioned in the previous review, 7 significant changes in re-exports are driven by the dynamics of Lithuania’s 6 used cars export market. Annual growth of re-export of vehicles was 7 per 5 cent in the third quarter of 2011 that is much weaker than previous quarter 4 (112%). The development of exports of goods of Lithuanian origin was 3 significantly more successful than that of re-exports – the annual growth 2 rate of the former even accelerated in the third quarter (to 28%). Major 1 contributors to overall export growth included faster growth in the exports of 0 2007 2008 2009 2010 2011 oil products (47%) and stable annual development of exports of the chemical, metal, machine and furniture as well as wood industries (above Re-exports 20% in each). Exports of goods produced in Lithuania Total exports Despite the slowing pace of exports, Lithuania’s export market shares Sources: Statistics Lithuania and Bank of Lithuania calculations. in its major trade partners increased further. Imports growth weakened particularly on account Lithuania’s export to the EU rose by 31 per cent in the third quarter of 2011, of a decline in the demand for capital goods. to Russia by 21 per cent year on year. Its export share in main trade Chart 18. Contributions to imports growth partners increased as well. Lithuanian exports to the EU countries (three-month moving sums) accounted for 0.29 per cent of the common market, a much bigger share Percentage points Per cent, annual change than a year ago (0.24%), meanwhile the expansion of its export share in 60 60

Russia was relatively moderate (from 1.44% to 1.45%). 40 40

Import data for the third quarter of 2011 point to expansion slowing 20 20 further down. Annual import growth was weaker than export growth. 0 0 Import grew at a slower pace on account of annual growth of capital goods –20 –20 weakening to 9 per cent in the third quarter of 2011, compared to the growth –40 –40

of 56 per cent in the second quarter. In addition, an important contributor –60 –60 was a fall in the re-exports of vehicles. According to seasonally adjusted 2007 2008 2009 2010 2011 data, imports shrank (by 1%) over the quarter for the first time over the last Capital goods two years. Intermediate goods, exlc. fuels Consumption goods Cars Other Imports of goods (rh scale) Imports of goods, excl. fuels (rh scale) Sources: Statistics Lithuania and Bank of Lithuania calculations. THUANIAN ECONOMIC REVIEW / February 2012

______LI 7 Foreign trade data of export of goods and import of goods in nominal values are reviewed in this section.

14 V. PRICES AND COSTS

The most important contributor to inflation in 2011 Average annual inflation was 4.1 per cent in 2011 (1.2% in 2010). was the rise in food prices. Approximately half of this inflation was driven by food price increases. Chart 19. Contributions to annual inflation Growth of fuel and administered prices added one fifth of inflation each. Percentage points Per cent 14 14 Thus, price increases largely reflected external factors, mainly global food 12 12 and energy prices. The prices of industrial goods and market services 10 10 8 8 related to domestic demand contributed to approximately one-tenth of 6 6 average inflation in 2011. 4 4 2 2 Annual inflation declined from the middle of the year with a few 0 0 exceptions. –2 –2 –4 –4 In May, annual inflation reached 5.0 per cent and was the highest in 2007 2008 2009 2010 2011 approximately two years. During subsequent months it mainly decreased Administered prices Prices of food incl. beverages and tobacco (increased somewhat in September and November), particularly in Prices of fuels and lubricants December, when it dropped to 3.5 per cent on account of base effect and a Prices of services Prices of industrial goods fall in prices over the month. Inflation decreased mainly due to decelerated Annual core inflation* (rh scale) food price growth in relation to changes in global food commodity markets. Annual HICP inflation (rh scale) Sources: Statistics Lithuania and Bank of Lithuania calculations. * Change in HICP, excl. food, fuels and lubricants, and administered prices. CORE INFLATION Annual core inflation8 was low, suggesting that there are no

substantial upward pressures on prices stemming from domestic demand. For approximately one and a half years the prices of industrial goods and market services, which are included in the calculation of the core inflation measure, were lower than a year ago. This trend reversed in March 2011 when annual core inflation turned positive. In subsequent months it increased but remained low with minor contribution to headline inflation. Although the seasonally adjusted turnover of non-food retail trade as well as of catering activity has continued to increase recently, this is not likely to cause substantial acceleration of core inflation due to the increasing risk of substantially lower domestic demand growth.

FOOD PRICES Annual growth of food prices in Lithuania moderated in the context of Annual growth rate of global food prices decelerated, resulting in smaller food price decelerated and most recently already negative annual growth in contribution to inflation in Lithuania. global food prices.

Chart 20. Global food prices The effect of food prices on inflation in Lithuania weakened, however, an Per cent, annual change increase in food prices remained the main factor behind inflation. The 120 previous strong growth in food prices was related to the rising food prices in 90 global markets, which were the highest in February 2011. Afterwards global 60 food prices declined amid improved supply projections and growing 30 concerns about global economy. In the context of slowing global economic 0 growth and sufficient food supply, global food prices are unlikely to grow

February 2012 –30 rapidly again. –60 In December, global food prices were already lower (by approximately 6%) 2007 2008 2009 2010 2011 Food prices than a year ago. The prices of and oil declined the most (by more Prices of meat products than one tenth), the prices of grain fell significantly as well. The decline in Prices of dairy products the prices of dairy products was the least pronounced, while meat was the Cereal prices only commodity group which recorded a positive growth in prices over a Oil and fat prices year. Sources: Food and Agriculture Organization of the and Bank of Lithuania calculations.

______8 Core inflation is the inflation indicator which reflects a long-term trend of the price development, LITHUANIAN ECONOMIC REVIEW / more stable, longer-term inflation not affected by short-term economic shocks. The Bank of Lithuania calculates the core inflation indicator as the change of the HICP, excluding prices of food, fuels and lubricants, and administered prices.

Compared to May, when prices of food products and non-alcoholic beverages in Lithuania per annum increased the most in several recent 15 years (11.1%), in December the rise in them became half as strong (5.5%). Nevertheless, the prices of some products with lower share in the food basket, such as fish, coffee and tea, sugar and confectionery, oils and fats, were higher by over one tenth in December year on year. Unlike the group of food products and non-alcoholic beverages which has great influence on inflation, the contribution from alcoholic beverages and tobacco products on inflation was insignificant. Their prices were only approximately 1 per cent higher in 2011 than in 2010.

ADMINISTERED PRICES

The prices of heat energy grew continuously in 2011 and could Administered prices contributed more to inflation increase further in nearest term. The electricity price for households due to accelerated growth of heat energy prices. increased in the beginning of 2012. Chart 21. Contributions of administered prices to annual inflation The annual growth of administered prices accelerated from May (except Percentage points some months), mainly fuelled by higher increases in the price of heat 3,0 energy. Its price was approximately 18 per cent higher in December year on 2,4 year. 1,8 1,2 In 2011, the price of heating dropped down just twice – marginally in 0,6 February and by 0.9 per cent in December, during the other months it 0,0 picked up because of the rising price of fuels used in heat energy –0,6 –1,2 production, mainly imported natural gas. According to the National Control 2007 2008 2009 2010 2011 Commission for Prices and Energy, its price declined somewhat in October Electricity Gas but increased in November and December. In December, this institution Heat energy also indicated that in the major cities of Lithuania the growth in heating Passenger transport by railway Passenger transport by road prices was not uniform: the lowest increase over a year (around 7%) was Other Sources: Statistics Lithuania and Bank of Lithuania calculations. recorded in Panev÷žys, while in Vilnius, , Klaip÷da and Šiauliai price of heat energy stood at levels approximately one fifth or more higher than in December 2010. The rising price of imported natural gas also influenced other administered prices: the price of natural gas provided to household consumers picked up rather noticeably in mid-2011, price of electricity increased from January 2012. Price of heat energy could also grow further. However, in the first half of 2012 the prices of natural gas remain unchanged from the second half of 2011.

FUEL PRICES

The pace of annual increase in oil prices moderated, but still was Crude oil price increased at a slower pace, annual growth of fuel prices decelerated markedly in significant and the oil price remained rather high. December.

In the second half of 2011, oil price developments depended also on market Chart 22. Crude oil price and fuel prices in Lithuania sentiments related to macroeconomic data. Prices picked up temporarily Per cent, annual change USD following announcement of good macroeconomic data and decreased on 90 150 account of growing uncertainty about global economic development. In 60 120 December, the OPEC pointed out that in order to ensure oil market stability in 2012 not only the key drivers behind oil prices (supply and demand 30 90 developments) but also the sentiments related to macro economy as well as 0 60 speculative actions should be monitored closely. –30 30 In December, annual growth of fuel prices in Lithuania decreased –60 0 significantly, from approximately 15 per cent to 6 per cent, it was the key 2007 2008 2009 2010 2011 driver behind the decline in annual inflation that month, which suppressed Average monthly oil price in US dollars (rh scale) the effects of decelerated growth in food prices. Annual fuel price increase World oil price, LTL slowed down mainly on account of base effect: annual change was no Fuel price longer affected by the particularly sharp rise in fuel prices (7%) in December Sources: Bloomberg and Bank of Lithuania calculations. 2010.

THUANIAN ECONOMIC REVIEW / February 2012 LI

16 Box 4. An overview of forecasts of global food prices Higher food prices were recently the major contributor to the inflation in Lithuania but their impact has weakened because of the decelerating growth of global food prices. Based on Food Price Index by the Food and Agriculture Organisation of the United Nations (FAO), global food prices for February 2011 were record high (exceeding the mid-2008 heights) with their annual growth rate fluctuating around 35 per cent. The rise in food prices was driven by short-term factors such as lower supply, more expensive energy resources, increased financial investment in food commodities, as well as long-term trends such as rising demand for biofuels and the demand for food products in emerging economies. Afterwards, global food prices declined driven by improving supply and growing concerns about the expansion of global economy. Given the high level of uncertainty present regarding the growth of global economy, the development of food prices in nearest future remains quite unclear; therefore, it would be useful to overview the forecasts published by international organisations lately. The table below contains forecasts for the development of prices of selected food commodities in 2012 compared to 2011, published by Bloomberg, Economist Intelligence Unit (EIU) and the . According to these forecasts, major commodity prices are expected to decline year on year substantially. EIU and the World Bank publish forecasts not only for specific commodities but also for commodity groups. According to EIU, prices for food products, feed, and beverages are expected to go down in 2012 by 12.5 per cent (15.1% for beverages, 12.8% for grains, 12.6% for sugar, and 9.8% for oils). The World Bank forecasts prices for food products to drop by 13.7 per cent (18.1% for oils, 11.3% for grains, and 8.8% for other food products), and for beverages by 13.2 per cent.

Table A. Forecasts for changes in food commodity prices (in US dollars) in 2012 compared to 2011

The median forecast by experts surveyed by EIU forecast World Bank forecast Bloomberg Data available at: Date of the forecast: Date of the forecast: 21st December 2011 14th December 2011 November 2011 Cocoa 2.3 –16,3 –11.5 Coffee –19.1 –14.8 –16.7 –3.5 –8.5 –15.3 Soybean oil 9.6 –9.8 –23.7 Sugar –14.0 –12.6 –17.2 –3.4 –15.7 –12.5 Sources: Bloomberg, EIU, World Bank and Bank of Lithuania calculations.

On average, the drop of food commodity prices in 2012 should not cause surprise as this is an average annual change calculated as the ratio of average price levels in 2012 and 2011. As indicated above, global food prices were record high in February 2011. Although afterwards they decreased, an average price level in 2011 was very high. Even with food prices staying stable, the average annual change would be negative in 2012. If we make an assumption that food prices remain unchanged, i.e. for the entire 2012 they stay at the level observed in December 2011, and calculate average annual changes in prices of food and its groups based on FAO Food Price Index, food index goes down about 7 per cent (a slight increase may be observed only in meat prices, while prices for other groups such as dairy, fats, sugar, cereals may go down by 9 to 12%). Nonetheless, such a decline in prices seems less pronounced compared to the forecast by EIU and the World Bank. Consequently, a certain decrease in prices (rather than stability) is expected in 2012. According to the November Food Price Watch by World Bank, improved supply is expected to dampen the surge in global food prices. The forecasts of United States Department of Agriculture (December 2011) show global wheat stocks to reach a 10-year high in 2011/2012 season following a rebound in production in major producing countries such as Kazakhstan, Australia and Canada, and in the euro area. Similarly for other cereals: maize production is forecasted to increase because of higher production in , Ukraine, Russia, and other countries, and rice output is also forecasted

February 2012 to increase on account of good harvest in India. Also, macroeconomic factors bode well for lower global food prices: concerns about the world economy, particularly in the euro area and US, have generally dampened demand, which is likely to lead to a decrease in global prices. Coupled with the decline in energy prices, declining global demand is also likely to lower the demand for ethanol, which grew fast in recent years. This may lead to lower use of maize and vegetable oils in the production of ethanol and biofuels. In addition, record high crops of maize in China and of rice in India, as well as Ukraine’s decision to end duties on grain exports will also contribute to dampening global price increase. The stock-to-use ratio is an important measure in the food commodities market. It indicates a relative supply and demand balance of a given commodity, and change in that market if compared to previous year. When this ratio fells down to a critical level, a commodity price jump can be expected. The chart contains this ratio for selected commodity groups, taken from the Food Outlook for November 2011, a publication of FAO. LITHUANIAN ECONOMIC REVIEW /

The stock-to-use ratio for wheat and coarse grains (cereals, Chart A. Global stock-to-use ratio for selected 17 excluding wheat and rice) contracted, but the same indicator for products other product groups such as rice, fats, and sugar went up. FAO Per cent forecasts the stock-to-use ratio for wheat, rice, and sugar to 40 increase in 2011/2012 (respectively by 1.5, 2.5, and 3.0 p.p.) but to 35 decline in the groups of coarse grains and oils. 30 25 Consequently, the supply and demand balance in case of rice and 20 sugar is to be positive and the upward price pressure is unlikely. 15 Record high wheat output in 2011 (global output is likely to grow by 10 6% in 2011/2012) will lead to higher stocks, thus stock-to-use ratio 5 in 2011/2012 will be significantly higher than the 2007/2008 lows 0 Cereal Wheat Rice Coarse Sugar and five-year average level. Very good rice harvest in major Oils grain producing countries will allow not only satisfying consumer demand 2009-2010 but also boosting the stocks notably. For the second consecutive 2010-2011 (estimate) year, global sugar production is expected to surpass its 2011-2012 (forecast) consumption. Higher sugar output, attributed to significant Source: Food and Agriculture Organization of the United Nations. expansion in crop area prompted by increasing prices in recent years, may weaken global sugar prices although demand for stock rebuilding is likely to provide some price support. Regarding the groups of coarse grains and oils, the stock-to-use ratio is expected to go down. The share of coarse grains used for food is small. Although the demand for coarse grains is forecast to grow at a slower pace than predicted earlier because of its dependence on macroeconomic environment (especially in case of maize which is used for feed and fuel production), this will not help to restore the stocks. Regarding the group of oils and fats, where soybeans and are the major commodities, the growing demand (especially in Asian market, mainly in China) is likely to prompt a tightening in the supply and demand balance. Unlike in the previous two years, production is to be lower than consumption. As a result of decreasing stocks and growing consumption, the ratio of these two indicators is likely to lower below 15 per cent and come close to an especially low level observed during the food price jump in 2008. The forecasts indicate that food prices are not likely to go up. However, they remain quite high at present time. Prices for some fertilisers remain much higher than a year ago, and uncertainties prevail in energy markets which are tightly related to food commodity markets (the growth of global economy is likely to decelerate, but potential oil supply disorders support concerns). According to the World Bank forecasts (November 2011), prices for energy and fertilisers, which are critical inputs for agricultural production, are likely to decline significantly in 2012 compared to 2011 (by 8 and 15% respectively). The previously discussed stock-to-use ratio is another potential factor for price volatility. Although for cereals a slight growth of this indicator is forecasted, it will not be large, and thus even small shocks can have significant effect on prices.

THUANIAN ECONOMIC REVIEW / February 2012 LI

18 VI. CREDIT AND DEPOSITS

9 Recovery in economy led to strenghtening of The banking loan portfolio returned to grow in the second half of borrowers’ financial standing and more signs of credit recovery. 2011, two and a half year after the start of economic downturn. Chart 23. Contribution to changes in banking loan In the period from July to November 2011, liabilities to banks increased by portfolio in January–November LTL billions LTL 1.3 billion or 2.5 per cent. The growth of economy and improvement of 20 the financial situation of banks’ debtors was followed by the recovery of 15 credit demand supported by easing of credit standards and low interest

10 rates. For example, nearly one fifth of the respondents in the Bank of

5 Lithuania’s bank lending survey in October 2011 reported an easing of lending requirements, while weighted average interest rates on new loans 0 remained in 2011 close to those in 2010. –5 During the first eleven months in 2011, the loan portfolio of the Lithuanian –10 banking system hiked by LTL 0.3 billion, although a decline of LTL 3.1 billion Government Financial institutions was observed in a corresponding period twelve months ago. In the said Non-financial corporations Households period, liabilities to banks by non-financial corporations and government Total sector went up, but liabilities of households and financial institutions went Source: Bank of Lithuania calculations. down (the first ones decreased year on year by two and a half times). The

Although internal funds have remained the main cancellation of the licence for AB bankas SNORAS may slightly dampen the business financing source, borrowing from banks growth of the banking system’s loan portfolio in future, as the crediting became more important due to the growth of investment. liabilities of the said bank for the period between 2007 and 2011 accounted Chart 24. Changes in loan portfolio to corporate sector for 3 to 4 per cent of the total crediting liabilities of the entire system. per quarter Since 2010, the situation in non-financial corporations has been LTL billions 3 improving supported by growing consumption and investments in local and foreign markets. 2 Profit earned by businesses in the first three quarters of 2011 totalled LTL 1 7.2 billion, higher by one third compared to twelve months in 2010. In the third quarter of 2011, the sales profitability by non-financial corporations 0 made up 4.1 per cent. Two thirds of all corporations reported profit, and the number of corporations which reported about bankruptcy proceedings –1 initiated against them went down. –2 2007 2008 2009 2010 2011 Regardless of the fact that most of non-financial corporations have been Non-tradable sector drawing on internal funds to satisfy their financial needs, an increase was Tradable sector Total observed in the number of corporations which decided to rely on bank Source: Bank of Lithuania calculations. lending driven by easing in lending requirements and comparatively low

interest rates on new loans. During the first eleven months in 2011, the banking loan portfolio to non-financial corporations grew by LTL 0.5 billion Households remain cautious about borrowing for other pruposes than house purchase. after decreasing by LTL 3.0 billion in corresponding period a year ago. The Chart 25. Changes in loan portfolio to households per biggest decrease in liabilities to banks was observed among real estate month enterprises, while the highest increase in bank borrowing following a LTL billions 0,6 recovery in domestic and foreign markets could be seen among trade companies. 0,4 However, growing concerns about the sustainable economic 0,2 development in major export markets and markets closely related to 0,0 them led to deterioration in businesses’ perceptions regarding their

February 2012 future. –0,2 The decline in economic sentiments of many businesses and consumer –0,4 2008 2009 2010 2011 confidence indicators towards the end of the year and a decrease in orders Loans for house purchase for the production output and works to be done (especially in non-Lithuanian Other loans markets) was followed by the growth in the number of businesses which

Source: Bank of Lithuania calculations. reported insufficient demand.

______LITHUANIAN ECONOMIC REVIEW / 9 On 24 November 2011, the Bank of Lithuania cancelled the licence for AB bankas SNORAS. To ensure the comparability of data and accurate analysis, the development of loans granted by banks in Lithuania and deposits received is viewed excluding the data of AB bankas SNORAS.

An increase in accumulated reserves and a slight decrease in the utilisation Bank borrowing costs increased due to the growth of interest rates in inter-bank market. of production capacities therefore have led to a reduction in the need for the 19 Chart 26. Contribution to changes in weighted average renovation of available equipment and acquisition of the new one, which is interest rate on new loans to private sector likely to contain the bank lending growth rate. (twelve-month moving average) Percentage points Percentages 0,3 7,5 Many non-financial corporations have encountered a shortage in labour force as their operational activity continued to be high, which 0,2 7,0 contributed to the growth of wages and strengthening of the financial 6,5 0,1 standing of households and credit demand. 6,0 0,0 In the environment of improving financial situation of households and 5,5 consumer confidence indicator with the latter having reached in mid-2011 –0,1 5,0 the level registered before the economic downturn, an increase in –0,2 households’ borrowing from banks was registered in some months of 2011. 4,5 During the first eleven months in 2011, the amount of repaid liabilities to –0,3 4,0 2006 2007 2008 2009 2010 2011 banks by households decreased compared to a corresponding period in the Dynamics of average weighted interbank interest rate (6 months) previous year: from the beginning of 2011 to November the same year, Dynamics of the margin Average weighted interest rate (rh scale) banking loans for house purchase contracted by LTL 0.1 billion (a year ago, Sources: Euribor-EBF and Bank of Lithuania calculations. the decrease made up LTL 0.5 billion), while other loans went down by LTL

0.6 billion (a year ago, the decrease made up LTL 1.3 billion).

Concerns about the trend of economic development in future had negative The growth of deposits was mainly determined by effect on consumer confidence in the second half of 2011, while halted less favourable future expectations and slight increase of interest rates on new deposits improvement of operational indicators of non-financial corporations may Chart 27. Contribution to changes in deposits in have a downward effect on the growth of wages, which is likely to curtail banking system per month households’ willingness and possibilities to use loans for financing LTL billions consumption and investments. 2

Growing concerns about decelerating economic growth and 1 deepening debt crisis made the ECB cut key interest rates to 1 per 0 cent and for the first time in its history start lending to commercial banks for a period of three years. –1 This led to a decline in the market-based financing costs, while improving –2 financial situation of borrowers made the borrowing margins to go down. –3 Consequently, costs of lending to retail banking clients decreased too. At 2008 2009 2010 2011 Government the end of November 2011, weighted average interest rate for private sector Households made up 4.4 per cent, a month-on-month decrease of 0.3 p.p. (the margin Non-financial corporations Financial institutions shrank by 0.2 p.p., and interbank interest rate decreased by 0.1 p.p.). The Monthly change in deposits effect of cancelling the licence for AB bankas SNORAS for interbank lending Source: Bank of Lithuania calculations. and its costs in Lithuania were marginal (making up 10 basis points) and short-term (about two weeks).

In the context of improving financial situation of households and non- financial corporations and amid a slow growth of consumption and investments, an increase in deposits within the banking system was observed. A gradual rise in interest rates could have also contributed to the improved activity of depositors. In the beginning of 2011, weighted average interest rates for new deposits

(with maturity of 1 month or more) of the private sector fluctuated around 1.4 per cent, but grew to 1.8 per cent in the second half of the year. This could have contributed to the growth of bank deposits: during the first eleven months in 2011, deposits of private sector and financial institutions grew by LTL 1.2 billion, while the amount withdrawn by the general government sector from the banking system made up LTL 1.0 billion. In comparison, during a corresponding period a year ago, private sector and financial institutions boosted their deposits with banks by LTL 0.3 billion while general government sector increased them by LTL 1.7 billion. THUANIAN ECONOMIC REVIEW / February 2012 LI

20 VII. GENERAL GOVERNMENT FINANCE

Accelerated economic growth increased tax revenues and led to faster growth of total As in the previous quarter, in the third quarter indirect taxes were the revenues in general government sector. main driver behind the growth of the general government revenues. Chart 28. General government revenue growth and contributions In the third quarter, VAT revenues grew faster than in the second one and

Percentage points Per cent, annual change the annual growth rate amounted to one sixth. The largest increase was 30 30 registered in VAT collected by the Lithuanian customs as a result of 20 20 improved import of capital and consumer goods. VAT which is administered 10 10 by the State Tax Inspectorate grew mainly due to higher retail turnover. In 0 0 the third quarter, the annual growth of revenues raised from indirect taxes –10 –10 other than VAT, mainly excise taxes, increased slightly more than by one –20 –20 tenth. According to the State Tax Inspectorate, the biggest increase was –30 –30 observed in the collection of excise taxes for energy products and 2005 2006 2007 2008 2009 2010 2011 processed tobacco, while the collection of excise taxes for alcohol Indirect taxes beverages and electricity went down. An increase in the collection of excise Social contributions Taxes on income, wealth, etc. taxes for energy products was the result of higher sales of diesel fuel; sales Other Total revenue (rh scale) of petrol and gas, however, declined year on year in the third quarter. The Sources: Statistics Lithuania and Bank of Lithuania calculations. revenues raised from indirect taxes in the last quarter of 2011 are expected to increase slightly less than in the third quarter, taking into account the data

of the national budget for October to December 2011. It owes to slower Due to significantly weaker impact of saving growth in both VAT and excise tax revenues. measures, total general government spending...

Chart 29. General government spending growth and Revenues from direct taxes continued to grow, but at a lower rate contributions compared to the previous quarter because of a significantly lower Percentage points Per cent, annual change increase in the wage bill within the economy. 40 40 They were pushed up only by an increase of slightly more than one sixth in 30 30 revenues from personal income tax. This was largely driven by a 1.6 per 20 20 cent increase in wages and a 2 per cent increase in the number of the 10 10 employed. Profit tax collection declined year on year by one sixth. The fall in 0 0 the collection of this tax could be attributed to a one tenth decrease in –10 –10 advance payments. Advance payments subsided because of lower tax tariff –20 –20 although the tax base – taxable profit in 2010 – was by one tenth higher 2005 2006 2007 2008 2009 2010 2011 than in 2009, and the number of profitable enterprises was bigger. It should Social payments Interest be noted that an average amount of the profit tax paid in four quarters Compensation of employees Intermediate consumption remained very low in the third quarter of 2011 standing at the level observed Total capital expenditure in the first half of 2004. In the third quarter, total revenues of the general Other consumpion Total expenditure (rh scale) government increased on the back of non-tax revenues which grew as a Sources: Statistics Lithuania and Bank of Lithuania calculations. result of EU capital and current transfers, more abundant than a year ago. The national budget data for October–December 2011 show that direct tax …and public consumption expenditure grew faster revenues for the last quarter of 2011 are likely to be lower than a year ago. than in the previous quarters. The main reason for the decrease is a strong fall in the profit tax and a Chart 30. Government consumption expenditure decelerated increase of personal income tax collection. growth and contributions Percentage points Per cent, annual change As a result of improved situation in the labour market, an annual 40 40 increase in social contribution collection in the third quarter was the 30 30 biggest in recent two years. 20 20 Contributions climbed driven mainly by a hike in social insurance February 2012 10 10 contributions paid by insurers, the insured, and the self-employed. The State

0 0 Social Insurance Fund Board‘s data for October–December 2011 imply that the annual increase in social contributions in the fourth quarter is likely to be –10 –10 the same as in the third quarter making up about 7 per cent. Contributions –20 –20 grew driven by continued improvement of the employed and dismissed 2005 2006 2007 2008 2009 2010 2011 people ratio. Compensation of employees Intermediate consumption Transfers in kind Social payments in the third quarter were the only factor which pushed Consumption of fixed capital down the total general government’s revenues, growth rate of which Sales Total expenditure (rh scale) was the biggest in recent two years. Sources: Statistics Lithuania and Bank of Lithuania calculations. LITHUANIAN ECONOMIC REVIEW /

Social payments declined due to lower support to families, a decrease in 21 sick and maternity leave compensation and unemployment benefits. No Lithuanian public finances continued to improve... change in funds for old age pensions was observed during the year. Much Chart 31. General government revenue, spending and higher subsidies, government investment and intermediate consumption balance expenditure were the main drivers behind an increase in the general government’s expenditure by about 5 per cent year on year in the third Per cent, compared to GDP Per cent, compared to GDP 45 3 quarter. Intermediate consumption expenditure grew mainly because of expenditure for current repair of long-term tangible assets and other 42 0 services. In the third quarter, compensation for general government 39 –3 employees went up by approximately 3 per cent, most in the government- financed professional, scientific research and technical activities, also 36 –6 forestry and timber preparation. Compensation to employees most likely grew because of higher wages, as the number of employed in public sector 33 –9 was lower than a year ago. Wage expenditure may have increased because 30 –12 of the number of professionals with higher skills, which climbed by one sixth 2005 2006 2007 2008 2009 2010 2011 during the year; the number of less-skilled personnel (lower ranking Revenue professionals, technicians, white-collar, unskilled workers) in the public Expenditure Balance (rh scale) sector fell in the third quarter by approximately one fifth. The growth of Sources: Statistics Lithuania and Bank of Lithuania calculations. interest payments remained strong. In the third quarter, they increased by approximately one fifth. …mainly due to the state budget, which was in surplus as a result of growth in revenues from The situation of the Lithuanian public finances continued to improve, indirect taxes, related to increased domestic and the general government deficit nearly halved during the year. consumption.

In the third quarter, the social security funds’ deficit made up more than Chart 32. Breakdown of general government balance LTL billions three-quarters of the general government deficit. The latter was well below the previous year level mainly because of increased amount of social 0,5 contributions. The central government (state budget and non-budget funds) 0,0 deficit, which went down markedly in the third quarter, was the main driver –0,5 behind a decrease of the general government deficit. After a long period, the –1,0 state budget revenue surpassed budget expenditure, and the central –1,5 government deficit was the result of the negative balance of non-budgetary –2,0 funds. Such change in the structure of the general government deficit, if –2,5 compared to previous quarters, may be explained by the growth of –3,0 economic activity, which is largely supported by consumption expenditure, 2009 2010 2011 Local government balance and inflation. This led to a notable increase in the state budget revenues of Balance of social security funds Balance of non-budgetary funds indirect taxes. The impact of economic growth on the labour market was State budget balance weaker, so the decrease of the social security funds’ deficit was relatively General government balance moderate. Local government deficit was narrow and did not have a notable Source: Ministry of Finance and Bank of Lithuania calculations. impact on the general government balance.

Public debt has increased mostly due to the The general government debt grew over the quarter as a result of a borrowing of social security funds in order to loan taken by social security funds; however, the ratio of debt to four- ensure a timely payment of social payments. quarter GDP went down due to improved economic activity. Chart 33. Breakdown of general government debt In the end of September, the debt to four-quarter GDP ratio stood at 37.6 per cent. As in previous quarter, the biggest increase was observed in the Per cent, compared to GDP debt of social security funds and local government, while the quarterly 40 change in the central government’s debt was negative for the second 35 consecutive quarter. The social security fund’s debt hiked during the quarter 30 nearly by LTL 0.5 billion driven by new credit agreements signed with 25 commercial banks. The funds (approximately LTL 1.5 billion) borrowed by 20 15 Sodra in the first three quarters were lower by nearly one fourth for the 10 projected amount in 2011, so a similar increase in the social security funds’ 5 debt is expected in the fourth quarter too. The latest data by the Ministry of 0 Finance indicate a significant increase in the central government and social 2005 2006 2007 2008 2009 2010 2011 security funds’ debt at the end of December as a result of the USD Securities 750 million bond issue. Debt to GDP ratio made up 36.4 per cent after Loans 33.7 per cent at the end of the third quarter. Consequently, a new bond Deposits (including saving notes) issue will contribute significantly to the general government debt in the last Sources: Ministry of Finance and Bank of Lithuania calculations. quarter of the year. THUANIAN ECONOMIC REVIEW / February 2012 LI

22 ANNEX

INTRODUCTION TO SOCIAL ACCOUNTING MATRICES

Social Accounting Matrices (SAM) present macroeconomic data in a matrix framework, i.e. in single entries. This way of data representation enables to see in a single matrix the interaction between production, income, consumption, taxes and transfers, investments and savings. Usually macroeconomic data used are from national accounts, however, other sources such as, for example, input-output tables, balance of payments, general government finances and other data are also employed. Thus, to compare with national accounts or input-output tables, a SAM covers more information about transactions in an economy and institutions and sectors realising these transactions. A SAM provides information about a country’s economic and social structure within a particular time period (usually a particular year). A SAM is represented in the form of a square matrix with rows and columns in which the same accounts (institutions and sectors) are indicated. Incomings are indicated as receipts for the row accounts and outgoings – as expenditure for their column accounts. Totals for corresponding rows (receipts) and columns (expenditure) must be equal for a given account in a SAM, as they are obtained from macroeconomic identities. For example, disposable household income is equal to the sum of their current consumption, paid up taxes, investments and net savings. Due to this characteristic of SAM, in matrix of n*n size it is possible to have in account n–1 a residual variable that balances the account. This is based on the law of the 19th century economist Leon Walras: if there is equilibrium in market n–1, market n will also be in equilibrium. This characteristic of SAM assists in trying to assess hardly measured economic variables, for example, “mixed income” the major part of which is composed of undeclared personal income earned in the shadow economy. The matrix framework allows seeing the economic structure and simplifies data processing: a transaction between two economic entities is reflected only by one entry because income of one entity is expenditure of the other. The System of National Accounts uses the double entry system: the transaction value is reflected as debit in the account of one entity and as credit – in the account of the other entity. Moreover, the matrix framework enables an easier usage of macroeconomic data in a mathematical simulation. The number of accounts used in a SAM depends on the purpose of the SAM formation. For example, in case of a deeper insight into public finances, one general government account may be insufficient due to over-generalised information. Therefore, SAM can be extended to include additional rows (and columns, correspondingly) by disaggregating the general government account into, for example, the accounts of central government, local government and State Social Security Funds. In general, however, the SAM most often covers 6 main groups of accounts: goods, capital, institutions (i.e. households, enterprises, and general government), net saving, rest of the world, and production activities (see Table A). Usually, the elements of the net saving account are residual, which balance out institutional accounts.

Example of the SAM structure This section presents an example of the SAM structure, on the basis of which it is possible to construct a table of nominal current economic flows. Every account has the following main income and expenses (see Table A):

1. Household (H) income consists of wages and mixed income, also of payments of the state social security system to households; they get dividends from enterprises, and from abroad – labour income and workers’ remittances (emigrant transfers). From gross income they pay the personal income tax, social security and health insurance taxes. The remaining disposable income is allocated to final consumption, household investments (acquisition of a new housing) and net saving (or borrowing in case net saving is negative).

2. General government (G) income is mainly income from various taxes and transfers from the EU. Expenses consist of social payments, public sector consumption and investment, also of interest payments for the public internal and external debts, other transfers to the rest of the world (e.g., taxes to the EU). As the entire support from the EU is administered by the state, transfers of the EU funds to the private sector are also paid out from this account. Gross February 2012 income and expenses are balanced by the general government budget balance in the net saving (S–I) account: if it is negative, the budget will be in deficit, and vice versa.

3. Enterprises account (F) in this SAM sample is separated from the production activities (A) account that shows the structure of the total output and value added as well as factors of output demand. Companies receive retained earnings, capital depreciation deductions (comprising a non-cash production expenses) and government transfers (e.g., EU support). These receipts are used for the payment of the profit tax and taxes on assets, for real investments (including investments into inventories), while the rest of the world is paid interest on foreign loans. The remaining amount refers to enterprise savings invested into financial assets.

LITHUANIAN ECONOMIC REVIEW /

23

A A Wages Wages Imports insurance (activities) ivities account employers) Gross profit Intermediate Intermediate consumption 6. Production 6. Taxes(social Use of capital of Use (depreciation) Mixed income Mixedincome contributions of act

ROW world) Current Current Eksports Eksports Workers’ EU funds EU (rest the of remittances 5. Rest of the of Rest 5. world account worldaccount account deficit account Labour income Labour transfers the of

S–I S–I account account (netsaving) 4. Net saving Net 4.

F Net Net Taxes saving assets) assets) Enterprise Enterprise (onprofits, inventories inventories changes of of changes investment, investment, (enterprises) payments on on payments foreignloans

H H

Final saving Household Household Household investment investment Taxes(PIC, consumption (households) new housing) new of employees) of (acquisitions of insurancetaxes social health and 3. Institutionaccount 3.

G Public balance balance General (general transfers transfers investment investment government government government) the EU funds EU the externaldebt domesticdebt Interest on the the Intereston the Intereston Socialsecurity Taxes to the EU Taxesthe to consumption and consumption Currenttransfers of

K K Taxes capital account account (capital) earnings Retained Retained of foreign of 2. Capital Capital 2. Dividends enterprises reinvestments (ondividends) Dividends and Dividendsand

C C Taxes basicprices (VAT, excises) Consumption at Consumption 1. Goods account Goods 1. (finalconsumption)

F K K C C H A G S–I S–I ROW (capital) (activities) (netsaving) (enterprises) (households) (restworld) the of (finalconsumption) (generalgovernment)

account account account 3. Institution 3. 4. Net saving Net 4. 6. Production 6. 5. Rest of the of Rest 5. world account worldaccount activities account 1. Goods account Goods 1. 2. Capital account Capital 2. Table A. Example of the SAM the SAM Example of Table A.

THUANIAN ECONOMIC REVIEW / February 2012 LI

4. Production activities (A) receive income (excluding consumption taxes, which go to general government) earned from 24 the sale of final consumption goods and services to households (including household investment into housing), also they get income from the exports, the sale of intermediate consumption and capital goods to enterprises, and government current consumption and fixed investment. Costs of production activities cover intermediate consumption, imports and value added comprised of wages, a share of social security tax paid by employers, mixed income, capital depreciation and gross profit.

5. Capital (K) account refers to distribution of gross profit of enterprises. In the form of dividends it is distributed to households and non-residents, general government receives profit tax, taxes on dividends and assets, while retained earnings remain in enterprises (in foreign capital companies such profit is called reinvestments).

6. Household consumption (C) account refers to the distribution of expenses incurred on sales of consumer goods and services: consumption taxes (VAT and excises) go to the general government, and the rest excluding consumption taxes – to production activities.

7. Income received by the rest of the world (ROW) comprise of production activities’ expenses on imported goods, reinvestments and dividends paid by foreign capital enterprises, general government payments for the public debt and transfers to the EU budget. The rest of the world pays to the activities for goods exported from Lithuania, it makes current transfers from EU funds (mainly – subsidies to farmers), workers’ remittances and labour income of those who temporarily departed from the country. The difference between the rest of the world current income and expenses refers to the balance of current account (CAB). A positive figure means a negative CAB of Lithuania. In other words, Lithuania uses foreign savings to finance current account deficit.

Example of the SAM application The SAM can be used not only for a general understanding of the country’s economic structure and a presentation of statistical data but also for the analysis of economic shocks and political changes. Although in performing an analysis an expert assessment aspect is important, the matrix structure introduces limitations on performed calculations and helps to avoid lapses in analysing both a direct and indirect shock impact on the entire economic system. Among the practical application possibilities of the SAM is the analysis of the impact of fiscal policy decisions on the country’s economy and general government budget balance. For example, according to the Government of the Republic of Lithuania Resolution on insured income of 201210, retirement and work disablement pensions are planned to be restored this year. According to the Ministry of Finance calculations, this would increase expenses of the State Social Insurance Fund (SODRA) by about LTL 0.5 billion11. The SAM enables to evaluate both direct and indirect impact of this decision on the general government budget balance and GDP. When the SAM is applied for the analysis of the public finances, it is useful to expand general government (G) and production activities (A) accounts for a more detailed presentation of the real flows in these accounts. Besides, some accounts (e.g., rest of the world) can be simplified because fiscal policy decisions have no influence on a part of the flows. Table B represents an expanded and simplified SAM, where the government account is broken down into two accounts – central government and local government (hereinafter referred to as government) account and the SODRA account, while the production activities account is disaggregated into private and public activities. The entries of SAM, which were insignificant to the analysis, were eliminated. The income and expenditure in the government (GN) and SODRA (GS) accounts are calculated separately. In other words, if the majority of taxes (VAT and excises, personal income, profit and other taxes) are directed to the national budget, the SODRA budget receives the social security contribution shares of the households and employers (the latter is paid up by production activities). The same principle is applied to separate the budget expenses. It should be noted that after the breakdown of the general government (G) account into two parts, the row of net saving (S–I) refers to the national and SODRA budgets separately, and their sum represents the general government budget balance.

February 2012 The expansion of the private activities account into private activity (AP) and public activity (AG) accounts permits to disaggregate the compensation of employees received by households of private and public sectors. The employees' share of the social contributions paid by the private and public sectors to the SODRA budget is calculated pro rata12. The aim of the analysis is the balance of income and expenses in all accounts. The introduction of economic shock into the initial balanced SAM imbalances the table (i.e. differences between income and expenses emerge in individual accounts). When assessing economic processes triggered by the primary shock, the SAM accounts are balanced for income to be again equal to expenses. Thus a new entirely balanced matrix is obtained.

______10 The Government of the Republic of Lithuania Resolution No. 1535 on the approval of current insured income of 2012, 28th December 2011. 11 Ministry of Finance “2012 state expenditure by areas”, 21st December 2011, http://www.finmin.lt/web/finmin/2012islaidos 12

LITHUANIAN ECONOMIC REVIEWHouseholds / also receive mixed income from production activities. In order to separate mixed income from the wage fund, the former was relocated to the capital account, i.e. both gross profit and mixed income became the income of the capital account, while mixed income and dividends paid to households became the expenses of the capital account.

Table B The initial SAM in 2010 (LTL billions)13 25 C H K F GN GS ROW S–I AP AG Total income C 63.2 63.2 H 28.8 1.9 12.3 20.5 10.5 74.1 K 32.0 32.0 F 3.2 10.0 13.2 GN 10.8 4.6 0.5 0.3 16.1 GS 2.2 6.4 3.3 11.8 ROW 65.8 65.8 S–I 2.5 3.0 –6.1 –0.5 1.0 0.0 AP 52.4 1.5 9.7 1.7 64.8 4.8 134.9 AG 18.6 18.6 Total expenses 63.2 74.1 32.0 13.2 16.1 11.8 65.8 0.0 134.9 18.6 Total income 63.2 74.1 32.0 13.2 16.1 11.8 65.8 0.0 134.9 18.6 Difference 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 General government budget balance –6.6 General government income 28.0 GDP by expenditure approach 93.7 Note: the row “Total income” is identical to the column of the same name and is used only for the sake of convenience – to see more easily the difference between income and expenses. Rounding errors can occur in the row ”Difference” of this and other tables.

A detailed example of the analysis is provided below. The initial economic shock is half billion litas increase of SODRA payments due to the planned restitution of pension payments to the level of 2009. Then the direct and indirect impact of this shock on other economic variables, in particular on general government budget balance and GDP, is assessed. 1. Higher pension benefits result in the increase of the social security (GS) transfers to households (H) by LTL 0.5 billion (from LTL 12.3 bn to LTL 12.8 bn). It should be noted that in this analysis the government accounts are always in balance because any mismatch between income and expenses in government accounts is automatically balanced by the corresponding budgets (row S–I). In the case of an increase of social security (GS) expenses, the budget deficit of this fund was also increased automatically by the same amount (from LTL 0.5 bn to LTL 1.0 bn). 2. Larger pension benefits increase total household (H) income. This results in a gap of LTL 0.5 billion between household income and expenses (Table C).

Table C. SAM balancing after the increase in SODRA expenses due to the restitution of pensions (LTL bn) C H K F GN GS ROW S–I AP AG Total income C 63.2 63.2 H 28.8 1.9 12.8 20.5 10.5 74.6 K 32.0 32.0 F 3.2 10.0 13.2 GN 10.8 4.6 0.5 0.3 16.1 GS 2.2 6.4 3.3 11.8 ROW 65.8 65.8 S–I 2.5 3.0 –6.1 –1.0 1.0 –0.5 AP 52.4 1.5 9.7 1.7 64.8 4.8 134.9 AG 18.6 18.6 Total expenses 63.2 74.1 32.0 13.2 16.1 11.8 65.8 0.0 134.9 18.6 Total income 63.2 74.6 32.0 13.2 16.1 11.8 65.8 –0.5 134.9 18.6 Difference 0.0 0.5 0.0 0.0 0.0 0.0 0.0 –0.5 0.0 0.0 State social security (GS) expenses are increased due to larger pension benefits. The increase in household (H) income opens a gap between income and expenses of this account.

3. To simplify the analysis in the case of the private consumption, the household saving ratio is assumed to remain unchanged. Therefore, the household consumption is increased by the total difference between income and expenses observed in Table C (LTL 0.5 bn).

13 THUANIAN ECONOMIC REVIEW / February 2012

The annual data for 2011 is still unavailable, thus data of earlier years is used for the analysis. It should also be mentioned that data for 2010 is not precise LI due to the SAM simplification. However, insignificant approximations do not influence the final results of the analysis as long as the used data reflect the general economic structure.

4. After increasing the final consumption of goods and services, a multiplier process takes place. First, there is a change 26 in the collection of consumption taxes and in sales income earned by private activities. Second, the private activities, in their turn, increase expenses, and so on. When balancing the economic system in this way, other entries of the table change; however, the main changing variable remains to be household consumption. Final results of the analysis are provided in Table D.

Table D. Balanced SAM after the increase of social payments (LTL bn) C H K F GN GS ROW S–I AP AG Total income C 63.8 63.8 H 28.9 1.9 12.8 20.6 10.5 74.8 K 32.1 32.1 F 3.2 10.0 13.2 GN 10.9 4.6 0.5 0.3 16.3 GS 2.2 6.4 3.3 11.9 ROW 66.1 66.1 S–I 2.5 3.1 –5.9 –1.0 1.3 0.0 AP 53.0 1.5 9.7 1.7 64.8 4.8 135.5 AG 18.6 18.6 Total expenses 63.8 74.8 32.1 13.2 16.3 11.9 66.1 0.0 135.5 18.6 Total income 63.8 74.8 32.1 13.2 16.3 11.9 66.1 0.0 135.5 18.6 Difference 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 General government budget balance –6.9 (–6.6 before simulation) General government income 28.1 (28.0 before simulation) GDP by expenditure approach 94.1 (93.7 before simulation)

When comparing Table B and Table D, differences of separate entries indicate the impact of the increase of pension benefits on respective economic indicators. In general, the results show that an increase in social benefits by LTL 0.5 billion worsen the overall government budget balance by approximately LTL 300 million (to LTL 6.9 bn). Thus, a total impact on the general government budget balance is smaller than the initial amount of a half billion, because with an increase of general government expenses, its income grows simultaneously (by almost LTL 170 m to LTL 28.1 bn). The decision to increase pension benefits also positively affects nominal GDP (by approximately LTL 400 m to LTL 94.1 bn). The estimated elasticity of general government budget balance to GDP is 1.2, i.e. if the government budget balance would deteriorate by LTL 1 billion because of such decision, the nominal GDP would grow by LTL 1.2 billion. Different economic impact would have a fiscal policy decision to increase the public sector wage fund instead of pension benefits. This is related to the fact that wages are a component of value added. Thus the analysis of higher public sector wage impact on economic variables is presented for the sake of comparison. As before, the initial economic shock is an increase of the wage fund in the public sector by half million litas, and Table B is used as the initial SAM. 1. The public sector wage increase would result in higher public activity (AG) expenses both on the wages (increase from LTL 10.5 bn to LTL 10.9 bn) and contributions to SODRA (from LTL 3.3 bn to LTL 3.4 bn), by LTL 0.5 billion in total. Income of this activity (AG) also grows by a respective amount (from LTL 18.6 bn to LTL 19.1 bn). After these modifications the public activity account (AG) remains balanced because both its income and expenses rise by LTL 0.5 billion.

2. As mentioned before, general government (G) accounts are always in balance due to automatically adjusting budget balances (row S–I). In other words, after a half billion increase of public activity (AG) income (this corresponds to government (GN) expenses on the public activity), the national budget deficit expanded by the same amount (from LTL February 2012 6.1 bn to LTL 6.6 bn). Simultaneously, when the public sector paid more social security contributions paid by employers, the SODRA budget deficit improved (from LTL 0.5 bn to LTL 0.4 bn).

3. The additional income of the household account (H) results in increased taxes paid to the general government budget. Again, general government accounts (GN and GS) are balanced automatically: the national budget improves due to the personal income tax and the SODRA budget becomes better because of a share of social contributions paid by employees. However, the gap between household income and expenses remains (Table E).

LITHUANIAN ECONOMIC REVIEW /

Table E. SAM balancing after the increase in public wage fund (LTL bn) 27 C H K F GN GS ROW S–I AP AG Total income C 63.2 63.2 H 28.8 1.9 12.3 20.5 10.9 74.5 K 32.0 32.0 F 3.2 10.0 13.2 GN 10.8 4.7 0.5 0.3 16.2 GS 2.2 6.4 3.4 12.0 ROW 65.8 65.8 S–I 2.5 3.0 –6.5 –0.3 1.0 –0.3 AP 52.4 1.5 9.7 1.7 64.8 4.8 134.9 AG 19.1 19.1 Total expenses 63.2 74.1 32.0 13.2 16.2 12.0 65.8 0.0 134.9 19.1 Total income 63.2 74.5 32.0 13.2 16.2 12.0 65.8 –0.3 134.9 19.1 Difference 0.0 0.3 0.0 0.0 0.0 0.0 0.0 –0.3 0.0 0.0 Public activity (AG) expenses are increased through the public wage fund and contributions to SODRA. After an increase of household (H) income, households pay more taxes to general government; however, a gap between income and expenses of their account (H) remains.

4. The same principles and assumptions as those used in the case of higher social benefits are applied in the analysis. Due to a constant household saving ratio assumption, private consumption is increased by the total difference of income and expenses observed in Table E (LTL 0.3 bn). Furthermore, similar to the previous case, a multiplier process takes place. Below are final results of the analysis.

Table F. Balanced SAM after the increase of the public wage fund (LTL bn) C H K F GN GS ROW S–I AP AG Total income C 63.6 63.6 H 28.9 1.9 12.3 20.6 10.9 74.6 K 32.1 32.1 F 3.2 10.0 13.2 GN 10.8 4.7 0.5 0.3 16.3 GS 2.2 6.4 3.4 12.0 ROW 66.0 66.0 S–I 2.5 3.0 –6.5 –0.3 1.2 0.0 AP 52.7 1.5 9.7 1.7 64.8 4.8 135.3 AG 19.1 19.1 Total expenses 63.6 74.6 32.1 13.2 16.3 12.0 66.0 0.0 135.3 19.1 Total income 63.6 74.6 32.1 13.2 16.3 12.0 66.0 0.0 135.3 19.1 Difference 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 General government budget balance –6.8 (–6.6 before simulation) General government income 28.3 (28.0 before simulation) GDP by expenditure approach 94.4 (93.7 before simulation)

According to the obtained results, a half billion litas increase of the wage fund in the public sector expands the general government deficit by LTL 200 million (to LTL 6.8 bn). The reason of lower than the initial impact is the increase in the collection of public income (by LTL 300 m to LTL 28.3 bn), which is rather similar to the results of the social benefit increase. The results, however, are different in the case of nominal GDP as it increases by almost LTL 760 million (or 0.8%). The estimated elasticity of the general government budget balance to GDP is 3.6; in other words, if the general government budget deficit would expand by LTL 1 billion due to the rise in public sector wages, nominal GDP would increase by approximately LTL 3.6 billion. A comparison of both analysed cases reveals that the public sector wage changes have a substantially stronger effect on the economy than the changes of social benefits. Thus, similar at first glance fiscal policy decisions may result in different economic consequences. This is immensely important in planning fiscal consolidation measures. For example, taking into account the results of SAM analysis, the attempts to reduce general government budget deficit by LTL 1 billion would decrease Lithuania’s GDP by approximately LTL 1.2 billion in case of a decision to reduce social benefits. A decision to reduce public sector wages would have a substantially stronger impact on country’s GDP of about LTL 3.6 billion. Therefore, when planning to take value-related decisions, official authorities have to envisage these consequences and

take them into account. THUANIAN ECONOMIC REVIEW / February 2012 LI