How does turbulence in the international arena affect Lithuania?
Comment by Mantas Vilniškis, Economist at the Macroeconomics and Forecasting Division of the Bank of Lithuania.
The scenario for Brexit is not yet written. What does that mean for Lithuania and almost 200 thousand of our fellow compatriots living in the United Kingdom? How do the 2018 events in international trade relate to slower growth of the European Union and Germany and what possible effects could they have on Lithuania?
The painful "divorce" weans off emigrants. Only 51 days to go before the United Kingdom (UK) is scheduled to leave the European Union (EU), nonetheless after more than two years since the Brexit vote the fundamental question remains unanswered – how will the UK execute its decision?
One of the main clauses in the Withdrawal Agreement and Political Declaration endorsed by the European Council is the right of nearly 3 million EU citizens in the UK and nearly 1 million UK nationals in EU countries to stay in their current place of residence until the end of 2022 within the procedures that are currently in place. Since the European Commission (EC) has expressed unwillingness to relaunch the negotiations, the principal clauses should not change even if Theresa May presses on. For Lithuanians already residing in or planning to emigrate to the UK, the approval of an agreement with the EC would mean that their living conditions in the UK or conditions of migration to the region would not change substantially for at least several years. Nevertheless, emigration to the UK became less attractive due to growing uncertainty. The situation will get even worse after the transition period on the back of introduced administrative procedures on entering the UK as well as on life and employment in the country. According to the preliminary data of Statistics Lithuania, emigration from Lithuania dropped in 2018, while emigration to the UK weakened in relative terms.
Emigration hurdles might also result in lower remittances to Lithuania. Due to fruitless negotiations and increasing uncertainty, non-resident cash outflows are visibly declining: since 2016, the bulk of emigrants’ income has been allocated to saving rather than, for instance, sending to Lithuania, which used to be the usual way of supporting close relatives. As a result of the slower rate of economic growth in the UK and weakening pound, emigrants’ income and remittances are likely to moderate in the future. While it is true that on a year-on-year basis remittances somewhat recovered in the second and third quarters of 2018, this can be explained by the temporary appreciation of the pound.
In the future, an agreement on trade relations between the UK and the EU will have significant implications for economic growth across the EU, Lithuania included. Based on the data of the International Monetary Fund, the scenario of a free trade agreement would cost the EU 0.8% of its GDP in the long run (the impact on the UK is stronger, ranging from 2.6% to 3.9% of GDP). In a worst-case scenario, the negative impact of a no-deal Brexit on economic growth in the EU would surge to 1.5%. The damage for the UK would be much greater, amounting to 5.2–7.9% of its real GDP. The economic ties between Lithuania and the UK cover several areas, mainly trade: exports to the UK constitute 4% of Lithuania’s total exports, thus the direct impact would be minimal. Lithuania’s exports to the UK mainly include food, oil, chemical products, as well as furniture and timber, hence trade restrictions would affect these sectors the most.
Uncertainty over Brexit is not the only threat, the economic slowdown in the EU and Germany is yet another pressing problem. The German car industry has been struggling since the beginning of 2018. The failure to implement the new EU pollution regulations in a timely manner caused disruptions in car production, which weighted on export volumes, and, in turn, GDP growth. The negative impact should cease once the technological problems are solved, while additional supply might even create more incentives for growth in the future. Trade tensions that further slash the already dropping growth expectations only exacerbate the situation. Germany is the world’s third largest exporter, therefore the decline in international trade demand has an inevitable negative impact on its economic growth. In January, the media raised serious concerns over the possibility of a technical recession in the country. Based on provisional data, the Federal Statistical Office of Germany claimed that, after slower growth in the third quarter, Germany’s economy in the fourth quarter was still growing, albeit at a sluggish pace, therefore it appears that Germany has managed to avoid the technical recession. Italy’s situation is worse. Although it has reached an agreement with the EC over its expansionary budget, risks prevail. The central bank of Italy forecasts that the country’s economy will grow at a slower rate for the second consecutive quarter, which would mean that Italy might lurch into a technical recession. In this case, the fiscal issue might resurface given that the country’s budget is underpinned by its forecast economic momentum. With regard to the state of the EU economy as a whole, a similar downward trend might develop. This, of course, concerns Lithuania too. A major portion of Lithuania’s GDP lies in trade with the EU, thus lower demand for our production weakens export growth.
In view of this situation, we believe there is downside risk to Lithuania’s growth in 2019. Exports of goods and services constitute 80% of the country’s GDP, which only attests to the dependency of Lithuania, as a small and open economy, on foreign demand and stability in the international arena. In the first–third quarters of 2018, Lithuania exported 61% of its goods and services to the EU. The decreasing EU consumer confidence and slower economic growth in the region directly relate to the demand for Lithuanian production. This is also evidenced by the weaker growth of exports to the EU in 2018 and less rapid expansion in the EU market share that Lithuania holds. Ultimately, this affects Lithuania’s growth prospects for 2019. According to the Bank of Lithuania projections, GDP is expected to increase by 2.8% in 2019, down by 0.4 percentage point compared to 2018.