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In the face of russia’s war against Ukraine and energy price shock, Lithuania’s economy has shown resilience, although economic growth will slow down next year. Against a backdrop of high inflation, it is crucial to align fiscal and monetary policies by applying targeted support measures. It is also necessary to continue implementing reforms aimed at boosting economic potential and consider additional sustainable sources of income. This is reported by the International Monetary Fund (IMF) staff following last week’s visit to Lithuania during which Lithuania’s economic situation and prospects were discussed with representatives of the country’s institutions. 

“In response to high inflation, the European Central Bank started raising interest rates in order to dampen aggregate demand, thereby reducing price growth. It is important that fiscal policy contributes to this objective, which requires responsible planning of the state budget in order to avoid excessive stimulation of the economy and indirect support for further price increases,” says Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania.

“Lithuania’s economy is demonstrating resilience to shocks and remains on the growth path even in the face of Russia’s war against Ukraine and energy price shocks. The IMF considers the measures proposed by the Government to absorb the impact of the energy shock on the society and the economy to be broadly appropriate. Experts also call for the elimination of non-targeted and market-distorting tax incentives that reduce budget revenues. Looking ahead, it is essential to pursue a cautious fiscal policy by preserving macroeconomic stability,” says Gintarė Skaistė, Minister of Finance.

Lithuania’s economy remains resilient in the face of multiple shocks and this year will grow faster than expected. According to the IMF, the good result lies in the available fiscal space, which allows for an effective response to emerging shocks, labour market flexibility and rapid economic growth before the outbreak of Russia’s war against Ukraine.

However, in the context of high inflation and deteriorating external demand, a slowdown in economic growth is expected next year. Despite more cautious forecasts, the labour market remains strong and the unemployment rate is lower than before the pandemic. This supports rapid wage growth, which, together with other factors, in particular external ones, contributes to inflationary pressures.

According to the IMF staff, next year Lithuania’s fiscal policy must be balanced in such a way as to support weaker economic growth and contribute to the maintenance of macroeconomic and financial stability but at the same time does not create additional inflationary pressures.

The IMF welcomes the Government’s rapid response to the energy price shock, which has mitigated the negative impact on the economy and households. At the same time, the IMF highlights that support measures place a heavy burden on the budget and therefore suggests considering more targeted measures in the future.

The IMF estimates that, in order to further increase spending on social security, address long-term structural challenges and invest in renewable energy and energy-saving solutions, it is necessary to improve the quality of public spending and search for additional sources of budget revenue by broadening the tax base through real estate and pollution taxes and by reducing exemptions that distort the tax environment.

Lithuania’s financial system is characterised by high capital and liquidity ratios and it is well prepared for the expected economic slowdown. Despite rising interest rates, the level of non-performing loans is well below the long-term average. In addition, the Responsible Lending Regulations established by the Bank of Lithuania and implemented for more than a decade, suggest that the formation of more significant credit risks in the economy will be avoided. The IMF estimates that further strengthening of the anti-money laundering framework should remain the focus of the transition of the FinTech sector from a rapid growth to a mature stage.

Read the IMF report here.