Bank of Lithuania
2020-12-15
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The second wave of the pandemic has already gained momentum and its potential repercussions pose the greatest challenge to Lithuania’s economy. However, businesses and people are now better prepared to work under the pandemic circumstances, thus the current wave is expected to have a less severe impact on economic activity compared to the first one.

“The escalating pandemic is putting huge pressure on economic development, particularly in the directly affected sectors, such as those related to tourism, accommodation, catering and entertainment. Today, we have to offer a decisive response by providing immediate economic aid to the most vulnerable groups, planning future investments as well as rationally assessing the state of public finances and the growing public debt,” said Vitas Vasiliauskas, Chairman of the Board of the Bank of Lithuania.

According to him, the darkest hour is just before the dawn, and the positive news on the vaccine front suggest that the economy will shift towards the recovery path already next year, after it started following it in the third quarter of 2020 yet slowed down in the fourth quarter of the year.

Under the Bank of Lithuania’s updated baseline scenario, the country’s real GDP is expected to decline by 2.0% in 2020 before increasing by 1.9% in 2021. Therefore, the central bank revised down its previously announced baseline projections which assumed a 3.1% growth in 2021. As uncertainty clouding the economic fallout from the pandemic remains high, the Bank of Lithuania has also prepared several alternative scenarios. COVID-19 vaccines, which have already been approved in some western countries, give greater confidence that the medical solution will soon become available in the EU and Lithuania. Should the pandemic be successfully managed and stabilised in the near future, the mild scenario would materialise. According to this scenario, Lithuania’s real GDP is expected to decline by 1.4% in 2020 before increasing by 4.5% in 2021. However, the challenging epidemiological situation requires projecting a severe scenario as well. It assumes that containment of the pandemic in the nearest future will be limited, whereas development of an effective medical solution will take longer. In such a case, the negative implications of COVID-19 would lead to a potential deterioration in the corporate financial situation and an increase in insolvency levels. Under the severe scenario, the country’s real GDP is expected to decline by 2.7% in 2020 and by 3.3% in 2021.

Inflation is not projected to increase over the next year, standing at 1.1% both in 2020 and 2021. Compared to 2019, headline inflation this year was largely restrained by cheaper fuels, while next year it will be halted by slower growth in services prices. The latter should also be curbed by much slower wage growth compared to this year. Nevertheless, wage growth in 2021 is anticipated to outpace inflation and stand at 2.2%.

Lithuania’s economic activity has so far been fairly resilient to the impact of COVID-19. Although some businesses were hit by the pandemic particularly hard, an even deeper economic downturn was avoided due to relatively strong manufacturing activity, increased net exports and government support measures that helped firms preserve jobs. The imposed restrictions and prevailing uncertainty will limit both private consumption and business investment. However, the overall financial health of households and firms gives rise to expectations of some positive developments in the near future, with economic activity returning to its pre-crisis levels. Following the onset of the pandemic, households and companies started saving up more. In 2020, the total amount of resident deposits with banks increased by 11% and reached €17 billion. Accordingly, corporate funds increased by a third to
€8.8 billion.

Both state support and central bank monetary policy measures play an important role during the pandemic, enabling governments to borrow on very favourable terms. The Eurosystem, which the Bank of Lithuania is part of, has already injected €700 billion into the economy under the pandemic emergency purchase programme (PEPP), while its total envelope is expected to reach €1.85 trillion and run at least until March 2020.

However, all government measures come at a certain price, which is particularly related to the rising budget deficit and public debt. This year, Lithuania’s budget deficit will account for almost 9% of GDP, and will be one of the highest among the EU countries. Next year, the country’s deficit is also projected to exceed 5%, while the difference will have to be covered by borrowed funds. As a result, the public debt, which already reached a record high this year, will continue to grow to above 50% of GDP in 2021. Moreover, the current situation entails a risk that public spending will further increase due to higher-than-expected expenditure for the management of the pandemic and its consequences. There is also a risk related to the efficient use of borrowed funds, particularly with regard to the implementation of Lithuania’s Plan for the DNA of the Future Economy, since it is not clear whether the measures set out in this plan will meet the European Commission’s requirements.

The Bank of Lithuania’s latest Macroeconomic Projections are available here.