Dalintis:

Lithuania’s economic development and outlook

26 September 2022

Russia’s war against Ukraine, the renewed pandemic in China and monetary tightening in many major economies due to extreme inflationary pressures are dampening global economic growth. Russia’s war against Ukraine, which started at the end of February, has significantly increased the prices of key energy and food raw materials. While prices of some energy and food raw materials have returned to the pre-war levels, other raw materials, in particular natural gas, remain at significantly higher levels and are particularly detrimental to the development of European economies. Due to the lack of generation and the algorithm used in the Nord Pool power exchange, many European countries have high final electricity prices set by natural gas-fired power plants, which has a significant negative impact on their competitiveness. China’s zero-COVID-19 policy is due to the slow vaccination of the population. It has a negative impact on Chinese consumption and production, slowing down the country’s economic growth and contributing to the persistent bottlenecks in supply chains. These factors have also contributed significantly to the global inflationary shock. It has forced most central banks in developed and developing countries to normalise monetary policy. Such central bank actions send signals that inflation expectations will not be allowed to drift away from the inflation levels consistent with price stability, even if they have a dampening effect on economic activity.

The effects of Russia’s war against Ukraine and extremely high inflation are dampening economic activity in Lithuania. Lithuania’s GDP contracted by 0.5% in the second quarter of 2022 compared to the previous quarter. The main contributing factor to this economic expansion is the sharp decline in real exports of goods and services. It was almost 5% lower than in the previous quarter. The main factors affecting the export trend were the sanctions on trade with Russia and Belarus, which restricted exports of transport services, the closure of AB ORLEN Lietuva for planned repairs and the temporary closure of AB LIFOSA due to the sanctions. Household consumption also fell significantly as a result of very high inflation. It was more than 2.5% lower than in the previous quarter, even in the context of relatively favourable developments in household disposable income. The war and accelerating inflation have worsened household sentiment and expectations, further reducing their willingness to consume. For example, consumer confidence in August this year was close to its lowest level in a decade. Further difficulties in Lithuania’s economic development are also evident in other recent higher frequency indicators. Business sentiment, after the significant deterioration in March, has remained significantly unchanged for almost half a year. Meanwhile, monthly data on business turnover in the largest sectors of the economy, namely, industry, construction, trade and services, show signs of declining activity between June and July. These unfavourable factors can only be partly offset by the forecast of a 10% increase in this year’s harvest.

Labour market tensions did not ease in the second quarter of 2022. The number of employed persons increased significantly during this period. In particular, the number of employees increased, but the share of self-employed also rose significantly. The surge in employment was driven by a strong increase in the labour force, especially for women. This is attributed to a particularly positive net migration balance. In January-August of this year, around 43,000 more people entered Lithuania than left. It is likely that the majority of immigrants are war refugees from Ukraine, who are successfully integrating into the Lithuanian labour market. The rapid growth of the labour force has not increased the unemployment rate, which dropped to 5.2% in the second quarter of this year, the last time such a low unemployment rate was recorded in Lithuania was before the global financial crisis in 2008. With fewer unemployed and more working persons, the country is facing a persistent labour shortage. Vacancy statistics for the second quarter of 2022 show that labour supply continues to fall short of rising demand, and the labour market situation in the country remains very tight: the job vacancy rate (the ratio of vacancies to total jobs) was 1.9%, almost on par with the record of 2% recorded in the third quarter of 2008 and the first quarter of 2022. Very high tension in the labour market has a significant impact on the country’s rapid annual wage growth of almost 14%. However, rising energy costs are likely to limit the ability of companies to increase wages at a very fast pace. According to the monthly labour income data (seasonally adjusted) published by Sodra, labour income growth slowed down significantly in May-July.

The effects of Russia’s war against Ukraine and its further course will be the main factors shaping the development of the Lithuanian economy in the coming years. The nature of this factor means that the country’s economic outlook is currently shrouded by a high degree of uncertainty. The extreme volatility of energy commodity prices, in particular natural gas, has a negative impact on household and business sentiment and expectations, leading to more cautious household consumption and limiting the willingness of businesses to invest. This will dampen economic growth in both Lithuania and its main trading partners. Foreign demand for Lithuanian goods and services is projected to decline in 2022 and, although it is expected to start recovering from early 2023, it will not reach the level that existed before Russia’s invasion of Ukraine during 2023. This evolution of external demand, together with the negative impact of high energy prices on competitiveness, will be the main contributors to the sluggish export growth. The less favourable development of the exporting sector is one of the main factors contributing to the weaker-than-expected development of investment, especially in 2022. However, the expected significant increase in government investment and the need for companies to reduce electricity and fossil fuel costs will allow investment to pick up this year and the next. Inflationary pressures, which will persist for longer than previously thought, will constrain domestic consumption not only in the main trading partners, but also in Lithuania. Even though nominal wages will continue to grow, higher inflation will lead to a decline in real wages and salaries in both 2022 and 2023. This, together with the expected normalisation of monetary policy leading to an increase in interest rates, will be the main factors limiting the growth of household consumption in Lithuania in 2022 and the decline in 2023. It is important to note that such assessment of developments in household consumption includes the measures to mitigate the effects of inflation and high energy prices adopted by the Government until 31 August 2022. If the Government decides on additional measures, household consumption would follow a more favourable path.

Lithuania’s real GDP is projected to increase by 2.1% in 2022 and 0.9% in 2023. At the same time, it should be noted that this outlook for Lithuania’s economic development is subject to a high degree of uncertainty, and the balance of currently observable risks is even more negative than it was at the time of the June projections, i.e. there is a significantly higher probability of a downward revision than an upward revision in future economic projections. If the severely adverse risks materialise, the country’s economic growth could slow by up to 3.8% percentage points in 2023 and inflation could be up to 5.1% percentage points higher than in the baseline scenario.

Inflationary pressures have increased as risks related to gas supply have materialised. Following Russia’s restriction of gas supplies to Europe, gas prices on the markets in August were more than five times higher than in the same period a year earlier. As gas is used as a feedstock for electricity and heat energy generation, it also contributes significantly to the increase in electricity and heat energy prices. The increase in gas prices on the market has led to a significant increase in demand for solid fuels, mainly firewood, as an alternative energy source. This has further boosted the already rapidly rising prices of solid fuels, with solid fuel prices up 166% year-on-year in August. Energy prices for customers are forecast to rise at an average annual rate of 56% this year. Energy price increases will moderate next year but will remain a key driver of inflation. Overall, the revision of energy price forecasts for both 2022 and 2023 has had the largest impact on the revision of inflation projections. As for food prices, which have made a significant contribution to inflation in recent months, they will also be affected by changes in the energy markets. Although global food commodity prices fell in August and were already only 8% higher than in the same period a year ago, food prices are projected to rise at an average annual rate of 21% this year, while next year food price growth is expected to moderate, but remain fairly strong at 10%, taking into account the fact that commodity price changes do not reach consumers immediately and that the cost of food commodities is significantly influenced by the sharp increase in energy prices. Meanwhile, growth in the core inflation components such as industrial goods and services stabilised in August. While subdued economic growth will ease the pressure on core inflation, growth in industrial goods in particular will be supported by a significant increase in producer prices, with producer prices for manufacturing, excluding refined energy products, 30% higher in August than a year earlier. Thus, while the prices of some commodities such as oil, food and metals are currently depressed on world markets compared to their peak at the outbreak of the war, record high energy prices will accelerate the increase in both energy prices for customers and the cost of other consumer goods and services. Against this background, average annual inflation is projected at 18.3% in 2022 and 8.4% in 2023.

	September 2022 forecasta			June 2022 forecast
	2021	2022b	2023b	2021	2022b	2023b
Price and cost developments (annual percentage change)
Average annual HICP inflation	4.6	18.3	8.4	4.6	15.2	4.6
Gross domestic product deflatorc	6.6	16.6	6.8	6.6	15.2	5.0
Wages	10.6	12.7	6.3	10.6	11.9	8.1
Import deflatorc	11.6	22.2	4.4	11.6	19.9	4.5
Export deflatorc	5.7	15.4	6.8	5.7	13.7	5.6
Economic activity (constant prices; annual percentage change)
Gross domestic productc	4.9	2.1	0.9	4.9	2.1	3.4
Private consumption expenditurec	7.3	1.0	-0.8	7.3	5.4	3.8
General government consumption expenditurec	0.6	0.3	0.0	0.6	1.5	-1.3
Gross fixed capital formationc	7.0	3.0	3.4	7.0	4.1	3.5
Exports of goods and servicesc	15.9	6.4	1.6	15.9	7.4	2.9
Imports of goods and servicesc	19.4	7.5	1.3	19.4	9.8	2.8
Labour market
Unemployment rate (annual average as a percentage of labour force)	7.1	6.3	7.1	7.1	7.3	7.2
Employment (%, annual percentage change)d	1.2	4.0	-0.6	1.2	0.6	0.3
External sector (percentage of GDP)
Balance of goods and services	4.2	-1.3	0.9	4.2	-1.9	-0.9
Current account balance	1.3	-6.6	-2.1	1.2	-4.5	-3.8
Current and capital account balance	2.7	-4.7	-0.2	2.7	-2.5	-1.8

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1.International environment

Commodity prices have stabilised, although they remain elevated.

Dalintis:

Most of the world’s economies have started to tighten their monetary policy.

Dalintis:

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2.Monetary policy of the Eurosystem

Over the past six months, the ECB Governing Council has taken significant decisions to accelerate the normalisation of monetary policy. Rising euro area inflation and the outlook for higher inflation in the future have prompted a further normalisation of monetary policy with a view to bringing inflation back to 2% in the medium term. At the June meeting, it was decided to suspend net purchases under the asset purchase programme (APP) as from 1 July. The Governing Council also determined that the conditions for the ECB to start raising its key interest rates were met.

On 21 July 2022, the ECB Governing Council raised interest rates for the first time in more than a decade and approved the monetary policy Transmission Protection Instrument. Key interest rates were increased by 0.5 percentage points, which means that the negative interest rate environment has been escaped (for more details on the reasons for and effects of interest rate hikes, see Box 1). In order to ensure the effectiveness of monetary policy transmission, the Governing Council adopted a new instrument to protect policy transmission. This instrument will allow the Eurosystem to make secondary market purchases of securities of euro area countries that are experiencing a deterioration in financing conditions that is not justified by fundamentals, thus helping to ensure a smoother transmission of monetary policy decisions to all euro area countries.

On 8 September 2022, interest rates were increased again in response to the continuing rapid rise in inflation. Price pressures have continued to pick up in recent months and have spread across more sectors, with the ECB’s September projections suggesting that inflation will remain above 2% in 2023–2024 (see Chart 3). For these reasons, key interest rates have been increased by 0.75 percentage points to accelerate the transition to the interest rate level that will help ensure that inflation returns to 2% in the medium term. The Governing Council also determined that it would continue to raise interest rates over the next few meetings in order to dampen demand and to prevent the emergence of rising inflation expectations. The Governing Council stressed that interest rate decisions would continue to depend on available data and would be taken at each meeting.

Financial markets have priced a gradual increase in interest rates over the coming years (see Chart 3). With the ECB Governing Council starting to raise interest rates and still considerable uncertainty about the future inflation outlook, financial market participants expect a further gradual increase in interest rates. Financial market futures suggest that interest rates could reach a level of 2.0%-2.5% in 1-2 years.

Key ECB interest rates have started to rise.

Dalintis:

Euro area banks started to raise lending rates following the normalisation of the monetary policy and increased uncertainty about the economic outlook. In the euro area, lending rates have been declining steadily since 2015, but the trend reversed at the beginning of this year when lending rates started to rise (see Chart 4). In Lithuania, average interest rates on new mortgage loans and loans to non-financial corporations (NFCs) have also risen slightly from the beginning of 2022. While average interest rates in Lithuania remain above the euro area average, the gap has narrowed significantly this year. The future dynamics of lending rates will depend on the pace of monetary policy normalisation and the financial situation of the economy and banks.

Financing conditions in the euro area have started to tighten.

Dalintis:

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3.Real sector[28]

The Lithuanian economy expanded faster than expected in the first half of 2022. After expanding by 1.2% in the first quarter compared with the previous quarter, the economy contracted by 0.5% in the second quarter. These economic developments caused Lithuania’s GDP to be 3.5% higher in the first half of 2022 than a year earlier. Value added increased in most economic activities. The fastest growth was recorded in manufacturing; arts, entertainment and recreation; information and communication; professional, scientific and technical activities; and administrative and support service activities. By contrast, the activities with the most development difficulties were trade, transport and real estate operations. The sanctions against Russia and Belarus, the EU Mobility Package and difficulties in acquiring trucks were the main factors affecting activity in the transport sector. The development of real estate operations was constrained by the declining activity in the RE market. It should be noted that the growth of value added in manufacturing in the second quarter of the year was limited by the performance of several companies, i.e. production at AB ORLEN Lietuva was suspended for planned repairs and AB LIFOSA was temporarily closed. In the first half of 2022, Lithuania’s economic activity continued to expand above its potential and the output gap remained positive. This is reflected both in the persistent labour market tensions and in one of the highest inflation rates in the EU, partly due to the greater ability of businesses to transfer rising costs to customers than in other EU Member States. These economic developments mean that the economic growth outlook for this year is not revised, but that growth will slow down significantly in 2023. Real GDP is projected to be 2.1% higher this year than in 2021 and to grow by 0.9% next year. This economic scenario is underpinned by a further deterioration in the risk balance, as it became even more negative than it was in June. The risk balance worsened mainly due to the particularly high uncertainty about energy prices in the next six months. Other prominent downside risks include very high inflationary pressures and decisive action by monetary policymakers to contain it, the further development of Russia’s war against Ukraine, the imposition of sanctions against the aggressor and the response to them, the ongoing COVID-19 pandemic and the fight against it, as well as further escalation of global recession topic, which is deteriorating business and consumer confidence.

The Lithuanian economy expanded faster than expected in the first half of 2022.

Dalintis:

Rapid increases in the prices of goods and services restrained household consumption in the first half of 2022. It increased by 0.1% in the first quarter of 2022 and contracted by 2.6% in the second quarter. The adverse impact of soaring prices on household consumption was limited by rapidly rising household income. According to the Bank of Lithuania estimates, nominal household disposable income in the first quarter of 2022 was around one-sixth higher than a year earlier. As its growth outpaced inflation rates during this period, real household disposable income also increased. The main contributor to the increase in household disposable income has been the increasing wage bill, which was boosted by both employment growth and wage increases (see Section 4 for more details). Rising property income also contributed significantly to household income growth, which was also influenced by the greater ability of businesses to transfer rising costs to customers, due to a favourable business cycle in Lithuania compared to other EU Member States, thus maintaining relatively good profitability ratios of companies. The strong growth in household disposable income is expected to continue throughout this year. However, even with rising incomes, household sentiment and expectations are deteriorating. The consumer confidence indicator in August this year was close to its lowest level over the past decade. Households’ expectations for the economic development in the next 12 months are particularly unfavourable and are the worst since the global financial crisis. This will partly contribute to a more cautious attitude towards consumption in the second half of the year, for example, the willingness of households to make larger purchases in the near future has decreased substantially. Nevertheless, it should be noted that although household expectations have deteriorated considerably, their assessment of the current financial situation is still quite favourable and significantly above the historical average. As a result of these factors, household consumption is expected to increase by 1.0% in 2022 and decrease by 0.8% in 2023.

Household disposable income continues to grow at a particularly rapid pace in 2022.

Dalintis:

Export growth remains relatively strong, but sluggish investment may constrain its future expansion. Exports increased by 2.8% in the first quarter of this year compared to the previous quarter and declined by 4.8% in the second quarter. This decline was mainly due to the suspension of production at AB ORLEN Lietuva for planned repairs, the temporary closure of AB LIFOSA and severely restricted exports of transport services due to the imposition of sanctions on trade with Russia and Belarus (for more on foreign trade, see Section 5). The trends in exports of other higher value-added goods and services remained relatively favourable. As a result, exports of goods and services in the first half of 2022 were 13.6% higher than a year earlier. However, while export developments were relatively favourable, high uncertainty about the further development of the economies of the main trading partners and the course of Russia’s war against Ukraine reduced incentives for companies to invest. After increasing by 2.8% in the first quarter of this year compared to the previous quarter, investment fell by -1.5% in the second quarter. Investment in civil engineering buildings and structures, partly constrained by the continuing increase in project construction estimates, and in transport equipment were the ones to fall the most. The decline of the latter is linked to the entry into force of the EU Mobility Package at the beginning of this year and the persistent difficulties in acquiring the necessary number of vehicles. Investment in information and communication technology (ICT) equipment also declined, albeit to a noticeably lesser extent. Only investment in housing and other capital goods has grown. The former increased due to strong demand, which was influenced by households’ concerns about the depreciation of existing savings. Meanwhile, higher investment in other capital goods was fuelled by increased incentives for businesses to use energy more efficiently due to higher electricity prices. Although business sentiment has remained significantly unchanged for almost half a year now, following a significant deterioration in March, the growing number of negative factors for the economy and business development, such as uncertainty about energy prices or the escalation of global recession topic, will limit companies’ willingness to invest, except for projects aimed at more efficient energy consumption and production. These factors point to a rather sluggish development of investment: 3.0% in 2022 and 3.4% in 2023.

High uncertainty about the further development of the economies of the main trading partners and the course of Russia’s war against Ukraine have reduced incentives for companies to invest.

Dalintis:

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4.Labour market

The largest sector in terms of employment, the services sector, contributed the most to the record employment growth, especially trade, transport, accommodation and food service activities (see Chart 8). The increase in hiring in these activities can be attributed to the effect of a low comparative base. It is the services sector that has been hardest hit by the second quarantine. Since the beginning of the second half of the last year, when the quarantine was lifted and the restrictions on contact activities were eased, the situation of the activities most affected by the pandemic started to improve. The current recovery in demand for services is matched by a growing demand for workers, which is the reason why employment is growing so rapidly in many economic activities of the services sector. This is also confirmed by the administrative data of the Social Insurance Fund (Sodra) on the number of persons insured. For example, since March this year, the number of persons employed in accommodation and catering, entertainment and recreation activities has started to recover after a relatively long period. Based on the September data, the number of people employed in the transport sector was about 14% higher than during the pandemic. The exceptionally high demand for transport workers this year is reflected in the increased number of quotas and their rapid use. For example, the services sector (which also includes transport activities employing third-country drivers) has been allocated around 38% more quotas this year than last year. According to the Migration Department, the quotas for facilitating the recruitment of foreigners in the services sector expired at the end of August.

The first half of this year saw a particular increase in employment in the services sector.

Dalintis:

Unemployment has fallen markedly as a result of a significant increase in employment. In the second quarter of 2022, the national unemployment rate fell to as low as 5.2%, some 2.2 percentage points lower than a year earlier (see Chart 9). Although the number of unemployed persons has been declining steadily since the end of the pandemic year, the last time Lithuania recorded such a low unemployment rate was before the global financial crisis in 2008. The falling long-term unemployment rate also reflects the extremely high demand for workers. Over the year, the long-term unemployment rate declined by more than 0.5 percentage points, reaching its pre-pandemic level. Registered unemployment data also signal a very similar labour market situation. According to the Employment Service, the registered unemployment rate in Lithuania had been declining since the beginning of last year, but in July this year, due to seasonal factors (young people aged 16-24 who graduated from university engaged in job search, so the number of unemployed people in this age group has increased the most), there were around 8,000 more unemployed persons than in the previous month. After adjusting for seasonal effects, the number of registered unemployed in July was almost unchanged compared to June. During this period, registered unemployment reached 9.1%, or around 159,000 people, including around 6,000 Ukrainians who had fled the war in Ukraine and were looking for jobs in Lithuania.

Unemployment fell to the level recorded more than 14 years ago, determined by a significant increase in the number of employed persons.

Dalintis:

With fewer unemployed people and more people being hired, the country is facing a persistent shortage of workers. Job vacancy statistics for the second quarter of 2022 show that labour supply continues to fall short of the growing demand, and the situation on the labour market is still very tight: the job vacancy rate (the ratio of job vacancies to total jobs) stood at 1.9%, almost on par with the record level of 2% recorded in the third quarter of 2008 and the first quarter of 2022. During that period, the country recorded around 27,000 vacancies for employees, up by around a tenth a year ago. However, the extent of the labour shortage varies across economic activities, with many vacancies in high-skilled activities. The highest job vacancy rates in the second quarter of 2022 were found in public administration and defence, compulsory social security (4.4%), financial and insurance activities (3.2%) and information and communication (3.1%) companies. The high number of vacancies in high-skilled activities indicates that it is difficult for employers to find workers with the right skills, either because the qualifications, skills or experience of those employed do not match the employers’ needs for the vacancies on offer, or because people with such qualifications are not interested in the working conditions and remuneration offered.

The lack of labour supply and high demand have a major impact on wage growth in the country. The wage spurt has continued in many economic activities since the beginning of the pandemic period (see Chart 10). In July, for example, employees in the transport sector earned almost one and a half times more than the average in 2019. The information and communication sector has not been lagging behind, with wages about 39% higher than in the same period three years ago. Although in the second quarter labour income increased at a more than double-digit annual rate in most economic activities, in April–June, the largest annual wage changes were recorded in accommodation and catering (20%) and entertainment and recreation (16%) activities. This can be attributed to the strong base effect, which leads to a much faster wage growth in these activities. In addition, the vacancy data show that the labour shortage in the contact-intensive sectors is still quite high. According to Statistics Lithuania, in the second quarter of this year, wages rose by 13.7% year-on-year. Wages in the private sector grew significantly faster than in the public sector, by 15.2% and 10.7% respectively. The latest administrative July data from Sodra also show double-digit wage growth of 12.3%. However, labour income growth has stopped accelerating in May-July (see Chart 10).

Wage growth has been decelerating from May to July.

Dalintis:

As a result of positive trend in net migration and a more cautious assessment of the economic outlook labour market tensions should ease, but no significant deterioration in labour market conditions is expected. The expected slower economic growth due to the negative impact of soaring energy prices will lead companies to be more cautious in their hiring decisions, which will have a negative impact on labour demand. Business hiring expectations deteriorated slightly in August, although they are still above the long-term average. If the electricity market remains tight, the number of companies facing labour shortages is likely to decrease in the near future. In addition, large flows of foreign immigrants should also contribute to the stabilisation of job vacancy rate this year. Despite the fact that the number of outflows of Lithuanian citizens is slightly higher than the number of arrivals, the balance of net migration of foreigners is positive (see Chart 11). The latter is influenced by the increase in immigration of foreign nationals, especially Ukrainians and Belarusians, due to the war in Ukraine. The decline in labour demand will be compounded in the future by the falling external demand, which will constrain the activities of exporting firms. And this will also have a negative impact on the labour market. Sluggish economic growth and higher energy costs will force Lithuanian businesses to reassess their need for employees and limit wage growth.

The balance of foreign migration is record-high and outweighs the negative net migration of Lithuanian citizens.

Dalintis:

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5.External sector

In the first half of 2022, Lithuania’s export and import volumes continued to grow, but foreign trade volumes increased at a slower pace and are expected to decline in the second half of the year. Based on seasonally adjusted national accounts data, real exports of goods and services increased by 4.2% and imports by 4.6% in the first half of 2022, compared to the second half of 2021. External demand for Lithuanian exports declined slightly in the first half of the year, but growth in exports remained positive due to a growing market share in trade in goods with the EU. In the first half of 2022, trade in goods was the main contributor to export growth, while trade in services declined. Exports of agricultural and food products have increased significantly, while the chemical industry also performed well. The increase in Lithuania’s foreign trade in goods was supported by the re-export of mineral and energy products to EU countries in January-April, offsetting most of the decline in trade with the Commonwealth of Independent States. Imports continued to grow at a similar pace to the previous half-year, with mineral and energy products being the main growth driver in the first half of 2022. Imports of almost all other commodity groups increased at a slower pace, including investment goods, which are linked to future developments. Further developments in the external sector are closely linked to developments in the global economy, which remains shrouded by heightened uncertainty. Weakening growth of Lithuania’s main trading partners will dampen demand for exports of Lithuanian goods and services, while higher commodity and energy prices will have a negative impact on import developments. The Bank of Lithuania forecasts that exports will grow by 6.4% and imports by 7.5% in 2022.

The slowdown in global economy will negatively affect (reduce) the demand for goods and services produced in Lithuania. Economic forecasts for 2022 are downgraded in many countries due to the negative impact of Russia’s war against Ukraine on the global economy, higher inflationary pressures and risks associated with central bank interest rate hikes. Slower global economic growth will also slow down the development of world foreign trade, which will reduce foreign demand for Lithuanian goods and services (see Chart 12). Demand for Lithuanian exports has been declining since the second quarter, and a return to growth can only be expected in 2023. Accordingly, exports are expected to decline in the second half of the year and to grow at a slower pace in early 2023. This will have a direct impact on imports due to lower demand for raw materials, intermediate goods and capital goods, production of goods for export, and production capacity expansion. Import growth will slow down but will be positively influenced by domestic demand for mineral and energy products in the second half of 2022.

The deteriorating global economic outlook in the second half of 2022 is leading to a decline in external demand for Lithuanian goods and services, which is negatively affecting export growth.

(at constant prices, seasonally adjusted data)

Dalintis:

Following a fall in supply of agricultural and food products and an increase in prices on world markets as a result of Russia’s war against Ukraine, Lithuania has expanded its exports of agricultural and food products. In the first half of 2022, at constant prices, agricultural and food products had the largest impact on the growth of commodity exports (see Chart 13). Exports of food products (e.g. milk and dairy products, food industry residues and animal feed) increased significantly in the second quarter.

The chemical industry experienced various difficulties in this period. Exports of anti-COVID-19 pandemic products fell due to subdued demand, while exports of fertilisers decreased due to the suspension of production by AB LIFOSA and a significant increase in the price of natural gas used in fertiliser production. Nevertheless, exports in this sector grew only slightly less than in the previous half-year. This was due to increased exports of rubber and plastic products, pharmaceuticals and enzymes. The suspension of AB ACHEMA operations due to cost increases is likely to lead to a further decline in fertiliser exports in the second half of the year. The suspension of production at AB LIFOSA will also contribute to this decline.

Exports of all commodity groups except machinery, equipment and transport equipment increased in the first half of 2022.

(change in export levels seasonally adjusted, compared to the previous period)

Dalintis:

Even in the face of disruptions in the supply of raw materials from Russia, Ukraine and Belarus, Lithuania’s share of the export market has been growing. Lithuania’s share of the world merchandise export market declined in the third and fourth quarters of 2021, before increasing again in the first quarter of 2022. As the impact of the pandemic softened, the market share of trade in COVID-19 pandemic response products was lost, but Lithuania’s trade in minerals and energy products increased considerably in early 2022. This is due to the re-export of gas imported via the Klaipėda LNG terminal. Despite the decline in Lithuanian exports in the second quarter of 2022 compared to the previous quarter (see Chart 14), Lithuania’s market share in the world increased, albeit moderately. This is due to a larger fall in demand for Lithuanian goods and services. The loss of competitiveness due to the strong increase in energy prices will significantly limit the growth of export market shares in the short term.

Lithuania’s exports have historically grown faster than external demand, but the gap between the two has narrowed in the second quarter of 2022, indicating a stagnation in market share growth.

(at constant prices, seasonally adjusted data, quarterly change)

Dalintis:

Trade in services fell in the first half of 2022, but not significantly. The level of services exports went up considerably in the fourth quarter of 2021 but fell again in early 2022. These fluctuations are linked to the evolution of exports of transport services. Freight volumes suggest that a decline in exports of rail and maritime transport services can be expected in the first half of 2022, while the level of exports of road freight transport services is expected to go down less. These changes are related to trade restrictions with Russia and Belarus. Meanwhile, imports of services have continued to increase, albeit at a slower pace, with transport services accounting for most of the growth. Their share in the structure of imported services continues to grow, which can be linked to the entry into force of the mobility package requirements for the regular return of trucks to their country of origin.

The widening of the current account deficit was mainly due to one-off factors.

(nominal, seasonally adjusted data)

Dalintis:

Lithuania’s current account deficit fell to historical lows in the second quarter of 2022, mainly due to one-off factors. In the first quarter of 2022, the current account deficit widened, mainly due to trade in goods (see Chart 15). The rise in energy prices and the need to change sources of their supply as a result of the war in Ukraine have significantly increased the value of nominal imports. With exports continuing to grow at a slower pace than imports and rising prices exerting a stronger pressure on import prices, net exports declined. In the second quarter of 2022, the same factors led to a slight drop in net exports and a widening of primary income deficit. It is mainly driven by dividends paid by Lithuanian businesses to foreign investors (€1.6 billion according to preliminary data). The Lithuanian economy has been flourishing over the past few years and economic activity has not slowed down even in the face of the pandemic. The increase in profits determined by this growth allowed for increased production capacity, active implementation of automation processes and research, and the expansion of products or services offered. In June, market participants distributed part of their profits to foreign investors, which greatly widened the primary income deficit on the balance of payments. The current account balance will remain in deficit in the coming months and over the projection horizon. This will be mainly driven by the external trade balance, as well as declining current transfers from abroad.

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6.Prices

Russia’s war against Ukraine has added to the pressure on inflation, which was already significantly increased before the war. Annual inflation in Lithuania stood at 14% in February and 21.1% in August (see Chart 16). The increase in annual inflation was mainly due to higher energy and food prices. While global prices of some commodities such as oil, food and metals are currently depressed compared to their peak at the outbreak of the war, record high energy prices will push up both energy prices for consumers and the cost of other consumer goods and services. Against this background, average annual inflation is projected at 18.3% in 2022 and 8.4% in 2023.

Inflation in Lithuania is mainly driven by rising energy prices.

Dalintis:

Rising energy prices continue to be the main driver of inflation. They directly reflect the turmoil in energy markets caused by Russia’s war against Ukraine. With Russia restricting gas supplies to Europe and threats of possible gas shortages in winter, gas prices in Europe averaged around €236/MWh in August, more than five times higher year on year. Following the increase in natural gas prices on the market, gas prices for consumers were also revised upwards, which were 74% higher in August than a year ago. The use of gas as a feedstock for electricity generation has also contributed substantially to the rise in electricity prices on the market: electricity prices on the Nord Pool exchange in August were more than five times higher than in August last year. This also led to a rise in electricity prices for consumers, with electricity prices for consumers being up by 63% year on year in August. Heat energy prices are also affected by the changes in gas prices on the market, as gas is used to produce heat energy as well. Taking into account the prices of purchased biofuels and gas, heat energy prices rose by 89% year on year in August, contributing 1.9 percentage points to headline inflation. Of all administered prices, heat energy had the highest impact on annual headline inflation (see Chart 17). The increase in gas prices on the market led to a peak in demand for solid fuels, which mainly consist of wood, as an alternative energy source. This further boosted the already rapid rise in solid fuel prices, with solid fuel prices rising by 166% year on year in August. However, not all energy markets have seen recent price increases. Fears of a recession and a possible drop in demand have pushed oil prices down from USD 118 per barrel in June to USD 98 per barrel in August. The fall in oil prices was accompanied by a decline in the annual growth of fuel prices, which was 38% in August.

Of the administered prices, heat energy prices have the largest impact on annual headline inflation.

Dalintis:

Accelerating food prices have been a major contributor to the rise in inflation in recent months. In August, food prices were almost one-third higher than in the same period a year ago, and as food accounts for around one-fifth of the consumer basket, the change in food prices has a significant impact on headline inflation. Dairy products, oils and other fats were among the food groups that have become particularly expensive, their prices in August were 47% and 40% respectively higher compared to the same period a year ago. The rise in dairy prices alone, mainly driven by a 76% year-on-year increase in milk farm-gate prices, contributed 1.7 percentage points to headline inflation in August (see Chart 18). In general, food price inflation is determined by the acceleration of global food commodity prices, which had already started to rise last year and went up even higher following the outbreak of the war. In addition to steep food commodity prices, other factors that increase the cost of food, such as higher prices for energy, fertilisers and animal feed, and rising wages, are also driving up food prices. However, global food commodity prices fell in August and were already only 8% higher than in the same period a year ago (23% in June). However, changes in raw material prices are not immediately felt by consumers. Moreover, while global food commodity prices have fallen compared to their peak at the outbreak of the war, the costs of food products will be significantly affected by inflated energy prices, therefore, food prices are expected to rise further.

The increase in dairy prices is the main contributor to the rise in food prices.

Dalintis:

The development of the components of underlying inflation is different, with more upward pressure on prices of industrial goods than those of services. The rise in energy and metal prices following the outbreak of war and the price of shipping by sea containers, which hit a record high in the third quarter of 2021, are pushing up the cost of producing goods. In August, producer output prices for manufacturing, excluding refined petroleum products, were around 30% higher than a year ago. This is passed on to prices of final consumer goods, with the annual price growth of 9.5% in August for non-energy industrial goods. The increase in producer prices will continue to affect the development of prices of industrial goods in the future, as the current decline in prices of metals and shipping by sea containers will not be reflected in producer prices for some time. In addition, their impact will be dampened by higher energy prices. The prices of another component of core inflation, i.e. services which are strongly linked to domestic economic developments, rose at an annual rate of 12.8% in August, similar to the 12.7% rate in July. This was significantly influenced by the increasing effect of a higher comparative base. The annual growth of prices of services should start to moderate following a slowdown in Lithuania’s economic activity and driven by base effects.

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7.Financing of the economy

Corporate financing has increased significantly, especially in the non-bank sector.

Dalintis:

With the flows of lending for house purchase, consumption and other purposes following an upward trend, the portfolio of loans granted by MFIs to households moved along the same path in the second quarter of 2022. The flow of new loans to households granted by MFIs in the second quarter of 2022 was 15.0% higher than in the previous quarter and 24.0% higher than the average quarterly flow in 2021.The increasing flow of loans was mainly driven by consumer and other loans, which grew by 40.0% during the second quarter of 2022 in the context of historically high inflation and as newcomers enter the consumer loan market. The flow of new housing loans was 7.0% higher in the period under review compared to in the first quarter of 2022. The increase in these loans in the recent months was mainly a result of the rapid rise in house prices and the need to borrow bigger amounts. As the flow of loans to households increased, the growth of the portfolio of loans to households granted by MFIs also accelerated: the portfolio was 11.5% bigger in June 2022 than a year ago (0.2 percentage points bigger than in March) (see Chart 20). The growth of the portfolio was underpinned by housing loans, which grew at the annual rate of 12.2%, i.e. 0.1 percentage points lower than in March, but still one of the fastest rates since 2009. The annual growth rate of the portfolio of consumer and other loans stood at 8.5% over the same period (2.1 percentage points higher than in March). The number of housing, consumer and other loans granted during the period was 7.3 and 123.9 thousand respectively, and their average amount was €81.2 and €4.0 thousand respectively. Compared to the same period a year ago, the number of housing loans decreased by 10.1% and their average amount increased by 18.0%. The number and average amount of consumer and other loans increased by 19.1% and 2.7% respectively.

The continued rapid growth in housing credit is driving the rapid pace of household financing, while the corporate loan portfolio continued to grow strongly in the second quarter of 2022.

Dalintis:

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8.General government finance

The increase in government revenue was driven by strong domestic demand, the easing of pandemic restrictions and the repayment of tax arrears.

Dalintis:

Government expenditure in the first quarter of 2022 was around 5% higher than a year ago, mainly due to higher spending on compensation of government employees, investment and capital transfers, and purchases of intermediate consumption goods and services (see Chart 22). General government investment, which had fallen by around a fifth in 2021, recovered in the first quarter of 2022 and was around 20% higher. This increase is mainly due to the transfer of state budget funds for the construction of the border with Belarus. It is also possible that the increased EU funds also contributed to higher investments: the State Budget Implementation Report shows that the amount of expenditure paid out of EU and other international support funds in the first half of 2022 was about a tenth larger than a year ago, and the implementation of the annual plan for EU funds also improved slightly, with a 52% completion. A considerable drop in pandemic-related assistance in the first quarter was accompanied by a decline in government support to families. Together with lower unemployment benefits, this was the main factor behind the reduction in total social benefits compared to the amount spent a year ago. The decline in unemployment benefits is influenced by the still healthy labour market situation, with the growth of labour force and employment, and the unemployment rate falling to almost 5% in the second quarter of 2022.

The increase in government expenditure was driven by higher compensation of employees and higher investment.

Dalintis:

The general government debt-to-GDP ratio was significantly lower in the first quarter than a year ago and stood at 40%. The decline in the debt ratio of around 5 percentage points was due to the redemption of more than €1 billion bond issue in February, as well as a potentially slightly lower borrowing requirement as a result of the surplus. If there are no economic shocks in the second half of 2022 that would require significant budgetary resources to mitigate their impact, the debt-to-GDP ratio is likely to stay close to 40% by the end of 2022.

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Abbreviations

EC                    European Commission

ECB                  European Central Bank

EU                    European Union

EURIBOR          Euro Interbank Offered Rate

Eurostat           Statistical Office of the European Union

Eurosystem      European Central Bank and central banks in the euro area

GDP                  gross domestic product

HICP                 Harmonised Index of Consumer Prices

ICT                   information and communication technology

IMF                   International Monetary Fund

MFI                   monetary financial institution

MMW                minimum monthly wage

NFC                  non-financial corporation

PMI                   Purchasing Managers’ Index

RE                    real estate

UK                    United Kingdom

US                    United States of America

VAT                  value added tax