Lithuania’s economic development and outlook
26 September 2023
The global economic situation is deteriorating. Although falling, global inflation remains high and has an adverse impact on household purchasing power. Economic activity is also restrained by higher interest rates which weigh adversely not only on the private sector, but also on the general government sector, especially in developing countries, as it is now harder for them to finance the various investments needed. The manufacturing sector is the main contributor to the deteriorating economic performance, and the situation is particularly bad in the euro area. With the weaker growth in demand for consumer goods, considerable economic and geopolitical uncertainty and higher borrowing costs, businesses are limiting their investment plans. This translates into a negative effect on the industrial production and international trade in goods. The growth rate of the services sector has also recently moderated. This sector saw a significant upturn in the first half of 2023, as post-pandemic demand for various services was still increasing at the time. With population mobility returning to its pre-pandemic levels, there is less and less room for the services sector to grow, and the weakening overall economic activity also has a restraining effect on the demand for services. For these reasons, growth projections of many countries and regions are being revised down, especially for 2024.
The Lithuanian economy improved in the middle of the year, but economic activity remains subdued. Real GDP is expected to be slightly lower this year compared to last year. The main drag on economic activity is the fall in industrial output. The deteriorating international economic environment, the rise in interest rates and the drop in temporary orders following the pandemic are aggravating the situation in the industry. The production capacity utilisation rate in this activity is lagging considerably behind the long-term average. Economic activity is also being held back by falling private consumption. While labour income has recently been growing more than prices, residents remain cautious and are not inclined to increase consumption. Real private consumption is projected to be lower this year compared to last year. However, not all economic activities are undergoing a downturn. As projects funded under the new EU Financial Perspective and the EU Recovery and Resilience Facility are implemented, there is an uptick in construction work. In particular, the construction of engineering buildings is increasing. The situation has also recently improved in the transportation sector. While the international economic environment poses challenges, the volume of road freight has grown significantly.
The labour market situation remains relatively good. The unemployment rate is close to 6%. In other words, unemployment is no higher now than it was before the shocks of the recent years. Anticipating that economic activity will pick up in the coming years, companies are making efforts to retain their existing staff. As a result, the total number of employed persons remains almost unchanged. This behaviour by employers leads to a fall in the value added per worker which has declined by around 3.5% over the last two years. Hiring expectations, however, are becoming more cautious. They are worsening in all major economic activities, but especially in industry. The composite indicator of employment expectations is below its long-term average. However, the deterioration in hiring expectations is relatively weak. The labour market situation is not projected to change significantly in the near future.
Lithuania’s economic growth outlook is deteriorating against the backdrop of weakening global economic developments. While the outlook for real GDP growth is revised upwards for 2023, the projections for 2024 are revised down. This reflects, first of all, the less favourable growth projections of trading partners, in particular euro area countries, which have a significant impact on the development of Lithuania’s exports. The exporting sector was previously expected to start recovering between 2023 and 2024 but is now projected to start growing significantly only in the first half of next year. Although households remain cautious and are not yet inclined to increase their consumption, private consumption is expected to grow next year as real income rises, thus contributing to an increase in overall economic activity. Economic development will also be spurred by EU support flows, which are expected to enhance during the projection horizon. After rising by 1.9% last year, real GDP is projected to fall by 0.6% this year and increase by 2.1% next year. This outlook implies that economic development will remain rather subdued in the coming quarters.
September 2023 projectiona |
June 2023 projection |
|||||
2022 |
2023b |
2024b |
2022 |
2023b |
2024b |
|
Price and cost developments (annual percentage change) |
||||||
Average annual HICP inflation |
18.9 |
8.8 |
2.6 |
18.9 |
8.9 |
2.7 |
Gross domestic product deflatorc |
17.0 |
8.8 |
2.8 |
17.0 |
9.0 |
2.9 |
Wages |
13.3 |
12.4 |
9.8 |
13.3 |
11.1 |
9.3 |
Import deflatorc |
24.8 |
-5.6 |
-0.1 |
24.8 |
0.1 |
1.0 |
Export deflatorc |
15.6 |
-1.5 |
0.5 |
15.6 |
3.9 |
1.8 |
Economic activity (constant prices; annual percentage change) |
||||||
Gross domestic productc |
1.9 |
-0.6 |
2.1 |
1.9 |
-1.3 |
2.7 |
Private consumption expenditurec |
0.5 |
-0.4 |
2.7 |
0.5 |
0.4 |
3.2 |
General government consumption expenditurec |
0.5 |
0.4 |
0.0 |
0.5 |
-0.2 |
0.0 |
Gross fixed capital formationc |
2.6 |
6.7 |
3.3 |
2.6 |
6.3 |
3.6 |
Exports of goods and servicesc |
11.9 |
-2.4 |
2.4 |
11.9 |
-3.0 |
2.9 |
Imports of goods and servicesc |
12.4 |
-4.3 |
3.1 |
12.4 |
0.0 |
3.1 |
Labour market |
||||||
Unemployment rate (annual average as a percentage of labour force) |
5.9 |
6.7 |
6.5 |
5.9 |
7.8 |
7.5 |
Employment (annual percentage change)d |
5.1 |
-0.4 |
-0.6 |
5.1 |
-1.3 |
0.1 |
External sector (percentage of GDP) |
||||||
Balance of goods and services |
-1.9 |
3.1 |
3.0 |
-1.9 |
-1.2 |
-0.7 |
Current account balance |
-5.1 |
0.0 |
-0.4 |
-5.0 |
-4.0 |
-4.3 |
Current and capital account balance |
-3.6 |
1.6 |
1.4 |
-3.4 |
-1.0 |
-2.4 |
a The macroeconomic projections are based on external assumptions, constructed using information made available by 22 August 2023, and other data and information made available by 31 August 2023.
b Projection.
c Adjusted for seasonal and workday effects.
d National accounts data; employment in domestic concept.
1.International environment
2.Monetary policy of the Eurosystem
Over the past six months, the Governing Council of the ECB has further tightened the Eurosystem’s monetary policy. Inflation in the euro area, which has been declining but is still far too high, and its outlook have prompted a rapid rise in interest rates. Since mid-2022, the key ECB interest rates have already been increased by 4.5 percentage points, with the aim of bringing inflation sustainably back to the 2% target over the medium term. It was also decided to terminate reinvestments under the asset purchase programme (APP).
At the May, June and July 2023 meetings, the key ECB interest rates were raised by 25 basis points to 3.75%. The Governing Council raised interest rates after taking into account the assessment of the inflation outlook, the dynamics of underlying inflation and the strength of the transmission of monetary policy effects. Although headline inflation in the euro area is declining, it is still too high and is expected to exceed the 2% target for the next couple of years. Underlying inflation also remains high. Higher prices are being fuelled by faster rising wages and higher corporate profit margins. The Governing Council also decided in June to end reinvestments under the APP as from 1 July. This further contributes to the tightening of monetary policy.
At the September 2023 meeting, interest rates were increased again by 25 basis points to 4%. According to the Governing Council, the key ECB interest rates have reached a level that, if maintained for a sufficiently long period of time, will make a substantial contribution to the timely return of inflation to the target. By its future decisions, the Governing Council will aim to ensure that interest rates will be set at a sufficiently restrictive levels for as long as necessary. It will continue to use all available data to decide on the appropriate level and duration of the restriction.
Rising interest rates are expected to help bring inflation in the euro area back to the 2% target in the medium term. Compared to October 2022, when inflation had exceeded 10%, it was twice as low in August 2023 (see Chart 1). In the medium term, as the impact of higher interest rates materialises, the ECB’s projections foresee a return of inflation to the 2% target. Financial market participants believe that interest rates have already peaked and could start to decline slowly in the summer of 2024. Financial market participants do not foresee zero or negative interest rates even in the long term.
Key ECB interest rates continued to rise.
Chart 1. Actual data on interest rates, the euro area inflation and market expectations
Sources: ECB and Refinitiv.
Note: Data as of 14 September are used in the Chart.
As the Governing Council of the ECB continued to raise key interest rates, Lithuanian and other euro area banks increased lending rates accordingly (see Chart 2). The rapid rise in interest rates on new loans is due to the increase in the variable component of interest rates on loans as a result of monetary policy decisions. Although interest rates on new loans in Lithuania remain higher than the euro area average, this difference is becoming more pronounced in the segment of new housing loans. This is explained by the fact that almost all housing loans (around 97%) in Lithuania are granted with a variable interest rate (usually 3, 6 or 12-month EURIBOR), while the euro area average is much lower (around 23%). The future dynamics of lending rates will depend on the monetary policy stance and the financial situation of the economy and banks.
Financing conditions in Lithuania and the euro area continued to tighten.
Chart 2. Average interest rates on new MFI housing loans and loans to NFCs
Sources: ECB and Bank of Lithuania calculations.
Notes: 3-month moving average. Excluding revolving loans and overdrafts.
3.Real sector
After experiencing a technical recession at the turn of the year, the Lithuanian economy returned to growth in the second quarter of this year. Lithuania’s economy grew by 2.9% quarter on quarter in the second quarter of 2023, after contracting by 2.1% in the first quarter. This caused Lithuania’s GDP to be only 0.8% lower in the first half of 2023 than a year earlier. The economic downturn in the first quarter of this year was still underpinned by the unfavourable factors that have emerged in the second half of 2022, such as the high cost of energy and other commodities, the imposition of sanctions on russia and Belarus, sluggish external demand, high inflation and tightening monetary policy. These factors weighed heavily on the activity in the manufacturing sector, especially in chemicals, wood and furniture, which contracted by 4.6% over the quarter and was 7.6% lower than a year earlier. Activity in trade, transport and RE operations also declined significantly. However, as these unfavourable factors gradually faded and the absorption of EU support flows increased, Lithuania’s economic activity started to recover. A pick-up in activity in many economic sectors was observed in the second quarter. There was a marked increase in construction activity. The volume of construction work in all major segments of the construction sector – residential, non-residential and engineering – increased, with the latter showing particularly favourable trends. Its growth is significantly influenced by projects financed by EU support funds and, probably, by investments in renewable energy generation. Faster growth in external demand and the fall in energy and other input prices have had a positive impact on activity in the tradable sector. However, the recovery of the manufacturing sector should be associated with the particularly weak development in the first quarter of this year rather than the improving situation in the second quarter. Most of this sales growth was driven by higher volumes of refined petroleum products and the renewed activity of AB Achema. In contrast, the volumes of manufacturing sectors such as furniture and wood products and plastics and other non-metallic mineral products declined. Nevertheless, the increased use of EU support funds this year, recovering external demand, subdued inflation and the resurgence of household purchasing power should contribute to the growth of Lithuania’s economy in the second half of this year. This year, real GDP is projected to be 0.6% lower than in 2022 and to grow by 2.1% next year. It should be further noted that the balance of risks remains negative, i.e. the probability that the economy will contract more than currently expected is higher than the probability that the economy will contract less. The uncertainty surrounding these projections is still very high.
After experiencing a technical recession at the turn of the year, the Lithuanian economy returned to a growth path in the second quarter of this year.
Chart 3. Contributions to GDP growth by the production approach
Sources: State Data Agency and Bank of Lithuania calculations.
Although household purchasing power has started to grow again, households are not yet inclined to increase consumption. In the first quarter of 2023, household consumption increased by 0.7% quarter on quarter but fell again by 0.8% in the second quarter. Meanwhile, due to a significant drop in household consumption expenditure in the last three quarters of 2022, it remained 2.0% lower in the first half of this year than a year earlier. Such a steep drop in household consumption was caused, in particular, by a very rapid rise in prices, which, on average, rose by 5.0% per quarter in 2022. Since the beginning of the year, price growth has gradually faded, from 1.7% in the first quarter to 0.2% in the second quarter (see Chapter 6 for more details). Household consumption decisions in 2022 were also negatively affected by a marked deterioration in household sentiment, but this has slowly improved since the last quarter of 2022 and is now close to the level observed before the outbreak of russia’s war in Ukraine. In addition to the subdued price growth, this improvement in sentiment has been affected by the situation on the labour market which was still favourable for employees, as the number of the employed did not decline significantly and wage growth remained strong (see Chapter 4 for more details). This labour market situation has been the main contributor to growth in nominal household disposable income: according to the Bank of Lithuania estimates, it was almost 16% higher in 2022 than in 2021 and increased at a slightly slower pace in the first half of 2023, compared to the corresponding period of the previous year. During this period, many other types of income (economic activity, property income, social and current transfers, etc.) also grew at a higher or lower rate. This, together with the slowing price growth, led to a recovery of growth in real household disposable income in the second quarter of 2023, a trend that is expected to continue in the second half of this year as well as in 2024. It is also noteworthy that there are no indications so far that a larger share of households would have experience financial difficulties. For example, the results of the EC’s consumer survey show that in August 2023, households were even more positive about their financial situation than in 2019, i.e. before the COVID-19 pandemic. Household expectations about their financial situation have also been improving since last October and are at their best since October 2021. However, this, combined with the still favourable labour market conditions and the anticipated slower price growth, does not currently encourage households to increase their consumption. The assessment of households as to the current affordability of larger purchases remains significantly below the long-term average, which is largely linked to uncertainty about the downward impact of further monetary policy tightening and rising interest rates on household consumption expenditure. The factors discussed above allow us to expect household consumption to contract by 0.4% this year and grow by 2.7% in 2024.
Household consumption remains sluggish in the context of subdued inflation.
Chart 4. Contributions to real household consumption developments
Sources: State Data Agency and Bank of Lithuania calculations.
Note: Due to lack of available data, the contributions to real household consumption of financing of consumption with savings and loans and financing of consumption with disposable income have not been separated in the second quarter of 2023. The combined effect of the above factors is shown as a mixture of colours.
Despite real exports of goods and services not picking up since the start of 2022, the development of investments in the first half of this year was the fastest since the start of russia’s war in Ukraine. Real exports of goods and services decreased by 5.3% in the first quarter of this year, compared to the previous quarter, but increased by 4.9% in the second quarter. As a result, exports of goods and services in the first half of 2023 were 2.0% lower than a year earlier. Overall, the level of real exports of goods and services has not increased significantly since the beginning of 2022 and remained lower in the second quarter of this year than in the first quarter of last year (see more on foreign trade in Chapter 5). It should be noted that, during this period, Lithuania’s exports of goods and services were mainly boosted by relatively low value-added reexports, while the trends in exports of goods of Lithuanian origin were noticeably weaker. This has also led to a significant decline in the level of capacity utilisation, which is currently at its lowest since late 2010. The high level of spare production capacity is likely to dampen demand for new investment, which has been growing at the fastest pace in the last six months since the start of russia’s war in Ukraine. After increasing by 5.0% in the first quarter of this year compared to the previous quarter, investment grew by 0.1% in the second quarter. Investment in non-residential buildings and structures, especially engineering structures, increased rapidly during this period. This growth has been significantly influenced by projects financed by EU support funds and, most likely, by investments in renewable energy generation. The increased use of EU support funds expected this year leads to a favourable development of this construction segment in the second half of 2023 as well. With the launch of both the Recovery and Resilience Facility and projects under the EU financial perspective for 2021–2027, the intensified implementation of EU-funded projects is expected to be a key driver of investment growth this year. However, the development of investments will be constrained by unfavourable factors, such as the high level of spare production capacity or the slowdown in the housing market due to rising interest rates (in the first half of this year, both the area of buildings which were under construction and that of buildings with building permits were noticeably lower than a year ago). Investment is projected to grow by 6.7% this year and by 3.3% next year.
Stalled Lithuania’s economic growth has not yet reduced companies’ propensity to invest – in the first half of this year, investment grew at its fastest pace since the start of russia’s war against Ukraine.
Chart 5. Contributions to investment developments
Sources: State Data Agency and Bank of Lithuania calculations.
The very rapid price increases observed in recent years have attracted a lot of attention from economists and policy makers. Corporate pricing policies have also been identified as one of the factors explaining the rapid price increases. It is argued that companies have taken advantage of supply-side constraints and the uncertain economic situation to improve their financial situation. According to this story, profit-driven price increases could have created additional upward pressure on prices. One of the methods for assessing the impact of rising profits on price increases is analysing the evolution of the operating surplus in the System of National Accounts. However, before applying this approach, it is important to take two aspects into consideration.
First, although the indicators of the operating surplus (in the national accounts) and profits (in business statistics) are quite similar in substance, they are not identical. In the system of national accounts, the operating surplus indicator shows the share of production income that is earned by the capital factor. This indicator differs from the profit ratio used in the corporate finance accounts in its treatment of depreciation and changes in the value of inventories, property income, extraordinary losses or gains, especially capital gains or losses, etc. The system of national accounts also attempts to measure the share of non-observed economy in both labour and capital income. This means that the evolution of the operating surplus in certain periods may differ significantly from the evolution of corporate profit reported in the financial statements (see Chart A).
Chart A. Development of Lithuania’s gross operating surplus and gross profit
Sources: State Data Agency and Bank of Lithuania calculations.
Second, the confusion between the operating surplus margin (commonly referred to as the profit margin) and the share of the operating surplus in value added (commonly referred to as the profit share in value added) is often misleading. In this case, it should be also noted that these are not identical indicators either. The operating surplus margin is the ratio of the operating surplus to the value of output of finished products, while the share of the operating surplus in value added is the ratio of the operating surplus to value added. As can be seen from Chart B, the gross value added composes only a share in the country’s total output of finished products. For this reason, there may be periods when the gross profit margin of domestic firms will fall, but the share of profits in value added will rise. In other words, a situation will arise in the country where the operating surplus of companies increases faster than the compensation of employees, but the total cost of production rises even faster due to the higher cost of production inputs (products of intermediate consumption). For this reason, an analysis of the development of the operating surplus in the System of National Accounts, based solely on an assessment of the share of the operating surplus in value added, cannot tell us how corporate profitability has evolved, but it can assess how the absolute profit earned in the country may have evolved and what its likely relationship was with the evolution of domestic output prices.
It is this latter interaction between the operating surplus of Lithuanian firms and price developments that will be discussed in more detail in this box. The first part of the box analyses to what extent the evolution of the operating surplus has contributed to the evolution of output prices (GDP deflator) for the country as a whole, while the second part of the box focuses on the impact of the latter on the evolution of the household consumption deflator.
Chart B. Structure of Lithuania’s production output
Sources: Eurostat and Bank of Lithuania calculations.
Although the evolution of the profit margin will not be analysed in this box, it is important to note that a growing unit operating surplus is not a sufficient indicator of changing corporate pricing. The table below provides a theoretical example of how different profit ratios evolve in the event of a shock to the prices of intermediate consumption (the spike in energy prices observed in the second half of 2022 can be seen as an example of such a shock). The table contains two scenarios. The first assumes no change in the profit margin (markup on production costs) in the event of a shock, the second assumes no change in unit operating surplus. Under the first scenario, the doubling of intermediate consumption expenditure due to price increases will lead to a 60% rise in production costs. The unchanged markup on production costs (25%) results in a 60% rise in the value of the operating surplus and the total nominal output. This enhances both the unit operating surplus and the deflator (the price level in the country) by a similar amount (60%), without changing real output. At the same time, the share of profits in value added also increases (30%) as a result of the growth in the operating surplus and the unchanged labour costs. Under the second scenario, the rise in production costs does not push up the operating surplus. This happens because in this scenario the operating surplus of firms depends on unchanged real output and unchanged unit operating surplus (i.e. under this scenario, the firm applies a fixed markup to each production unit, while under the previous scenario the firm applies it to production costs). Without an increase in operating surplus, the nominal value of production and the deflator (the domestic price level) expands less (48%) than under the first scenario. There is also no change in the share of profit in value added, while the profit margin and the markup on production costs decrease. The examples in the table below show that, in the presence of a production cost shock, an increase in unit surplus and its impact on inflation can be reconciled with a constant profit margin (markup on production costs), i.e. unchanged pricing. They also show that the profit margin (markup on production costs) has to decrease if the unit operating surplus is to remain unchanged in the event of a production cost shock.
Example of changes in profit ratios in response to a production cost shock
|
Scenario 1 |
Scenario 2 |
|||
|
Fixed markup assumption |
Fixed unit operating surplus assumption |
|||
Initial period |
Post-shock period |
Change, % |
Post-shock period |
Change, % |
|
Markup on production costs |
25% |
25% |
0 |
16% |
-38 |
Real production |
100 |
100 |
0 |
100 |
0 |
Intermediate consumption |
6,000 |
12,000 |
100 |
12,000 |
100 |
Labour costs |
4,000 |
4,000 |
0 |
4,000 |
0 |
Production costs = intermediate consumption + labour costs |
10,000 |
16,000 |
60 |
16,000 |
60 |
Operating surplus = production costs x markup on production costs = unit operating surplus x real production |
2,500 |
4,000 |
60 |
2,500 |
0 |
Nominal production = production costs + operating surplus |
12,500 |
20,000 |
60 |
18,500 |
48 |
Unit operating surplus = operating surplus / real production |
25 |
40 |
60 |
25 |
0 |
Deflator = nominal production / real production |
125 |
200 |
60 |
185 |
48 |
Profit share = operating surplus / (operating surplus + labour costs) |
38% |
50% |
30 |
38% |
0 |
Profit margin = operating surplus / nominal production |
20% |
20% |
0 |
14% |
-32 |
Source: Bank of Lithuania.
Effect of operating surplus on domestic output prices
The GDP deflator measures the ratio of nominal GDP (the value of domestically produced output) to real GDP (the volume of domestically produced output). The GDP deflator can thus be said to measure the evolution of the average domestically produced unit price.
(1)
where: – GDP deflator, – real GDP, – compensation of employees (labour costs), – gross operating surplus (hereinafter – operating surplus), – taxes on production and imports and – subsidies.
Dividing the two sides of the identity (1) by real GDP (), unit indicators, i.e. indicators per production unit, are obtained. Thus, the unit price of GDP, or GDP deflator, is the sum of unit labour costs (), unit operating surplus () and unit net taxes (), after deduction of unit subsidies . This decomposition of the GDP deflator allows price developments to be interpreted in terms of changes in the individual components, such as the labour factor, the capital factor, taxes and subsidies.
(2)
Chart C. Evolution of unit profits and unit labour costs (left-hand panel) and the determinants of the change in the GDP deflator over time (average annual change) (right-hand panel)
Sources: State Data Agency and Bank of Lithuania calculations.
Lithuania’s GDP deflator growth over the past two years has been the strongest since joining the EU in 2004 and is significantly above the level seen before the global financial crisis (see Chart D). The impact of unit operating surplus on the GDP deflator has differed between the two periods, with a noticeably higher impact in recent years. Over the last two years (from the third quarter of 2021 to the second quarter of 2023 inclusive), the evolution of the unit operating surplus has accounted for more than two-fifths of the growth in the GDP deflator, compared with slightly more than one-third in 2005–2008. The smaller impact of the unit operating surplus on the GDP deflator growth in 2005–2008 is explained by the greater overheating of the economy (due to the very high labour market tightness, wages and the wage fund grew at a significantly higher rate than output prices, thus increasing labour share in value added) and the absence of supply-side shocks of this magnitude, related to commodity prices, especially for energy, as well as to tensions in supply chains. This has meant that domestic output prices have been more affected by labour market tensions (which were higher before the global financial crisis than in recent years), making it more difficult for companies to pass on rapidly rising wage costs to final product prices in the absence of large supply-side fluctuations. The situation has been different in the last few years, where the inflationary environment caused by supply-side shocks has made it easier for Lithuanian companies to pass on rising costs to final product prices. However, the situation is changing as these shocks are coming to an end. As Lithuania is a small open economy, international competition further limits price increases for domestically produced goods. However, due to the persisting tensions in the labour market, workers, when negotiating for a more rapid increase in wages, try to recover the purchasing power lost following the significant spike in inflation. This leads to an enhancing impact of rising unit labour costs on the evolution of the GDP deflator, with unit costs accounting for more than half of the increase in the GDP deflator from the fourth quarter of 2022.
Chart D. Development of the GDP deflator and its contributions
Sources: State Data Agency and Bank of Lithuania calculations.
The impact of changes in the operating surplus on the evolution of household consumption deflator
The analysis of the decomposition of the GDP deflator provides an assessment of the extent to which the main factors of production – labour or capital – have contributed to the evolution of output prices in Lithuania. However, as the GDP deflator is an indicator of price developments in the Lithuanian economy as a whole, it covers not only price developments of goods and services consumed by households, but also price developments of exported goods and services, as well as of goods and services used for investment and of those used by the general government. For this reason, it is important to be cautious when trying to interpret the results of this analysis in terms of the evolution of household consumption prices in the country, as, for example, the successful performance of Lithuanian exporters in foreign markets, which would increase the country’s operating surplus, could be misinterpreted as a factor that has contributed significantly to the growth of prices in the Lithuanian domestic market. Against this background, this box further analyses the development of the household consumption deflator and its contributions using national account identities.
The household consumption deflator is calculated as the ratio of nominal household consumption expenditure to real household consumption expenditure (the quantity of goods and services purchased for household consumption). Its evolution is very close to that of the HICP, the conventional measure of inflation. Nominal household consumption expenditure can be expressed through the identity of GDP calculated using the expenditure approach by the following formula:
(3)
where: , , , , and – deflators for household consumption expenditure, GDP, imports of goods and services, exports of goods and services, investment and general government consumption expenditure respectively; , , , , and – the volume of household consumption expenditure, GDP, imports of goods and services, exports of goods and services, investment and general government consumption expenditure respectively. By dividing equation (3) by real household consumption expenditure () and expressing the GDP deflator () through the identity in equation (2) the following expression is obtained:
(4)
Chart E. Development of household consumption expenditure deflator and its contributions
Sources: State Data Agency and Bank of Lithuania calculations.
Chart F. Development of household consumption expenditure deflator and its contributions in different periods
Sources: State Data Agency and Bank of Lithuania calculations.
During both periods, after the initial import price shock, there was an increase in the unit operating surplus and unit labour costs. However, due to the different economic situations (the first period was characterised by a severe recession and the current period by economic stagnation) the factors behind the increase in the unit operating surplus and the growth in unit labour costs were different. Moreover, the impact of import prices on the indicators analysed was noticeably shorter due to the economic downturn in the first period. The increase in the unit operating surplus during the global financial crisis (2008–2009), which lasted until the end of 2008, is more likely to be related to the inertia of price developments in household consumption, where the initial decline in production costs was not immediately passed on to final product prices. In recent years, unit operating surplus has started to grow rapidly even as production costs have continued to rise. This suggests that the excess demand created in the economy has allowed firms to significantly revise their pricing and boost the profits they generate. The increase in unit labour costs can also be explained by the influence of different factors. The rise in unit labour costs during the global financial crisis, which lasted until mid-2009, is more likely to be related to the lower productivity of firms due to the contraction in aggregate demand and to the slower adjustment to the new demand level. In recent years, unit labour costs have started to rise more rapidly, reflecting the ongoing tensions in the labour market and the willingness of workers to regain their purchasing power, which had been eroded by the significant inflationary surge.
In summary, a number of factors have contributed to the increase in the prices of household consumption expenditure in recent years. The COVID-19 pandemic and russia’s war against Ukraine have led to large supply-side shocks linked to disruptions in global supply chains and the supply of raw materials, especially energy. This gave the first impulse to the rise in the prices of household consumption expenditure through increasing prices of imported goods and services. This impulse was further reinforced when companies, taking advantage of the strong demand in Lithuania at the time and the inflationary environment caused by supply-side shocks, significantly revised their prices upwards to boost profits, as manifested by the growth in unit operating surplus. In addition, the persistent tensions in the labour market allowed workers to negotiate faster wage increases in order to recover the loss of purchasing power following the sharp inflationary spike, which was manifested in higher unit labour costs. Thus, the analysis shows that during this period of high inflation, the absolute operating surplus earned by companies (an indicator close to profits in substance) grew and contributed to the price rises in Lithuania, but the analysis does not show whether companies increased their profitability, i.e. whether they improved their financial situation, during this period.
The box analyses heterogeneous changes in the wealth of Lithuanian households in 2017–2021. This period was strongly influenced by the pandemic (COVID-19) shock, while many other factors (e.g. significant fluctuations in different asset markets, sharp increase in the minimum wage, low interest rates) also influenced particular changes in the household balance sheet. Therefore, this box complements the aggregate information by looking at the changes in net household wealth and the dynamics of wealth inequality in 2017–2022, based on the information collected from the Household Finance and Consumption Survey (HFCS) in Lithuania and the experimental data from the Distributional Wealth Account (DWA).
The left-hand panel in Chart A shows the dynamics of the share of total net wealth held by the bottom 50% and the top 10% of households in Lithuania. In other words, the graph shows what share of total household wealth in Lithuania is held by the poorest 50% and the richest 10%. The blue line shows the share of total wealth owned by the bottom 50%, which declined from 2016 to 2020. It came to a halt in 2020 and picked up again, reaching just over 11% of total household wealth at the end of 2022. Conversely, the red line increases steadily until 2021 and then decreases slightly. As a result, the share of the top 10% of households in total household wealth is just over 58% at the end of 2022. Taken together, these results suggest that the wealth gap between the bottom 50% and the top 10% of households rose until 2020 and then declined slightly in the final years.
Chart A. Changes in household wealth inequality in Lithuania and Europe in 2017–2022
Sources: Experimental data on Distributional Wealth Account (DWA) (left-hand panel) and HFCS 2021 (wave 4) (right-hand panel).
However, it is also important to note that wealth inequality in Lithuania remains one of the lowest in Europe. This is documented in the right-hand panel of Chart A, which shows the ratio between the wealth of the top 10% of households and that of the bottom 50% of households. In other words, it demonstrates how much richer the top 10% of households are compared to the bottom 50% of households. The wealth distribution in a country is more equal when the ratio is lower. The results show that this ratio is 3.3 in Lithuania, much lower than the euro area average (8.9). It is also lower than in the other Baltic countries (Estonia – 8.0, Latvia – 6.9). One reason for Lithuania’s comparatively low wealth inequality, as compared to Europe, comes from institutional and historical factors surrounding the housing market following the 1990s. Namely, the encouragement of households to privatise their real estate and become homeowners resulted in the majority of households owning property. Therefore, the high rate of homeownership in Lithuania contrasts with most of western European countries, and housing inequality is the primary factor responsible for the relatively low measures of wealth inequality, even though income inequality is one of the highest in Lithuania. However, since this situation is related to the institutional factors mentioned previously, it is crucial to track housing affordability as it can significantly impact the dynamics of housing and wealth inequality in Lithuania over the long term.
As Chart A focuses more on trends in wealth inequality in recent years, Chart B shows how the median household net wealth has changed in 2017–2021. Both panels of Chart B demonstrate that median net wealth increased by 17%, from €45,900 to €53,700. At the same time, the increase was heterogeneous across different socio-economic groups. The left-hand panel shows that the middle age group (aged 35–44) experienced the highest increase in median net wealth of almost 50%, while the lowest increase of 3.5% was recorded by older households in the 65–74 age group.
Chart B. Changes in median household net wealth in Lithuania in 2017–2021
Sources: HFCS 2017 and 2021 (waves 3 and 4).
Note: p – percentile.
Heterogeneous effects were also found when looking at households by wealth percentile. The right-hand panel shows that households in the bottom 20 percentile or the top 10 percentile experienced a fall in their median net wealth. The fall in median net wealth for the bottom 20 percentile could be related, among other things, to job or income losses associated with the COVID-19 shock. In contrast, the losses in median net worth at the top of the distribution may be due to the fact that their portfolio contains a significant proportion of financial assets. In particular, the start of the pandemic period was associated with significant losses in shares and other financial assets (e.g. S&P 500 stocks recorded significant declines in the first months of 2020 and 2022). At the same time, households in the middle of the wealth distribution experienced the highest percentage increase in their median net wealth. This result may be related to the fact that most of the portfolio of these households is largely concentrated in real assets (mainly housing) and that the pandemic period was associated with a significant increase in the value of housing and other real assets (e.g. house prices in Lithuania increased by around 25% in 2021).
In summary, using household level data (HFCS), this box documents the dynamics of increasing wealth inequality in Lithuania since 2016, with a slight decrease in recent years. However, in 2017–2021, wealth inequality in Lithuania remained one of the lowest in Europe. Moreover, the results capture heterogeneous changes in the median net wealth of households, showing that some age cohorts experienced a higher increase in their wealth than others. Finally, households at the top and bottom of the wealth distribution lost some of their wealth, while households in the middle of the wealth distribution increased their net wealth in 2017–2021.
4.Labour market
The slower employment growth was mainly driven by declining employment in agriculture, construction and public sector activities.
Chart 6. Number of employed persons by economic activity (contributions)
Sources: State Data Agency and Bank of Lithuania calculations.
In the second quarter of 2023, Lithuania’s unemployment rate fell significantly, mainly due to unskilled workers. During the period under review, Lithuania’s unemployment rate stood at 5.9% (see Chart 7) and was by 0.7 percentage points higher than a year earlier. The annual increase in the unemployment rate was mainly (by 1.6 percentage points) caused by the very rapid growth of the working-age population. However, quarterly developments remained very favourable. After eliminating seasonal effects, the unemployment rate was even 1.5 percentage points lower than in the previous quarter. The total number of the unemployed shrank by 18,000 over the quarter, down by almost a sixth. The recent fall in the unemployment rate is mainly due to a decrease in the number of unskilled unemployed persons. Unemployment among such workers fell by as much as 6 percentage points in the quarter (seasonally adjusted) but was still twice as high as among skilled workers. It is likely that these persons became employed, as the number of economically inactive people in the country did not increase during the quarter after eliminating the seasonal effects. There was also a decrease in the number of the long-term unemployed, i.e. those unemployed for more than a year, who account for around one third of the total number of the unemployed. The number of the short-term unemployed, which declined earlier, was significantly higher than a year ago, which makes it more likely that the long-term unemployed have entered the labour market rather than leaving it. Looking at the unemployment trends by age group, the most marked changes were observed in the 15-24 age group. In the second quarter of 2023, the youth unemployment rate shrank by around 3 percentage points over the year to 8.5%, half the two-decade average. This unemployment trend is positive as young people aged 15-24 in education have not significantly increased the inactive population in the country, although they represent a significant share (around 16%) of the total inactive population.
Labour market trends remain favourable, with a continuing increase in the number of employed people and a decline in the unemployment rate reflecting the resilience of the labour market.
Chart 7. Developments in labour force, the number of employed persons and unemployment rate
Sources: State Data Agency and Bank of Lithuania calculations.
After a significant decline last year, real gross wages have started to grow again in Lithuania. According to data from Sodra, gross wages have been rising faster than prices at all income percentiles already in May of this year, which means that the household purchasing power has been increasing, irrespective of the level of labour income. According to the State Data Agency, real gross wages were 0.6% higher in the second quarter of this year compared to the same period last year (see Chart 8). With the labour market showing resilience and inflation continuing to decline, nominal wage growth should continue to outpace inflation in the second half of this year, which should further increase household purchasing power.
Lithuania’s household purchasing power started to grow again.
Chart 8. Contributions to real gross wage developments
Sources: State Data Agency and Bank of Lithuania calculations.
While wages rose by double-digits over the year in most economic activities, the overall annual economic grow in Lithuania was mainly driven by the wages of workers in the service sector. The fastest wage growth in the second quarter of the year was observed in financial and insurance activities, representing a rise of as much as 16.1% compared to the same quarter of the previous year. This is due to the low supply of skilled workers (unemployment rate of highly skilled professionals is 5.4% and that of the unskilled stands around 12%) and the high demand for skilled workers (a high number of vacancies), which puts more upward pressure on employers in these highly skilled activities. Strong annual growth was also observed in those economic activities where the share of MMW earners in the total number of employees in that sector is relatively high. For example, in arts, entertainment and recreation, as well as agriculture, forestry and fishing wages rose by around 16% over the year. However, some economic activities recorded less significant wage changes during the period under review. The decline in activity in the real estate operations and manufacturing sectors also affected wage developments in these activities, with the lowest wage increases of around 8% and 10% respectively. Wages in the national economy were one and a half times higher than the pre-pandemic average during the period under analysis. In the information and communication sector, earnings were 56% higher than the average in 2019. Meanwhile, in the transport sector, where the number of job vacancies is a fifth of the total number of job vacancies in the national economy and is around three times higher than before the pandemic, wages were 59% higher than the pre-pandemic average. This, combined with increases in the MMW (posted drivers are subject to a factor of 1.65 on the MMW), is the reason for the rapid evolution of wages in this sector.
Tensions in the labour market persist as the unemployment rate falls and the number of job vacancies rises.
Chart 9. Labour market tightness indicator
Sources: State Data Agency and Bank of Lithuania calculations.
Note: The level of labour market tightness is measured by the ratio of job vacancies to the unemployed.
The box analyses the consequences of the (COVID-19) pandemic shock that occurred in 2020, affecting the economic and financial situation of households in different subgroups of the population. National accounts provide aggregated information on the main developments that occurred during the pandemic, such as the slump in expenditure, the moderate reduction in income, the significant changes in the value of different asset classes and the sharp increase in savings in liquid assets. The box complements this aggregate information by showing trends and changes in these variables at the household level, based on the information collected by the Household Finance and Consumption Survey (HFCS) in Lithuania. It also presents key stylised facts that help to understand the economic and financial behaviour of households during the pandemic period. Finally, it sheds light on how households adjusted their finances and behaved during the period of uncertainty.
The impact of the pandemic on labour market status and earnings was heterogeneous across households (Chart A). The left-hand panel shows that more than 80% of households in Lithuania reported that their employment status did not change as a result of the pandemic situation. The only difference is that some employees started working from home instead of going to the office, while the working hours remained the same. In addition, more than 12% of employees took time off work with the support of social benefits, and only less than 1% of respondents were dismissed due to the pandemic situation.
As labour market status typically has implications for the household’s financial situation, the middle panel of Chart A adds information on changes in personal income during the pandemic. As the employment status of most households was not affected by COVID-19, personal income remained the same for more than 73% of households. At the same time, benefits were less generous than previous wages. As a result, around 13.5% of households saw their income fall by up to 25% and more than 3% of households – by more than 25%. To cope with the drop in personal income, more than 10% of households reduced their usual spending on food, clothing, travel and household goods (right-hand panel). In addition, 6.3% of households used their accumulated savings to compensate for the reduced income, while 3.4% of households postponed planned major purchases.
Chart A. Changes in the employment status and income of households in Lithuania during the COVID-19 period
Sources: HFCS 2021 (wave 4), questions from the special module on the impact of coronavirus on household finances.
As the beginning of COVID-19 was associated with a strict closure of economic activities and a significant drop in household spending, it created great uncertainty in the following years, which affected the consumption behaviour of households for a longer period of time. The top left panel in Chart B shows that more than 23% of households planned to make major purchases in 2020. However, a third of households decided to change their plans due to the uncertainty created by the pandemic situation or the global quarantine imposed (top right panel).
The quarantine and its enforcement were cited by more than 35% of households as the main factor explaining this behaviour (bottom left panel). On the other hand, 28.3% of households in Lithuania cited the uncertain economic situation as the main factor for their consumption behaviour. It is also important to note that almost 11% of households saw changes in household finances and price developments as limiting their economic behaviour and spending. Finally, the bottom right panel (Chart B) shows that the COVID-19 shock did not have a lasting impact on household consumption in Lithuania, as more than 80% of households reported that their expenditure did not change between 2019 and 2020. However, more households reported that their expenses decreased rather than increased, which is consistent with the decline in aggregate consumption that occurred at the beginning of the pandemic period.
Chart B. Household consumption and expenditure in Lithuania during the COVID-19 period
Sources: HFCS 2021 (wave 4), questions from the special module on the impact of coronavirus on household finances.
In line with changes in consumption, the pandemic period also had a significant impact on the prices and values of different asset classes as well as on household savings. The left-hand panel in Chart C shows that 80% of households describe their financial assets as unchanged during the COVID-19 period. Additionally, only 5.8% of households increased their financial assets during the pandemic period, while almost 10% of households experienced a significant decrease in the balance of their financial assets. Households’ saving behaviour was also affected by this situation. The right-hand panel shows that household savings did not change significantly for two thirds of respondents. At the same time, the pandemic period and job losses meant that some households had to compensate for the loss of income by drawing on their accumulated savings. According to the survey data, about 10% of households faced a similar situation and reported a decrease in their accumulated savings. However, the most important fact and the highlight of the pandemic situation is that almost 20% of households experienced a significant increase in their accumulated savings. In some cases, this was due to a reduction in their personal consumption. This finding complements the aggregate statistics, which show that total household deposits rose significantly during the COVID-19 period.
Chart C. Changes in household financial assets and saving habits in Lithuania over the COVID-19 period
Sources: HFCS 2021 (wave 4), questions from the special module on the impact of coronavirus on household finances.
The economic shock that occurred during and after the COVID-19 period affected household finances and economic behaviour in Lithuania. By using household-level data (HFCS), this box shows that only a small proportion of households experienced a significant drop in income due to job losses, the higher share of households changed their saving behaviour and improved their balance sheets. This was partly due to mobility restrictions, the closure of some economic activities and increased economic uncertainty. Both of these factors impacted household behaviour, as they increased their savings to protect themselves against the uncertain economic future.
5.External sector
A significant decline in import prices since the beginning of the year and a positive balance in the volume of goods and services led to a net surplus in exports of goods and services. The surplus, calculated at current prices and adjusted for seasonal and workday effects, amounted to €8.7 billion, or 4.8% of GDP in in the second quarter of 2023. This surplus position in trade was observed for the first time since the beginning of 2022, when the growth of import prices started to exceed the growth of export prices. In contrast, since the beginning of 2023, the positive balance in the volume of goods and services and the rapidly falling prices of imported goods, the decline of which significantly exceeded the drop in the prices of exported goods, led to a positive trade balance. For example, prices of imported goods declined by more than 10% in the first half of 2023 compared to the price level in the second half of 2022. Over the same period, export prices fell by just over 5%. One of the main reasons for such a decline in the prices of imported goods was a sharp decline in commodity and energy prices. And while in recent months there has been a slowdown in the decline in import prices due to stabilisation of commodity and energy prices, the fall in import prices is still likely to outpace the fall in export prices in the short term. The slower decline in export prices can be explained by the fact that Lithuanian producers still have stocks of products that were produced in a period of high energy prices and that have a relatively high cost price. The faster fall in prices is also limited by rising interest costs and unit labour costs. However, price differentials between imported and exported goods and services are likely to narrow and stabilise in the medium and long term. This suggests that the net balance of exports of goods and services will continue to be positive. Export prices of goods and services are projected to fall by 1.5% this year and import prices by 5.6%, while export prices are expected to increase by 0.5% in 2024 and import prices to decline further by 0.1%.
A significant decline in prices of commodities and energy resources since the end of 2022 and the positive balance in the volume of goods and services led to a return of net surplus in exports of goods and services.
Chart 10. Developments in net exports of goods and services, adjusted for seasonal and workday effects
Sources: State Data Agency and Bank of Lithuania calculations.
Lithuania’s nominal exports of goods and services fell in the first half of 2023 compared to the second half of 2022. One of the reasons for the decline is the high base effect. Ever since the start of the publication of exports data, the highest level of exports of goods and services was observed in the second half of 2022. Exports were particularly high in the third quarter of 2022 due to a significant increase in exports of mineral products and agricultural products. However, the decline in export levels that started in the fourth quarter of 2022 is still continuing. The slowdown in exports of services was mainly due to a decline in exports of transport services. The decline in exports of goods has been strongly influenced by the fall in the prices of petroleum products as well as prices of other exported goods. Exports of goods were also negatively affected by a decline in the volume of the main export commodities, i.e. products from the chemical, wood and furniture sectors. More generally, rising interest rates and slowing economic development in Europe are dampening demand for Lithuania’s exports. Although the energy price shock, which reduced the price competitiveness of companies, is gradually unwinding, energy prices remain above historical averages. The latter, in conjunction with rising unit labour costs, do not create favourable environment for improving price competitiveness. The combination of these factors suggests that the growth of Lithuanian exports will continue to be limited this year and beyond. Exports of goods and services are projected to decline by 2.4% this year and increase by 2.4% next year.
Both falling prices and volumes of exports of goods and services led to a decline in nominal exports in the first half of 2023.
Chart 11. Developments in nominal exports of goods and services
Sources: State Data Agency, Bank of Lithuania and Bank of Lithuania calculations.
Reduced price competitiveness and weakening external demand, as well as re-exports, led to a decline in nominal exports of goods in the first half of 2023.
Chart 12. Developments in nominal exports of goods, adjusted for seasonal and workday effects (left-hand panel), and the relationship between the energy intensity of economic sectors and developments in nominal exports of goods (right-hand panel)
Sources: State Data Agency, Bank of Lithuania and Bank of Lithuania calculations.
Notes: C codes in the panel represent the following sectors: C10 to C12 – manufacture of food products, beverages and tobacco; C13 to C15 – manufacture of textiles, wearing apparel and leather goods; C16 to C17 – manufacture of wood and articles of wood, except furniture; paper and paper products; C20 – manufacture of chemicals and chemical products; C21 – manufacture of basic pharmaceutical products and pharmaceutical preparations; C22 – manufacture of rubber and plastics products; C23 – manufacture of other non-metallic mineral products; C24 – manufacture of basic metals; C25 – manufacture of fabricated metal products, except machinery and equipment; C26 – manufacture of computer, electronic and optical products; C27 – manufacture of electrical equipment; C28 – manufacture of machinery and equipment n.e.c.; C29 – manufacture of motor vehicles, trailers and semi-trailers; C30 – manufacture of other transport equipment; C31-C32 – manufacture of furniture; other manufacturing.
With a significant decline in the trade deficit of goods, Lithuania’s current account balance became positive in the first quarter of 2023. In the third and fourth quarters of 2022, as for the rest of the previous year, the current account deficit was mainly caused by the trade deficit of goods. The particularly strong increase in trade deficit of goods was due to higher prices of energy resources. As for the balance of trade of goods, excluding trade in minerals, there was no significant widening of the deficit last year and it remained at a similar level as in 2021. Thus, from the end of 2022 onwards, with a significant reduction in the energy and commodity prices, and therefore trade deficit of goods, the current account balance has turned back to a positive position.
The impact of the other components of the current account balance on the overall balance changed slightly in the first quarter of 2023. Trade surplus of transport services continues to slowly decline, although its losses for the overall trade surplus of services are compensated by increasing trade surpluses of other services. The secondary income balance is still positive, amid significant decline in flows of personal transfers from abroad. The primary income balance remained roughly the same as in the fourth quarter of 2022. The primary income balance is strongly affected by the decisions of Lithuanian businesses operating in Lithuania and abroad regarding their reinvestments, other type of investments and dividend payments. Thus, the decrease in the primary income balance deficit in the fourth quarter of 2022 and the first quarter of 2023 compared to the previous periods can mainly be attributed to a decline in the investment income deficit. The latter was mainly due to a decrease in payments made to foreign enterprises and an increase in payments from abroad to Lithuanian companies. The primary income deficit was also significantly reduced by increased transfers of EU subsidies to the agricultural sector in the fourth quarter of 2022.
The current account balance turned positive again in the first quarter of 2023 as energy prices and the trade deficit of goods narrowed.
Chart 13. Components of the current account balance
Sources: State Data Agency, Bank of Lithuania and Bank of Lithuania calculations.
6.Prices
Inflation is easing both in Lithuania and globally, as energy and other commodity prices fall and the supply disruptions caused by the sudden post-pandemic recovery fade. In Lithuania, inflation has been declining at a particularly fast pace, driven by a strong base effect, with annual inflation standing at 6.4% in August, around 3.5 times lower than in September last year (22.5%) (see Chart 14). Energy prices were the main contributor to the decline in annual inflation, but the subdued impact of food price increases, including alcoholic beverages and tobacco, also made a significant contribution. Annual inflation is projected to continue to decline as price pressures ease. Average annual inflation will be 8.8% this year and 2.6% in 2024.
A drop in inflation in Lithuania is mainly driven by cheaper energy products.
Chart 14. HICP inflation and its contributions
Sources: State Data Agency, Eurostat and Bank of Lithuania calculations.
Fuel was the main contributor to the decline in energy prices.
Chart 15. Impact of energy prices on annual headline inflation
Sources: State Data Agency and Bank of Lithuania calculations.
As food commodity and energy prices fall, annual food price increases and their impact on annual inflation are decreasing.
Chart 16. Impact of food, including alcohol and tobacco, on annual headline inflation
Sources: State Data Agency and Bank of Lithuania calculations.
Core inflation, which is most closely linked to domestic economic developments, has continued to decline, but at a slower pace than headline inflation, which is strongly influenced by rapidly rising wages in Lithuania. In August, core inflation stood at 9.4% (12.7% at its peak in November last year). The rapid increase in wages – 12.3% year on year in the second quarter of this year – is a significant contributor to the core inflation inertia. Given the negative trend in labour productivity, unit labour costs increase at a particularly rapid pace (see Chart 17). This has a particularly significant impact on prices of services, as wage costs represent a large share of their total costs. The reopening effects in terms of demand for travel-related services also seem to be contributing to the pressure on prices of services. While this influence is starting to recede according to the August data, annual increases in prices of services, such as flights (27.2%) or accommodation (23.6%), remain strong. All this means that, while the growth in prices of services is declining, it is still at a high level (10.9% in August). Meanwhile, external factors, such as the fall in the prices of various commodities and the fading of supply disruptions caused by the sharp post-pandemic recovery, also have a significant impact on price developments in the other component of headline inflation – industrial goods. The easing pipeline pressure on prices of goods in the supply chain is clearly reflected in the year-on-year decline in producer prices for manufacturing, excluding refined petroleum products, on the domestic market (-4.4% in August) as well as in the decline in the annual growth of prices of imported consumer durables (down by 3.0% in June) and non-durables (down by 5.1% in June). Against this background, core inflation is projected to further decline but still remain above headline inflation as wages continue to grow rapidly.
Unit labour costs have been rising at a particularly fast pace in the context of strong wage growth and decreasing labour productivity.
Chart 17. Development of wages, labour productivity and unit labour costs
Sources: State Data Agency and Bank of Lithuania calculations.
The price of energy imports and output produced for the Lithuanian market have risen sharply, making energy products more expensive for consumers.
Chart A. Evolution of prices of energy products
Sources: State Data Agency and Bank of Lithuania calculations.
Energy-related costs account for a significant share of the prices only in a few groups of goods and services.
Chart B. Price structure of goods and services consumed by households in 2015 and Q2 2022
2015 second half of 2022
Sources: Eurostat, State Data Agency and Bank of Lithuania calculations.
The supply-side modelling of the evolution of prices of goods and services shows that the factors analysed from the first quarter of 2021 to the second quarter of 2023, namely, more expensive domestic production, imported production and wage increases, should have increased the price level of goods and services provided to households by 44%. The decomposition of this increase into the analysed supply-side factors shows that all the main factors, such as higher prices of imported goods and services, rising wages, and the growth of corporate operating surplus, contributed significantly to this increase (see Chart C). The wage growth in the non-energy sector accounted for 40% of the increase, while 60% was driven in broadly similar proportions by higher energy costs (including the impact of imports and domestic production), more expensive imports of non-energy goods and services, and a rise in corporate operating surplus (the impact of operating surplus on price developments is calculated as the residual of the overall change in the price index minus other factors analysed).
The increase in corporate costs in recent years may not yet have been fully passed on to consumer prices of goods and services.
Chart C. Price level developments for goods and services consumed by households calculated on the basis of the input-output tables
Sources: Eurostat, State Data Agency and Bank of Lithuania calculations.
As price pressures from supply-side factors started to ease, the annual growth rate of the HICP outpaced that of the input-output table-based measure of prices of goods and services consumed by households (see Chart D). This trend has been observed since April this year and has continued for four consecutive months. The main contributors to the relatively faster decline in the development in the prices of goods and services consumed by households, as calculated on the basis of the input-output tables, have been falling energy prices and imports (prices of domestically produced energy products in Lithuania in June this year were 17.2% lower than in the second half of 2022 on average, while those of imported energy products were 49% lower), and the slower growth of corporate operating surplus. The upward pressure on annual price growth stemming from wage growth has remained relatively stable over the whole period under review, currently at around 5 percentage points. Given that the modelling still suggests that the increase in corporate costs in recent years may not yet have been fully passed on to consumer prices of goods and services, the annual growth rate of the HICP indicator is still likely to be faster in the coming months than the growth rate of prices of goods and services consumed by households as measured by the input-output tables.
The increase in the prices of goods and services supplied to households was driven by higher prices of imported goods and services, rising wages and the expected rise in corporate operating surplus.
Chart D. Evolution of the growth rate of the price index for goods and services consumed by households calculated on the basis of the input-output tables
Sources: Eurostat, State Data Agency and Bank of Lithuania calculations.
To summarise, the modelling of the evolution of prices of goods and services consumed by households based on the input-output tables shows that these prices could have increased by almost 44% in the period from the first quarter of 2021 to the second quarter of 2023. A number of factors have contributed significantly to the increase, such as higher prices of energy and other imported products, higher wages and increased corporate operating surplus. Wage growth accounted for around 40% of the modelled price increase, while the rest was accounted for in broadly similar proportions by higher energy costs (including the impact of imports and domestic production), more expensive imports of non-energy goods and services, and corporate operating surplus (profits) in the non-energy sector which should have increased. The modelling also shows that the increase in corporate costs in recent years may not yet have been fully passed on to consumer prices of goods and services. Therefore, price developments for households’ consumption goods and services are likely to be more elevated in the coming months than changes in the prices of imported goods and services or domestically produced goods and services for the domestic market would suggest.
Prices of various food commodities are falling.
Chart A. Development of food producers’ production costs
Sources: State Data Agency, Nord Pool and Bank of Lithuania calculations.
According to the calculations based on the input-output tables, the increase in agricultural costs between 2020 and the second quarter of 2023 is similar to the increase in output prices. In the last quarter of 2022, prices of the output sold had risen significantly more than agricultural production costs. The price and cost developments became similar to a significant fall in farm-gate prices. In contrast, agricultural production costs stopped increasing from the fourth quarter of 2022. They have remained around 40% higher than the 2020 average for three consecutive quarters.
Farm-gate prices of agricultural products have fallen significantly, and their growth is currently at a similar level to that of costs compared to 2020.
Chart B. Dynamics of agricultural production expenditure and farm-gate (product sale) prices
Sources: Eurostat, State Data Agency and Bank of Lithuania calculations.
Production costs in the food industry have risen at a similar rate as the prices of the products sold by producers. The fall in prices of food commodities and other inputs has led to a significant decrease in food producers’ costs in 2023 compared to 2022, but they are still higher than in 2020 (see Chart C). While raw material costs continued to account for the bulk of total costs, it was the fall in food commodity prices (Methods 1 and 2) and electricity prices (Method 2) that contributed most to the decrease in costs. An assessment of the expected increase in food producers’ costs compared to 2020 shows that, following the drop in commodity and energy prices, food producers’ costs in the first half of this year increased in line with food producers’ output prices.
The food industry’s production costs have increased in line with output prices.
Chart C. Developments in food producers’ costs and output prices
Method 1 Method 2
Sources: Eurostat, State Data Agency, Nord Pool and Bank of Lithuania calculations.
Consumer prices for food have risen more than merchants’ costs. In the first half of this year, merchants’ costs also dropped, mainly as a result of falling electricity prices (Method 2) (see Chart D). The bulk of the increase in merchants’ costs (compared to 2020) continues to be driven by the value of goods for resale. This share was almost unchanged at around 30 percentage points in the first half of 2023, compared to the fourth quarter of 2022. As merchants’ costs have fallen, consumer prices for food have continued to rise. This has meant that in the first half of this year, consumer prices for food are likely to have risen by more than merchants’ costs, compared to the average level in 2020.
Consumer prices for food have risen more than merchants’ costs.
Chart D. Development of food merchants’ costs and consumer prices for food
Method 1 Method 2
Sources: Eurostat, State Data Agency, Nord Pool and Bank of Lithuania calculations.
In the first half of 2023, exceptionally high levels of return on equity have not been observed in activities relevant to the supply of food products (see Chart E). In agricultural activity, these estimates show that, over the period under review, the share of agricultural return on equity in value added has fallen below its long-term average due to the fall in agricultural prices. However, this decrease is not exceptional, its deviation from the long-term average is not greater than one standard deviation, i.e. the limit up to which the fluctuations are considered a typical variation determined by the specifics of the activity. In the food industry, the share of return on equity in value added has increased markedly as input prices have started to fall and output prices have remained stable. However, the level itself is still below the long-term average, although it has returned to the range of typical variation. In retail trade, the share of return on equity in value added remained at a low level in the first quarter of 2023. It remains more than one standard deviation below the long-term average. In retail trade, however, the share of return on equity in value added has been declining since 2015, possibly reflecting the structural changes taking place in this economic activity, which will bring the distribution of business value added between return on equity and compensation of employees into a new equilibrium.
In the first half of 2023, no exceptionally high levels of return on equity were observed in activities relevant to the supply of food products.
Chart E. Development of the share of operating surplus* in value added (2004–2020) and calculated estimates (Q1 2021–Q2 2023)
Sources: State Data Agency, Eurostat and Bank of Lithuania calculations.
* The indicator covers the following national accounts data series: operating surplus and mixed income (national accounts code –B2A3N), other subsidies (D.39) and other production taxes (D.29).
** Agriculture corresponds to the activities listed in NACE as crop and animal production, hunting and related service activities (code A.01), food production – manufacture of food, beverages and tobacco (C.10–12), retail trade – retail trade, except of motor vehicles and motorcycles (G.47).
In summary, the analysis based on the business structure and financial indicators and the input-output tables shows that, in the first half of this year, compared to the average level in 2020, costs in agricultural sector and food industry increased at a similar pace as the prices of their production, while consumers prices for food have increased more than merchants’ costs. Similarly, the level of return on equity in activities relevant to food supply was not observed to be exceptionally high in the first half of 2023.
7.Financing of the economy
As the cost of debt servicing went up, the private non-financial sector slowed down the rise in financial liabilities, resulting in a net increase in financial assets of households and companies. In the first quarter of 2023, financial liabilities held by the Lithuanian population amounted to €16.5 billion, a contraction of 1.2% in half a year. The decline in households’ liabilities was mainly driven by slower growth in trade credit and payables. Liabilities of non-financial corporations increased by 1.9% over six months to €59.1 billion. The main contributor to this increase was the faster-than-usual growth in the loan portfolio of other financial institutions. Total corporate financial assets, in particular unlisted shares, grew by more than total corporate liabilities during the half-year (€3.2 billion and €1.1 billion respectively), and as a result, corporate net financial assets increased by 17.7% (amounted to €14.2 billion in the first quarter of 2023). In the first half of the year, the net financial assets of households increased by 4.4% (to €52.2 billion in the mentioned period). The slowdown in the growth of financial liabilities is most likely due to the need to manage risks associated with higher interest rates.
Compared to the euro area average, the credit portfolio of MFIs in Lithuania is still growing at a relatively fast pace, but, taking inflation into account, credit developments are sustainable.
Chart 18. Annual change in the loan portfolio of MFIs to non-financial corporations and households (left-hand panel) and in the real credit portfolio (right-hand panel)
Source: State Data Agency and Bank of Lithuania.
The growth rate of the household loan portfolio continues to slow down but remains relatively elevated at the euro area level, notably due to an increase in consumer credit. The nominal portfolio of loans granted by MFIs to households grew at an annual rate of 9% in the second quarter of 2023, i.e. 3 percentage points slower than in the third quarter of last year, when the peak in growth was recorded (see Chart 18, left-hand panel). Despite the fact that this growth rate is still around four times higher than the euro area average of 2%, prices in Lithuania have been growing faster than credit (see Chart 18, right-hand panel). Moreover, the gap between the ratio of household loan portfolio to GDP and the long-term trend remains negative, so no excess borrowing has been observed. As the interest rate on new housing loans has risen to 5.6% and market activity has decreased, housing lending continued to decline: in the second quarter of 2023, 5,800 new housing loans amounting to €470 million were granted (down by 20.7% and 15.4% respectively year on year). On the other hand, the flow of consumer loans grew by almost 12% year on year, despite a slight decrease in the number of loans. The historically high nominal flow of consumer credit is due to the increase in prices of consumer durables and the cost of home furnishing, as well as to the slower rise in interest rates than in the housing loan segment. In general, there are no household credit imbalances, with the gap in the ratio of household loans to GDP remaining negative and broadly unchanged from its long-term trend. The bank lending survey results show that a slight increase in demand has been recorded only in the consumer loans segment, and banks do not expect significant changes in demand in the next quarter. Further developments in lending to households will benefit from a return to real labour income growth, driven by slowing inflation, and the likely end of the monetary tightening cycle.
Despite the dampening effect of rising interest rates and subdued credit demand, nominal new lending by MFIs to non-financial corporations and households remains at a relatively high level but declined year on year in the second quarter of 2023.
Chart 19. Quarterly flows of MFI loans to NFCs and households
Source: Bank of Lithuania.
Corporate borrowing, both from credit institutions and other sources, continues to slow down. The portfolio of loans granted by MFIs to non-financial corporations grew at an annual rate of 7.1% in the second quarter of 2023, which is 12 percentage points slower than in the last quarter of 2022, when the peak of growth was recorded (see Chart 18, left-hand panel). Although slightly faster, the annual growth rate of the portfolio is already close to the euro area average of 5%. Moreover, the rapid growth of business-to-business lending in 2022 slowed down in the first quarter of this year. With the second consecutive quarter of minimal contraction in the PFI credit portfolio, the overall level of corporate indebtedness decreased slightly, while the debt burden, which had reached its historic highs in the last quarter of 2022, also eased slightly. On the other hand, the nominal flow of new loans to MFIs remains at a high level (see Chart 19), despite the fact that the Bank of Lithuania’s bank lending surveys show a fourth consecutive quarter of declining loan demand: in the second quarter of 2023, 8,500 new loans worth €878 million were granted to companies (down by 11.7% and up by 4.1% year on year respectively). The increase in the flow of loans was driven by isolated cases of larger loans, with the average loan value increasing by as much as 17.4% over the year. However, the situation varies across sectors, with real turnover of industrial firms falling exceptionally sharply over the year and confidence indicators remaining below even the pandemic levels. Along with the worst assessment by banks of the financial outlook for RE operations and industrial companies, credit flows to these sectors declined: compared to the first half of last year, lending to these activities fell by 7.7% and 1.8% respectively (€450 million and €315 million). Looking ahead, the financial outlook and credit to companies should benefit from the rising household purchasing power, increased investment and the slowly improving situation of foreign trading partners.
8.General government finance
Government expenditure, which has been growing faster than revenues in the last two quarters, has contributed to a budget deficit higher than a year ago. The general government deficit widened by 1.1 percentage points over the year to 1.2% of GDP (measured as a ratio of 4-quarter totals) in the first quarter of 2023. The increase in the deficit is mainly driven by the rapid growth in government expenditure (see Chart 20). The main factors behind the faster year-on-year growth in government expenditure in the first quarter of 2023 were a more than one-quarter year-on-year increase in social spending, a roughly one-tenth year-on-year increase in compensation of employees and higher subsidies. The main contributors to the increase in social benefits were the indexation of pensions (from the beginning of the year and the additional effect of the supplementary indexation of pensions from July 2022) and the increase in the number of retirement pension beneficiaries by around 4,000 in the first half of the year. Temporary fiscal decisions taken in the second half of 2022 in response to the significant rise in energy prices (partial compensation for households for heating, electricity and utility bills, partial subsidies for businesses for electricity prices) lead to higher government subsidies in 2023 than a year earlier.
The increase in government expenditure is driven by bigger social benefits, higher compensation of employees and larger subsidies.
Chart 20. Annual growth of general government expenditure and their contributions
Sources: State Data Agency and Bank of Lithuania calculations.
Slower wage bill growth and a return to the pre-COVID-19 levels of VAT arrears have contributed to a slower growth in general government revenue than a year ago. In the first quarter of this year, government revenue increased by around 14%, i.e. around 6 percentage points slower than during the same period a year ago. The main contributors to the increase in the growth of general government revenue were higher revenues from social contributions and indirect taxes (see Chart 21). In the first quarter of 2023, social contributions increased by 33.7%, compared to the first quarter of 2022. Social contributions are closely linked to the number of employees and wages, so a 13.3% year on year increase in the nominal average national wage and a 2.2% increase in the number of employees led to a rise in social contributions. This rise may also be due to a slightly earlier than usual payment of budget contributions for the publicly insured. The largest part of the increase in indirect taxes came from the 10.7% increase in VAT revenue collected compared to last year. The increase in VAT revenue is mainly due to a rise in the value of household final consumption expenditure, which was 15.5% higher in the first quarter of 2023 than in the same quarter a year ago. Notably, in the first half of this year, general government revenue was no longer affected by the reversal of VAT payments (deferred) for the previous year, as, according to the latest STI data, the level of VAT arrears in the first half of this year has returned to the level observed before the COVID-19 pandemic.
The increase in general government revenue was driven by greater social contributions and bigger collected amounts of indirect taxes.
Chart 21. Annual growth of general government expenditure and their contributions
Sources: State Data Agency and Bank of Lithuania calculations.
The ratio of general government debt to GDP declined by 1.4 percentage points to 38.3% in the first quarter of 2023, compared to the same period a year ago. The decline in the ratio of general government debt to GDP is driven by strong nominal GDP growth. In the first quarter of 2023, the total debt amount was around €2.9 billion higher than in the same period a year ago, and the nominal GDP (measured by a 4-quarter moving sum) increased by approximately €10 billion. According to the latest Government borrowing and debt repayment statistics, total borrowing between January and June this year exceeded the repaid amount by €1.1 billion. However, with nominal GDP continuing to grow at a rapid pace and the latest data showing that 67% of total general government debt consists of central government liabilities to foreign creditors, 98.4% of which are at fixed interest rates, the ratio of general government debt to GDP is expected to remain largely unchanged over the course of this year.
Abbreviations
EC European Commission
EC European Commission
APP asset purchase programme
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
HFCS Eurosystem’s Household Finance and Consumption Survey
HICP Harmonised Index of Consumer Prices
IMF International Monetary Fund
NFC non-financial corporations
MFI monetary financial institution
MMW minimum monthly wage
PMI Purchasing Managers’ index
RE real estate
UK United Kingdom
US United States of America
VAT value added tax
© Lietuvos bankas Gedimino pr. 6, LT-01103 Vilnius The Lithuanian Economic Review analyses the developments of the real sector, prices, public finance and credit in Lithuania, as well as the projected development of the domestic economy. The material presented in this review is the result of statistical data analysis, modelling and expert assessment. The review is prepared by the Bank of Lithuania. The cut-off date for the data used in the publication is 14 September 2023. Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. ISSN 2029-8471 (online) |