Bank of Lithuania

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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.

Sluggish global developments are reducing pressure on prices. Global supply chains are normalising due to both supply and demand factors, and tensions have eased significantly. This year, global oil prices in euro are foreseen to be lower by around one fifth, gas prices in the euro area by around two thirds and food prices on the EU market by around 2.5% year on year. This has a dampening effect on price developments in Lithuania. Over the last six months, the general price level in Lithuania has barely changed.[1]
[1] Based on seasonally adjusted data.
However, prices that are more closely linked to domestic economic developments, in particular prices for services, continue to rise quite significantly. A substantial rise in wage expenditure is contributing to such changes in service prices. Over the projection horizon, the latter prices are expected to be the main contributor to overall price increases in Lithuania, although the growth rate of service prices will slow down as labour costs will not rise as much as they have recently. Average annual inflation, which stood at 18.9% last year, is projected to fall to 8.8% this year and to 2.6% next year.

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

Global GDP growth continues to slow down, and risks of a further slowdown are still high. The IMF’s July forecasts project the world economy to grow by 3.0% in 2023 and beyond, i.e. 0.8 percentage points slower than the long-term average.[2]
[2] The IMF winter projections showed that the world economy would grow by 2.9% this year and, and there was little change (2.8%) compared to the spring forecasts. The EC spring forecast projected the world GDP to grow by 2.8% this year. Thus, the economic growth outlook is stable this year.
The reduction of risks posed by COVID-19[3]
[3] In May, the World Health Organisation announced that COVID-19 was no longer an international public health emergency.
and the cancellation of the zero-COVID policy in China have led to de-escalation in supply chain tensions.[4]
[4] In August, the value of the Fed Global Supply Chain Pressure index stood at -0.86. The estimate measures standard deviations from the long-term trend.
Moreover, the price of crude oil is expected to stand lower by 20.7% on average,[5]
[5] It is understood as the arithmetic average of Brent, Dubai Fateh and WTI crude oil prices.
while the prices of non-energy commodities are assumed to fall by 4.8% in 2023, compared to 2022. However, economic activity will continue to be constrained by high inflation and increased borrowing costs, while the balance of risks remains tilted to the downside due to the russian war in Ukraine, the intensification of other geopolitical risks, the increased frequency of extreme weather events, and the RE crisis in China.
The main drivers of recent global economic growth are the consumption of services and the relatively robust growth of developing economies. Global economic growth in 2023 is underpinned by services consumption, which is growing in world’s major economies. The manufacturing sector is expanding at a more sluggish pace due to high borrowing costs and the relatively subdued demand for goods, as the consumption of services is prioritised. With slower expansion in the manufacturing sector, international trade growth is expected to slow down from 5.2% in 2022 to 2.0% in 2023. Although international trade growth will accelerate to 3.7% in 2024, it will remain subdued compared to the 2000–2019 average (4.9%).[6]
[6] IMF’s summer 2023 macroeconomic projections.
Another feature of global GDP growth this year is its uneven distribution; it is projected that, despite the slowdown in their economies,[7]
[7] Based on the IMF’s summer projections, in 2023, India’s economy is projected to grow at a pace that is 1.1 percentage point slower, and China’s economy will grow by 2.2 percentage points faster this year than in 2022. Despite a short-term acceleration in China’s growth, driven mainly by the base effects, the country’s growth is projected to slow down over the medium term.
China and India will account for around half of global growth.[8]
[8] According to the latest IMF forecasts, the growth rate of advanced economies will be 1.4% next year, 0.7 percentage points slower than the 2015–2019 average. Meanwhile, developing economies are projected to grow by 4.1% in 2024, only 0.3 percentage points slower than the 2015–2019 average.
Inflation will fall in most economies but will remain high. It is projected that inflation will decline from 8.7% in 2022 to 6.8% in 2023. Such trends are caused by falling energy prices and base effects in the majority of developed economies. However, due to labour market tensions, accelerating wage growth, slower productivity gains and high corporate profitability,[9]
[9] IMF’s summer 2023 macroeconomic projections.
core inflation is projected to fall only slightly – from 6.5% in 2022 to 6.0% in 2023. Core inflation will decline further but remain elevated (4.7%) in 2024. Longer-term inflation expectations remain anchored, despite high inflation and the acceleration of nominal wage growth induced by labour market tensions in most economies.
The US economy remains resilient, but a slowdown in growth is projected in the mid-term. GDP growth is expected to slow to 1.8% this year. Despite the high interest rates, private consumption is expected to grow at a sustainable pace and stand at 2.0%. An important supporting factor is the increase in household real purchasing power, driven by nominal wage growthand declining inflation. In addition, the US economy is positively affected by government spending, which continued to remain high in the first and second quarters of 2023, exceeding last year’s quarterly average. Private investment is estimated to fall by 1.9% this year due to rising interest rates, but the associated negative impact on GDP growth will be mitigated by a 4.9% increase in public investment.[10]
[10] IMF, United States: 2023 Article IV Consultation Report.
An even slower pace of economic growth (up to 1.0%) is forecast for 2024, when high interest rates are expected to slightly push up the unemployment rate (up to 4.2%) and slow down consumption growth to 0.8%.[11]
[11] IMF, United States: 2023 Article IV Consultation Report.
Compared to the long-term average, China is expected to experience an economic slowdown both this year and over the medium term. Although the country’s GDP growth is projected to reach 5.2% this year, the economy is going to remain well below its potential.[12]
[12] Based on the IMF’s China: 2023 Article IV Consultation Report, China’s economy in 2022 was 2.8% below its potential.
Inflation is subdued – based on the August data, annual consumer price inflation in China stood at 0.1%, and the IMF forecast shows average inflation at 1.5% this year.[13]
[13] IMF, China: 2023 Article IV Consultation Report.
The main reasons for this trend are the declining household[14]
[14]In China, RE accounts for approximately 80% of household assets.
and business confidence due to the falling RE prices. Accordingly, consumption growth is expected to equal 4.7% this year, while investment should grow by 4.0%. Although, compared to 2022, when the country was implementing a zero-COVID policy, both consumption and investment will rebound, the slowdown is evident compared to the pre-pandemic period. Another effect of the RE slowdown is the expected rapid decline in imports, resulting in the growth (to 3.6%) of trade account surplus next year. These trends are contributing to the decline of commodity price indices,[15]
[15] For example, S&P GSCI or BCOM.
and as China’s economic growth slows in the medium term, the country’s demand for commodities may remain subdued.
Economic growth in the euro area will be subdued. After the 3.3% growth in 2022, GDP in the euro area is expected to increase sluggishly (0.8%) in 2023.[16]
[16] EC summer macroeconomic projections.
This year consumption growth, which was 4.5% in 2022, will slow down to 0.5% due to a fall in real wages and consumer confidence.[17]
[17] IMF, Euro Area Policies: 2023 Article IV Consultation Report.
Higher borrowing costs are weighing down investment, which is expected to decelerate to 1.5% in 2023, after growing by 3.7% last year. Finally, stagnant public consumption (which should grow by 0.0%) is not expected to offset a slowdown in private consumption.
The German economy is expected to contract by 0.4% this year, while forecasts are more favourable for other euro area economies. Rising borrowing costs and the energy price shock due to russia’s war against Ukraine are weighing on German industry[18]
[18] The EC summer macroeconomic projections show that, despite the drop in energy prices, they still remain higher in Germany, compared to the energy costs of industrial companies operating outside the EU. Therefore, the competitiveness of the German industry is negatively affected.
: the manufacturing PMI stood at 39.1 in August, one of the lowest readings over the last three years. The country is also projected to suffer a stagnation in private consumption (0.0%) and a contraction in public consumption (-2.3%).[19]
[19] The figures for private and public consumption projections are based on the IMF’s 2023 Germany: Article IV Consultation Report.
However, the economic situation is better in other euro area economies. In Spain, for example, growth is expected to reach 2.2% in 2023 according to the EC’s latest macroeconomic projections, due to a pick-up in consumption of tourism services in the first half of the year. However, it should be noted that the positive impact of the tourism sector on the Spanish economy will fade in the second half of the year.[20]
[20] EC summer macroeconomic projections.
Although inflation in the euro area is declining, it is expected to remain high. Inflation in the euro area is projected to decrease from 8.4% in 2022 to 5.6% in 2023, on the back of declining energy prices and base effects.[21]
[21] EC summer macroeconomic projections.
Services inflation,[22]
[22] IMF, Euro Area Policies: 2023 Article IV Consultation Report.
an important driver of inflation in the near horizon, stood at 5.5% in August. One of the main reasons for such a trend are tensions in the labour market. It is shown by the 3.0% vacancy rate, which was at its historic highs in the second quarter of 2023 and the historically low unemployment (6.4%, based on the July data). The EC does not foresee any easing in labour market conditions, and no significant increase in unemployment is expected.[23]
[23] EC summer macroeconomic projections.
Although, due to labour market tensions, the nominal wage growth was 5.5% in the first quarter of 2023 (compared to the same period in the previous year), but the purchasing power has been declining.[24]
[24] EC summer macroeconomic projections.
Poland’s economy will grow slowly, and inflation will remain high. GDP growth is forecast to decelerate to 0.5% this year due to rising interest rates and sluggish increase in output in euro area. In 2023, private consumption is negatively affected by falling consumer confidence and declining real wages.[25]
[25] EC summer macroeconomic projections.
Export growth is expected to slow down from 6.2% in 2022 to 2.3% in 2023, while import growth will fall from 6.2% to 0.0% this year. Overall, the trade sector will still make a positive contribution to GDP development.[26]
[26] EC spring macroeconomic projections.
In addition, government spending on defence should have a positive impact on economic growth. Although inflation has been declining this year due to strong base effects and weakening domestic demand, it is expected to remain high at 11.4%.[27]
[27] EC summer macroeconomic projections.
The main drivers of high inflation are labour market tensions (the unemployment rate stood at 5.0% in July) and food price developments.[28]
[28] A decomposition of inflation is provided in the IMF’s 2023 Poland: Article IV Consultation Report.
Estonia’s GDP is projected to decrease by 0.4% in 2023, while Latvia is expected to avoid a contraction with a 1.4% growth. The main headwinds to growth in Estonia include tight financial conditions, high inflation (9.2%) and slower economic growth in the Nordic countries (the main trading partners). GDP development is expected to be positively affected by public consumption which will increase from -0.3% in 2022 to 4.3% in 2023 and a corresponding rise in investment from -10.9% to 1.8% accordingly.[29]
[29] EC spring macroeconomic projections.
In Latvia, private consumption growth, which was 8.1% in 2022, will slow to 3.0% (9.3% inflation in 2023), and will not only be the fastest in the Baltics, but will also be the biggest positive contributor to Latvia’s GDP growth. Another important factor contributing positively to Latvia’s GDP growth is the acceleration of investment to 1.7%, which will be significantly influenced by the increase in EU funding in the second half of the year.[30]
[30]EC spring macroeconomic projections.

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.

The GDP deflator is broken down into its components using national accounts data: real GDP and the components of nominal GDP calculated by the income approach[31]
[31] Based on quarterly data adjusted for the seasonal and workday effects.
– compensation of employees, gross operating surplus and mixed income, net taxes:

P×Y=WIN+GOS+TAX -SUB,                                                                       (1)

where: P – GDP deflator, Y – real GDP, WIN – compensation of employees (labour costs), GOS – gross operating surplus (hereinafter – operating surplus), TAX – taxes on production and imports and SUB – subsidies.

Dividing the two sides of the identity (1) by real GDP (Y), 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 (ULC), unit operating surplus (UGOS) and unit net taxes (UTAX), after deduction of unit subsidies USUB. 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.

P=WINY+GOSY+TAXY-SUBY=ULC+UGOS+UTAX-USUB.                                                  (2)

After being relatively stable in 2015–2019, the unit operating surplus varied considerably between 2020 and 2021 and increased significantly in 2022, i.e. after the outbreak of russia’s hostilities against Ukraine (see Chart C). The contribution of the operating surplus to GDP deflator growth after the start of russia’s war against Ukraine has been significantly higher than in the previous periods (see Chart C). In 2000–2019, the contribution of unit operating surplus to GDP deflator growth was close to that of labour costs.[32]
[32] It should be noted that the dynamics of unit labour costs and unit operating surplus affect the structure of value added, i.e. what share of value added is generated through compensation of employees and what share is generated through operating surplus. This relationship between compensation of employees and operating surplus can vary both as a result of the evolution of the business cycle and structural changes in the economy. Taking this into account, if the differences in the growth of unit labour costs and unit operating surplus are due to cyclical factors, it is likely that, after a certain period, the relationship between compensation of employees and the operating surplus in value added should revert to the longer-term trend observed previously. Accordingly, in the light of the changes due to structural factors, the relationship between compensation of employees and the operating surplus in value added should stabilise at a level different from the previously observed longer-term trend.
During the COVID-19 pandemic period (2020–2021), unit labour costs contributed significantly more to GDP deflator growth. From 2022 onwards, unit labour costs and unit operating surplus have been rising even faster, well above historical growth averages, leading to an increase in the GDP deflator that is almost three times faster. During this period, the increase in the unit operating surplus had the largest impact on the GDP deflator. While the growth of the unit operating surplus slows down from 2023 onwards, the high growth rate of the GDP deflator is sustained by the rapid increase in unit labour costs.

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:

PCC=PY+PMM-PXX-PII-PGG,                                                                     (3)

where: PC, P, PM, PX, PI and PG – deflators for household consumption expenditure, GDP, imports of goods and services, exports of goods and services, investment and general government consumption expenditure respectively; C, Y, M, X, I and G – 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 (C) and expressing the GDP deflator (P) through the identity in equation (2) the following expression is obtained:

PC=αULC+UGOS+UTAX-USUB+ zMPM-zXPX-ψ,                                                 (4)

where: α – the ratio of real GDP to real household consumption expenditure, zM and zX – the ratio of real imports and exports of goods and services to real household consumption expenditure.[33]
[33] The positive impact of imports of goods and services on the price level is intuitive: a rise in the prices of imported goods and services leads to an increase in the prices of goods and services of both intermediate consumption and final consumption. In contrast, the negative impact of export prices on the household consumption deflator is explained by the fact that exported goods and services do not contribute directly to changes in the domestic price level. For example, if most of the imported goods and services with a significant price increase were used in the production of exported goods and services, their export (sale outside the Lithuanian market) would have no impact on the domestic price level. In other words, the higher the share of imported goods and services used in the production of exported goods and services, the less the prices of imported goods and services affect the price dynamics of the domestic market.
The effect of other domestic demand factors (general government consumption expenditure and investment) is expressed as ψ. Charts E and F show the annual changes in the household consumption expenditure deflator and the main contributions in 2005–2023.

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.

The decomposition of the household consumption deflator shows that, in both periods of high inflation,[34]
[34] In the period before and after the global financial crisis (from the first quarter of 2005 to the first quarter of 2010) and the period covering the COVID-19 pandemic and russia’s war against Ukraine (from the first quarter of 2019 to the second quarter of 2023).
the significant impact on price increases was primarily driven by a significant worsening of terms of trade. In 2006–2007, the rapidly expanding world economy boosted demand for food and energy products, and consequently their prices. In addition to external factors, rising unit labour costs also contributed significantly to the increase in the household consumption expenditure deflator. During this period, the positive impact of external and some of domestic factors on the deflator was reduced by other factors such as general government final consumption expenditure and investment. Similar trends were observed in 2021–2022, when disruptions in supply chains caused by the COVID-19 pandemic and the energy price shock triggered off by russia’s war against Ukraine significantly increased the prices of imported goods and services and contributed to the first impulse in the growth of the household consumption expenditure deflator.

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

Annual employment growth is slowing down, but employment developments vary across sectors. In the second quarter of this year, the total number of employed persons in the country reached 1.4 million, 0.6% higher than in the same period last year. The services sector was the main contributor to the annual increase in employment (around 1.2 percentage points). In particular, the rise in employment was concentrated in trade, transport, accommodation and food service activities (see Chart 6). The fastest declines in employment during the period under review were observed in agriculture, forestry and fishing as well as public administration, education, and health care activities. These sectors contributed around 1.0 and 0.7 percentage points respectively to employment growth in the country. While the total number of people in employment is still rising, growth has been slowing for a year. These employment dynamics were also driven by a technical factor – the high comparable base effect, which is due to the particularly strong employment growth last year as a result of the successful integration of war refugees into the Lithuanian labour market. In addition to less favourable migration trends this year, other factors contributed to lower hiring: the economic downturn at the turn of the year, the spike in energy prices in winter, geopolitical tensions and uncertainties in the international environment, and the challenges posed by rising interest rates and the impact of monetary policy tightening. These and other factors have led to a more cautious assessment of the outlook for corporate activity, including expansion, and hiring. According to the EC survey, the hiring expectations of companies have been deteriorating since February last year, and in August this year they were worse than usual.[35]
[35] In August 2023, the employment expectations indicator was 1.4 points lower than the long-term average.
However, the latest daily administrative data from Sodra continue to show that the number of people in employment continues to grow: the number of insured persons in July-August was around 0.9% higher than in the same period last year.

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.

The stable labour market situation has been favourable to continued wage growth. According to the State Data Agency, in the second quarter of 2023, average monthly gross wages in the country were 12.3% higher than a year earlier and 2.5% higher than in the previous quarter (seasonally adjusted data). Private sector wages increased by 12.1% year on year, while public sector wages rose slightly more – by 13.1%. The strong growth was driven not only by a favourable labour market situation for employees, linked to a tight labour shortage situation, but also by the increase in the minimum monthly wage (MMW) at the beginning of the year.[36]
[36] According to the Bank of Lithuania’s calculations, a 15% increase in the MMW in 2023 will lead to a 1.5-2.4 percentage point faster growth in average wages.

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.

The wage growth spurt will continue in the country as there are still tensions over labour shortages. With the unemployment rate falling to 5.9% and the number of vacancies standing around 28,000, the labour market in Lithuania is tight (see Chart 9). The level of tension, measured as the ratio of vacancies to unemployed persons, increased significantly in the second quarter of this year and is more than double the average for the period 2008-2023. The extremely high demand for new workers and the supply of vacancies (the job vacancy rate is close to historical highs at 1.9%)[37]
[37] Adjusted for seasonal and workday effects.
are leading to better employment opportunities and allowing workers to negotiate more confidently on remuneration. The factors discussed above are expected to contribute significantly to strong wage growth over the period under review. Annual wage growth is projected at 12.4% in 2023 and 9.8% in 2024.

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.

Lithuania’s exports of goods fell in the first half of 2023. Exports of almost all types of Lithuanian-origin products declined. Significant export contraction was still observed in those sectors where energy costs make up a significant share of production costs. Only a few manufacturing sectors, which produce machinery and equipment and transport equipment, managed to export more than in the second half of last year. Declining demand for reagents and other medical equipment in the aftermath of the COVID-19 pandemic, along with the remarkably elevated natural gas prices and the constraints imposed on AB Lifosa’s operations due to sanctions, resulted in a decline of exports of chemical products and plastics by more than 20% during the first half of 2023 compared to the second half of 2022. However, it should be noted that the decrease in natural gas prices and the corresponding recovery of activities of AB Achema led to higher exports of chemical products and plastics in the second quarter of 2023 than in the previous quarter. The furniture and wood industry, another major manufacturing sector in Lithuania, continued to face difficulties. Its nominal exports in the second quarter of 2023 were more than a fifth lower than in the second quarter of 2022. In addition to wood supply disruptions[38]
[38] Further information is available in the commentary by K. Vasiliauskas “Effectiveness and impact of sanctions in the timber trade on the Lithuanian timber industry”.
and high energy prices, furniture and wood producers were affected by a slowdown of the RE market in main trade partner countries, the worsening sentiment and financial situation of consumers, and their reluctance to make bigger purchases. As for re-exports, it should be noted that the significant growth observed from the second quarter of 2022 onwards to the Commonwealth of Independent States countries, excluding russia, is gradually fading. In the second and third quarters of 2023, re-exports grew by 2.3% and 16%, respectively, while a gradual decline is observed from the fourth quarter of 2022. In the fourth quarter of 2022 and in the first and second quarters of 2023, re-exports fell by 2.4%, 1.4% and 8.2% respectively.

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.

The fall in energy prices is the main driver of the decrease in inflation. Energy prices rose at an annual rate of 73% at their peak in September last year, and after the reduction in prices of energy resources, they were already 13.4% lower in August this year compared to the previous year. The stabilisation of supply and the reduction of threats of possible gas shortages have led to a particularly significant drop in gas prices on the market, with gas prices in August being almost seven times lower than in the same period a year ago. The fall in gas prices also contributed significantly to the drop in electricity prices, with electricity prices on the market going down by almost five times year on year in August. Oil also became cheaper, with Brent crude oil in August around an eighth cheaper than a year earlier. This also led to a fall in the price of oil-intensive products such as fuels. Fuel and lubricant prices were 13.7% lower in August than a year earlier, contributing the most (by 1 percentage point) to the decline in inflation (see Chart 15). The fall in prices of energy resources also led to a decline in annual price growth or even an annual price decrease for other energy products. In the latter case, heat energy was 20% cheaper in August than a year earlier, following the fall in biofuel and gas prices. Heat energy, like fuel, has been exerting downward pressure on inflation for some time now, and in particular heat energy had an impact of -0.5 percentage points on annual headline inflation in August. Energy futures show that energy prices will rise slightly in the run-up to the heating season due to stronger demand but will remain significantly lower than in the corresponding period last year. For example, according to Refinitiv data,[39]
[39] Data as of 13 September.
the market price of gas during the heating season will be close to €49 per MWh (currently around €37 per MWh), but still almost half the price of a year ago. Recently,[40]
[40] Data as of 13 September.
the price of Brent crude oil has also risen to an average of USD 92 per barrel. This is mainly due to the decision by Saudi Arabia and russia to reduce oil supply in order to raise its price on the markets. However, no further increase in the oil price is foreseen on the markets, as growth is limited by fears of weak oil demand due to both China’s slower recovery and the impact of rising interest rates. Against this background, energy prices for consumers in 2023 are projected to be on average lower than in the previous year.

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.

The impact of food prices, including alcoholic beverages and tobacco, on annual inflation has diminished significantly, but it remains the main driver of inflation. Price increases for these goods peaked in November last year, when prices rose at an annual rate of 28.5% (contributing 7.8 percentage points to headline inflation; see Chart 16). As both energy and food commodity prices fell in the markets, consumer prices for food increased at a slower pace. In August, food prices, including alcoholic beverages and tobacco, were 11% higher year on year, contributing 3.1 percentage points to headline inflation. The annual growth in food prices slowed down, and the price level of some goods also declined. For example, russia’s war against Ukraine and the resulting disruption of supply chains led to a sharp increase in the price of oils and other fats. As supply chains recovered, prices for these goods were declining and were 8.2% lower in August than at the peak in November last year. The fall in farm-gate prices of milk has continued to push down consumer prices for dairy products in recent months. In August, prices for milk, dairy products and eggs fell by 4.4% since their peak at the beginning of the year. Although the price levels of oil and other fats and milk, dairy products and eggs have fallen in recent months, prices for these goods are still significantly higher than in the pre-pandemic period.[41]
[41] The prices of oil and other fats were 48% and the prices of milk, dairy products and eggs were 58% higher in August this year compared to the 2019 average.
As for meat, although the annual growth of meat prices slowed down to 14.2% in August, the price level continued to rise. Currently, meat prices are the main driver of food price inflation (accounted for 0.7 percentage points of headline inflation in August). Both current food price developments and future food price changes are, and will continue to be, strongly influenced by the purchase prices of food commodities. In August, global food commodity prices were 11.8% lower than a year ago. Looking deeper into the local market and into individual categories, even larger changes are visible. For example, in July, farm-gate prices for whole milk and cereals in Lithuania were respectively 33% and 31% lower than a year ago. In contrast, the purchase prices of the most popular meat – pork – continue to rise, with a year-on-year increase of 43%[42]
[42] Compared to the pre-pandemic period, farm-gate prices for all these food commodities have increased significantly. In July, farm-gate prices for whole milk in Lithuania were 18.2%, for cereals 19% and for pork 61.9% higher than the 2019 average.
in July. This is due to both the reduced supply of pork in Europe and the continued impact of higher production costs. Taking into account the evolution of other costs in the food chain,[43]
[43] For more on food chain cost developments, see Box 4.
food price increases should continue to decline. However, the situation will vary across categories: for example, dairy prices are forecast to fall further this year, while meat prices are expected to continue to rise.

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.

This box looks at how supply-side factors have influenced the evolution of the household consumption deflator (an indicator the evolution of which is very close to the HICP) from the first quarter of 2021 to the second quarter of 2023. Using the input-output tables, this box intends to assess the impact of the expected increase in production costs on the final prices of household consumption goods and services. Assessments were made on the basis of the methodology applied in the article by M. Schneider.[44]
When analysing the drivers of the surge in inflation observed in recent years, many economists point to the rise in energy prices as the main cause. The energy price spike has also been particularly strong in Lithuania. In the analysis described in this box, energy products are assigned to the output of four economic activities: forestry and logging (NACE[45]
[45] Statistical classification of economic activities, NACE Rev. 2.
code A.02), mining and quarrying (B), manufacture of coke and refined petroleum products (C.19), and supply of electricity, gas, steam and air conditioning (D.35). As can be seen from Chart A, the prices of both the products produced in these activities and the products imported from other countries increased very rapidly during the period under review. For many products, prices in mid-2022 were 2-3 times higher than the average for 2021 and, for example, the price index for imported electricity, gas, steam and air-conditioning in August 2022 was almost 5 times higher than the average value for 2021. The increase in the prices of these imported and domestically produced output for the Lithuanian market has also made energy products more expensive for consumers. Many of them were also 2-3 times more expensive in mid-2022 than in 2021 on average.

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.

An analysis of the price structure of the household consumption basket shows that, before the energy price spike, only in a few groups of goods and services did energy-related expenditure account for a more significant share of the price. Based on the 2015 input-output tables, a supply-side breakdown of the twelve main groups of household consumption goods and services[46]
[46] According to the classification of individual consumption by purpose (COICOP).
shows that only in the group of housing, water, electricity, gas and other fuels goods and services, and in the group of transport goods and services, energy-related costs were higher than 5% of the total value of the goods and services sold to households (see Chart B). They accounted for 36.7% and 38.8% respectively, and 13.2% of all goods and services purchased by households. However, these indicators markedly changed due to the significantly higher prices of energy products in the second half of 2022. Based on the 2015 input-output tables and various price and input indices (e.g. the price index for imported goods, the price index for industrial goods sold by producers, economic activity deflators, wage developments, etc.), supply-side modelling of the evolution of the prices of goods and services[47]
[47] The following assumptions were made in the modelling: (a) the structure of production of goods and services produced in Lithuania remains unchanged; (b) the structure of household consumption remains unchanged; (c) the ratio of imported and domestic production in the household consumption basket remains unchanged for groups of household consumption goods and services; (d) the share of wages in value-added remains unchanged; and (e) the margins on trade and transport remain unchanged.
suggests that the share of energy-related expenditure in the total basket of goods and services purchased by households could increase to 16.5% in the second half of 2022 (12.6% in 2021), and in the group of housing, water, electricity, gas and other fuel goods and services and the group of transport goods and services – 44.6% and 47.7% respectively (in 2021: 36.4% and 38.8% respectively).
Although the rise in the prices of energy products has been particularly pronounced and has had a marked impact on price developments in Lithuania, the price structure of the various groups of goods and services (see Chart B) also reveals that other factors have an impact on price developments of goods and services. In the groups of household consumption goods and services, where goods have traditionally made up a more significant share, trade and transport margins and the value of imported goods and services, excluding energy (for example, food and non-alcoholic beverages, tobacco and drugs, clothing and footwear) accounted for a particularly large share of the output price, and the main contributors to the value of imported goods and services were wages and salaries and operating surplus[48]
[48] In this box, the operating surplus is used as an abbreviation for the sum of the following indicators: gross operating surplus, gross mixed income, taxes on production and imports, subsidies (-).
(an indicator close in nature to the profit indicator) in those groups of household consumption goods and services in which services were more important (e.g. education, restaurants and hotels, communications). Changes in these components have therefore also had a significant impact on the evolution of household purchases of goods and services in recent years.

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).

It is important to note that the price level of goods and services supplied to households, as measured by this method, increased more than is shown by the HICP – by 43.8% and 35.5% respectively. This 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.[49]
[49] The assessments use the HICP published by the State Data Agency, with weights revised annually. As the modelling assumed that the structure of household consumption remained unchanged, additional estimates were made of the impact of the weights on the value of the HICP indicator. The results show that the impact of changes in the HICP weights on the evolution of the price level has been modest.
Due to the methodology used to estimate these factors, it is likely that the evolution of the operating surplus is the most overestimated of all the factors analysed (the impact of the operating surplus on price developments is calculated as the residual of the overall change in the price index minus the other factors analysed), i.e. the impact of the corporate operating surplus (profits) on the increase in the price level has been lower.

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.

Annual food inflation, which peaked at 34.7% in November last year, has been steadily declining, reaching 11.6% in August. Prices of food commodities and many other inputs for food production are also falling[50]
[50] Further information on the evolution of food prices and prices of various commodities is available in Chapter 6.
(see Chart A). This box provides the updated analysis of food prices[51]
[51] The analysis of food prices carried out in February is available here.
through cost and price developments in the key sectors of the food supply chain – agriculture, food industry and trade. The results of the updated analysis will allow us to assess how costs and prices have evolved in each of these sectors over the last six months. As before, the analysis of food prices is carried out following two approaches: input-output tables (Method 1) and business structure and financial indicators (Method 2). The detailed methodology for food price analysis can be found here. However, in contrast to the previous one, this box does not present annual price changes but rather changes compared to 2020. The aim is to assess the overall outcome of both the exceptional price spike and the stabilisation and fall in prices.

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


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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)