Bank of Lithuania

Sustainability of general government finances in Lithuania and other Baltic countries


The analysis of estimates of sustainability indicators of general government finances shows that the mid-to-long term risk to the sustainability of Lithuania’s general government finances is higher than the respective risk for Latvia or Estonia. The lower score results from the impact of ageing-related expenditure, the bulk of which goes towards pension benefits. However, the previous estimates of sustainability indicators of general government finances do not take into account the changes to Lithuania’s state social insurance system, which were adopted in 2016 and will come into effect in 2017 and 2018. The analysis shows that when taking into account these changes, the evolution of old-age pension expenditure in Lithuania becomes more aligned with the expected developments in other Baltic countries hence the country’s fiscal sustainability score should become similar as well.
Long-term developments in the ratio of old-age pension expenditure to GDP are driven by demographic factors, factors stemming from pension arrangements as well as the country’s macroeconomic situation. Population ageing-related factors will put upward pressure on pension expenditure in all three Baltic countries in the long term. This impact, however, will be offset by the decreasing generosity of the pension system, the rising retirement age and the increasing employment rate. As a result, the old-age pension expenditure-to-GDP ratio will decrease by 2060 in all Baltic states.
Even though the situation of pension systems of all Baltic countries may look sustainable in the long term from a formal point of view, i.e. when measured in terms of financial flows (the ratio between pension expenditure and GDP will decrease by 2060), the key factor underlying sustainability, i.e. the decreasing ratio of the average pension to the average wage, raises serious doubts. This ratio implies a substantial future decrease in the generosity of the pension system and insufficient adequacy of old-age pensions. The assessment of fiscal sustainability, which disregards the adequacy of the pension system, is too narrow and limited. The anticipated low old-age pension-to-average wage ratio might act as a deterrent to participation in the social insurance system. Therefore, the authorities would likely end up seeking resources to increase pensions, which would undermine fiscal sustainability. In a scenario which implies no change in the old-age pension replacement rate from its current level and which looks the most feasible due to political risks, Lithuania’s fiscal sustainability score is likely to be lower than estimated by the European Commission, which points to the need to take measures that could ensure fiscal and social sustainability.
The alternative scenario analysis of Lithuania’s pension expenditure–to-GDP ratio indicates that some measures could partly offset the effect of ageing. The analysis of various demographic scenarios indicates that population ageing is inevitable in Lithuania, i.e. the proportion of older persons in the population will increase compared to the proportion of the working age group. This implies that an increasing share of the budget will have to be allocated for old-age pensions and that the replacement rates of the first pillar pensions will be negatively affected. Such measures as increasing labour market activity, promoting employment, and raising the retirement age could increase sustainability of Lithuania’s pension system in the long term.

The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

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