Bank of Lithuania
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Economic and Monetary Affairs Committee (ECON)
European Parliament
17 March 2014, Brussels


Honourable Members,

The European Parliament is a key stakeholder in the euro area enlargement process. I greatly appreciate the opportunity to provide the Committee with a fresh update on the state of the Lithuanian economy and financial sector. I believe that today’s discussion will contribute to the forming of an institutional view.

I will focus on issues that are closely related to the mandate of the central bank:

– Firstly, how did the Lithuanian economy react to the crisis?

– Secondly, how do we see price stability?

– Thirdly, what does the financial sector look like?

The Lithuanian economy staged a quick recovery after the crisis and demonstrates solid growth rates. The pre-crisis level of output will be exceeded this year. The cumulative GDP increase since 2009 has been 15.3 per cent. The essential elements of the adjustment strategy have been frontloaded policy response, preserved financial stability, and economic flexibility.

Economic rebalancing has occurred, supported by labour and product market flexibility. The current account is close to balance. Competitiveness has improved after substantial adjustment in unit labour costs. Economic recovery was led by the tradable sector. Domestic demand has strengthened as well. Real exports are 40 per cent higher than during the pre-crisis peak. Unemployment has almost halved since the crisis peak and currently is at around the euro area average.

The adjustment process confirmed that the economic structure in Lithuania is sufficiently flexible to operate under the fixed exchange rate regime. It has also confirmed the ability to adjust policies when needed.

Inflation sustainability

Domestic price pressures are firmly contained and inflation is comfortably below the price-stability criterion. The average annual inflation is projected to stay at 0.7 per cent in the first quarter of 2014. As regards the medium-term sustainability, the outlook is more encouraging than in the past. The effective prevention of unsustainable developments in asset prices will be ensured by macro-prudential tools.

The pass-through of global price shocks in Lithuania is relatively higher due to a higher share of food and commodities prices in the consumer basket. However, with the on-going income convergence, it has been steadily declining.

There are also important policy initiatives underway that will reduce energy intensity while increasing diversification of energy sources at the same time. These initiatives, notably the housing renovation program, LNG terminal, integration with the European power grid, unbundling of gas supply and distribution networks, are supported by the EU.

Financial sector

While there are no specific convergence criteria to detect fragilities in the financial sector, the crisis has reminded us of the important interlinkages between the financial sector and the real economy. When assessing economic sustainability and convergence, we have a strong story to tell on financial sector issues.

The Lithuanian financial sector is dominated by traditional retail banking. The banking sector is not oversized and banks account for 65 per cent of GDP. The funding structure is domestically oriented. Banks fund themselves mostly through deposits, with the loan-to-deposit ratio at 107 per cent. The share of non-resident deposits is negligible — only about 3 per cent — and geographically diversified.

The banking sector is well capitalized and liquid, with addressed fragilities. The banking sector has more than twice as much capital as is required by the Bank of Lithuania and nearly all of it is of the highest quality (Tier 1). The non-performing loans have been steadily declining and currently stand at 10.7 per cent.

The lending conditions have normalised and there is no growth constraining debt overhang. Private sector indebtedness in Lithuania is second lowest in the EU (43.1% of nominal GDP). The loan portfolio is expected to increase by about 3 per cent in 2014. The surveys of the Bank of Lithuania also do not indicate crediting constraints on the supply side.

A comprehensive macro-prudential toolkit is in place to prevent unsustainable lending practices and the macro-prudential powers of the Bank of Lithuania will be further enhanced by granting an explicit macro-prudential mandate. There are binding loan-to-value, debt-to-income, and loan amortization requirements for banks.

The Bank of Lithuania, as the supervisory authority, will be prepared to join the Single Supervisory Mechanism from the date of entry into the euro area. As has been noted, the financial sector is in good shape, with addressed residual risks and no legacy assets.

I will stop here and will be pleased to answer your questions.