Economy hits the brakes after strong growth
The Lithuanian economy was on a strong growth trend. However, with the Russian invasion of Ukraine, the outlook changed abruptly. Russia was Lithuania’s largest trading partner, representing 10.8% of goods exports (No. 1 in 2021) and 12.1 % of imports (No. 2). These trade flows are now being impacted by sanctions and trading bans. The same accounts for Belarus, which was on the import side Lithuania’s ninth-largest trading partner (3.5% of all goods imports in 2021) and on the export side the 11th export destination (3.0%). The biggest share of imports from Russia were oil and natural gas. Indeed, in 2021, Russia accounted for 40% of all natural gas imports and 83% of all oil and refined oil products to the Baltic country. That said, Lithuania was the first EU-country to stop all energy imports from Russia in mid-May 2022. The main reason for this is the LNG terminal on the coast in Klaipeda, together with the Klaipeda pipeline into the interior of the country, which made Lithuania very flexible for diversifying its gas sources.
However, energy independence from Russia came at a high price. Due to soaring energy and food prices, headline inflation reached 24% year-over-year in early autumn 2022, the highest level of all Eurozone countries. For Lithuania, this was the highest inflation rate since 1996. It is expected that consumer prices will increase further over the year 2023, but at a slower pace than in 2022. Therefore, the inflation rate should shrink noticeably, but remain at a very elevated level.
The explosion of consumer prices has slashed the purchasing power of consumers, with private consumption (62% of nominal GDP) as well as private investments (22% of GDP) decreasing sharply in 2022. In 2023, the decrease of savings and higher interest rates will negatively affect both. Against this backdrop, private consumption could remain slightly more robust than investments given the very positive labour market situation. With an unemployment rate of around 8.3% at the end of 2022, jobless rate has manage to drop below the pre-pandemic level. This could boost consumer confidence. Interest rates will be highly dependent on ECB monetary policy. The central bank already hiked interest rates by 250 basis points to 2.5% for the main refinancing rate at end-2022. More rate hikes are in the pipeline and are expected to reach between 3.50% and 4.0% by the end of 2023. In addition, from March 2023, the ECB balance sheet will be reduced by EUR 15 billion per month. From the end of Q2, this monthly reduction will be increased. External trade (exports represent 92% of GDP and imports 84%) will also weigh on economic growth. Although Lithuania re-allocated and diversified trading relationships over last summer, its main export destinations are Latvia, Germany and Poland, where demand should decrease over the winter and subsequently slowly recover over the second half of the year. Some support, however, will come from the government. First, the EU’s Recovery Fund (NextGenerationEU) has reserved EUR 2.2 billion in grants (4.5% of GDP) for Lithuania between 2021 and 2026. This will support longer-term infrastructure programmes. In addition, in 2022 the government began rolling out several measures representing 4.1% of GDP which will continue in 2023 to help private households and companies cope with high inflation. This should support the economy especially over the winter months.
Budget deficit rises while current account deficit falls
The public deficit widened somewhat in 2022 due to inflation support measures and to high expenditures to support Ukrainian refugees. Both are expected continue as is or even increase in 2023. Combined with lower tax revenues on back of lower economic growth, this will push the deficit above the Maastricht line of 3%. Public debt is therefore likely to increase in 2023 but remain below the pandemic level. The current account switched to a deficit in 2022 due to the change in trade patterns, especially with Russia, and extremely high energy import prices. In 2023, Lithuania’s goods trade is expected to be more diversified, which should improve somewhat the trade- and, therefore, the current account-balance.
Wavering public support
Since October 2020, Prime Minister Ingrida Šimonyt? of the conservative “Homeland Union” party, which holds 50 out of 141 seats in Parliament, leads a coalition together with the Liberal Movement (12 seats) and the Freedom Party (11 seats). The government (especially the Homeland Union) lost some support from the population after poor handling of migration flows from Belarus in mid- and late- 2021. However, with the start of the war in Ukraine in spring 2022, the government gained back some of its popularity as the common enemy restored cohesion among both the population and political parties. Because of the shared border with Belarus and the Russian exclave of Kaliningrad, Lithuania has a sizeable geopolitical security issue. EU and NATO memberships are limiting the threat of military confrontation, but Lithuania keeps a very hawkish stance against Russia and even banned the transit of some goods to Kaliningrad as a part of EU sanctions in June 2022. This stance could lead to retaliatory action from Russia. e.g. trade sanctions or cyber-attacks.