Lithuania: More upturn in yields may trigger IMF loan

This year Lithuania may apply for a loan from the International Monetary Fund (IMF). But if so, this will not be triggered by the unfolding of an acute domestic economic crisis, with difficult imbalances like now and earlier in Hungary or at one time in Latvia and various other Eastern European countries that received international bail-out loans during and after the initial phase of the 2008-2009 global credit crunch. The motive will be that Lithuania, which still has a large budget deficit and borrowing requirement, wants to avoid excessive borrowing costs in the capital market if the contagion from the euro zone crisis should increase. What might then be appropriate is a temporary special loan from the IMF not a multi-year stand-by arrangement of the kind that Hungary terminated but will now probably resume, or the one in Latvia, whose three-year programme expired at the end of 2011.
Lithuania mainly like Estonia but also Latvia has recovered nicely from the deep recession of 2009, although a clear slowdown is now likely, from an estimated GDP growth rate of 6.5 per cent in 2011 to 2.0 per cent this year (adjusted downward from the 2.5 per cent we predicted in the November 2011 issue of Nordic Outlook) due to the repercussions of the slowdown in the global economy and the financial crisis in the euro zone.

MONDAY JANUARY 16, 2012

Likewise, the public sector budget deficit is at a high level, although it shrank from 9.5 per cent of GDP in 2009 to an estimated 6.0 per cent in 2011. And we believe that Lithuania has halted its rapidly rising public sector debt at just above 40 per cent of GDP up from a low, stable 15-18 per cent of GDP during the years before the crisis struck. All this represents the fruits of significant budgettightening and pay cuts in both the public and private sector, which repaired Lithuanias competitiveness after the previous several years of wage and salary explosion. In other words, Lithuanias economy is on the right track. When neighbouring Latvia received its international bailout package in December 2008 (mainly European Union and IMF loans), Latvia and the other two Baltic countries were clearly headed towards a profound crisis. At that time, Lithuania avoided the need to apply for IMF/EU help, and in the following year, the government carried out successful though relatively expensive bond issues. But because its budget deficit remains large and its public sector debt has climbed considerably (although to a relatively low level, and less than half of the euro zone average), Lithuania is still dependent on loans and decent capital market conditions.
Public sector budget and debt, Lithuania and Latvia Per cent of GDP

2007 2008 2009 2010 2011 2012 Lit. budget Lat. budget Lit. debt Lat. debt -1.0 -3.3 -9.5 -7.0 -6.0 -3.5 -0.4 -4.2 -9.7 16.8 15.5 29.4 9.0 19.8 36.7 -8.3 -4.2 -2.6 38.0 40.4 40.6 44.7 44.5 44.0

Lingering high unemployment, budget deficits

Since mid-2010 Lithuania has shown year-on-year growth. Domestic demand has gradually become a major factor in the upturn, which was initially export-driven. The current account balance swung from very large deficits in 2007-2008 to moderate surpluses and in 2011 to a moderate deficit which we expect will increase gradually in 2012-2013. Unemployment admittedly remains high and poses difficult challenges, along with a new wave of emigration. But after peaking at more than 18 per cent in the first half of 2010, the jobless rate fell below 15 per cent in the third quarter of last year.

Source: European Commission, SEB forecast (2011-2012)

The budget trend will of course be an important factor in the size of this years borrowing requirement. Late in December 2011, the Lithuanian Parliament (or Seimas) adopted a relatively tight 2012 budget. The government foresees a fiscal deficit of 3.0 per cent of GDP, which also meets the criteria of the European Commission. In the final stage of budget deliberations, the government succeeded in pushing through further austerity measures
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Economic Insights

totalling LTL 1 billion (EUR 290 million) to fill gaps that arose during the autumn, when growth projections were lowered from 4.7 to 2.5 per cent. This included 4 per cent cuts in nearly all expenditure areas. The 2012 budget makes the following tax changes: a new luxury property tax, temporary cuts in provisions to private pension funds via the SODRA social insurance system, higher hotel value-added tax and higher fees on stateowned natural resources for commercial use. We are somewhat surprised by the tightness of the 2012 budget and had earlier predicted a shift from a relatively neutral fiscal policy in 2011 to a slightly expansionary direction during 2012, an election year. But at the same time, we believe that the government is somewhat too optimistic about economic growth, and we foresee a larger fiscal deficit this year: 3.5 per cent of GDP. To meet the EU budget criterion, new tax hikes may thus be considered during 2012. Among other things, discussions are under way about introducing progressive taxation of private income, a tax on fixed income savings and higher corporate tax. It may be politically tricky for the ruling centre-right government to implement these hikes, since an election is scheduled for October 2012.

The stress level throughout the European financial system has increased noticeably during the past six months as a consequence of debt problems in Western Europe. In recent months this has also impacted Lithuanian market yields. For example, 5-year yields on government securities have risen from 4.5 to 5.6 per cent, after peaking at 6.0 per cent in December. Given the risk of continued yield increases and a less welcoming international response to future bond issues, Lithuanias central bank governor and finance minister have both opened the door slightly to the prospect of applying for an IMF loan: I wouldnt rule out the possibility that the IMF could be an option in case there are unfavourable conditions on the capital markets, said Bank of Lithuania Governor Vitas Vasiliauskas in an interview with Reuters on December 23, 2011. One month earlier, in November, Finance Minister Ingrida Simonyte declared in the Lithuanian media that the country would have no choice but to ask the IMF for a special loan if yields on Lithuanian sovereign debt in the international market should climb to 2009 levels: In 20099 per cent interest did not seem very much. But now if we had to pay 9 per cent for new debt, I think we would not even consider borrowing at this rate, she told IQ.lt. In 2009 Lithuania issued a five-year loan at a yield of 9.4 per cent. The debate on a possible IMF loan began as early as midOctober, when Kestutis Glaveckas, chairman of the parliamentary Budget and Finance Committee, said it is necessary to consider the possibility of borrowing from the IMF, given the difficult international market situation. It is better to be preventive and agree on a loan before the situation becomes more acute; borrowing from the IMF would also be economically more advantageous than going via the market, he added. But IMF loans are politically controversial. Statements from Prime Minister Andrius Kubilius and President Dalia Grybauskaite indicate that neither supports Glaveckas proposal. Grybauskaite has said turning to the IMF would be viewed as a sign of weakness and Lithuanias inability to stand on its own feet. Such a loan would affect the possibilities of borrowing from other sources which would lead to unfavourable obligations, according to the president.

Euro zone stress impacting Lithuanian yields

According to Finance Ministry estimates published on December 21 last year, Lithuanias sovereign borrowing requirement in 2012 will total LTL 10.3 billion (equivalent to 10.8 per cent of GDP). Of this, LTL 3.3 billion will cover the budget deficit, while LTL 6.1 billion is debt refinancing and LTL 0.9 billion consists of loans from international institutions (the European Investment Bank and Nordic Investment Bank). In May, EUR 1 billion in euro-denominated bonds will fall due. Lithuania plans to rely on the international capital market for nearly two thirds of this borrowing. The Finance Ministry press release does not say so, but these plans may be partly revised if international conditions should deteriorate further.
Lithuania: Government bonds
Per cent, 7-day moving average
20 20

15

15

10

10

Euro zone crisis will determine loan decision

Weighing together the various statements by political and central bank leaders, a reasonable conclusion is that future developments in the euro zone crisis will be crucial to Lithuanias position on borrowing. If the euro zone crisis deepens, this will unavoidably have contagious effects on financial and capital markets all over Europe,

0 jan apr

0 jul 09 okt jan apr jul 10 okt jan apr jul 11 okt jan 12

10 year

5 year
Source: Reuters EcoWin

Economic Insights

including Lithuania. At present, Lithuanias large budget deficit also creates extra vulnerability, although its government and parliament have shown continued firm resolve, including an unexpectedly tight 2012 budget. If long-term bond yields should rise from 5.5-6.0 per cent towards 8-9 per cent, an IMF loan would be considered. Worth noting in this context is that in such a case, Lithuania will seek a special loan, according to the finance minister. What this would be is unclear. Briefly, the IMF offers six main types of loan facilities: Stand-By Arrangement. Has existed since 1952 and is used by countries in economic crisis, often to correct balance-of-payment problems. These programmes often run for up to three years and include clear demands for remedial action, for example budget-tightening and reforms. Since 2009, SBAs have become more flexible and their conditions narrower than previously. They may also be granted more quickly and for preventive purposes. Flexible Credit Line (FCL). Available for 1-2 years to countries with very strong fundamentals and policies, as well as a good track record of policy implementation. Precautionary and Liquidity Line (PLL). An upgraded, broader version of the previous Precautionary Credit Line (PCL), added last November. Available to countries in order to manage actual or potential balance-of-payment problems, provided that their economic policies are sound. May be used under many different circumstances, for example when a country is affected by regional or global economic and financial stress. Rapid Financing Instrument (RFI). This is a quick bail-out mechanism for acute balance-of-payment problems. Used in case of various economic shocks, such as commodity price shocks or natural disasters. Extended Fund Facility. Available to countries with longer-term structural balance-of-payment problems. Trade Integration Mechanism. Available to emerging market countries affected during a transitional period by multilateral foreign trade liberalisation.

outlined above, what might be suitable in case of future need is for Lithuania to apply for the new PLL agreement.

Modest upturn in Lithuanian CDS rates

The financial market also seems to believe that Lithuania is not moving towards a crisis situation. In the past six months, prices of credit default swap (CDS) contracts for Lithuania have shown moderate increases and have not surged higher in response to growing worries about possible future defaults in countries like Ukraine and Hungary. Lithuanian CDS rates have moved in tandem with Latvian ones and have also largely tracked Polands CDS rates, although the gap between Lithuania-Latvia and Poland has recently widened somewhat. For some time, Estonia has maintained low, stable CDS contract prices. The reason is that Estonia has among the strongest public sector finances in Europe, with a balanced budget and debt of a mere 6 per cent of GDP.
10-year CDS in Central and Eastern Europe
Basis points
1000 900 800 700 600 500 400 300 200 100 0 jan 1000 900 800 700 600 500 400 300 200 100 0 mar maj jul 11 sep nov jan 12

Lithuania Latvia

Poland Hungary

Ukraine Estonia
Source: Reuters EcoWin

Mikael Johansson, Economic Research + 46 8 763 80 93

IMF thus has a variety of loan mechanisms. As indicated, in recent years the IMF has adopted a more flexible approach to the needs of different countries. An SBA seems very unlikely for Lithuania, since no new economic crisis seems imminent. Of the six IMF mechanisms