IMF Concludes Article IV Consultation With Lithuania

by Ulrika Lomas, for LawAndTax-News.com, Brussels

29 April 2008

The International Monetary Fund has released details of its Article IV consultation with Lithuania, which concluded on 16th April.

The IMF observed that economic performance over much of the past decade has been very strong, reflecting in part broad macroeconomic stability. The growth rate of real GDP per capita has been one of the highest among emerging market countries, inflation one of the lowest, and the unemployment rate has declined.

These favorable developments have been supported by EU accession, rapid financial integration, and generally sound macroeconomic policies, including the currency board arrangement, the low and declining level of public debt, and relatively flexible labor and product markets.

Although the IMF's Executive Directors commended Lithuania's impressive economic performance over much of the past decade, citing the factors mentioned above, they raised concerns about the recent rise in external and internal imbalances, characterized by an unsustainable current account deficit and an increase in domestic inflationary pressures, resulting from excess domestic demand.

Directors observed that these imbalances will need to be reduced significantly over the medium term in order to contain external vulnerabilities. They also noted that, although the level of the real effective exchange rate is still broadly appropriate, continued rapid wage growth could erode competitiveness. Given the currency board arrangement, Directors stressed that fiscal and structural policies hold the key to stabilization and growth.

Looking ahead, the Directors suggested that tightening financing conditions would lead to an orderly easing of imbalances in 2008-09, and concurred that a soft landing of the economy is the most likely scenario. Given tighter bank lending standards and the cooling of the housing market, a substantial slowdown in credit growth is likely.

Directors welcomed the planned tightening of fiscal policy in 2008, and suggested additional fiscal contraction to support a soft landing. They recommended that the government start preparing for further fiscal consolidation in 2009, with the goal of achieving cyclically-adjusted balance by 2010.

They further urged the government to resist pressures to cut taxes, introduce new exemptions or tax credits, or raise spending in the run up to the October 2008 elections. They welcomed the new fiscal responsibility law, and supported the government's plans to further enhance transparency and reduce the risk of procyclicality in an economic upturn. They also encouraged the authorities to give priority to increasing government efficiency within the context of a medium term fiscal strategy.

The IMF officials emphasized that the priorities for bank supervision are to maintain high lending standards and strong risk management and to increase capital buffers. They welcomed the findings of the Financial Sector Assessment Program (FSAP) update, namely that indicators of the banking system's soundness are generally satisfactory and are expected to remain so under the soft landing scenario.

The Directors observed that the regulatory and supervisory framework for banks is in line with international standards, and that the Bank of Lithuania conducts effective supervision of all banks operating in Lithuania. They welcomed the Bank of Lithuania's measures in recent years to strengthen banks' capital bases and encourage strong risk management.

They also noted that the dominance of reputable foreign banks supports the banking system's resilience but also exposes Lithuania to the risk of financial contagion. Nevertheless, given the potential impact of low-probability extreme events on the banking system, Directors recommended that banks' capital buffers be raised and that contingency plans, including credit lines, in the event of liquidity shocks be further discussed with banks, parent banks, and home country authorities.

With regard to the non-bank financial sector, Directors urged the authorities to improve supervision given the rapid growth of assets and the increasing sophistication of financial institutions.

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