DBRS Morningstar Confirms Republic of Lithuania at “A”, Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Lithuania’s Long-Term Foreign and Local Currency – Issuer Ratings at “A”. At the same time, DBRS Morningstar confirmed the Republic of Lithuania’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings is Stable.

KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar’s assessment that the risks to the ratings remain broadly balanced, even when confronted with the current crisis. As a reminder, on May 22, 2020, DBRS Morningstar changed the trend on Lithuania’s ratings to Stable from Positive to reflect the downside risks to Lithuania’s near term fiscal and debt outlook from the Coronavirus Disease (COVID-19) shock. The abrupt shock from the pandemic will make its mark on the economy. However, the contraction this year is expected to be less pronounced than in most other euro area countries. Strong signs of recovery started to emerge with the lifting of the restrictions in June, although uncertainty remains high and the strength of the recovery will depend on Lithuania’s ability to contain new outbreaks of the virus and on how it will affect its main trading partners.

The “A” ratings are underpinned by Lithuania’s otherwise sound fiscal position and its low public debt ratio. The sizeable fiscal package to mitigate the impact of the pandemic will increase the deficit and place the public debt ratio on an upward trend. However, Lithuania’s sound fiscal position in the years prior to the crisis and the relatively low debt compared to its euro area peers allows the authorities space to provide stimulus to cushion the impact of the COVID-19 shock. Lithuania’s euro system membership is another key credit strength. The EU’s Recovery and Resilience Facility will likely allocate EUR 2.4 billion (5.0% of 2019 GDP) of grants to Lithuania and this could help raise growth potential. Nonetheless, credit challenges remain related to structural factors including income inequality; the need for further productivity improvements; the declining and ageing population; and economic informality.

RATING DRIVERS

Factors that could lead to an upgrade include one or more of the following: (1) evidence of continued economic resilience (2) continued effective fiscal response to address the COVID-19 crisis, coupled with measures to preserve long term fiscal sustainability (3) successful implementation of reforms that increase growth potential.
Factors that could lead to a downgrade include: (1) failure to stabilize the public sector debt ratio in the longer term, or (2) the emergence of significant macroeconomic imbalances.

RATING RATIONALE

The Restrictive Measures Will Lead to an Economic Loss in 2020 But Milder than in Most Other Euro Area Countries

After the recent resurgence in COVID-19 infections the Lithuanian authorities imposed a three-week national lockdown in an attempt to contain the spread of the virus. As of November 19, Lithuania’s cumulative 14-day infection case number stood at 741.5 per 100,000 people. The second national lockdown started on 7 November and the containment measures will be in place until at least the end of the month. The measures, which are less stringent than in Spring 2020, include closures of restaurants and bars, a ban on public gatherings and restrictions on movement for non-essential reasons.

The economy contracted by 4.6% year-over-year in the second quarter of 2020 due to the halt of economic activity from mid-March until the end of May. The coronavirus pandemic has affected the economy through various channels. The closure of businesses and mobility restrictions have negatively affected private consumption and investment, whilst travel restrictions and closure of borders combined with depressed global demand triggered a drop in exports of goods and services. However, the impact of the pandemic on the Lithuanian economy has been lower than initially anticipated and more moderate than in the rest of the euro area. This is due to the comparatively low infection rates that allowed the smooth reopening of the economy, the lower reliance on tourism-related activities and the support measures introduced by the government. The Ministry of Finance in its 2021 Draft Budgetary Plan forecasts a -1.5% contraction in 2020.

After the easing of restrictions strong signs of recovery emerged with preliminary estimates pointing to a moderate -1.7% year-over-year decline in seasonal and work day adjusted GDP in the third quarter of 2020. However, the newly imposed restrictions in Lithuania and the resurgence of cases in its main trading partners could dampen the outlook. In the context of a highly uncertain environment, the Ministry of Finance estimates that the economy will grow by 3.3% in 2021 as exports and investment are expected to recover. In addition, the government approved in June a national development plan consisting of new and previously agreed investments amounting to EUR 6.3 billion (13% of 2019 GDP), which is likely to enhance the future growth prospects of the Lithuanian economy.

Current Account to Remain in Surplus But Recovery Depends also on EU Trade Partner Performance

Given Lithuania’s small and open economy the pace of recovery will depend also on how the crisis impacts Lithuania’s main trading partners. In terms of the external accounts, since 2009, Lithuania’s external position has strengthened significantly, with its current account position shifting from a 15.0% deficit-to-GDP ratio in 2007 to a 4.3% surplus in 2019. Lithuania’s strong external performance has been supported by strong exports of services and a positive secondary income balance. Despite the crisis, the current account is expected to remain in positive territory in 2021 and 2022. From a stock perspective, a net international investment liability position of 60% of GDP in 2009 has decreased to 22.8% at the end of June 2020.

Extraordinary Fiscal Measures Will Result in a Sizeable Fiscal Deficit and an Increase in Public Debt

In response to the pandemic, the government introduced a combination of economic and financial measures to support households and businesses, amounting to 6% of GDP. Measures announced so far include additional spending for the health system and measures to preserve jobs and household income, and government guarantee schemes for agriculture and SMEs. In addition, the government has established a fund with a target of EUR 1 billion to provide liquidity to medium and large sized enterprises to accelerate public and private investment.

The support package to mitigate the impact of the pandemic will lead to a sizeable fiscal deficit in 2020 and 2021, at 8.8% of GDP and 5.0% respectively, as estimated by the Ministry of Finance. Despite the higher expected fiscal deficits, since 2014 Lithuania has strengthened its budget benefiting from its euro area membership and the EC’s economic governance remaining committed to a prudent fiscal strategy.

However, the coronavirus shock adds to Lithuania’s key fiscal challenges, including its ageing population and tax evasion from Lithuania’s informal economy. Lithuania has one of the fastest ageing populations in the EU with the old-age dependency ratio (15-64) expected to rise to 63.9% in 2060 from 29% in 2016 according the EC. Moreover, Lithuania’s informal economy, which is measured as one of the largest relative to the size of its economy among EU countries, remains pervasive and obstructs a more efficient allocation of resources.

The public debt-to-GDP ratio is set to increase this year due to the economic downturn and higher fiscal deficits.
Given the increased financing needs for the implementation of the Economic and Financial Action Plan to tackle the economic implications of the pandemic, Lithuania has increased its borrowing limit to an additional EUR 5.4 billion. Public debt is set to increase from 37.7% of GDP in 2019 to 48.3% in 2020 according to the IMF’s forecast. The government applies a conservative debt management strategy of extending debt duration in a low yield environment. The weighted-average term to maturity of central government debt was 10.8 years at end-August 2020. Almost all central government foreign debt is fixed rate and all the debt is in euros. The favorable environment in the international bond markets have led to a further decline in interest costs to 0.9% in 2019 of GDP from 1.5% in 2015.

Covid-19 Pandemic Will Put Banks Under Pressure, However Risks to Financial Stability Appear Contained

Lithuania’s banking system entered the crisis with strong profitability, sound capitalization, with the CET1 ratio standing at 22.4% in Q2 2020 and a good liquidity position. To maintain credit supply to the economy and to mitigate the effects of the pandemic, the Bank of Lithuania has reduced the counter-cyclical capital buffer (CCyB) from 1% to 0% allowing banks to provide liquidity to businesses and individuals. Most of the banking sector is foreign-owned, therefore, spillovers from parent Nordic banks due to the pandemic pose a risk to Lithuania’s financial stability. However, the Bank of Lithuania’s stress test exercise assessing different scenarios of severity in economic contraction in 2020 and 2021, indicate that the Lithuanian banking sector could weather the economic shock caused by the pandemic. Moreover, private sector debt is relatively low. The debt-to-GDP ratio of non-financial corporations amounted to 38.3% and the household debt-to-GDP ratio was 23.8% at the end of June 2020. In total, the Bank of Lithuania, in order to support banks’ lending capacity, announced measures to reduce capital adequacy requirements, liquidity reserves and other supervisory measures worth EUR 2.5 billion.

DBRS Morningstar Expects Policy Continuity From the New Centre Right Coalition Government.

The parliamentary elections held in October 2020 delivered a victory for the center right party Homeland Union. DBRS Morningstar views that the new coalition government, formed by three centre-right parties, will likely maintain policy continuity, as successive multi-party government coalitions have helped to promote stable policies and institutions. EU and NATO membership are likely to provide a broadly stable political environment for Lithuania, but unexpected geopolitical shifts in Europe could pose significant risks. Nonetheless, Lithuania performs strongly in the World Governance Indicators.

ESG CONSIDERATIONS
Human Capital and Human Rights (S) is a key driver behind this rating action. Compared with its euro system peers, productivity and human capital as measured by Lithuania’s per capita GDP is relatively low at $19,482 in 2019.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/370306.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in Euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The principal methodology is the Global Methodology for Rating Sovereign Governments (July 27,2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments.

The sources of information used for this rating include: Ministry of Finance (Economic Development Scenario September 2020, Investors Presentation July 2020, Bank of Lithuania (Financial Stability Review 2020), International Monetary Fund October 2020, OECD, European Commission (Autumn 2020 Economic Forecast), Bank for International Settlements, European Centre for Disease Prevention and Control, United Nations Development Program (UNDP), Eurostat, Stockholm School of Economics in Riga, Lithuania Department of Statistics, European Central Bank, World Bank, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/370277.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Nichola James, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Rating Committee Chair: Thomas Torgerson, Managing Director, Co-Head of Sovereign Ratings, Global Sovereign Ratings
Initial Rating Date: July 21, 2017
Last Rating Date: May 22, 2020

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