Standard & Poor’s Ratings Services said today it revised its outlook on the Republic of Lithuania to negative from stable, due to a pick up in domestic demand in the first part of 2007, increasing the likelihood of a hard landing for the country’s economy. At the same time, Standard & Poor’s affirmed its long-term ‘A’ and its short-term ‘A-1’ sovereign credit ratings on the republic.
“The high annual growth rate of more than 7% in the past few years will raise Lithuania’s comparatively low GDP per capita, estimated at $11,000 in 2007,” said Standard & Poor’s credit analyst Eileen Zhang. “The surge in disposable income, as well as rapid credit expansion, continues to stimulate strong domestic demand growth in 2007, after some signs of cooling in the second half of 2006. As a result, macroeconomic imbalances are again building up in the economy.”
Given the very limited scope of monetary policy under a currency board regime, fiscal policy is the main macroeconomic instrument in demand management. Although conservative budgeting has allowed Lithuania to achieve low deficit and debt levels in recent years, this has been insufficient to dampen demand pressures during the period of economic overheating.
The ratings are constrained by limited external liquidity, which could be mitigated if Lithuania joins the Eurozone. Inflationary pressures are likely to persist, however, pushing EMU membership to 2011 or 2012.
“The negative outlook on Lithuania reflects the increasing risk of a hard landing faced by the Lithuanian economy as domestic demand regains pace after some degree of slowdown in the second half of 2006,” said Ms. Zhang.
If the government fails to tighten its fiscal stance and implement additional measures to tame domestic demand, the external imbalances would build up further and the ratings on Lithuania could be lowered.
Conversely, the government could tighten its fiscal stance in the short term to restrain domestic demand and to reduce inflationary pressures, and the banks could tighten their lending policy to reduce credit growth. This would allow macroeconomic imbalances to unwind in a gradual and orderly fashion, and the outlook could be revised back to stable.
