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The Lithuanian economy has started to recover modestly, with the stabilisation in the economy backed mainly by strong export growth, writes Nordea Markets in its new Baltic Rim Outlook, the Baltic Business News portal informed.

The main worry remains private consumption, which has continued to edge down. Although retail sales figures are showing a modest return to growth, domestic demand has yet to find proper foothold.

We expect to see the economy returning to modest growth this year, but a proper expansion will not be seen until 2011-2012. A gradually strengthening recovery requires a continued rebound in external demand, helping Lithuanian exports.

The level of exports is already very close to the highs of 2008. Thus exports are currently the main engine of growth, boosting industrial production as well as employment.

Future growth in exports remains dependent on the recovery in Lithuania’s main trade partners: the EU, especially the neighbouring countries, and Russia. The global recovery prospects for next year remain very uncertain.

For a more sustained recovery an improvement in domestic demand would be very welcome. It is important that domestic demand gains strength, so that private consumption can substitute some of the possibly waning export growth.

We expect to see private consumption recovering further over the next year. There are some indications that unemployment is finally turning towards a slow decline, which should help consumption. Unemployment expectations in the consumer confidence index have also encouragingly declined quite clearly from their peak. In addition, the declines in wages are slowing, further removing one drag from the outlook for consumption.

The improving economic situation has also helped consumer confidence to rise fairly strongly this year. Households see both the general economic situation and the financial situation of households as less dire over the next 12 months than earlier. The consumer confidence index points towards increased spending, but this requires more decisive improvements in employment and incomes.

Inflation still at modest levels
After a very short deflationary dip Lithuanian consumer prices has turned back to growth. Inflation has been boosted by accelerating food, electricity, alcohol and tobacco prices. The decline in wages is also starting to reverse, giving a further boost to inflation. In addition, the tax hikes implemented to cover the budget deficit
have supported consumer prices. As long as unemployment remains high and the domestic economy weak, inflation is unlikely to accelerate significantly. Thus inflation is seen remaining weak over our forecast horizon.

Considering euro adoption the earliest possible target date at the moment seems to be 2014-2015. A later date appears, however, more probable in the current circumstances.

First of all, enough fiscal discipline to cut the deficit to below 3% of GDP in 2012 is needed. This requires some tough political decisions, but is likely to be rewarded through a stronger credit rating and thus lower borrowing costs.

Budget cuts still needed
As the most severe stage of the crisis has been passed focus has shifted to the longer term structural changes needed to balance the budget and improve the effectiveness of the public sector. A crucial question is how to increase government revenues without hiking taxes significantly, which would result in limiting the households’ purchasing power.

Spending has been cut vigorously, but in order to reach a balanced budget, higher government revenues would be welcome. The budget deficit for 2009 was recently corrected to show a larger than anticipated shortfall of 9.2% of GDP. The road to a balanced budget, or even a deficit below 3% of GDP, is thus still very long. The risk is that with foreign finances readily available at a currently reasonable cost and the economy recovering the motivation to take politically harsh decisions could wane.

This could be especially pronounced in late 2011 ahead of the parliamentary elections in 2012. However, the encouraging result in the Latvian elections in early October supports the current fiscal consolidation path in Lithuania as well. Making the situation potentially more difficult is that the government recently lost the support of a small opposition party. Without that support the government is now two seats short of a majority. Unless the government finds new support this could make it harder to push through new fiscal consolidation measures in the
2011 budget.

Lithuania needs to stabilise its government finances mainly because it needs to safeguard its credit rating, strive towards sustainable growth and fulfil its aim of joining the euro area within the foreseeable future. So far the government has managed without help from international lenders, and has been able to borrow money on the international financial markets. Currently the government is planning to raise approximately LTL 2.3bn from the international financial markets next year.

However, for the international markets to remain accessible credibility in the economy needs to be maintained.