Lithuania is on the brink: the beginning of next year will be crucial

„The budget partly reflects the electoral cycle. We see a very aggressive overall budget deficit of almost 3% of gross domestic product (GDP). This is a hair's breadth away from the Maastricht criteria“, believes Alexander Izgorodin, an economist at Citadele Bank. He stressed that the first half of next year will have to be handled with extreme caution.

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Nov 21, 2023, 10:19 AM

Encourages caution

„We see quite aggressive spending growth next year – close to 8%. Almost €1 billion will be spent on raising personal income.

While these are the right objectives, they are also linked to next year's elections.

How reasonable is the forecast for revenue growth? In next year's budget, expenditure is projected to increase by 9.4%. This is twice as fast as Lithuania's nominal GDP.

„My understanding is that this will be the main challenge. I am not saying that it is impossible. Still, given the risks of the macroeconomic situation in Lithuania and the eurozone for next year, it will not be easy to ensure a 9.4% growth in budget revenues,“ the economist said on the Lietuvos Rytas TV programme New Day.

We need to monitor how efficiently the state collects taxes.

It is also necessary to borrow carefully and to plan additional spending cautiously, as changes to the European Commission's fiscal rules prohibiting European Union (EU) countries from running a budget deficit of more than 3 per cent have come into force from next year.

While we have been living freely in recent years, the EU is now taking a tougher line on fiscal policy.

Who needs stricter rules? The coronavirus pandemic has pushed EU countries deeper into debt, making debt levels intolerable.

In addition, the money supply in the EU economy has increased sharply, leading to higher inflation.

This means that markets will be looking at the fiscal situation of all EU countries next year. If Lithuania's budget deficit exceeds 3% next year, the cost of borrowing on the markets will increase.

The outlook for economic growth is also weakening. In the summer, we said Lithuania's GDP would grow by 3%, now 2.3%. „We see that the impact of interest rates on economies is not immediate – we are seeing much slower growth in both the US and the euro area economies, so we have lowered the macro forecast,“ he said.

How can a country's income change if the tax administration system is not improved? According to him, we could talk about a 5% to 6% increase from around €17 billion, which would be a similar increase in nominal GDP but not twice as much as the forecasts currently paint.

He said that even if Lithuania loses this amount, it should not be too much of a surprise. In a worst-case scenario, Lithuania could ask the European Central Bank (ECB) to intervene in the financial markets. However, he stressed that this would be a very extreme case.

On the contrary, it is already possible to talk about a faster recovery of the Lithuanian economy. Let's say that industrial indicators are improving.

After a couple of members of the Freedom Group supported the Workers' proposal to remove the draft budget for next year from Tuesday's Seimas agenda, the elder of the Freedom Group, Vytautas Mitalas, says that he does not take this situation seriously. He said the vote should not be linked to tensions within the ruling coalition.

How flexible is this budget for last-minute proposals? The economist is confident there will be such proposals, but there is no scope for increasing spending.

„We are already within a hair's breadth of the 3% of GDP budget deficit limit“, Izgorodin continued. He notes that the first half of next year will be the riskiest, as the impact of interest rate hikes could be more damaging than analysts expect.

Already foreseeing when interest rates will fall

However, according to the economist, there is about a 40% chance that the ECB will cut interest rates in June or July next year. However, it is expected that the rate cuts will be gradual.

Regarding the world economy, he mentioned that the US economy remains robust, which is vital for the German industry, the largest export market for Lithuanian industry.

In Lithuania and the euro area, there are signs that industry will pull the economies further upwards.

It is also important to mention the actions of the ECB. From an economist's point of view, the peak in interest rates is now in the past.

He also looked on the less positive side. „The only downside risk is that the central banks will overdo it with interest rate hikes, both in the euro area and in the US economy, which sooner or later will not be able to withstand it, and there are signs of that. In the German construction sector, for example, 40% of companies surveyed by the European Commission are already complaining of a lack of demand,“ he explained.

At the time of the global financial crisis, 36% of firms were such.

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