OECD Economic Outlook, Volume 2023 Issue 1

Lithuania

GDP is projected to stagnate in 2023 and rebound to 2.6% in 2024. High inflation will continue to weigh on private consumption. A weak outlook for global trade, uncertainty and geopolitical tensions affecting key trading partners will contribute to a sharp slowdown in exports. Inflation will start to ease with lower import prices for gas and oil. Public investment, strengthened by EU funds, will support growth. Unemployment is projected to increase slightly in the near term but wage growth is likely to remain robust due to labour shortages.

Fiscal policy support has helped households and firms with elevated energy costs. Support measures should become increasingly targeted on those not sufficiently protected by the general social protection system. Improving the quality of compulsory education would help to reduce skill-mismatches, while better management of state-owned enterprises would support productivity. Complementing emission reduction efforts with a carbon tax would both reduce the dependency on oil and gas imports and support the green transition.

The economy is slowing in face of headwinds

Economic activity slowed in the second half of 2022, as the impact of increasing inflation, uncertainty from geopolitical tensions, rising interest rates and deteriorating business confidence began to materialise. GDP declined by 2% in the first quarter of 2023 relative to the final quarter of 2022. Headline inflation stood at 13.3% in April 2023. Business confidence fell throughout 2022 and was again negative in the early months of 2023. Manufacturing production recorded a 8% contraction in February 2023 and retail sales contracted in the first three months of 2023. Unemployment has increased slightly but remains below the long-term average, wage growth remains robust and labour costs are rising.

Lithuania: Confidence and inflation indicators

Source: Eurostat, Business Confidence Indicators; and OECD, Consumer Prices database.

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Lithuania: Demand, output and prices

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The ongoing re-orientation towards new trading partners has substantial economic costs. Replacing energy imports from Russia, which accounted for 73% and 42% of oil and gas imports, respectively, in 2020, has contributed to the highest inflation in 25 years, exacerbating the effects of rising food prices. Supply chain disruptions are weighing on activity as Belarus and Ukraine are important for the supply of some intermediate goods, such as metals and wood. Up to March 2023, almost 80,000 Ukrainian refugees have been registered for temporary protection.

Energy and price falls will ease public spending

Fiscal policy will be broadly neutral in 2023 and mildly restrictive in 2024. To ease the burden of inflation, the government extended a zero VAT rate on district heating for two more winter seasons in September 2022. In December 2022, a partial compensation of electricity and natural gas prices for consumers was extended until mid-2023. Lower energy prices are now reducing the fiscal cost of these measures and in conjunction with fewer benefit applications from new refugee arrivals, this will reduce public spending, despite rising defence outlays. Looking ahead, support should increasingly move away from general price compensation towards more targeted measures to assist vulnerable households, before eventually being phased out. Investment will be boosted by a quicker implementation of projects tied to the EU Recovery and Resilience plan, in addition to European Green Deal projects. Tighter monetary conditions are cooling the housing market and leading to a slowdown in investment. The number of building permits has been in decline, down 26% over 2022.

Inflation will restrain growth

GDP will stagnate in 2023 due to historically high inflation, which however will come down over 2023 and 2024 under the impact of tighter monetary policy and lower energy and food prices. Export growth will weaken due to the uncertainty from geopolitical tensions in key trading partners. Weakening business confidence and high levels of uncertainty will slow business and real estate investment. Public investment will partially counteract this with an accelerated deployment of EU funds, albeit at the risk of adding to inflationary pressures. Wage growth will become more moderate under the impact of a modest upturn in unemployment. Nevertheless, there are still considerable issues with skills shortages and employers are reluctant to release staff and rely on future hiring. GDP will rebound in 2024 as declining energy prices ease headline and eventually core inflation, leading to a recovery in consumption and exports. The main risk is slower than expected reductions in inflation that cut into confidence and growth.

Securing stronger and more sustainable growth

Persistent skills mismatches and low educational outcomes are increasingly holding back growth and earning opportunities and could be addressed by renewed policy efforts to improve the quality of compulsory education, including through better teacher training. Effective career guidance in schools and universities could help to reduce gender imbalances in STEM fields. Given the significant role of state‑owned enterprises, a more transparent regulatory framework and improvements in management and governance of these enterprises would support productivity. Complementing emission reduction efforts with a carbon tax would both reduce the dependency on oil and gas imports and support the green transition. Such a tax could gradually align carbon prices across sectors, including those that are not covered by the European Emission Trading System.