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      FRIDAY, 28/04/2023 - Scope Ratings GmbH
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      Scope affirms Lithuania's credit ratings at A and revises the Outlook to Stable from Positive

      The country's prolonged exposure to the cost-of-living crisis amid higher geopolitical risk drives the Outlook revision. The economy's resilience and a sound fiscal position support the ratings.

      For the updated rating report, click here.

      Rating action

      Scope Ratings GmbH (Scope) has today affirmed the Republic of Lithuania’s (Lithuania) long-term issuer and senior unsecured local- and foreign-currency ratings at A and revised the Outlook to Stable from Positive. Scope has also affirmed Lithuania’s short-term issuer ratings at S-1 in both local and foreign currency and revised the Outlook to Stable, from Positive.

      Summary and Outlook

      The revision of the Outlook to Stable from Positive on Lithuania’s A credit ratings reflects prolonged effects of the present cost-of-living crisis and heightened geopolitical risks on economic and fiscal fundamentals. In the absence of rapid resolution of the conflict between Russia and Ukraine, such challenges have reduced the likelihood for a credit rating upgrade in the near term despite significant economic resilience demonstrated to date by Lithuania.

      Lithuania is exposed to the cost-of-living shock, with the crisis’ persistent ramifications affecting growth and external-sector competitiveness alongside government finances. In view of its history and geography, Lithuania is especially at risk amid heightened geopolitical tensions following Russia’s invasion of Ukraine, although a direct military action against Lithuania and Baltic states remains a low likelihood and a tail risk affecting the ratings. Nevertheless, geopolitical risks have risen sufficiently as to be meaningful since the Positive Outlook was assigned in December 2021.

      The Outlook revision reflects updated Scope assessments of Lithuania under the ‘domestic economic risk’ and ‘public finance risk’ categories of its sovereign methodology.

      The affirmation of Lithuania’s A long-term ratings is underpinned by significant credit rating strengths including: i) sound institutions, anchored by euro-area and NATO memberships, which ensure a robust framework for fiscal and economic policy making alongside mitigating external security risks; ii) improved economic resilience and a solid medium-run growth outlook, underpinning an expectation for continued convergence of income levels to euro-area averages over the coming years; and iii) a sound fiscal position with only moderate public debt levels – fundamental for strong debt affordability despite fiscal costs of the economic crisis and higher financing costs for the government following rapid tightening of ECB monetary policies in the past months.

      The main challenges for the ratings are: i) still moderate income levels, despite continued convergence of income towards euro-area averages over past decades; ii) exposures to external shocks given the small size and openness of the economy; iii) adverse demographic trends exacerbating labour-market shortages and fiscal pressures; and iv) financial-sector risks related to the system’s dependence on Nordic banks and elevated cross-border financial flows.

      The Stable Outlook reflects Scope’s view that risks to the ratings are balanced over the next 12 to 18 months.

      The ratings/Outlooks could be upgraded if, individually or collectively: i) geopolitical risks affecting the region moderated significantly; ii) solid economic growth and continued income convergence were maintained via reform implementation and investment; iii) the public debt-to-GDP ratio continued its declining trajectory, supported by balanced government finances medium run; and/or iv) external- and/or financial-sector vulnerabilities continued to moderate.

      Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) fiscal fundamentals weakened, resulting in a significant rise in the debt-to-GDP ratio medium run; ii) macroeconomic imbalances rose, weakening growth prospects; iii) external- and/or financial-sector vulnerabilities rose substantially; and/or iv) geopolitical risks rose further, undermining macroeconomic stability.

      Rating rationale

      The revision to Stable from Positive for the Outlook on Lithuania’s A credit ratings reflects prolonged effects of the cost-of-living crisis and heightened geopolitical risks affecting the economic and fiscal outlooks.

      Lithuania is exposed to the cost-of-living crisis, as reflected in high inflation, an economic slowdown and wider current-account deficits over recent months. In view of its history and geography, Lithuania is comparatively exposed to heightened geopolitical tensions following Russia’s full-scale invasion of Ukraine, although a direct military action against Lithuania remains a low likelihood and a tail risk affecting the ratings. Still, geopolitical risks have risen non-negligibly since the escalation of the war in Ukraine and already require significant fiscal outlays for the strengthening of external and energy security.

      Lithuania’s economy has proven significantly resilient since the Covid-19 pandemic crisis. In 2021 and 2022, GDP grew 6.0% and 1.9%, respectively, and did not contract (0%) in 2020. However, the slowdown last year was meaningful. Calendar-year growth was driven mostly by carry-over effects from 2021, with quarterly growth being negative (-0.1%) on average, driven by weakened private consumption and net exports. Tight financing conditions will weigh on growth in 2023. At the same time, energy-price inflation has moderated while the deployment of EU funding will support investment, which should help avert recession. A rapid economic rebound is unlikely, however. Scope expects GDP growth of 0.5% and 2.8% in 2023 and 2024, respectively.1

      Lithuania, alongside other Baltic states, is heavily affected by exceptional inflationary pressures owing to a large share of energy and food items in its consumption basket and deregulation of gas and electricity markets. A continued normalisation of this pressure over the coming months is likely, however, following the marked decline in energy-price inflation and rapid tightening of monetary policies. However, inflation will remain exceptionally high this year, affecting growth via an erosion of purchasing power (within a context of still moderate nominal incomes) and strong wage-increase pressures (weakening external-sector competitiveness). Harmonised inflation stood at 15.2% YoY in March 2023, easing from peaks of 22.5% as of September 2022. Core inflation is also declining, although from high levels (of above 12%) and only at a moderate pace. Scope expects annual inflation to decline to about 9.0%, from 18.9% in 2022, before approaching the ECB’s 2% objective by 2024-2025.2

      Lithuanian exports have gained global market share over past years thanks to improvements in their value-added structure. A decreasing importance of Lithuanian trade with Russia has mitigated effects of trade sanctions and counter-sanctions between the EU and Russia, as most Lithuanian exports to the latter were re-exports even before the Russia-Ukraine war escalated. The current account, however, weakened significantly last year following a rapid rise in commodity prices – turning to a 5.1% of GDP deficit from a 1.1% surplus of 2021. In the coming years, Scope expects the current account to recover but remain in deficit of 2-3% of GDP due to persistent pressure from elevated energy and commodity prices, and the effect of high inflation on external-sector competitiveness.

      Said shocks are furthermore affecting government finances. Before the Covid-19 crisis, fiscal performance was sturdy with the budget consistently in surplus. Fiscal recovery from the Covid-19 crisis was furthermore rapid: with the deficit narrowing to 1.2% of GDP in 2021 from 6.5% in 2020. While the deficit was restrained to only 0.6% of GDP in 2022, combined effects of Russia’s war in Ukraine and the associated cost-of-living crisis are expected to keep the budget in deficit over coming years. The escalation of conflict in Ukraine has been costly for the government of Lithuania, requiring spending to reinforce energy and external security, support refugees and help households and businesses cope with the crisis. While last year the budget benefitted from rapid revenue growth boosted by elevated nominal output growth, the impact on government spending because of high inflation, such as vis-à-vis civil servant wage increases and the higher cost of healthcare and education, will be felt for years, requiring higher borrowing under presently less favourable financial market conditions.

      This year, Scope expects about 1pp of GDP of outperformance against a budget-balance target of -4.9% of GDP, in view of energy-support measures being unlikely to be used in full. Scope furthermore expects a rapid recovery in 2024-25 as about half of the 2023 deficit relates to temporary measures, even though the deficit will remain around 2% of GDP. The government budget would then converge around a 1% of GDP deficit by 2028, although low social spending amid high inflation and the burden of an ageing population could slow budgetary consolidation further. Such pressures could be dampened by budgetary-process reforms aimed at strengthening tax collections and the efficacy of public spending, which are important given a still-sizeable shadow economy and restricted tax base. Recently-announced reforms to expand property taxes and limit selective tax exemptions could also help.3,4

      Direct military risk from Russia or its allies remains very low due to Lithuania’s strong international alliances. Still, external security risks have risen meaningfully since the Russia-Ukraine war escalated. Lithuania shares borders with Russia and Belarus, and tensions could intensify quickly, such was the case during the imposition of sanctions between the EU and Russia and following Russia’s announcements of escalation dangers such as plans to construct storage facilities for nuclear weapons in nearby Belarus.

      The affirmation of the ratings at A reflects significant credit strengths including sound institutions, underpinned by euro-area and NATO memberships, ensuring a robust framework for fiscal and economic policy making, and mitigating external security risks.

      Lithuania’s ratings benefit from effective policy making anchored by EU and euro-area memberships. Said memberships provide a sound and credible framework for economic, fiscal and monetary policy making, conferring the benefits of issuing in a reserve currency for Lithuania’s economy. The reserve-currency status of the euro is especially relevant for economic resilience when markets are volatile. Euro-area membership furthermore ensures sound banking-sector supervision. Together with ample access to and efficient absorption of EU funding for public investment, said memberships have supported the country’s significant economic convergence over the recent years and provided support for continued modernisation and technological development. GDP per capita was above 60% of the euro-area average as of last year, a rise from 32% in 2010. Measured under purchasing power parity standards, GDP per capita is above 85% of the euro-area average.

      The NATO memberships of Lithuania and peer Baltic states significantly reduce the risk of Russian aggression expanding to the Baltics region. Lithuania’s security guarantees are underpinned by Article 5 of the NATO Treaty, stating an armed attack on one NATO member state constitutes an armed attack against all, requiring support – such as armed support. Both NATO and Lithuania have continually affirmed their commitments to Article 5.

      The affirmation of the A long-term ratings also reflects the country’s improved economic resilience and solid medium-run growth prospects, underpinning an expectation of continued income convergence against euro-area averages over the coming years.

      This economic resilience was demonstrable during recent global shocks such as the Covid-19 pandemic crisis and since Russia’s full-scale war in Ukraine. This is supported by an ongoing economic shift from lower value-added sectors to more technology- and knowledge-intensive industries of information, technology and cyber security, and financial services. Sound economic policies and a stable business environment also support continued convergence of productivity towards euro-area averages. In the medium run, Scope estimates growth potential of a robust 2.5%, underpinned by access to EU funding, which exceeds 22% of (2021) GDP over 2021-27 (aggregating funding from the Recovery and Resilience Facility, Cohesion Fund and Common Agricultural Policy). The Russia-Ukraine war is having both direct and indirect adverse impacts on the Lithuanian economy, primarily owing to the inflation shock, shortages of raw materials and weaker economic growth of main trading partners. At the same time, Scope does not expect the conflict to cause permanent economic scarring, abetted by a continued improvement of energy security allowing for rapid and complete substitution of Russian energy imports. Furthermore, the connection of the Baltic states’ and continental Europe’s electricity networks is due for completion by 2025, with synchronisation under emergencies already possible.5

      The country’s economic progress also benefits from a flexible and inclusive labour market. Employment was at a record high in Q4 2022, of above 1.4m workers. This was supported by record net migration, mainly from Ukraine, with such persons being swiftly integrated into the labour market. Labour-force participation remains high, with the active population at close to 80% of the aggregate labour force, while the unemployment rate is moderate at 6.5%. As economic growth will stay subdued, Scope expects the unemployment rate to stabilise around an average of 6.5% over 2023-2024.

      The A ratings are also underpinned by a sound fiscal position given an historical record of balanced budgets and moderate public debt levels, anchoring strong debt affordability despite the fiscal costs of recent economic crises and presently higher financing costs.

      The sovereign’s record of prudent fiscal policies has resulted in the government having one of the lowest debt-to-GDP ratios of the euro area, at 38.4% as of end-2022. Moderate budget deficits and resilient economic growth should keep said debt ratio on a declining path medium run. Scope anticipates the general government debt to slightly rise to 39.5% of GDP this year – (only) 3.7pp above the level from before the Covid-19 crisis. The public-debt ratio should thereafter stabilise around 40% of GDP over 2024-2026 before slightly declining to 38.5% by 2028. According to such internal estimates, Lithuania would preserve strong debt affordability compared with ratings peers despite the high interest rate environment. Scope estimates the credit’s debt ratio to remain below the EU’s 60% Maastricht threshold even under an adverse economic scenario of weaker economic growth and weaker fiscal consolidation.

      Prudent debt management policies have supported the debt profile. The average maturity of the debt is high at nine years and almost all of debt is on fixed rates. The Treasury can issue on favourable terms in domestic and international capital markets, although yields have markedly risen since last year. Lithuania has also access to EU funding vehicles and recently announced plans to request additional loans of EUR 1.8bn under the Next Generation EU programme. Government borrowing requirements will remain moderate around 5-8% of GDP annually over the coming years. Prudent liquidity management including pre-funding efforts and an ample cash buffer further mitigate risks amid volatile market conditions.6

      Despite these strengths, Lithuania’s ratings face several challenges.

      Firstly, a small economic size (GDP of EUR 67bn), characterised by a significant degree of openness (export and import sectors accounting each for nearly 90% of GDP) and still moderate wealth levels (GDP per capita of EUR 23,600), exposes Lithuania to external shocks and makes growth dependent on external funding for investment.

      Secondly, adverse demographic trends are increasing labour shortages and fiscal pressures. Lithuania’s working-age population is projected to decline nearly 30% over the next 20 years; by the end of this horizon, the old-age dependency (the ratio of those aged 65 and over to those of working age) could approach a ratio of 50. Such trends would cause labour and skills shortages to worsen, thereby hindering output growth. The labour-market shortages will also likely further fuel wage growth, already in double digits over the recent years, weakening external competitiveness. Adverse demographic trends are furthermore a challenge for fiscal sustainability in the long run. The IMF estimates the net present value of changes in healthcare and pension spending through 2050 at above 60% of GDP.

      Finally, the ratings account for financial-sector risks related to dependence on Nordic banks and elevated cross-border financial flows, which are, however, mitigated by the sound fundamentals of Lithuanian banks.

      The banking sector is exposed to concentration and spill-over risks due to its integration with Nordic and Baltic banking systems. Two Swedish banking groups, Swedbank and SEB, account for over half of Lithuania’s system-wide bank assets. Capital flight and cross-border money-laundering risks are reduced by the moderate share of non-euro area foreign deposits (accounting for 8.1% of the total). Deposits from residents of other euro-area countries have, however, rapidly increased since last year, to above 16%, following the relocation of financial institutions from the United Kingdom due to Brexit and as a consequence of the rapidly growing fintech industry. Such trends require continued upgrade of anti-money laundering policies. Associated risks are mitigated, however, by strong fundamentals of the banking system. The sector’s resilience is underpinned by comfortable capitalisation and liquidity positions, with common equity tier 1 and liquidity coverage ratios of 18.8% and 390.7%, respectively, as of Q4 2022, as reported by the European Banking Authority. Strong asset quality, with a non-performing loan ratio of 0.5%, and low cost-to-income ratios relative to peer-country banking sectors should support profitability and resilience of financial institutions over the coming years, although the weaker economic outlook and rising uncertainties in the global banking sector following monetary policy normalisation represent risks.7

      Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

      Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative rating of ‘a-’ for the Republic of Lithuania. The country receives a one-notch positive adjustment for the euro’s status as a global reserve currency under the methodology’s reserve-currency adjustment.

      The resulting ‘a’ indicative rating can be adjusted in the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses versus a peer group of countries. For Lithuania, no relative credit strength or weakness has been identified qualitatively. As such, the QS does not generate any further adjustment to the indicative rating, resulting in A long-term ratings for Lithuania.

      A rating committee has discussed and confirmed these results.

      Factoring of Environmental, Social and Governance (ESG)

      Scope explicitly factors in ESG sustainability issues during its ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) and 20% weighting in the qualitative overlay (QS).

      With respect to environmental factors, Lithuania’s performance among CVS variables is strong. The country receives a weak score for its emissions per capita, but obtains strong performance scores on emissions per unit of GDP, exposure and vulnerability to natural disaster risks, and the ecological footprint of its consumption as compared with available biocapacity. Lithuania’s QS evaluation on ‘environmental factors’ is ‘neutral’ against a peer group of countries. Lithuania has made important progress in the development of renewable energies. The share of energy from renewable sources in gross final energy consumption exceeded 28% in 2021, higher than the EU average of less than 19%. Lithuania has an ambitious plan in place to increase this share to 50% by 2030. By that year, renewables would cover some 70% of electricity production. However, reducing the carbon footprint of the economy has proven challenging in recent years, especially given rising emissions in the transport sector. Also, resource productivity and the scale of the circular economy lag EU averages and require further policy support and investment. Lithuania has dedicated 38% of its Recovery and Resilience programme funding to climate actions and plans to allocate the resources to upgrading its building stock, enhancing the sustainability of the transport sector and further developing its renewable-energy sector.

      Regarding socially-related criteria, in the CVS model, Lithuania receives a very strong score on labour-force participation, an average mark on income inequality and a very weak score on the old-age dependency ratio. The complementary QS assessment of ‘social factors’ is ‘neutral’ against a peer group of countries, accounting for Lithuania’s inclusive labour market and progress on social-exclusion and poverty risks, which, however, remain above EU averages. Adverse demographics are a core social challenge, as captured by CVS quantitative indicators.

      Under governance-related factors in the CVS, Lithuania holds strong scores on the World Bank’s Worldwide Governance Indicators. In the QS assessment of Lithuania’s ‘governance factors’, Scope evaluates this qualitative analytical category as ‘neutral’ versus Lithuania’s sovereign peer group. Policy making in Lithuania has been effective and enjoyed comparative continuity. Lithuania’s EU and euro-area memberships enhance the quality of macroeconomic policies and the macroprudential framework. The centre-right coalition government led by Prime Minister Ingrida Šimonytė assumed office in 2020, with the next parliamentary elections due by 2024. External security risks for Lithuania have increased since the escalation of war in Ukraine. However, Scope believes Lithuania's NATO membership strongly reduces the risk that conflict expands to the Baltics region.

      Rating Committee
      The main points discussed by the rating committee were: i) Lithuania’s economic outlook and medium-term growth potential; ii) fiscal and debt-sustainability developments; iii) external-sector vulnerabilities; iv) banking-sector and non-financial private sector balance sheet developments; v) ESG considerations; and vi) peers comparisons.

      Rating driver references
      1. Bank of Lithuania – Macroeconomic projections 
      2. ECB Monetary policy decisions 
      3. Ministry of Finance – 2023 Budget 
      4. European Commission – Opinion on the 2023 Draft budgetary plan 
      5. European Commission – Recovery and Resilience Facility 
      6. Ministry of Finance: Investor presentation – March 2023
      7. Bank of Lithuania – Financial stability review 

      Methodology
      The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
      The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

      Solicitation, key sources and quality of information
      The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
      With Rated Entity or Related Third Party participation    YES
      With access to internal documents                                  NO
      With access to management                                           YES
      The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
      Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
      Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

      Regulatory disclosures
      These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
      Lead analyst: Giulia Branz, Senior Analyst
      Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
      The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 10 December 2021.

      Potential conflicts
      See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings. 

      Conditions of use / exclusion of liability
      © 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.

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