European Commission European Commission assessment of the 2008 assessment of the 2008 update of the Lithuanian update of the Lithuanian convergence convergence programmeprogramme

Ralph WilkinsonRalph WilkinsonDirectorate Member States IIDirectorate Member States II

DG ECFIN, European CommissionDG ECFIN, European Commission

Vilnius, 1 April 2009Vilnius, 1 April 2009

The EU fiscal rules in a nutshell - I

The Treaty rules (Article 104)

deficit < 3% of GDP, unless it has declined and reached a level close to 3% or the excess is small, exceptional (‘severe economic downturn’) and temporary

debt < 60% of GDP, or should be on a decreasing trend and approaching 60% at a satisfactory pace

The EU fiscal rules in a nutshell - IIThe Stability and Growth Pact (Regulations 1466/97 and 1467/97, amended in 2005 and

complemented by improved fiscal and statistical governance )

Preventive arm: Pursuit of medium-term budgetary objectives (MTOs)

Stability and convergence programmes and annual updates Early warning mechanism Corrective arm: Specifies the steps of the excessive deficit

procedure (EDP) Sets up a timetable for the correction of excessive deficits Economic analysis in the application of the rules

The 2005 SGP reform - salient featuresPreventive arm of the SGP Country-specific medium-term budgetary objectives Larger fiscal consolidation efforts required in ‘good times’ Incentives for structural reforms, emphasis on sustainability

Corrective arm of the SGP 3% and 60 % remain the anchors of the system More economic analysis in the application of the rules Minimum fiscal effort, possibility to extend deadlines

Improved fiscal and statistical governance Recognition of the role of national rules and institutions Focus on the importance of high quality and reliable

statistics

Lithuania’s Lithuania’s convergence convergence programme programme assessment - assessment - proceduresprocedures Lithuania submitted the updated Lithuania submitted the updated

convergence programme 2008-2011 on 23 convergence programme 2008-2011 on 23 January 2009January 2009

The European Commission assessed the The European Commission assessed the programme and adopted a programme and adopted a recommendation for a Council Opinion on recommendation for a Council Opinion on 25 February 200925 February 2009

It was discussed at the Economic and It was discussed at the Economic and Financial Committee (EFC) Financial Committee (EFC)

The Council adopted its Opinion on 10 The Council adopted its Opinion on 10 March 2009March 2009

Lithuanian economy - Lithuanian economy - scenescene setting setting

Overheating pressures: wages, inflation, Overheating pressures: wages, inflation, current account deficit soaring; external current account deficit soaring; external competitiveness weakeningcompetitiveness weakening

Weak policy response – expansionary and pro-Weak policy response – expansionary and pro-cyclical fiscal policy, measures supporting cyclical fiscal policy, measures supporting credit growth, high public sector wage growthcredit growth, high public sector wage growth

Previous Commission and Council advice (but Previous Commission and Council advice (but not followed): Stronger policy response not followed): Stronger policy response needed to correct internal and external needed to correct internal and external imbalances and maintain macroeconomic imbalances and maintain macroeconomic stabilitystability

The underlying The underlying economic assumptions economic assumptions

2007 2008 2009 2010 2011

CP Jan 2009 8.9 3.5 -4.8 -0.2 4.5COM Jan 2009 8.9 3.4 -4.0 -2.6 n.a.CP Dec 2007 9.8 5.3 4.5 5.2 n.a.CP Jan 2009 5.8 11.2 5.4 3.6 -0.1

COM Jan 2009 5.8 11.1 5.6 4.8 n.a.CP Dec 2007 5.8 6.5 5.1 3.6 n.a.CP Jan 2009 7.1 5.4 -2.8 -5.7 -4.0

COM Jan 20092 7.7 6.6 -0.5 -4.8 n.a.CP Dec 2007 3.3 1.5 -0.4 -1.3 n.a.CP Jan 2009 -12.7 -10.2 -1.8 -4.7 -5.7

COM Jan 2009 -13.2 -10.7 -4.8 -4.7 n.a.CP Dec 2007 -12.5 -12.7 -14.5 -15.4 n.a.

Notes:

Source :

1Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission

Convergence programme (CP); Commission services’ January 2009 interim forecasts (COM); Commission

Real GDP(% change)

HICP inflation(%)

Output gap1

(% of potential GDP)

Net lending/borrowing vis-à-vis the rest of the

world

Medium-term Medium-term budgetary strategybudgetary strategy

The main goal of the medium-term The main goal of the medium-term budgetary strategy: the general budgetary strategy: the general government structural deficit of 1% by government structural deficit of 1% by 20102010

Headline deficit to narrow to 1% in Headline deficit to narrow to 1% in 2010 and to be in balance in 20112010 and to be in balance in 2011

Mainly to be achieved through Mainly to be achieved through revenue-to-GDP ratio and a modest revenue-to-GDP ratio and a modest reduction in the expenditure ratioreduction in the expenditure ratio

Medium-term Medium-term budgetary strategybudgetary strategy

2007 2008 2009 2010 2011CP Jan 2009 33.9 33.8 35.8 37.3 36.4

COM Jan 2009 33.9 33.9 34.8 36.0 n.a.CP Dec 2007 35.5 37.4 38.6 39.4 n.a.CP Jan 2009 35.2 36.7 37.8 38.3 36.4

COM Jan 2009 35.2 36.8 37.8 39.4 n.a.CP Dec 2007 36.4 37.9 38.5 38.6 n.a.CP Jan 2009 -1.2 -2.9 -2.1 -1.0 0.0

COM Jan 2009 -1.2 -2.9 -3.0 -3.4 n.a.CP Dec 2007 -0.9 -0.5 0.2 0.8 n.a.CP Jan 2009 -2.6 -4.9 -1.8 0.1 1.1

COM Jan 2009 -2.7 -4.6 -2.9 -2.1 n.a.CP Dec 2007 -1.2 -0.9 0.3 1.1 n.a.CP Jan 2009 17.0 15.3 16.9 18.1 17.1

COM Jan 2009 17.0 17.1 20.0 23.3 n.a.CP Dec 2007 17.6 17.2 15.0 14.0 n.a.

Notes:

Source :Convergence programme (CP); Commission services’ January 2009 interim forecasts (COM); Commission

Government gross debt(% of GDP)

3Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary

General government balance

(% of GDP)

Structural balance3

(% of GDP)

General government revenue

(% of GDP)General government

expenditure(% of GDP)

Policy measures to Policy measures to achieve the achieve the programme objectives programme objectives With the 2009 budget, a fiscal consolidation package With the 2009 budget, a fiscal consolidation package

adopted aimed at restoring market confidence and adopted aimed at restoring market confidence and limiting financing needslimiting financing needs

A comprehensive tax reform introduced with the A comprehensive tax reform introduced with the 2009 budget 2009 budget

Significant expenditure cuts, including public sector Significant expenditure cuts, including public sector wages (3%), current expenditure and investmentwages (3%), current expenditure and investment

But some measures underpinning the budget But some measures underpinning the budget rejected and have to be replaced by new measures rejected and have to be replaced by new measures

Are the adopted measures sufficient to achieve the Are the adopted measures sufficient to achieve the medium-term budgetary strategy?medium-term budgetary strategy?

Risk assessment Risk assessment

Budgetary outcomes subject to Budgetary outcomes subject to significant downside riskssignificant downside risks

In 2009, tax increase may not lead to In 2009, tax increase may not lead to higher revenue and expenditure cuts higher revenue and expenditure cuts may prove difficult may prove difficult

2010 and 2011 consolidation base on 2010 and 2011 consolidation base on markedly favourable macroeconomic markedly favourable macroeconomic assumptionsassumptions

Additional measures are needed to Additional measures are needed to underpin the budgetary targetsunderpin the budgetary targets

Long-term Long-term sustainability of sustainability of public financespublic finances The long-term budgetary impact is The long-term budgetary impact is

lower than the EU average due to lower than the EU average due to enacted pension reformenacted pension reform

However, starting position worsened However, starting position worsened considerably considering budgetary considerably considering budgetary outcome in 2008 outcome in 2008

Lithuania is at medium risk to long-Lithuania is at medium risk to long-term sustainability of public financesterm sustainability of public finances

Achieving primary surpluses over the Achieving primary surpluses over the medium term would help to reduce medium term would help to reduce risksrisks

Medium-term Medium-term budgetary framework budgetary framework

Medium-term budgetary framework has Medium-term budgetary framework has not succeeded in preventing expenditure not succeeded in preventing expenditure overrunsoverruns

The Law on Fiscal discipline lacks The Law on Fiscal discipline lacks necessary forward looking medium-term necessary forward looking medium-term planning elementsplanning elements

Scope for enhancing planning and the Scope for enhancing planning and the binding character of expenditure ceilingsbinding character of expenditure ceilings

Framework needs to ensure fiscal Framework needs to ensure fiscal consolidation in good times - would help consolidation in good times - would help during the downturnduring the downturn

Fiscal response to Fiscal response to current downturncurrent downturn

All three Baltic countries embark on the All three Baltic countries embark on the fiscal consolidation which is in line with the fiscal consolidation which is in line with the European Economic Recovery PlanEuropean Economic Recovery Plan ““For those Member States, in particular outside the For those Member States, in particular outside the

euro area, which are facing significant external and euro area, which are facing significant external and internal imbalances, budgetary policy should internal imbalances, budgetary policy should essentially aim at correcting such imbalancesessentially aim at correcting such imbalances.”.”

… … and is largely driven by pragmatic and is largely driven by pragmatic considerationsconsiderations Difficulty in securing new financing at acceptable Difficulty in securing new financing at acceptable

conditions due to the market risk aversionconditions due to the market risk aversion Euro accession as a confidence measureEuro accession as a confidence measure

ERM2 contextERM2 context

““For a sustained period wage growth For a sustained period wage growth has exceeded productivity growth by has exceeded productivity growth by far, thus weakening the country's far, thus weakening the country's competitiveness, hindering prospects competitiveness, hindering prospects of export-led economic recovery.” of export-led economic recovery.”

In the context of ERM II membership In the context of ERM II membership and to improve cost competitiveness, and to improve cost competitiveness, urgent need to correct high wage urgent need to correct high wage growthgrowth

SummarySummary The adopted consolidation The adopted consolidation

programme is an appropriate programme is an appropriate response to needs to correct response to needs to correct macroeconomic imbalancesmacroeconomic imbalances

The adjustment should be backed The adjustment should be backed by additional measures to prevent by additional measures to prevent breaching the 3% threshold in 2009 breaching the 3% threshold in 2009 and 2010and 2010

Need to reduce high wage growthNeed to reduce high wage growth

Policy Policy invitationsinvitations Implement measures to achieve Implement measures to achieve

budget target in 2009 by prioritising budget target in 2009 by prioritising expenditures and continue fiscal expenditures and continue fiscal consolidation in the medium-termconsolidation in the medium-term

Implement public sector wage restraintImplement public sector wage restraint Strengthen public sector governance Strengthen public sector governance

and transparency, by enhancing the and transparency, by enhancing the medium-term budgetary framework medium-term budgetary framework and reinforce expenditure disciplineand reinforce expenditure discipline

Spring 2009 - what Spring 2009 - what now?now?

Economic situation in Lithuania, Baltic Economic situation in Lithuania, Baltic region and globally has deteriorated region and globally has deteriorated further (European Commission spring further (European Commission spring economic forecasts to be published 4 economic forecasts to be published 4 May)May)

Budgetary prospects weakerBudgetary prospects weaker Consolidation package imminent, with Consolidation package imminent, with

hints of further action in summerhints of further action in summer Speculation of international financing Speculation of international financing

supportsupport