Lithuania Business Forecast Report

Recession To Last Through 2010 Lithuania remains in the midst of a severe macroeconomic and financial crisis. Following the release of Q2 GDP data, which showed the economy contracting by a staggering 20.2% yearon- year (y-o-y), we have revised down our forecast for Lithuanian growth in 2009, and now project real GDP to fall by 15.9% - making the Baltic economy one of the worst performing in the world this year. Indeed, with Vilnius attempting to correct the economy's external asymmetries through an 'internal devaluation', we caution that output, wages and prices are all set to contract precipitously. This correction has already taken hold, as highlighted by the rapid unwinding in the country's current account deficit through the first half of the year. Although this will ultimately benefit economic stability over the long term, we caution that it nevertheless reflects a massive collapse in internal demand.

Lithuania's newly elected president, Dalia Grybauskaite, appears set to pursue a gradual improvement in bilateral relations with Russia throughout her term in office (which will run until 2014), boding well for the Baltic state's underlying risk profile over the long term. Indeed, following a telephone meeting between Grybauskaite and her Russian counterpart Dmitry Medvedev in late August, the two leaders agreed to deepen co-operation in trade, economic and cultural spheres. While we caution that the scope for a significant improvement in relations will inevitably be constrained by deep-rooted historical animosity and distrust between the two states, we are nevertheless encouraged by the apparent willingness of Grybauskaite and Mevedev to seek a change of course in the near term.

Lithuania's banking system remains in the midst of a large-scale structural adjustment, with underlying stability set to remain compromised through 2011. Having embarked on an unsustainable expansion path in the run up to the global financial crisis, with prudent lending policies having been sacrificed in the process, we caution that 2009 and 2010 will see asset growth and profitability collapse concomitant with one of the Baltic state's worst recessions on record. While the size of the industry compared to the broader economy remains smaller compared to that seen in some of Lithuania's neighbours, with assets-to-GDP remaining under 100%, we nevertheless caution that the ongoing adjustment towards a new equilibrium for the banking sector will have significant repercussions for aggregate demand going forward.

Ratings agency Standard and Poor's (S&P) informed Lithuania that it risked a possible credit rating downgrade as rising economic and political risks in the country were depressing tax revenues.

S&P put the Baltic state's BBB long-term sovereign credit rating on negative credit watch in August, which is often seen as a precursor to a downgrade. Should Vilnius' credit rating fall two notches to below investment-grade status, we caution that the cost of borrowing throughout the economy would rise. This, in turn, would further weaken the economic recovery, as both the public and private sectors would face increased difficulty tapping international credit markets.