Scope Ratings AG today upgrades the Republic of Lithuania’s long-term local-currency rating to A- from BBB+, following the release of its revised sovereign rating methodology, and converts its status from subscription to public. The agency also assigns a long-term foreign-currency issuer rating of A-, along with a short-term issuer rating of S-1 in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at A-. All Outlooks are Stable.

Rating drivers

The rating upgrade is driven by improvements in Scope’s ‘domestic economic risk’ and ‘public finance risk’ analysis categories and reflects Scope’s assessment of Lithuania’s (1) continued fiscal consolidation; (2) increased economic and external resilience underpinned by its euro area membership; (3) commitment to structural reforms including in the labour market, tax and pension systems, and in energy infrastructure, supporting Lithuania’s future macroeconomic performance. However, the ratings are constrained by unfavourable demographics, a low potential-growth outlook and vulnerability to external shocks. The Stable Outlook reflects Scope’s assessment that the risks are broadly balanced.

The first driver of the rating upgrade is Lithuania’s improved fiscal performance and commitment to fiscal consolidation underpinned by a robust budgetary framework. Scope views positively the strengthening of Lithuania’s fiscal framework based on strict expenditure ceilings, including the extension of its medium-term budgeting framework over a three-year horizon and the implementation of a structural balance rule enshrined into the constitution. After hitting a record high deficit of 9.1% of GDP in 2009, Lithuania recorded a budget surplus for the first time (of 0.3% of GDP) in 2016, reflecting strong fiscal discipline over an extended period. Although Scope expects the headline balance to temporarily decrease to 0.05% of GDP in 2017, following the costs related to labour market and pension reforms amounting to 0.5% of GDP, we assess Lithuania’s fiscal performance as robust and expect the budget to remain in surplus over the coming years, averaging 0.3% of GDP. Lithuania’s public finances also benefit from a moderate and falling debt burden of around 40% of GDP in 2016, well under the European Union (EU) average of 85% of GDP and the EU’s 60% reference value. Going forward, Scope expects the downward trajectory of the debt ratio to continue and remain below 35% of GDP over the medium term. Furthermore, Lithuania’s conservative debt management strategy has led to an improvement in the debt structure, reflected in the increasing share of debt denominated in local currency, an extension in the average debt maturity to 5.6 years, and a decreasing burden of interest payments.

The rating upgrade is also supported by the country’s entry to the euro area in 2015, giving access to a large common market, a strong reserve currency, an independent European Central Bank effectively acting as a lender of last resort, and an economic governance and macro prudential framework supporting credible macroeconomic policies. Scope believes that these are important elements which reflect a better protection of Lithuania from external adverse shocks, underpinning the sovereign’s resilience, effectiveness of policy-making and creditworthiness.

Finally, the rating upgrade is also driven by the government’s commitment to structural reforms aimed at tackling long-term challenges, which will continue to support Lithuania’s improving macroeconomic performance. After growing by 2.3% in 2016, Scope expects Lithuania’s economic outlook to remain robust in the short-to-medium term with real GDP growth rising to 3.5% in 2017 and 2018 driven by solid private consumption growth (bolstered by improving conditions in the labour market alongside rising wages), a pick-up in the absorption of EU funds, alongside a favourable external environment. However, given the persistence of structural weaknesses in the economy, Scope believes structural reforms are key to sustain economic growth long-term. Recent/present initiatives include: (1) a new labour market reform introduced in 2016 to enhance labour market flexibility and address challenges arising from the pension and health care systems, (2) the 2017 National Reform Programme also takes steps towards addressing poverty, income inequality and labour productivity by reducing the tax burden for low-income earners, and improving the coverage and adequacy of unemployment benefits and social assistance, (3) the government’s continued efforts to increase tax compliance and create incentives to move activities into the formal economy.

Despite these strengths, Lithuania faces a number of challenges. Lithuania’s demographic outlook is faced with one of the strongest declines in its economically active population in the EU due to an ageing population alongside high emigration. The labour force declined at an annual compounded rate of 0.4% from 2010 to 2016 and the participation rate stands at below 60%. In combination with high wage growth and a preponderance of low value-added economic activities, unfavourable demographics is increasingly becoming a challenge to the country’s competitiveness. In addition, despite measures taken by the government, the potential growth outlook in Lithuania remains low, due to decreasing productivity growth, high poverty and income inequality, as well as the persistence of a large informal economy estimated at 16.5% of the economy in 2016. All those factors combined sharply dampen Lithuania’s potential-growth outlook.

An additional constraint to the ratings is Lithuania’s vulnerability to external shocks, reflected in its small size and openness, the composition of Lithuania’s exports (mainly limited value-added products), and a reliance on energy imports. Lithuania’s negative net international investor position (of 43.2% of GDP in 2016) reflects the relatively high dependence of the country on foreign capital inflows. In 2016, gross external debt stood at 85.7% of GDP, below its Baltic peers and the euro area average but in line with its CEE peers. Under Scope’s public debt sustainability analysis and given the combined small economic size, openness and high share of public debt held by non-residents (69.3% of the total public debt stock in 2016), the key risk to Lithuania’s debt sustainability in the short-to-medium term is a scenario of protracted weak GDP growth and capital outflows stemming from an external shock coupled with reversals in investor sentiment. However, even taking into account a major economic and external shock, Scope does not envision the debt-to-GDP ratio increasing over the Maastricht threshold of 60%.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “A” (“a”) rating range for the Republic of Lithuania. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Lithuania, the following relative credit strength has been identified: i) public debt sustainability. Relative credit weaknesses are indicated for: i) growth potential of the economy, ii) macroeconomic stability and imbalances, iii) vulnerability to short-term external shocks, iv) geo-political risk, v) macro-financial vulnerabilities and fragility. Combined relative credit strengths and weaknesses indicate a sovereign rating of A- for Lithuania. A rating committee has discussed and confirmed these results.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The confirmation of the Stable trend reflects Scope’s view that risks to the ratings are now broadly balanced.

The ratings/outlook could be upgraded if: i) Lithuania’s potential growth outlook improves, ii) stronger debt reduction materialises compared to expectations, iii) structural reforms address unfavourable demographics and low productivity growth. Conversely, the ratings or outlooks could be downgraded if: i) public finances deteriorate due to a reversal in fiscal consolidation, ii) the absorption of EU funds is lower than expected, weakening investment and growth, and/or iii) structural measures failed to address Lithuania’s low potential-growth outlook.

For the detailed research report, please click HERE.

Rating committee

The main points discussed during the rating committee were: (1) Economic growth potential and outlook, (2) demographics and productivity growth, (3) public finance performance and debt sustainability analysis, (4) external position and resilience, (5) economic structural imbalances and structural reforms, (6) the banking sector’s performance, (7) recent political and geopolitical developments, (8) peer considerations.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please 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’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by John Francis Opie, Lead Analyst

Person responsible for approval of the rating: Dr Stefan Bund, Chief Analytical Officer

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.

The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Republic of Lithuania are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of the Republic of Lithuania, Bank of Lithuania, World Bank, European Central Bank (ECB), European Commission, Statistical Office of the European Communities (Eurostat), IMF, OECD, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings 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.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
© 2017 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings AG, Scope Analysis, Scope Investor Services 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 cannot, 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 otherwise 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 as 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 AG at Lennéstraße 5, D-10785 Berlin.

Scope Ratings AG, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 161306, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund; Chair of the supervisory board: Dr. Martha Boeckenfeld.