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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Lithuania’s long-term issuer and senior unsecured debt ratings at A in both local and foreign currency and revised the Outlooks to Positive. Short-term issuer ratings have been affirmed at S-1 in both local and foreign currency, with the Outlooks revised to Positive.

Summary and Outlook

The Outlook revision to Positive on Lithuania’s ratings reflects the following two key drivers:

• The robust recovery prospects and stronger resilience of the Lithuanian economy, underpinned by its government’s credible and effective macroeconomic policy framework and the country’s European Union and euro-area memberships; and
   
• The continued improvements in external finances on top of current account surpluses, the stability in the banking sector, and the track record of fiscal prudence that underpin the strength of the government’s balance sheet and moderate debt levels.

Scope expects that the improvements in Lithuania’s economic and financial stability will further reduce the country’s underlying macroeconomic volatility.

The Outlook revision reflects updated assessments of the ‘domestic economic risk’ and ‘external economic risk’ categories under Scope’s sovereign rating methodology.

However, Lithuania’s ratings remain constrained by credit challenges relating to: i) adverse demographics reflected in an ageing population and skilled-labour shortages, alongside still lower per-capita income relative to the euro-area average; ii) a large export sector relative to the size of the economy increasing its susceptibility to external shocks; and iii) risks in the banking sector related to the dependence on large Nordic banks.

The Positive Outlook represents Scope’s opinion that risks to the sovereign ratings are tilted to the upside over the next 12 to 18 months.

The ratings could be upgraded if, individually or collectively: i) growth prospects improved through the continued implementation of structural reforms, including those aimed at further liberalising the labour market, supporting innovation and education and/or improving infrastructure; ii) the public debt-to-GDP ratio regained a firm downward trajectory, supported by the government’s fiscal consolidation; and/or iii) external vulnerabilities continued to reduce.

Conversely, the Outlooks could be revised to Stable if, individually or collectively: i) the public-finance outlook weakened, resulting in a meaningful increase in public debt ratio; ii) Lithuania’s external position deteriorated, and its external competitiveness declined; and/or iii) an external shock or heightened geopolitical risks undermined Lithuania’s macro-economic stability.

Rating rationale

The first driver for the Outlook revision to Positive reflects the robust recovery prospects and stronger resilience of the Lithuanian economy. This is helped by the government’s prudent and predictable macroeconomic policies focused on supporting sustainable growth, underpinned by the country’s EU and euro-area memberships.

Following de facto no contraction in real GDP in 2020 with 0.0% growth, Lithuania’s output is projected to grow by 4.7% this year and 4.3% in 2022, supported by a solid recovery in private consumption and investment assisted by Lithuania’s prudent absorption of EU funds. As of September 2021, Lithuania spent over 70% of EU funds allocated under the 2014–20 budget, the highest such absorption rate of the EU’s Central and Eastern European region. Lithuania has been allocated a sizeable EUR 2.2bn in grants (equivalent to 4.4% of 2020 GDP) via the EU’s Recovery and Resilience Facility¹, plus another EUR 12.1bn (24.5% of 2020 GDP) of structural funds under the Cohesion Policy and Common Agricultural Policy under the new 2021-2027 EU budget. This considerable allocation of EU monies helps anchor solid medium-run growth and strategic public investment projects.

Scope estimates Lithuania’s medium-term potential growth at around 2.5% annually. This will be supported by strategic public-infrastructure projects co-financed by the EU, including the construction of Rail Baltica, which connects the Baltic region with the European rail network via Poland (completion of the Lithuanian section planned by 2026). Important for Lithuania’s medium-term growth and economic resilience is the country’s ability to improve the security and sustainability of its energy supply and diversify domestic energy sources. Here, Scope notes positively that the connection of the Baltic states’ and continental Europe’s gas and electricity networks is planned to be completed by 2022 for gas and by 2025 for electricity².

As a result of the favourable economic performance, Lithuania’s per-capita income is projected to increase substantively to 83.5% of the euro-area average in 2021 in purchasing-power-standard terms, from 71% in 2016 and 55.5% in 2010. This compares favourably to other sovereign peers such as Estonia (84% of the euro-area average in 2021), Latvia (69%) but also to other euro area sovereigns such as Spain (81%) and Portugal (72%).

In addition, the Covid-19 crisis has not exacerbated macroeconomic imbalances. Debt ratios remain low among households and non-financial corporations as of Q2 2021, at 24.2% and 39.4% of GDP respectively, virtually the same as pre-Covid levels³. Scope considers Lithuania’s Nordic-dominated banking sector capable of absorbing the current economic shock. The banking sector is highly profitable compared with those of euro-area peers, is highly capitalised and displays strong asset quality. As of Q2 2021, the system-wide Tier 1 capital ratio was 22.5% of risk-weighted assets and the return on equity was 10.9%, both among the highest in the euro area, and the non-performing loan ratio was low at 0.9%⁴.

The second driver for the Outlook revision to Positive is Lithuania’s improved external position. Lithuania’s net international investment position (external financial assets minus liabilities) improved to -11.5% of GDP in Q2 2021, from -28.8% in Q2 2019. In addition, nearly half of gross external liabilities relate to inward foreign direct investment, which not only curbs the risk that external balance sheets deteriorate markedly in times of global stress but also enhances the long-term sustainability of the external position. Lithuania has been continuously gaining global export market shares over the last five years, supported by improvements in the value-added structure of its exports. As a result, Scope projects Lithuania’s current-account surplus at around 3% of GDP in 2021 (7.3% of GDP in 2020) and 2% in 2022. This will further improve Lithuania’s external finances.

Despite unit labour costs rising by 3.4% annually over the last five years relative to the euro-area average, the relative wage level in Lithuania still compares favourably to relative productivity when compared with the euro-area average, and wage growth has not significantly undermined the competitiveness of Lithuania’s export sector. Net earnings in purchasing-power-standard terms amounted to 62% of the euro-area average in 2020, while productivity per hour was 64% (and 79% per person) of the euro-area average in the same year.

The Positive Outlook is further supported by Lithuania’s moderate debt levels compared to those of sovereign peers and its record of effectively consolidating public finances. Scope projects the general government deficit to narrow to 3% of GDP in 2022 and further to 1% in 2023, from 4.3% this year. This is also being actively assisted by an improved outlook for tax revenue growth and a gradual expiry of Covid-19-related expenditure measures, the latter estimated at around 3% of GDP in 2021⁵.

The medium-term budget framework reform, aimed at improving the effectiveness of public spending, incorporates strategic goals and expenditure reviews in the design of budgets starting in 2022. The authorities are also reviewing the tax system to enhance tax collection and improve its efficiency, given the still-sizeable shadow economy⁶ and comparatively restricted tax base in Lithuania. The realisation of these reforms could enhance Lithuania’s fiscal space and fiscal forecast by Scope over the medium term.

Lithuania’s general government debt will stabilise and gradually decline to 44% of GDP by 2023, well below the EU’s 60% Maastricht threshold. This is supported by solid growth in nominal GDP and narrowing fiscal deficits in the medium term. Lithuania’s public finance outlook benefits from favourable financing conditions and a supportive debt profile. The yield on the 10-year government bond was close to 0.2% at the time of writing, supported by Lithuania’s access to the European Central Bank’s asset purchase facilities. The average maturity of Lithuanian debt is high at 9.7 years, which helps keep general government gross financing needs moderate at around 6% of GDP annually over 2022-23. Lithuania’s foreign-currency-denominated debt (reflecting one Eurobond denominated in US dollar⁷), totalling USD 1.5bn, will be repaid by 2022 through accumulated pre-financing.

Despite these credit strengths, Lithuania’s ratings remain constrained by several credit challenges.

Lithuania’s longer-term growth prospects are hindered by unfavourable demographics, reflecting an ageing population that constrains labour supply. The old-age dependency ratio (those aged 65 years or over as a percentage of those aged 15-64) is projected to increase to 41% by 2030⁸, from 31% in 2021, representing one of the highest such increases among EU-27 economies. Strong productivity growth will be necessary to mitigate the negative demographic trends. Immigration has exceeded emigration since 2019: by around 10,000 persons in 2019 and 20,000 persons in 2020 but has slowed to around 1,000 persons so far in 2021. In Scope’s view, should immigration continue to significantly surpass emigration, mitigating sectoral labour shortages, this could support growth.

The ageing population will also pose budgetary pressures over the longer-term, exacerbated by the currently low levels of pensions, which may be socially unviable and could thus increase over the medium-term. Lithuania’s pre-retirement income replacement rate through pensions was a modest 35% as of 2020, among the lowest of the EU-27.

A second challenge refers to Lithuania’s small, open economy that remains vulnerable to external shocks and is reliant on external demand. This is due to its large export sector (in goods and services) relative to the size of its economy, of around 78%. The recent reform of the EU road transport sector (as part of the EU Mobility Package), set to enter into force in early 2022, could negatively impact Lithuania’s transportation services exports to the rest of the EU, the latter accounting for around 13% of Lithuania’s total exports. The reform is aimed at improving the working conditions of lorry drivers by requiring their regular return to their home countries, which could increase service costs for operators.

Finally, Lithuania’s 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 66% of Lithuanian bank assets⁹. However, capital flight and cross-border money-laundering risks are curbed by the small share of non-resident deposits, at 3.6% of total deposits as of October 2021, significantly under that of Latvia (16.2%) and Estonia (15.1%). At the same time, the swift expansion of fintech companies, while benefitting the quality of the financial infrastructure, brings new challenges for anti-money-laundering supervision.

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 a first indicative rating of ‘aa-’ for Lithuania. Lithuania receives a one-notch positive adjustment to this indicative rating based on the reserve currency adjustment under Scope’s methodology. As such, an indicative rating of ‘aa’ can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Lithuania, no relative qualitative credit strengths have been identified. The following relative qualitative credit weaknesses have been identified: i) growth potential of the economy; ii) macro-economic stability and sustainability; iii) fiscal policy framework; iv) current account resilience; v) resilience to short-term external shocks; vi) financial imbalances; vii) environmental risks; and viii) social risks.

The QS generates a three-notch downward adjustment and indicates A long-term ratings for Lithuania.

A rating committee has discussed and confirmed these results.

Factoring of environment, social and governance (ESG)

Scope explicitly factors in ESG sustainability issues during the rating process via the sovereign methodology’s stand-alone ESG sovereign risk pillar. This pillar has a 20% weighting in the quantitative model (CVS) and the qualitative overlay (QS). Under governance-related factors in the CVS, Lithuania’s performance is stronger than that of Central and Eastern European peers as assessed under the World Bank’s Worldwide Governance Indicators. In general, policymaking in Lithuania has largely been effective and enjoyed relative continuity. Lithuania’s EU and euro-area memberships enhance the quality of its macroeconomic policies and macroprudential framework.

Lithuania’s performance across key social factors is mixed. This is reflected in the above-EU-average poverty ratio, although the ratio is declining (24.8% of the population at risk of poverty or social exclusion in 2020, compared with the EU-27 figure of 22%), the relatively high income-inequality, an unemployment rate (6.7% as of September) at around the EU average, and high labour participation rates. The European Commission’s Digital Economy and Society Index 2021, which ranks the EU-27 countries for digital competitiveness, placed Lithuania at 14th (average). Demographics, however, are the key weakness also compared to peers.

Environmental factors are explicitly considered in the rating process via the environment sub-category under the ESG risk pillar. In 2020, nearly 60% of Lithuania’s electricity was from renewable sources. The share of renewable energy in total energy consumption in Lithuania is estimated at 27.2% in 2020, which exceeds the EU average of 21.3% and the national target for 2020 of 23%. Lithuania has an ambitious plan to increase this share to 45% by 2030, including by making use of EU development funds such as the EUR 385m for renewable-energy installations. The synchronisation of the Baltic states’ electricity networks with those in continental Europe, the recent liberalisation of the retail-electricity market and the incentivisation of households to self-generate and store solar electricity support Lithuania’s objectives for energy sustainability.

Rating committee
The main points discussed by the rating committee were: i) Lithuania’s growth outlook; ii) fiscal dynamics and debt sustainability; iii) labour market and demographics; iv) external sector developments; v) financial sector developments; vi) ESG; and vii) peers.

Rating driver references
1. European Commission, Press release
2. European Commission, Baltic energy market interconnection plan
3. Bank of Lithuania, Private sector debt
4. ECB, Supervisory banking statistics
5. Ministry of Finance, 2022 Lithuanian Draft Budgetary Plan
6. SSE Riga, Shadow Economy Index for the Baltic Countries
7. Ministry of Finance
8. Eurostat, Old-age dependency ratio increases across EU regions
9. Bank of Lithuania, Banking sector in Lithuania

Methodology
The methodology used for these Credit Ratings and Outlooks, (Rating Methodology: Sovereign Ratings, 8 October 2021), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
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-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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-scale. 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://www.scoperatings.com/#!methodology/list.
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         NO
With access to internal documents                                      NO
With access to management                                                NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain. 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 Outlooks and the principal grounds on which the Credit Ratings and 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: Levon Kameryan, Senior Analyst
Person responsible for approval of the Credit Ratings: Alvise Lennkh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 29 January 2021.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope 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.