European Commission assessment of the 2008 update of the Lithuanian convergence programme Ralph Wilkinson Directorate Member States II DG ECFIN, European Commission Vilnius, 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 - II The 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 features Preventive 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 convergence programme assessment - procedures Lithuania submitted the updated convergence programme on 23 January 2009 Lithuania submitted the updated convergence programme on 23 January 2009 The European Commission assessed the programme and adopted a recommendation for a Council Opinion on 25 February 2009 The European Commission assessed the programme and adopted a recommendation for a Council Opinion on 25 February 2009 It was discussed at the Economic and Financial Committee (EFC) It was discussed at the Economic and Financial Committee (EFC) The Council adopted its Opinion on 10 March 2009 The Council adopted its Opinion on 10 March 2009

Lithuanian economy - scene setting Overheating pressures: wages, inflation, current account deficit soaring; external competitiveness weakening Overheating pressures: wages, inflation, current account deficit soaring; external competitiveness weakening Weak policy response – expansionary and pro- cyclical fiscal policy, measures supporting credit growth, high public sector wage growth Weak policy response – expansionary and pro- cyclical fiscal policy, measures supporting credit growth, high public sector wage growth Previous Commission and Council advice (but not followed): Stronger policy response needed to correct internal and external imbalances and maintain macroeconomic stability Previous Commission and Council advice (but not followed): Stronger policy response needed to correct internal and external imbalances and maintain macroeconomic stability

The underlying economic assumptions

Medium-term budgetary strategy The main goal of the medium-term budgetary strategy: the general government structural deficit of 1% by 2010 The main goal of the medium-term budgetary strategy: the general government structural deficit of 1% by 2010 Headline deficit to narrow to 1% in 2010 and to be in balance in 2011 Headline deficit to narrow to 1% in 2010 and to be in balance in 2011 Mainly to be achieved through revenue-to- GDP ratio and a modest reduction in the expenditure ratio Mainly to be achieved through revenue-to- GDP ratio and a modest reduction in the expenditure ratio

Medium-term budgetary strategy

Policy measures to achieve the programme objectives With the 2009 budget, a fiscal consolidation package adopted aimed at restoring market confidence and limiting financing needs With the 2009 budget, a fiscal consolidation package adopted aimed at restoring market confidence and limiting financing needs A comprehensive tax reform introduced with the 2009 budget A comprehensive tax reform introduced with the 2009 budget Significant expenditure cuts, including public sector wages (3%), current expenditure and investment Significant expenditure cuts, including public sector wages (3%), current expenditure and investment But some measures underpinning the budget rejected and have to be replaced by new measures But some measures underpinning the budget rejected and have to be replaced by new measures Are the adopted measures sufficient to achieve the medium-term budgetary strategy? Are the adopted measures sufficient to achieve the medium-term budgetary strategy?

Risk assessment Budgetary outcomes subject to significant downside risks Budgetary outcomes subject to significant downside risks In 2009, tax increase may not lead to higher revenue and expenditure cuts may prove difficult In 2009, tax increase may not lead to higher revenue and expenditure cuts may prove difficult 2010 and 2011 consolidation base on markedly favourable macroeconomic assumptions 2010 and 2011 consolidation base on markedly favourable macroeconomic assumptions Additional measures are needed to underpin the budgetary targets Additional measures are needed to underpin the budgetary targets

Long-term sustainability of public finances The long-term budgetary impact is lower than the EU average due to enacted pension reform The long-term budgetary impact is lower than the EU average due to enacted pension reform However, starting position worsened considerably considering budgetary outcome in 2008 However, starting position worsened considerably considering budgetary outcome in 2008 Lithuania is at medium risk to long-term sustainability of public finances Lithuania is at medium risk to long-term sustainability of public finances Achieving primary surpluses over the medium term would help to reduce risks Achieving primary surpluses over the medium term would help to reduce risks

Medium-term budgetary framework Medium-term budgetary framework has not succeeded in preventing expenditure overruns Medium-term budgetary framework has not succeeded in preventing expenditure overruns The Law on Fiscal discipline lacks necessary forward looking medium-term planning elements The Law on Fiscal discipline lacks necessary forward looking medium-term planning elements Scope for enhancing planning and the binding character of expenditure ceilings Scope for enhancing planning and the binding character of expenditure ceilings Framework needs to ensure fiscal consolidation in good times - would help during the downturn Framework needs to ensure fiscal consolidation in good times - would help during the downturn

Fiscal response to current downturn All three Baltic countries embark on the fiscal consolidation which is in line with the European Economic Recovery Plan All three Baltic countries embark on the fiscal consolidation which is in line with the European Economic Recovery Plan  “For those Member States, in particular outside the euro area, which are facing significant external and internal imbalances, budgetary policy should essentially aim at correcting such imbalances.” … and is largely driven by pragmatic considerations … and is largely driven by pragmatic considerations  Difficulty in securing new financing at acceptable conditions due to the market risk aversion  Euro accession as a confidence measure

ERM2 context “For a sustained period wage growth has exceeded productivity growth by far, thus weakening the country's competitiveness, hindering prospects of export-led economic recovery.” “For a sustained period wage growth has exceeded productivity growth by far, thus weakening the country's competitiveness, hindering prospects of export-led economic recovery.” In the context of ERM II membership and to improve cost competitiveness, urgent need to correct high wage growth In the context of ERM II membership and to improve cost competitiveness, urgent need to correct high wage growth

Summary The adopted consolidation programme is an appropriate response to needs to correct macroeconomic imbalances The adopted consolidation programme is an appropriate response to needs to correct macroeconomic imbalances The adjustment should be backed by additional measures to prevent breaching the 3% threshold in 2009 and 2010 The adjustment should be backed by additional measures to prevent breaching the 3% threshold in 2009 and 2010 Need to reduce high wage growth Need to reduce high wage growth

Policy invitations Implement measures to achieve budget target in 2009 by prioritising expenditures and continue fiscal consolidation in the medium-term Implement measures to achieve budget target in 2009 by prioritising expenditures and continue fiscal consolidation in the medium-term Implement public sector wage restraint Implement public sector wage restraint Strengthen public sector governance and transparency, by enhancing the medium- term budgetary framework and reinforce expenditure discipline Strengthen public sector governance and transparency, by enhancing the medium- term budgetary framework and reinforce expenditure discipline

Spring what now? Economic situation in Lithuania, Baltic region and globally has deteriorated further (European Commission spring economic forecasts to be published 4 May) Economic situation in Lithuania, Baltic region and globally has deteriorated further (European Commission spring economic forecasts to be published 4 May) Budgetary prospects weaker Budgetary prospects weaker Consolidation package imminent, with hints of further action in summer Consolidation package imminent, with hints of further action in summer Speculation of international financing support Speculation of international financing support