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International Monetary Fund. European Dept.

1. After a past shock that led to a reduction in transnational banking transactions, Lithuania’s financial sector has readjusted to serving non-residents, posing higher money laundering risk, mostly through Fintech companies.2 The non-resident activity in Lithuania has decreased significantly following the financial integrity breaches at Snoras and Ukio banks that lost their licenses in 2011 and 2013, respectively, with involvement of the latter in the “laundromat” operations where Lithuania was used as a transit point for suspicious transactions allegedly linked to foreign criminal activity.3, 4 Subsequently, the BoL focused its monitoring on daily non-resident deposits and transactions in Lithuanian banks. Due to the recent growth of the fintech hub, Lithuania’s financial sector’s focus shifted away from bank-centric focus on servicing domestic market to facilitation of cross-border payments, with most transactions conducted by non-residents with origination and destination outside Lithuania, including higher Money Laundering and Terrorism Financing (ML/TF) risk countries.5 Fintech developments have impacted the financial sector and risk profile of the country, challenging the authorities’ resources and capacity to mitigate the ML/TF risks.

International Monetary Fund. European Dept.

With a demonstrated resilience to the crisis and the recovery gaining strength, macroeconomic policies should aim at preserving stability and complementing structural reforms that address long-standing challenges. A medium-term plan to rebuild buffers, support potential growth, and target pockets of vulnerability would help address pre-existing disparities and poverty. Sustained productivity growth, supported by the implementation of politically difficult but needed structural reforms, is the only way to support high wage growth and convergence with Western Europe. Failure to do so could jeopardize Lithuania’s hard-earned competitiveness gains.

International Monetary Fund. European Dept.
This 2019 Article IV Consultation highlights that the Lithuanian economy has continued to enjoy a strong macroeconomic and fiscal performance, but long-term challenges remain largely unaddressed. The continued strong economic performance suggests that a neutral fiscal stance would have been preferable in the year 2019. The report discusses that Lithuania needs sustained productivity gains to ensure higher living standards and convergence with Western Europe. Macroeconomic and financial stability is a prerequisite for sustained growth and has been achieved through prudent policies and labor market flexibility. Nevertheless, significant and well-identified structural challenges have yet to be addressed with ambitiously designed and decisively implemented productivity-enhancing reforms. The current expansionary cyclical environment and strong fiscal and external positions provide an ideal opportunity to address these challenges. Fintech provides big opportunities to improve financial services and produce high-skill jobs; however, it also brings challenges, particularly related to antimoney laundering. The authorities’ efforts to promote fintech are already delivering results.
International Monetary Fund. European Dept.

Thanks to sound macroeconomic management and an overall favorable business climate, income convergence with Western Europe is advancing. In 2015, sharply contracting exports to Russia temporarily dragged down growth. Ensuring good economic progress over the medium term requires continued productivity improvements, safeguarding competitiveness in a tightening labor market, and beginning to address high income inequality.

International Monetary Fund. European Dept.

KEY ISSUES Context and outlook. Lithuania’s economic comeback over the past five years has been impressive. Real GDP has surpassed its previous peak and external and internal imbalances have been corrected. Euro adoption in January went smoothly and came with important upgrades to policy frameworks. Financial stability has increased further. Resilient growth in the face of recent external challenges speaks to Lithuania’s strong economic fundamentals and augurs well for the future, but risks in the external environment persist. Key policy issues. The Article IV discussions focused on policies to support the next chapter of convergence with living standards in Western Europe and to ensure continued stability in the face of population ageing and wage convergence with the EU. • Fiscal policy. Repair of public finances has come a long way, but there is a need for some further consolidation to build fiscal space. Structural reforms to defuse spending pressures, raise spending quality, and reduce the tax burden on labor are also called for. The authorities should take corrective measure this year to avoid backsliding, target a structural fiscal balance of -0.5 percent of GDP from 2016 onward to put the public debt ratio on a downward trajectory, and articulate a strategy for fiscal structural reform. • Investment and innovation. Both need to be stepped up. Plans to frontload and better leverage EU structural funds and tap resources under the “Juncker Plan” are welcome, especially to the extent they benefit SMEs. Fragmentation in innovation policies should be addressed. Investment will also depend on structural reforms, in particular measures that unlock labor resources and attract foreign investors. • Labor resources and structural reform. With one of the most challenging demographic profiles in Europe, Lithuania needs to make the most of available labor resources. The labor market is rather flexible in practice, but the rigid and poorly applied labor code should be modernized, mismatches between skills taught by the education system and those sought by the labor market need to be addressed, and budget-neutral alternatives to currently high labor taxation should be actively considered.

Nir Klein
The limited access to bank credit in recent years has increased the pressure on small and medium size enterprises (SMEs), forcing them to scale down investment plans and production. This paper, which explores the macroeconomic implications of this channel, finds evidence that countries with high prevalence of SMEs tended to recover more slowly from the global financial crisis than their peers, implying that the interaction of the economic structure and access to bank financing plays a critical role in episodes of economic recovery. This conclusion is reinforced by a VAR estimation, which demonstrates that a negative credit supply shock applied to SMEs has an adverse effect on economic activity, and this impact is amplified in countries that have a high share of SMEs.
International Monetary Fund. European Dept.

This 2014 Article IV Consultation highlights that Lithuania’s economy has entered a broadly favorable trajectory of healthy and balanced growth, but income convergence with Western Europe has a long way to go. With inflation at historical lows and well-advanced repair of public finances damaged by the 2008/09 crisis, meeting the entry criteria seems on track. Financial stability has improved further in 2013, with the capital adequacy ratio exceeding 17 percent and steady progress in reducing nonperforming loans. The main challenge is now resuscitating the sluggish private sector credit growth, which could undermine investment and the recovery if it continued for much longer.