August 25, 2017 / 8:07 PM / 3 months ago

Fitch Affirms Lithuania at 'A-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, August 25 (Fitch) Fitch Ratings has affirmed Lithuania's Long-term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'A-', with Stable Outlooks. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Lithuania's ratings are supported by prudent fiscal management, reflected in modest fiscal deficits and a declining debt burden, as well as institutional strengths and a credible policy framework that come with EU and eurozone membership. However, external finances are weaker, and the rating remains constrained by structural bottlenecks that weigh on the country's progress in convergence towards income levels of higher-rated peers. Economic growth has picked up faster than Fitch projected six months ago. Robust domestic demand, led by household consumption and a recovery in export growth, resulted in average annual growth of 4% in 1H17, compared with 2% over the same period a year ago. As a result of this cyclical upswing, Fitch has revised up its 2017 real GDP forecast to 3.3% from 2.7% previously, pushing Lithuania's five-year average real GDP back in line with the median rate (2.9%) of its category peers. With inflationary pressures picking up on the back of higher food and energy prices, a moderation in growth is forecast for 2H17, with Fitch anticipating a slowdown in private consumption to be offset by a pick-up in EU-fund related investment, while contribution from net exports stays negative. For 2018 and 2019, Fitch forecasts average real GDP growth of 2.7%. Lithuania's level of GDP per capita is 18% below the median level of its 'A' category peers, and has stalled in recent years. Levels of gross domestic investment and savings to GDP are also below peers, reflecting a small but developing economy. Reinvigorating income convergence is a key policy challenge for Lithuania. Adverse demographics, a tightening labour market, and with the Bank of Lithuania's estimate of a closing output gap, strengthening productivity growth towards higher-valued added sectors will require ongoing government commitment on efficient structural reform. Positive steps have been made in light of the government's recently adopted New Social Model, although structural inefficiencies remain in the healthcare and education sectors, and the grey economy is relatively large. Public finances continue to improve. Lithuania achieved its first ever fiscal surplus of 0.3% of GDP in 2016, significantly outperforming the median 1.8% deficit of its 'A' category peers. Under Fitch's calculations, structural reform costs will turn the balance back to a deficit of around 0.2% of GDP in 2017, remaining at 0.3% of GDP until 2019. This contrasts with the government's stability programme, which targets fiscal surpluses from 2018 onwards, relying largely on increasing tax collection against a gradually declining GDP growth baseline. Lithuania's total revenues to GDP ratio is in line with the 'A' median, but the share of tax revenues to GDP is among the lowest in the EU. Currently, the government is planning a package of tax reforms for 2018, aimed at improving income inequality and social welfare. General government debt at 40.2% of GDP (end 2016) remains well below the 52.4% debt ratio of its 'A' category peers. Fitch forecasts general government debt to fall to 39.8% of GDP in 2017, and under the agency's latest baseline, the government debt burden gradually declines over the long term. Debt sustainability is further underscored by a manageable share of debt redemptions (3.6% of GDP, 2017) and an increasing average maturity (6.2 years). Some of Lithuania's external finance indicators are weaker than its 'A' category peers. Fitch's forecast for rising energy prices and a pick-up in investment-related imports, will lead to a gradual widening of the current account deficit from 0.9% of GDP in 2016 to around 2% of GDP by 2019. This contrasts with the median current account surplus of 2% across 'A' category peers. In addition, Lithuania is a large net external debtor (24.4% of GDP) relative to its peers (6.4% of GDP), with the majority as public sector debt in the form of long-term government debt and liabilities to the ECB. A stable banking sector supports Lithuania's ratings. Banks are profitable, well capitalised (average capital adequacy ratio 20%, 1Q17) and asset quality continues to improve (NPLs, 3.8%, 1Q17). The sector is highly concentrated with subsidiaries of Nordic banks, and while this reduces the risk of financial sector liabilities falling on the sovereign's balance sheet, spillovers from vulnerabilities in parent banks present an ongoing tail risk. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Lithuania a score equivalent to a rating of 'A' on the Long-Term FC IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - External Finances: -1 notch, to reflect high net external debt relative to the peer median. In addition, though Lithuania benefits from euro's "reserve currency flexibility", Fitch believes that this status would likely offer Lithuania only limited protection in case of a global or domestic financial crisis. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced. The main factors that could, individually or collectively, trigger positive rating action include: - A sustained improvement in external debt ratios - A longer track record of strong and stable economic growth that fosters higher income per capita, without the re-emergence of macroeconomic imbalances The main risk factors that could, individually or collectively, trigger negative rating action are: - Deterioration in Lithuania's public debt dynamics, for example, from sustained fiscal slippage or economic underperformance - Deterioration in external finances, for example, associated with overheating of the domestic economy KEY ASSUMPTIONS The global economy performs broadly in line with Fitch's Global Economic Outlook The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'A-'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'A-'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F1' Short-Term Local-Currency IDR affirmed at 'F1' Country Ceiling affirmed at 'AAA' Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at 'A-' Issue ratings on long-term senior-unsecured local-currency bonds affirmed at 'A-' Contact: Primary Analyst Kit Ling Yeung Associate Director +44 20 3530 1527 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Arnaud Louis Director +33 144 299 142 Committee Chairperson Shelly Shetty Senior Director +1 212 908 0324 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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