A Survey of the Lithuanian Economy 2004-2005 [1]
Forecasts for 2004 (updated) and 2005
According to the survey of market participants conducted by the Lithuanian Free Market Institute (LFMI) in July-August 2004, the economic situation in Lithuania should remain stable in the near future. The economy is still growing rapidly, the financial situation of Lithuanian companies is improving, the unemployment rates are declining, and the average salaries are increasing. Economic growth is stimulated by a rising domestic market and export growth, growing investments, and brighter expectations of both companies and people. On the other hand, the survey shows that the shadow economy has not been shrinking for several years, and as many as four in ten people that officially earn the minimum wage additionally get paid ”under the table.” In the previous survey, inspired by high expectations of the upcoming membership of the European Union, the market participants voiced very optimistic prognoses in almost all sectors. However, during this survey their forecasts were more moderate. And while they expect to see a constant growth in such areas as employment, average salaries, investments and foreign trade, market participants do not project any rapid changes brought about by any external factors.
According to the LFMI survey, the Lithuanian economy will grow by 7 percent in 2004, as compared to ex poste estimate of the 2003 GDP growth of 7.4 percent. Market participants have increased their 2004 GDP growth estimates since the last survey, but expect to see a slower economic growth rate of 6.5 percent in the year 2005. Such prognoses coincide with the forecasts put forward by the official national and international institutions. The main factors to be blamed for relatively slower economic development in 2004 and 2005 are a shortage of a qualified work force (felt even more acutely after the 1st of May because of the migration to other EU labour markets), a prolonged scarcity of foreign investment and a slower export growth. On the other hand, the economy is stimulated by a rapid expansion of the domestic market, foreign trade and increasing investment flows. The LFMI survey indicates that the bright forecasts are also being encouraged by the membership of the European Union. Market participants are positive about Lithuania’s membership in the Union and expect it to have the biggest impact on the country’s economy in 2005 through 2008.
According to market participants, in 2004 the Lithuanian export is growing at a slower rate than in the previous year, while the import growth has increased. In the mid-year market participants lowered their forecast of export growth from the previous survey by almost ten percent and expect to see an 11.6 percent growth this year. Lower prognoses of import growth can be explained by the long stagnated investment processes, dwindling expectations of household income growth, as well as changes in the trade regime with the non-EU members. Lower estimates of export growth are likely to be related to a slower than expected recovery of Lithuania’s major export markets, particularly the euro zone.
The survey shows that both export and import will grow faster in 2005. Again, import growth will outpace the export growth by one percentage point, and will have grown by 12.6 percent at the end of 2005. Export is expected to rise by 12.5 percent.
In the middle of this year, market participants updated the forecast of the shadow economy from the previous survey. The survey participants predict that the shadow economy will account for 19.6 percent of GDP in 2004, although they expect it to shrink to 18.7 percent in 2005. In the previous survey market participants predicted the shadow economy to go down to 18.5 percent, as compared to the stable 20 percent in 2002-2003. However, the forecasts have been raised by one percent during this survey, and currently the shadow economy is expected to remain at the previous level. A still growing tax burden, rigid employment regulations, rising excise duties on tobacco products and fuel plus aggravated conditions for sole proprietorship are the main factors holding back a decline in the shadow economy.
According to the survey, this year both consumer and producer prices are growing more rapidly than in 2003, and an even greater surge is forecasted for 2005. Market participants think that after a rapid slowdown last year, prices of consumer goods and services will go up by 2.5 percent, while the producer prices will rise by 2.7 percent, as compared to the 0.8 percent growth in 2003. Prices are being augmented by changes in the foreign trade regime related to the EU membership, excise duties, and record high oil prices. Other contributing factors are lower unemployment rates and increasing salaries, which fuel consumption and, in turn, domestic demand.
The survey reveals an especially marked change in the producer price forecasts for 2004. Over six months the survey participants have increased their estimates by as much as forty percent: from an estimated 1.9 percent to 2.7 percent. The consumer price forecasts have been raised by 7 percent. The increased prognoses for the consumer prices might be attributed to an upsurge in household consumption rather than rising investments, which have been fuelling price rises over the last couple of years, but are expected to be lower in 2004. The producer prices are at the same time tending upwards due to the subsidies for export to countries outside the EU as well as the laws against importing the subsidised agricultural produce from the EU member states. Also, the changes in the already mentioned trade regime made both goods and raw materials from the third countries more expensive. High oil prices also contribute to the increase in producer prices.
According to market participants, lower unemployment rates, rising salaries, household income and domestic consumption will be the main factors driving the prices up even more in 2005. The survey shows that prices of consumer goods and services will go up by 2.8 percent in 2005, while the producer prices will rise by 3.1 percent. In addition to the already mentioned factors, an increase in prices will be influenced by higher excise duties and oil prices, and gradual EU tax harmonisation.
The survey shows that the situation in the labour market continues to improve in line with a steady and rapid economic growth. According to the survey, the unemployment rate is to go down to 9.6 percent at the end of 2004, as compared to 11 percent a year earlier. Market participants believe that unemployment will continue to decline gradually and will be less than 9 percent at the end of 2005.
A decline in unemployment is affected by, inter alia, high expectations about business conditions and more optimistic business financial indicators. The migration of the labour force to the EU labour markets has also reduced the unemployment figures. On the other hand, a more rapid reduction in unemployment is being forestalled by a heavy tax burden for business and individuals, tight employment regulations, an increase in the minimum wage, a large pool of unskilled workers and a shortage of a qualified labour force.
Market participants think that the tax burden has increased since last year and currently accounts for 36.5 percent of GDP. According to the ex poste estimates, the tax burden accounted for 35 percent of GDP in 2003, and at the beginning of the year survey participants did not envisaged any changes in 2004. Nonetheless, market participants raised the forecast for this year by nearly one percent. Higher forecasts of the tax burden may be the result of slightly reduced forecasts of economic growth and the government’s EU oriented tax policies. The tax burden is not expected to change much the next year and will account for about 36 percent of GDP. Such figure is still bigger than both the tax burden in 2003 and the expectations of respondent in the previous survey.
As the survey indicates, personal earnings have started to recover after a two-year long standstill. Market participants have raised their forecasts for 2004, and anticipate the average salaries to go up by as much as 7 percent over the course of the year, reaching 1,113 litas per month at the end of the year. Falling unemployment, growing demand for labour and higher corporate indicators all contribute to these optimistic forecasts. The upward trend should continue into the next year. Market participants predict that average monthly net earnings will grow by 7.7 percent, or 86 litas per month, and at the end of 2005 will amount to 1,119 litas.
The economic growth has had a continuous positive impact on the financial situation of Lithuanian households. Having provided a much lower ex poste estimate of average monthly household income for 2003, market participants were extremely hopeful about the prospects of growth in 2004. In the previous survey they expected household income to grow by as much as 8 percent and amount to 2,058 litas by the end of the year 2004. However, as the latest survey suggests, shrinking unemployment and increasing average wages will not be sufficient enough to produce any noticeable improvement in household financial standings. The prognoses in the latest survey are considerably lower; this time market participants do not expect the average household income to grow much above the last year’s level: they believe that average monthly income will rise by only 1.2 percent and reach 1,928 litas at the end of the year. Average monthly income per household member will amount to 756 litas. Since the figures of average net earnings are relatively big, and both pensions and social benefits have been raised this year, pessimistic forecasts about household’s financial situation might have been influenced by lower non-labour income, as well as high expectations, stirred by the upcoming membership in the EU and unfulfilled during the first months of membership. But the expectations for 2005 are more optimistic. Survey participants believe that household income will grow by 6.6 percent (127 litas per month) in 2005 reaching 2,055 litas at the end of the year. The envisaged rise in household income may be related to a further reduction in unemployment and a rise in non-labour income. The size of household income will also be influenced by increases in pensions, social benefits and other payments form the budget.
The LFMI survey reveals that household investments and savings, which grew rapidly in 2002-2003, will slow down this year. While the volume of savings in the household budgets will not change much, investments will go down significantly. Market participants believe that household savings will increase by 1.5 percent (4 litas) in 2004 and will amount to 267 litas. At the same time, households will invest approximately 247 litas per month, which is 46 litas, or 16 percent, less than in 2003.
Market participants considerably altered their forecasts of the growth of household savings and investments, as compared to the survey conducted six months earlier. At the beginning of 2004 LFMI survey participants were more optimistic about the dynamics of both household savings and investments. Market participants predicted that household savings would rise by 6.5 percent in 2004 and equal 280 litas per month, while household investments would go up by 13.7 percent, reaching 333 litas per month. If a change in market participants’ expectations in terms of savings was not marked (they think that savings should get a positive impulse from the growing interest rates and continue to increase), so their forecasts of investment growth shrank by almost one third. Significantly lower forecasts of household investment could be a direct result of low expectations regarding household income, and surging prices of construction. Market participants also think that household investments should decrease because the lasting upswing in investments has already saturated the market. Moreover, a rising share of household budgets allotted for consumption in part accounts for the lower investment share.
Growing earnings and household income will continue to augment household savings and investments in 2005, while the amount spent for everyday goods will decrease. It is expected that savings will rise by 6.7 percent and investments by 10.5 percent next year, although savings will still comprise a greater share in total household income: according to the market participants, every month households will save approximately 285 litas, as compared to the 273 litas they will invest.
As the LFMI survey shows, corporate indicators are moderately optimistic. Market participants predict that the average profit margin will increase to 6.3 percent, while the average return on equity will rise to 10.2 percent, both numbers closely resembling those of the last year. The profit margin is expected to go up to 6.5 percent in 2005, while the average return on equity will be 10.6 percent, up by four percentage points. These optimistic, but moderate, forecasts are likely to be positively influenced by such factors as ongoing economic growth, rising domestic demand, and the expected beneficial effects of EU membership. On the other hand, they might be negatively affected by the growing demand for qualified labour and the related costs.
The survey shows that the share of reinvested profits increased steadily in 1997-2000, however, this trend reversed noticeably in 2002. This year the share of reinvested profits is expected to average 52 percent, down from 66 percent in 2001. Market participants do not expect that the share of reinvested profits will change in 2005.
The LFMI survey participants think that the dwindling share of reinvested profits does not have much effect on companies’ expenses on research and development. As the results of the survey show, expenses on research and development are expected to account for 6.2 percent of companies’ total expenses in 2004, which is more than in 2003, but still does not reach the 2001 level, when companies’ expenses on research and development were as high as 7.2 percent. The LFMI survey participants are more optimistic about the prospects in 2005, during which, they believe, the share of expenses on research and development will increase by 6.7 percent.
According to the LFMI survey participants, the yield on 3-year government bonds in the primary market will be 3.95 percent at the end of 2004. It is likely that this higher yield is related to the U.S. Federal Reserve System policies, particularly the decision to raise the interest rate.
The costs of borrowing from commercial banks have stabilised and are expected to remain at the same level as in 2003. According to market participants, at the end of 2004 the costs of borrowing will increase slightly, with both one-year and five-year loans in litas costing on average 5.6 percent of annual interest. The LFMI survey shows that the non-bank loans, especially lease and factoring, are becoming more and more popular. During the first nine months of this year, these services accounted for one fourth of the total credit market. Market participants predict that the share of the non-bank loans will not change and will account for 18 percent of the market in 2004.
Market participants predict that the U.S. dollar will cost 2.88 litas at the end of 2004, their predictions virtually coinciding with the exchange rate registered on the market in late July 2004.
***
The next survey will be conducted at the beginning of 2005 and provide market participants’ ex poste estimates of 2004 and their expectations for the year 2005.
About the survey
Launched in 1997, the LFMI survey is aimed to provide estimates and forecasts of economic variables in Lithuania based on the opinion of market participants, to analyse factors that influence the outlooks of market participants, to compare the survey results with official statistics and data from other sources, and to offer interpretations of the most distinct differences.
T
he LFMI survey is based on the expert consensus paradigm originating from the theory of rational expectations. This theory states that, if a connection exists between an economic variable and certain processes in the economy, market participants will use all available information to make estimates and forecasts.
Thirty-five respondents participated in the fourteenth survey. The survey was funded by „JTI International“, „Maþeikiø nafta“, „Kappa Packaging Baltic“, „Klaipëdos kartonas“, „Ragutis“, „Rimi Lietuva“, „Santa Monika Networks“, SBA and „Vakarø elektros skirstomieji tinklai.“
