A Survey of the Lithuanian Economy 2004-2005 [2]
Estimates of 2004 and forecasts for 2005 (updated)
Market participants are more pessimistic about the prospects of economic development and reforms in Lithuania
According to the 15th survey of market participants conducted by LFMI in January to February 2005, the economic situation in Lithuania in 2004-2005 remained stable. The economy is still growing rather rapidly, but not as fast as in 2003; the financial situation of Lithuanian companies is improving, unemployment rates are declining, and the average salaries, although not growing as fast as expected in 2004, , are expected to increase rather considerably in 2005. Economic growth is stimulated by growing consumption, a strong domestic market and export growth, growing investments, and brighter expectations of both companies and people. On the other hand, the survey also shows that the size of the rather large shadow economy has not been decreasing for several years, and instead appear to be growing: the market participants believe that currently the levels of shadow economy are growing. Moreover, as many as four in ten people that officially earn the minimum salary additionally get receive payments in “envelopes.” Overall, the market participants’ estimates are much more moderate than a year ago. At the beginning of 2004, inspired by high expectations of the upcoming European Union (EU) accession, the market participants voiced very optimistic prognoses in almost all sectors. This time, however, while they still expect to see a constant growth in employment, average salaries, investments and foreign trade, market participants do not project any rapid changes brought about by any external factors.
As the LFMI survey shows, Lithuania’s economic growth remained steady in 2004 but not as rapid as in 2003. Lithuania’s gross domestic product (GDP) grew by 6.8 percent in 2004 as compared to 7.4 in 2003. It is projected that the economic growth will slow down even more significantly in 2005 – it is estimated that the economy will grow only by 6.3 percent. The estimates of 2004-2005 GDP growth provided by market participants are a little bit lower than the previously reported forecasts, but in general coincide with the forecasts put forward by official national and international institutions. According to the most recent LFMI survey, the most prominent factors resulting in the lower growth estimates are, first, a shortage of a qualified labour (a result of large-scale outbound migration to the other countries of the EU, and a declining quality of the education system); and, second, a failure to initiate and implement structural reforms in a number of strategic sectors where reform is badly needed, the latter resulting in a prolonged scarcity of foreign investment. On the other hand, the economy is stimulated by the rapid expansion of the internal market, consumption, foreign trade and gradually recovering investment flows.
Contrary to the market participants’ earlier expectations, the levels of shadow economy have not decreased; just the opposite, over the past year, the shadow economy appears to have expanded. According to the market participants, in 2004 the shadow economy accounted for as much as 20.8 percent of GDP as compared to the expected 18.6 percent. It is not expected to change much in 2005: the market participants project that it will only go down to 20.6 percent by the end of the year.
Market participants’ expectations have changed significantly over the course of the last year. In the spring of 2004, in light of optimistic expectations regarding the country’s membership of the EU and awaiting the long-incubated tax reform, market participants predicted a shift in the shadow economy for the first time in three years, down from the stable 20 percent in 2002-2003 to 18.6 percent in 2004. This is more than 2 percent less than the estimate given in the last survey, when the market participants raised the estimates to almost 21 percent. The continued large shadow economy is a result of a high tax burden – which is also likely to increase, inconsistency and unpredictability of government tax policy, strict regulations of labour relations, further increases of excise duties on cigarettes and fuel and deteriorated conditions for individual businesses.
Market participants polled by LFMI believe that foreign trade continues to grow rapidly, and the growth rate is not expected to decline in the near future. The ex poste estimates of the growth of both exports and imports are higher than market participants’ earlier forecasts. Market participants also believe that exports again grew more rapidly than imports. According to the survey, in 2004 exports grew by 13.2 percent and imports rose by 12.4 percent as compared to 12 percent and 11.4 percent respectively in 2003. Higher estimates of export growth as compared to import growth can be attributed to the membership of the EU, which has arguably had a stronger effect on the dynamics of import growth, making import from some third countries more expensive. On the other hand, these higher prices could be offset by seeking cheaper alternatives elsewhere and by the lower price of imports from EU countries.
Market participants’ higher expectations and resulting higher estimates and forecasts for the foreign trade growth (and export growth in particular) are bolstered by the removal of trade barriers after EU accession, the slowly recovering economy of the euro area, accelerating economic growth in the US, and rising prices of oil and metals. Higher expectations regarding import growth can also be related to increased estimates of household income, the purchasing power and daily consumption expenditures, and, partly, to slightly recovering investment processes. Survey participants predict that foreign trade will increase even more this year: exports are expected to go up by 13.8 percent and imports by 12.6 percent. As in the previous year, in 2005 export growth is likely to continue to surpass import growth.
Market participants have increased their prognoses of price growth and now report that prices grew at a higher rate in 2004 than in 2003. Similar upward trends are expected to persist this year. According to market participants, after a very slow growth in 2003, both consumer prices and producer prices increased more considerably during 2004. Consumer prices rose by 2.96 percent, while producer prices increased by 3.3 percent, compared to only 0.8 percent in 2003. The main factors that contributed to the higher prices were higher household income and stimulated domestic demand reinforced by long-term consumption, changes in the trade regime, increases in excise duties, and sharply mounting oil prices. Consumer prices were also partially inflated by the expectations that EU accession would in any case push up the level of inflation as well as by increasing prices in the state-regulated sectors, steadily growing government consumption, rising prices of transport services and increasing wages.
The much higher – almost doubled – forecasts of producer prices during the previous year may be directly related to the leap in oil prices. The level of producer prices was also affected by markedly increased excise duties after EU accession, which contributed to rising prices of raw materials used by individual producers in Lithuania. Mostly driven by the same factors as in 2004, this year consumer prices are projected to go up by 3.28 percent, while producer prices are estimated to increase by 3.67 percent.
The survey shows that the situation in the labour market continues to improve as a result of the steady economic growth. According to market participants, the rate of unemployment was 9.6 percent at the end of 2004, compared to 11 percent at the end of 2003. It is expected that unemployment will continue to fall steadily and will stand at 8.4 percent at the end of 2005. Emigration of Lithuanian workers to other EU countries has also significantly contributed to the lower unemployment rate. On the other hand, a more rapid decrease in unemployment is stalled by unfavourable tax policies, rigid employment regulations, and increases of the minimum wage. Moreover, the lower unemployment rates should not be seen as a solely positive development, since it is in large part caused by outbound migration, and covers up more fundamental problems of the Lithuanian labour market, such as structural unemployment and a large number of people who are out of work for a prolonged period of time – 2 years or longer. This specific – and not too encouraging – feature of the Lithuanian labour market is partly a result of the serious deficiencies of a national education system that produces a large number of poorly skilled workers that are not valued in the labour market.
According to market participants, the tax burden was 35.4 percent of GDP in 2004. They expect the tax burden to grow and constitute 36.3 percent in 2005. The ex poste estimate of the 2003 tax burden was 35 percent and the market participants believed it would not change in the near future. However, in the current survey the market participants raised both the estimates of 2004 and, especially, the prognosis for 2005. . The higher estimates are possibly a result of the government’s unpredictability, both unclear and inefficient tax policy, and the EU membership. And even if the predicted still relatively rapid GDP growth should to some degree countervail the tax increases introduced in 2004 and 2005, market participants project that the increase in the tax burden will be more noticeable this year. In order to ensure the country’s competitiveness in the global market, it is crucial to implement a consistent tax policy and to conduct structural reforms that in the long run would reduce the overall tax burden.
In the last couple of surveys market participants have tended to make optimistic forecasts of personal earnings growth but provide much lower ex poste estimates. This time, too, after (one year ago) having forecast a rapid wage growth, reaching 1,113 litas at the end of 2004, market participants have been reducing their prognoses over the course of the last year. According to their current estimates, the average monthly earnings grew very insignificantly last year. Market participants estimate that average monthly net earnings grew by a mere 11 litas in 2004, to a total of 1,052 litas. Reduced forecasts of earnings growth in 2004 may be directly related to previously high expectations of a rapid leap in earnings after the EU accession on May 1 and subsequent unfulfilled hopes. The slower earning growth might also be influenced by high labour taxation, and non-monetary wage supplements.
Market participants think that net earnings will grow by more than 8 percent and amount to 1,138 litas by the end of 2005. The more optimistic forecast could be driven by declining unemployment and increased competition in the labour market (resulting from emigration and gaps in the education system), as well as by growing corporate profits. The increased minimum wage, and the prospects of it being increased again this year, could also have contributed to the higher average monthly earning expectations.
The economic growth has had a continuous positive impact on the financial situation of Lithuanian households. The yearly estimates obtained from the survey of market participants show a steady growth of household income over the past five years. However, just like with earning forecasts, the market participants’ ex poste estimates are often much lower than the initial prognoses. According to the ex poste estimates of market participants, average monthly household income amounted to 1,980 litas in 2004 while the average income per household member totalled 776 litas. Even though this estimate is higher than expected in the previous survey (when the market participants were warning about a potential stagnation of the household income growth), it is still far from the optimistic prognosis of 2,058 litas, given at the end of 2003.
According to the market participants, unfulfilled hopes related to the membership of the EU had the biggest impact on the reduced estimates. Most market participants had expected a rapid increase of income after accesssion, which explains their considerably higher initial forecasts for 2004. As the first months after EU accession failed to bring any leaps in incomes, the forecasts were consequently reduced. On the other hand, a rapidly falling unemployment and earning growth alone possibly had a positive influence on the estimates of household income. In addition to that, the year 2004 saw another increase of pensions, various social benefits and other budget outlays.
Market participants think that the financial situation of the Lithuanian people will improve in 2005 but, just as before, it will not reach the previously forecasted level. It is predicted that the average household income will increase by almost 7 percent and amount to 2,127 litas per month in 2005, while the average income per household member will total 834 litas per month. Household income is expected to be boosted by declining unemployment, rising incomes, higher social benefits and continuing deposit compensations.
At the beginning of 2005, LFMI survey participants raised the ex poste estimates of both household investments and savings as compared with the forecasts from mid-2004. The current survey shows that the year 2004 saw an increase in both household savings and investments. As compared with 2003, household savings grew at a higher rate in 2004, while household investments slumped after an upsurge in 2002 and 2003. Market participants think that average monthly household savings edged up by 7.5 percent (20 litas per month) in 2004, as compared to a 14-percent increase in 2003, to a total of 283 litas per month. Household investments amounted to an average of 265 litas per month, down by 28 litas or 9.6 percent from 2003. Household savings again exceeded household investments after a one-year break.
Growing consumption is one of the key factors of lower saving and investment indicators. However, higher income expectations, growing confidence of economic players, intense competition among the banks and lease companies, and a growing interest in life insurance are instead boosting the investment growth. Market participants, having raised the savings estimate somewhat, expect the investments to increase by as much as one-fourth. Market participants now predict that household savings will rise by 12.2 percent and household investments will go up by 27.1 percent in 2005. Savings will be smaller than investments, 317 litas per month and 337 litas per month respectively. Savings will account for about 15 percent of household budgets, whereas investments will constitute some 16 percent. To sum up, market participants took into account the recent consumption boom and lowered their 2004 household saving and investment estimates. However, a much higher rate of growth is forecasted for household savings and especially investments in 2005.
The expectations of market participants in terms of corporate indicators have been modestly optimistic and have changed very inconsiderably for some time now. In the LFMI survey presented six month ago, market participants forecast that the profit margin and return on equity would improve slightly, by increments of a percentage point. The 2004 ex poste ex poste estimate is virtually unchanged: the profit margin was reduced by 0.1 percentage point, whereas return on equity was increased by 0.4 percentage point. Market participants reported that the average profit margin was 6.2 percent and that the return on equity stood at 10.6 percent in 2004.
The LFMI survey indicates that the profit margin and return on equity will go up in 2005. Market participants predict that the average profit margin will increase to 6.3 percent and return on equity will stand at 10.9 percent in 2005. Such modestly optimistic expectations are very likely related to the continued growth of the Lithuanian economy, rising domestic demand and the membership of the EU. A growing demand for, and costs of, skilled labour and a shortage of qualified workers may have an adverse impact on corporate indicators.
The LFMI surveys show that the share of reinvested profits increased steadily from 1997 until 2001, but also that this trend reversed noticeably in 2002. According to market participants, the proportion of reinvested profits averaged 49 percent in 2004, down from 66 percent in 2001. Market participants did not change their forecast from the beginning of 2003 and do not predict any big changes in 2005. They do, however, think that reinvested profits will decrease by one percentage point and stand at 48 percent in 2005.
Although the share of reinvested profits, according to the LFMI survey participants, shrank, innovation processes did not slow down. According to the survey, expenses on research and development (R&D) accounted for 5.9 percent of companies’ total expenses in 2004, i.e. approximately as much as in 2003 (5.8 percent), but less than was expected in the previous survey, and much less than in 2001 (7.2 percent). The 2005 forecasts are more optimistic. Market participants think that the share of expenses on research and development will grow to 6.5 percent of total expenses in 2005 (which, despite the increase, is still below the 2001 level).
According to the LFMI survey participants, the yield on 3-year government bonds on the central market was 3.75 percent at the end of 2004. This estimate is higher than the average yield on 3-year government bonds in the market, as recorded at the end of 2004: the average yield on three-year government securities issued at the end of 2004 was 3.21 percent. Moreover, if in the previous survey the market participants projected a moderate increase in interest rates, this time the forecasts are more cautious. In fact, the LFMI survey participants lowered their 2005 forecasts and do not expect any sizeable rise in the yield on government securities. They predict that at the end of 2005 the yield on three-year government bonds on the central market will be 3.67 percent.
The LFMI survey shows that the cost of borrowing from commercial banks rose slightly at the end of 2004. According to market participants, at the end of 2004 both one- and five-year loans in litas cost on average 5.5 percent. The modest increase in interest rates in Lithuania is a reflection of trends on the world’s financial markets. A high liquidity of the Lithuanian banking system and strong competition among banks are other reasons behind the modest growth of interest rates.
According to the survey, the costs of borrowing will tend upwards in 2005. Market participants predict that interest rates on one-year loans in litas will be 5.6 percent, and that the rates for five-year loans in litas will stand at 5.7 percent at the end of 2005, which are still rather modest indicators if compared to the ones predicted in 2004.
In addition to bank loans, lease and factoring are getting increasingly popular. The lease and factoring portfolios account for an increasingly bigger proportion of bank loans (including bank loans extended to other banks and financial institutions) and their rate of growth is as high as that of bank loans. LFMI survey experts believe that the share of non-bank loans (including lease and factoring) represented 15.7 percent of the loan market in 2004 and that it will remain at a similar level, 16 percent, in 2005.
The participants in the LFMI survey reported that one US dollar was equal to 2.62 litas at the end of 2004. This is practically the same exchange rate as that registered on the market at the end of January 2004. Market participants do not foresee any major changes in the value of the US dollar, and forecast that one US dollar will be equal to 2.7 litas at the end of 2005. Thus although market participants do not expect a further slide of the US dollar in the short run, they do not think that the currency will strengthen either.
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The next survey will be conducted in the middle of 2005 and will show if and how market participants’ expectations for the year 2005 will change and what trends are expected in 2006.
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.
The 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.
Forty-two respondents participated in this survey. The survey was funded by “Constructus”, “Maþeikiø naftos“ prekybos namai“, „Ragutis“, “Rimi Lietuva”, „Tamro“ ir “VST”.
