Budget Policy Monitoring

The National Audit Office of Lithuania implementing the function of the fiscal institution (NAO FI) has assessed the economic development scenario for 2023-2026 published by the Ministry of Finance on 11 September.
  
According to the assessment of NAO FI, the growth of Lithuania's real GDP in the second quarter of 2023 allowed to mitigate the projected economic contraction in 2023 compared to the June scenario. In the background of geopolitical tensions and the tightening of monetary policy due to high inflation, global economic developments remain uncertain, resulting in a cautious assessment of Lithuania’s growth prospects in 2024.
  
“On the one hand, a strong recovery in Lithuania's real exports of goods and services in 2024 is not expected due to the projected sluggish external demand, while on the other hand, real GDP growth should be supported by investment and a strong labour market. We consider the projected moderate economic growth in 2024 to be plausible. Since the opinions on the economic prospects have no significant differences, we endorse the economic development scenario for 2023-2026," said Jurga Rukšėnaitė, Head of the Budget Monitoring Department.
  
For the first time, the NAO FI is also publishing its macroeconomic forecasts together with the opinion on the endorsement of the economic development scenario. These forecasts, along with other elements of the analysis, help the NAO FI to assess the scenario and take a decision on endorsement.
  
“The OECD is delighted to see the Budget Monitoring Department starting to publish its macroeconomic forecast alongside its endorsement of the economic development scenario. This aligns with good practice across peer institutions in the OECD and will further enhance the institution’s transparency and credibility." said Scherie Nicol, representative of the OECD. Together with other foreign and Lithuanian experts of the OECD, she conducted the first external review of the National Audit Office implementing the functions of the fiscal institution in 2019, where publication of macroeconomic forecasts was one of the recommendations made.
  
With Lithuania's economic development remaining relatively stable, anticipating more balanced risks from energy prices and falling inflation, large-scale support measures should no longer be used. Moreover, starting in 2024, EU Member States will need to return to common fiscal discipline rules. In the absence of evidence at the time of endorsement of economic development scenario that grounds for the application of exceptional circumstances persist in Lithuania, the NAO FI believes that all national fiscal discipline rules should be invoked. With the economy remaining below its potential level in the coming years and without applying exceptional circumstances, general government deficits could be generated up to the extent allowed by fiscal discipline rules.

The National Audit Office of Lithuania, implementing the function of the fiscal institution, assessed and endorsed the Economic Development Scenario for 2023–2026 published by the Ministry of Finance on 30 June.

The favourable performance of the global economic growth in Q1 2023 was driven by the continued resilience of the US labour market, the recovery of the Chinese economy, and the smaller-than-expected contraction of the euro area economy. This also contributed to the European Commission's projections for the world and the EU in May, which were more favourable than in February. Nevertheless, uncertainty about economic developments remains.

In Q1 2023, the Lithuanian economy experienced a stronger-than-expected contraction of 2.4%, driven by the negative performance of industry, trade, transport and real estate companies. The decline in the country‘s real GDP was driven by a fall in exports due to weakening external demand, a fall in household consumption expenditure affected by high inflation and the base effect. The unemployment rate rose to 7.7% in Q1 2023, but the job vacancy rate remained high.

"The second half of this year is expected to be more favourable for the country's economic development and a severe economic downturn will be avoided in 2023. After the unemployment rate rose due to lay-offs during the pandemic, employers found it difficult to find workers later on and some sectors are still experiencing shortages today. For this reason, we believe that employers will try to retain staff in anticipation of a short-term economic slowdown. Investment is also expected to keep the economy from falling sharply, and the efficient implementation of public sector projects could contribute to increasing the resilience of the economy by tackling the problems of energy dependence," said Jurga Rukšėnaitė, Head of the Budget Monitoring Department.

Lower-than-last-year prices for raw materials and energy resources will facilitate a slowdown in inflation and the development of the Lithuanian economy in the second half of 2023, but the remaining uncertainty about prices and external demand precludes strong GDP growth. The presented projections for the Lithuanian economy are influenced by the expected slowdown of the economies of the country's main export partners in 2023 and their recovery in 2024. The June economic scenario projects a 1.0% contraction in real GDP in 2023 and growth of 2.5% in 2024. The country's economy will be positively affected by investment and net exports.

According to the National Audit Office, implementing the function of the fiscal institution, rising investment and favourable migration trends are increasing potential GDP in the period 2023–2026. In the event of a slowdown of real GDP growth in 2023, the economy is projected to be below its potential level.

The National Audit Office, implementing the functions of the budget policy monitoring institution, carried out an assessment of compliance with the fiscal discipline rules of municipal budgets. The aim of the assessment is to determine whether the rules have been complied with when approving and implementing municipal budgets.
 
The assessment of municipalities' compliance with fiscal discipline has been carried out from two perspectives: assessing the 2022 budgets (ex-post) based on actual data and analysing how the 2023 budgets were planned (ex-ante).
 
The preliminary assessment of the 2023 budgets indicated that the initial 2023 budget adopted by the Council of one municipality did not meet the requirements. According to the financial statements, there were 15 such municipalities. Following the identification of possible errors in the documents submitted by the municipalities, it was requested to review the data and, if justified, to clarify the information.
 
In 2023, a new version of the Constitutional Law defining fiscal discipline rules for municipalities entered into force, giving more flexibility to promote investment. In order to take advantage of this flexibility, compliance with municipal fiscal discipline rules is essential.
 
"We use our assessment also to help municipalities to identify the risks of non-compliance, so that they can adjust their budgets and ensure compliance before the end of the year. We would like to point out that there are still errors in municipalities' financial reporting documents. Municipalities providing incorrect information risk losing the opportunity to finance investments through borrowing, as the application of the flexibility rule may be restricted if the actual assessment shows that the rules are not complied with," said Jurga Rukšėnaitė, Head of the Budget Monitoring Department.
 
In recent years, municipal budget balances have been better than planned. On average, municipal budgets have exceeded revenue plans by around 19% and expenditure plans by around 11% between 2019 and 2022. This cautious municipal revenue planning has contributed to the result of all municipalities complying with fiscal discipline rules in 2022.
 
To ensure that the data provided by municipalities is reliable and that budgets are prepared in compliance with the fiscal discipline rules, training sessions for municipal representatives, where specialists from the National Audit Office and the Ministry of Finance presented the changes in regulations, were organised this year. In addition, the National Audit Office website includes a supporting calculator on municipalities' compliance with fiscal discipline rules, which includes the financial statements used for the assessment. The aim is to help municipalities to make a preliminary assessment of the compliance of their budgets with the rules.

Implementing the functions of the fiscal institution, the National Audit Office carried out an assessment of Lithuania’s Stability Programme for 2023.  In 2022, the rules of fiscal discipline applied during the period of exceptional circumstances were complied with. It is expected to return to the full application of the rules in 2024.
 
The post-pandemic economic situation and high inflation have led to an unexpectedly strong performance of public finances in 2022, but this could be a one-off phenomenon. Inflation increases the level of general government revenue, but expenditure tends to be higher in subsequent years. In the medium term, expenditure may increase due to government commitments and possible decisions by policymakers. In view of revenue uncertainty and upward pressure on expenditure, compliance with fiscal discipline rules will require specific measures in the future.

"Higher budget revenues are essential in order to ensure high-quality public services. Currently, tax revenue-to-GDP ratio in Lithuania is one of the lowest in the euro area. In our view, the changes to the tax system that have been presented are necessary, but the proposals could be more ambitious and could better reflect the recommendations of international organisations. The need to increase the efficiency of public spending should also be kept in mind," said Jurga Rukšėnaitė, Head of the Budget Monitoring Department.

The proposed changes to personal income tax are likely to contribute to a simpler and more neutral tax system. However, the recommendations of international institutions to unify the corporate tax rate for all companies or to lower the threshold for registering for VAT are not being followed.

The presented changes to budget planning, which would allow policymakers to foresee decisions for three years instead of one, are welcomed. This would contribute to more accurate and transparent forecasting of public finances, but risks remain regarding their implementation.

According to the National Audit Office, implementing the functions of the fiscal institution, debt may reach around 40% of GDP in 2026 and is likely to remain among the lowest in the EU. With the economy below its potential level, a moderate stimulus to the economy is foreseen for the period 2023–2024.