Budget Policy Monitoring

The National Audit Office of Lithuania, implementing the functions of the fiscal institution, assessed and endorsed the Economic Development Scenario for 2022–2025, published by the Ministry of Finance on 21 December.
 
In 2022, the global economy was more resilient than expected, but the risk of recession has shifted to 2023. Continued geopolitical tensions and the risk of prolonged high inflation, which is expected to lead to further interest rate hikes, are leading international institutions to revise downwards the growth outlook for the world’s major economies, including the ones in the euro area, for next year. This will affect the economic activity and price development in Lithuania.
 
“The unexpectedly strong performance of international trade in Q3 this year contributed to higher real GDP growth in 2022. Despite the downward revision of the GDP growth projection for 2023, the level of this indicator is expected to be higher than forecasted in the autumn. As a result, the budget’s revenue collection could be better than we expected in the October assessment of the 2023 draft budget. At the moment, the outlook is subject to extreme uncertainty, it is therefore possible that the country’s economy and public finances could be worse than expected”, says Principal Economist of the Budget Monitoring Department Jaroslav Mečkovski.
 
In the Economic Development Scenario a real GDP growth rate is projected to reach 0.7% next year. The level of global economic activity is particularly important for the highly open Lithuanian economy. Investment and household consumption will support Lithuania’s GDP growth in the face of a slowdown in the main export partner economies. In 2023, inflation is projected to moderate, however, the price growth will remain significant. The 2023 draft budget includes measures to increase income of population and mitigate the impact of rising energy prices, while strong wage growth will have a positive impact on households’ disposable income level and real household consumption.

Increased immigration, mainly due to the arrival of Ukrainians, and an increase in the activity rate of the working-age population are contributing to the acceleration of potential GDP growth projected by the National Audit Office. The slowdown in real GDP growth in 2023 is projected to keep the economy below its potential level.

The National Audit Office, implementing the functions of the budget policy monitoring authority, assessed the draft Law on the Approval of Financial Indicators of the State Budget and Municipal Budgets of the Republic of Lithuania for 2023 (hereinafter - the draft budget) and submitted its opinion to the Seimas.

The energy crisis caused by the geopolitical situation has led to an increase in electricity and gas prices, which is why the draft budget provides support measures for the population and businesses.

"International organisations recommend short-term measures targeted towards the most vulnerable groups in society. In our assessment, most of the temporary energy-related measures in the draft budget are not well-targeted. The long-term measures foreseen in the draft budget will continue to contribute significantly to the growth of long-term expenditure not covered by revenue. Such expenditure will amount to 1.6% of GDP in 2023, compared to an average of 0.9% of GDP in 2017-2021. Rising interest rates will make it more expensive to finance deficits and refinance existing liabilities, risks to economic developments remain significant, so it is crucial that decisions to increase spending and reduce revenues are justified," says Rasa Ibelhauptaitė, Principal Economist at the Budget Monitoring Department.

The fiscal institution, the functions of which are implemented by the National Audit Office, projects that the general government deficit in 2023 will be close to the deficit specified in the draft budget and will amount to 4.9% of GDP. However, it is emphasized that it could be higher due to emerging risks. For example, some of the support measures foreseen in the 2023 draft budget are planned for the first half of 2023 only. There are risks that they could be extended for a longer period. In addition, geopolitical tensions in the region and their escalation may lead to higher spending needs for national defence and security. A change in the economic environment could lead to a more sluggish economic development, which would put pressure on additional spending and reduce general government revenues.

Under the conditions of exceptional uncertainty, a strong stimulus to the domestic economy is projected in 2023 without the application of fiscal discipline rules. As rising interest rates lead to more expensive deficit financing, it is important to note that, in the face of rising expenditure that is not covered by long-term revenues, specific measures are needed in the future to achieve a reduction of the general government deficit in the period 2024-2025.

The National Audit Office, implementing the function of fiscal institution, assessed and endorses the Economic Development Scenario for 2022–2025 published by the Ministry of Finance on 12 September as suitable for the preparation of the draft budget for 2023. The cancellation of the exceptional circumstances underlying the COVID-19 pandemic, initiated by the Ministry of Finance, and the compliance of the geopolitical situation and its possible negative impact on the financial position of general government in 2022 with the definition of exceptional circumstances is also endorsed. Deviations from the budgetary requirements for the general government are allowed during the period of exceptional circumstances.
 
After strong economic growth in early 2022, the growth slowed significantly in the second quarter of this year. In the opinion of the National Audit Office it is noted that the tense situation in energy resource markets and the rapid increase in consumer prices, the deteriorating expectations of business and consumers, and the worsening economic prospects of Lithuania’s main international trading partners will create difficult conditions for the country’s economy to grow at the end of 2022 and early 2023. In the September Economic Development Scenario, real GDP growth is projected at 1.6 % in 2022. Slower growth rate of the economy is expected in 2023. The scenario is in line with the assumptions outlined, but the National Audit Office notes that, while the above-mentioned challenges remain, it is possible that the Lithuanian economy could shrink in 2023.

“In August–September, the forecasts of all institutions publishing GDP projections of Lithuania differed significantly. This confirms that currently it is particularly challenging to foresee the economic perspectives for 2023. The increased uncertainty in macroeconomic development and the unprecedented rise in energy prices call for the space for national fiscal policies to react promptly to the challenges that have arisen. It is not known how long prices of energy resources will remain high and therefore non-targeted financial support measures can become unbearably expensive. It is important to focus more on finding long–term solutions, such as investing in renewable energy sources. In addition, the growing long–term expenditure needs to be kept in mind," says Jaroslav Mečkovski, Principal Economist of the Budget Monitoring Department.

International institutions note that targeted measures supporting the most vulnerable groups in society are justified in order to manage risks from public finances. However, horizontal measures, such as tax cuts or various compensations, are appropriate in order to respond quickly to the changed situation, but should not last for more than a few months due to the high budgetary burden and the aim to reduce energy consumption. Measures that do not directly affect the general government balance, such as guarantees or loans, could contribute to a significantly lower deficit and debt at the end of medium–term.

Favourable economic growth and low interest rates from 2020 till the beginning of 2022 prevented the public debt-to-GDP ratio from growing as expected. The tense current situation shows that these favourable factors may be less likely to occur in the future. As the need for various support measures increases, general government debt is likely to increase and it is therefore important to foresee a strategy for debt reduction in the future.