Economic transformation process in Lithuania

Jekaterina RojakaSenior Analyst

October 6, 2008. Sofia, Bulgaria

Strengths, Weaknesses, Advantages & Threats

2|

The economic backlog shrank over a last couple of years

184

123117 113

8981

72 69 63 60 58 5441 38

No

rway

Den

mar

k

Fin

lan

d

Ger

man

y

Slo

ven

ia

Cze

chR

epu

blic

Est

on

ia

Slo

vaki

a

Hu

ng

ary

Lith

uan

ia

Latv

ia

Pola

nd

Ro

man

ia

Bu

lgar

ia

2000 2007

GDP per capita in Purchasing Power Standards, EU-27=100

Source: Eurostat

3|

Technological level in EU old-timers remains several times higher than in new member states

Value added per employee in manufacturing industry, EUR thousand

71.1

51.1

10.3 8.811.3

7.4

63.5

19.7 17.6 16.712.3

86.8

Finland Denmark Lithuania Estonia Poland Latvia

2000 2007

* Data of 2006, estimate

*

Source: Eurostat

4|

Earnings in the Baltics still lag behind those in the Western Europe

*2007 September ** 2006 m. industry

Source: national statistics offices

Average monthly earnings in 2007, EUR

221

594 635 721 784 852 919

1326

2330

3103

3784

Bulg

ari

a*

Lith

uania

Latv

ia

Hungary

Est

onia

Cze

ch R

.

Pola

nd

Slo

venia

Irela

nd**

Germ

any**

Norw

ay*

5|

Lithuania enjoyed the sharpest drop in unemployment rate

18.8

16.2

7.5

9.0

6.96.4

8.7

16.4

9.8

7.3

5.6

13.7

8.7

6.7

12.8

16.4

4.3

11.1

9.68.4 8.3

7.5 7.4 7.1 6.9 6.96.4 6.1 6.0

5.3 4.9 4.7 4.33.8

Slo

vaki

a

Pola

nd

Ger

man

y

Fran

ce

Bel

giu

m

Hu

ng

ary

EU

-27

Bu

lgar

ia

Fin

lan

d

Ro

man

ia

Sw

eden

Latv

ia

Cze

chR

epu

blic

Slo

ven

ia

Est

on

ia

Lith

uan

ia

Den

mar

k

2000 2007

Unemployment rate, %

Source: Eurostat

6|

Productivity growth lags behind that of labour costs

3.9 3.5 4.3 4.9

11.0

15.917.3

20.8

12.8

15.4

7.7 8.1

2.9 3.52.0

3.1

16.8

20.2

23.3

30.2

18.5

20.9

5.8

11.2

2006 2007 2006 2007 2006 2007 2006 2007 2006 2007 2006 2007

Denmark Finland Estonia Latvia Lithuania Poland

Labour productivity

Labour costs

Labour costs and value added per employee, annual changes, %

Source: Eurostat

7|

Lithuania enjoyed spectacular economic growth…

4.16.6 6.9

10.3

7.3 7.9 7.78.8

6.20.5

-0.3

0.1

-1.0

2.9

6.1 7.1

9.3 14.8

4.6

6.47.0

9.310.2

14.114.7

18.1

21.0

2000 2001 2002 2003 2004 2005 2006 2007 2008 I H

Deflator

Real GDP

Nominal GDP

Gross domestic product, annuual changes, percent

Source: Eurostat, DnB NORD Bankas

8|

Share of employed in industry dropped from 22 percent in 1998 to 19.5 percent last year

0

200

400

600

800

1000

1200

1400

1600

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Services

Construction

Industry

Agriculture

Number of employed, by economic sector, thousands

Source: Statistics Lithuania

9|

Structure of economy has changed slightly

Structure of value added by activity, percent

7.0

0.7

3.8

6.0

1.5

12.3

2.1

10.3

6.1 6.37.2

5.2

0.5

3.7

10.0

17.2

1.3

13.1

2.9

11.8

4.8 4.6

6.8

16.5

19.4 19.1

Ag

ricu

ltu

re,

hu

nti

ng

an

dfo

rest

ry

Min

ing

,q

uar

ryin

g

Man

ufa

ctu

rin

g

Ele

ctri

city

, g

as,

wat

er s

up

ply

Con

stru

ctio

n

Dom

esti

c tr

ade

Hot

els

and

rest

aura

nts

Tran

spor

t,st

orag

e,co

mm

un

icat

ion

Fin

anci

alin

term

edia

tion

RE

, ot

her

bu

sin

ess

Pub

licad

min

istr

atio

nan

d d

efen

ce

Ed

uca

tion

Oth

er

2000 2007

Source: Eurostat

10|

Exports growth has lost its steam

9.5

21.219.4

6.94.4

17.7

12.2

4.7

14.4

29.6

0.8

-2.0 -0.5

7.6

9.3

5.8

4.8

12.9

39.1

22.0

17.4

6.4

12.0

27.0

18.0

9.5

27.4

2000 2001 2002 2003 2004 2005 2006 2007 2008 IH

Price component

At constant prices

At current prices

Exports of goods and services, annual change, %

Source: Statistics Lithuania, DnB NORD Bankas

11|

About 55 percent of all manufacturing products are exported

0

20

40

60

80

100

M.

of

tob

acc

o

Ex

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ctio

n

of

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at

Ex

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as

M.

of

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oth

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an

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duct

s

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nu

fact

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ng

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of

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ery

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en

t

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of

furn

itu

re

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of

rubb

er,

pla

stic

s

M.

of

ba

sic

me

tals

M.

of

pu

lp,

pa

pe

r

Min

ing

an

d q

ua

rry

ing

M.

of

lea

the

r

M.

of

fab

rica

ted

me

tal

p.

M.

of

food

pro

du

cts

Pu

blis

hin

g,

pri

nti

ng

M.

of

oth

er

no

n-

me

talli

c p

.

M.

of

com

pu

ters

Qua

rry

ing

of

sto

ne

,e

tc.

2004 2007

1998

Share of exports in total production by industry, %

Source: Statistics Lithuania, DnB NORD Bankas

12|

Share of high-tech exports in Lithuania remains negligible

54.6

40.7

29.026.5

20.318.1 17.9 16.7

14.1 13.4 12.8 12.711.2

8.05.4 4.9 4.7 4.2 3.1

Malt

a

Luxem

bou

rg

Irela

nd

Un

ited

Kin

gdom

Hu

ngary

Fin

lan

d

Fra

nce

EU

-27

Germ

an

y

Sw

eden

Den

mark

Cze

chR

epu

blic

Au

stri

a

Est

on

ia

Slo

vakia

Spain

Lith

uan

ia

Latv

ia

Pola

nd

Exports of high technology products as a share of total exports in 2006, %

Source: Eurostat

13|

... since low and medium-low technologies dominate in manufacturing

3.3

19.3

25.2

52.1

12.9

31.4

24.2

31.5

4.3

13.0

37.5

45.2

High technologyindustries

Medium-high technologyindustries

Medium- low technologyindustries

Low technologyindustries

Lithuania in 2007 EU-15 in 2001

Lithuania in 2004

Manufacturing industries by level of technologies, % of total value added in manufacturing

Source: Eurostat, DnB NORD Bankas estimates

14|

Nearly a third of all machinery and equipment, as well as food products is exported to Russia

Exports to Russia, share in total Lithuania's exports, %

27.025.1

24.2

12.6

8.1 7.4

4.43.1

1.2

21.9

34.6

26.3

31.2

11.39.8

11.2

4.8 4.7 4.2

0.7

28.7

15

11.4

15

Mac

hin

ery

and

equ

ipm

ent

Tra

nsp

ort

veh

icle

s

Foo

dp

rod

uct

s

To

tal

Met

als

and

arti

cles

ther

of

Plas

tics

,ru

bb

er

Tex

tile

s an

dte

xtile

arti

cles

Ch

emic

alp

rod

uct

s

Furn

itu

re

Wo

od

an

dar

ticl

esth

ero

f

Min

eral

pro

du

cts

Oth

er

2004 2007 2008 IH

Source: Statistics Lithuania

15|

Lithuania does not seem attractive for foreign investors

12815

100129596

83977986

5428

3376 3184 29522477

1598

EU

-27

Cze

chR

epu

blic

Fin

lan

d

Est

on

ia*

Bu

lgari

a

Slo

vakia

Slo

ven

ia

Latv

ia*

Lith

uan

ia*

Pola

nd

Rom

an

ia

Foreign direct investments per capita in 2006, EUR

* in 2007

Source: Eurostat

16|

Manufacturing accrued the most of FDI, however new injections drain off

0.5 1.1

28.8

2.50.7

22.7

2.3 1.9

16.9 16.2

5.2

1.20.6 0.5

36.3

9.3

1.6

11.5

0.82.0

10.9

17.2

8.4

1.1

Agri

cult

ure

Min

ing,

quarr

yin

g

Manufa

cturi

ng

Ele

ctri

city

,gas,

wate

rsu

pply

Const

ruct

ion

Dom

est

ictr

ade

Hote

ls a

nd

rest

aura

nts

Tra

nsp

ort

,st

ora

ge

Com

munic

ati

on

Fin

anci

al

inte

rmedia

tion

RE,

oth

er

busi

ness

Oth

er

2000 2007

Foreign direct investments by economic activity, %

Source: Bank of Lithuania

17|

US investments account for just a mere share of total FDI

2.0

17.3

14.7

5.8

9.7

8.4 8.6

1.5

3.4 3.1

1.5

8.5

5.0

2.9

18.0

12.911.7

9.68.6

5.95.2

4.4 4.33.1

1.8 1.7 1.6 1.5

Pola

nd

Denm

ark

Sw

eden

Russ

ian

Federa

tion

Germ

any

Est

onia

Fin

land

Latv

ia

Neth

erl

ands

Norw

ay

Unit

ed S

tate

s

Unit

ed

Kin

gdom

Sw

itze

rland

Fra

nce

2000 2004 2008

FDI structure by investing country, as of 1st of J anuary, %

Source: Bank of Lithuania

18|

Unfortunately, Lithuania fails in attracting FDI - the key stimulus to robust long-term economic growth

391 561 370 637 530 505-612 -475

1501 1755 2604436 1421 1893

4199 3388

1057 40

845588

-744-670 -765

-393

510 2974625

4559

980712845

1058

-244

2000 2001 2002 2003 2004 2005 2006 2007

Loans

Portfolio investment

FDI

Other

Investment balance, LTL Mio

Source: Bank of Lithuania

19|

RE developers have skimmed off the largest share of issued loans

2.0

18.7

6.4

3.1

17.5

1.62.6

11.110.5

4.5

0.10.8

1.8

10.6

2.1

11.5

2.4

6.2

18.8

1.90.4 0.3

1.5

3.9

Ag

ricu

ltu

re,

hu

nti

ng

an

dfo

rest

ry

Ma

nu

fact

uri

ng

Ele

ctri

city

, g

as,

wa

ter

sup

ply

Co

nst

ruct

ion

Do

me

stic

tra

de

Ho

tels

an

dre

sta

ura

nts

Tra

nsp

ort

,st

ora

ge

,co

mm

un

ica

tio

n

Fin

an

cia

lin

term

ed

iati

on

RE

, o

the

rb

usi

ne

ss

Pu

blic

ad

min

istr

ati

on

an

d d

efe

nce

Ed

uca

tio

n

He

alt

h a

nd

soci

al

wo

rk

2004 2008 IH

Loan portfolio structure by economic activity, %

Source: Bank of Lithuania

20|

Energy intensity in the new member states is extraordinary high

1582

1165

967 949869 823

645585 544

438 417320

241 241 237 219 212 204 203 196 191 185 157 149 144 118 114

Bulg

ari

a

Rom

ania

Est

onia

Lith

uania

Slo

vakia

Cze

ch R

epublic

Latv

ia

Pola

nd

Hungary

Turk

ey

Cro

ati

a

Slo

venia

Fin

land

Port

ugal

Gre

ece

Spain

Norw

ay

Sw

eden

Unit

ed K

ingdom

Neth

erl

ands

Italy

Fra

nce

Germ

any

Aust

ria

Irela

nd

Japan

Denm

ark

Gross inland consumption of energy divided by GDP, in 2005, kgoe per 1000 euro

EU average

Source: Eurostat

21|

The optimism of economic agents lost momentum

-30

-20

-10

0

10

20

30

2003 2004 2005 2006 2007 2008

Economic sentiment indicator

Industrial confidence indicator

Consumer confidence indicator

Dynamics of economic sentiment and consumer confidence indicators in Lithuania

Source: Statistics Lithuania

22|

Flat rate introduction – one of the most successful policies

TOP statutory personal income tax, % of income in 2006 Adjusted top statutory tax rate on corporate income, % of income in 2007

Source: Eurostat

• Early implementation – attracted foreign investments• Easy administration• Boost in tax collections

23|

The list of less successful policies is longer…

Doing business difficulties - to get suitable personnel, percent

16.423.0 23.0 25.0

30.2 31.1 33.7 36.0 36.640.9

51.6

61.064.8

67.8

76.7

Cze

ch R

epub

lic

Swed

en

Den

mar

k

Slov

akia

EU

Rom

ania

Aus

tria

Ital

y

Slov

enia

Bul

gari

a

Lux

embo

urg

Port

ugal

Lat

via

Est

onia

Lith

uani

a

Doing business difficulties - to find suitable premises, percent

16.0 17.119.0

25.0 25.927.9 28.4

33.635.1 36.6

41.3 42.3 42.344.0 44.4

Den

mar

k

Swed

en

Aus

tria

Cze

ch R

epub

lic

Slov

enia

EU

Ital

y

Rom

ania

Slov

akia

Bul

gari

a

Est

onia

Lat

via

Lux

embo

urg

Lith

uani

a

Port

ugal

Among the least successful policies:• Inability to maintain robust FDI inflows• “Resting on laurels” strategy: no policies to combat swelling

prices, especially on property; no actual reform of education system, postponing investment

24|

Opportunities

• The trade flows through Lithuania are expected to intensify – favourable prospects for transport sector;

• Considerable potential in exports of tourism services;

• Positive impulses from mounting Eastern markets;

• Opportunities to magnify investment flows to the country remain robust;

• Benevolent trends in global markets for agriculture and food industry;

• Promising engineering industry;

• Enough room for expanding exports of IT, trade-related, financial and construction services.

Weaknesses

• Worsening macro conditions, pessimistic expectations;

• Decreasing competitiveness of individual export-orientated industries.

• Slower productivity growth compared to that of wages;

• Deteriorating attractiveness for foreign investors;

• Rising costs of finance;

• Tight public finances;

• Strong inflationary pressure and potential hikes in energy prices;

• High energy consumption intensity;

• Low quality of public sector services;

• Scarce share of value added created in the higher technologies sectors.

25|

The new Government will have toroll up their sleeves

KEY Economic policy directions:

• To improve business conditions (ensure higher quality of Governance, depress corruption, fine rule of law, etc.)

• To increase attractiveness of investment climate (eliminate bureaucratic barriers, liberalize labour market, tax system reforms, development of public services for business, promote industrial parks, render active cooperation with potential investors, enhance of Government support for exports activities, etc.)

• To refine Lithuanian economic structure (introduce essential investment promotion system, enhance clusterisation processes, Increase financing for (R&D) and establish effective incentives for innovations).

• To bridge social differentiation and combat inflation.

26|

DnB NORD Bankas Economic Research Publications are available at:http://www.dnbnord.lt/en/about/reviews/

Thank you for your attention!

27|

KEY FOREIGN INVESTORS IN LITHUANIA

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28|

Bureaucracy and corruption are the key obstacles for businesses

5448 44

3526 24 24 21 20 18 16 16 12 12

44

4344

5362

36 39

30

50 53

41

56

33

64

05 12

8 9

39 33

39

30 29

9

13

15

18

Bu

reau

cracy

Corr

up

tion

Lab

ou

r fo

rce

short

ag

e

Everl

ast

ing

lych

an

gin

g,

con

flic

tin

gle

gis

lati

on

base

Diffi

cult

ies

tog

et

fin

an

cin

g

Hig

hco

mp

eti

tion

Hig

h t

axes

Un

skill

ed

lab

ou

rfo

rce

Com

plic

ate

dp

roce

du

res

for

start

-up

Un

secu

rep

rop

ert

y r

igh

ts

Ineff

ect

ive

cou

rt s

yst

em

Įsta

tym

ųvir

šen

yb

ės

neb

uvim

as

Non

tran

sap

ren

tco

urt

s

Mon

op

olie

s an

dre

stri

ctio

ns

Very important obstacle Obstacle Not an obstacle Do not know

Obstacles for busineses in 2007, % of total respondents

Source: DnB NORD bankas, 2007

29|

The situation has worsened substantially

-54

-59

-62

-62

-69

-76

-79

-82

-82

-85

-85

-88

-97

-100

42

29

35

18

19

0

21

15

9

15

3

9

0

0

Overall business environment

Access and cost of finance

Tax rates

Regulations and limitation in ind. business areas

Crime and theft

Legal system or conflict resolution

Skills and education of available workers

Quality of legislation

Ease of starting a new business

Competition

Corruption

The supremacy of law

I nefficient government bureaucracy

Limited labour supply

Worsened or has not changed Improved

Changes in business conditions over the last 2-3 years, % of total respondents

Source: authors calculations, Competitiveness Project

30|

Other new member state are more attractive

5341 41 38 36 34 29 26 22 19 16 10

2541 41

31 4031 39

3250 56 63 71

6 3 316 4

13 6

0

9 36 3

Taxes

Bure

aucr

acy

Qualit

y o

f le

gis

lation

Acc

ess

and c

ost

of

finance

Overa

ll bu

siness

env

ironm

ent

Ease

of

start

ing a

ne

wbusi

ness

Corr

uption

Cou

rts

and c

on

flic

t re

solu

tion

Pro

pert

y r

ights

Reg

ula

tions

and lim

itatio

n in

ind.

busi

ness

are

as

Skill

s and a

vaila

bili

ty o

fla

bour

forc

e

Com

petition

Worse Similar More favourable Do not know

Business conditions, compared to other NMS, % of total respondents

Source: authors calculations, Competitiveness Project

31|

EU-11 rankings by ease of doing business in 2008

• Lithuania: drastic slump in EoDB from 16th position in 2006, and still among the average by ease of doing business index

• Most of categories fall behind though• Positive changes in 2009

Source: World Bank, authors calculations

DK FI IE EE LV LT PL CZ HU SK SL

Ease of Doing Business 5 13 8 17 22 26 74 56 45 32 55 1. Starting a business 18 16 5 20 30 57 129 91 67 72 120

2. Dealing with licenses 6 39 20 14 82 57 156 83 87 50 62

3. Employing workers 10 127 37 156 96 124 78 55 81 75 166

4. Registering property 39 17 79 21 85 4 81 54 96 5 99

5. Getting Credit 26 26 7 48 13 36 68 26 26 7 68

6. Protecting investors 51 51 5 33 51 83 33 83 107 98 19

7. Paying taxes 83 83 6 31 20 71 125 113 127 122 63

8. Trading across borders 2 5 20 7 19 23 40 30 45 90 69

9. Enforcing contracts 30 7 39 29 3 18 68 97 12 50 79

10. Closing a business 7 5 6 50 64 31 88 108 53 36 34

Improved

No changes

Worsened

32|

EU-11 rankings by global competitivness

• Slovakia’s macro stability under the question, while that of Lithuania - among the best country's indicators

• Higher education: quantity versus quality• Institutions: the longest list of imbalances

Source: World Economic Forum, authors calculations

Rank DK FI IE EE LV LT PL CZ HU SK SL

GCI 2007-2008 3 6 22 27 45 38 51 33 47 41 39 Basic requirements 1 2 27 29 47 43 64 42 55 50 37 1. Institutions 2 1 18 34 59 58 82 69 54 60 44 2. Infrastructure 7 10 49 36 56 48 80 41 54 58 37 3. Macroeconomy 10 9 21 14 44 38 56 43 107 62 29 4. Health and primary education 3 1 16 30 45 43 36 29 41 39 22 Efficiency enhancers 4 14 19 27 42 41 43 30 40 34 38 5. Higher education and training 3 1 21 23 29 25 35 28 33 41 24 6. Goods market efficiency 3 10 4 27 47 44 69 38 59 35 39 7. Labour market efficiency 5 29 19 26 36 44 49 35 58 25 51 8. Financial market sophistication 6 17 5 31 38 54 64 53 51 33 47 9. Technological readiness 5 11 25 19 40 38 51 35 41 36 29 10. Market size 45 49 46 91 82 67 22 38 41 57 72 Innovation and sophistication factors 8 6 22 35 72 44 61 28 43 52 30 11. Business sophistication 6 11 22 44 71 42 68 30 46 52 31 12. Innovation 10 3 19 31 77 48 58 27 37 51 30

Improved

No changes

Worsened

33|

World Bank: tax rates is the key obstacle to business

Source: World Bank

34|

WEF: taxes again lead the anti-ranking

0.0

1.9

2.8

1.5

2.1

3.0

5.4

6.8

10.4

6.8

10.6

16.1

15.9

16.6

0.2

1.6

2.3

2.7

3.5

4.0

4.5

5.2

9.2

10.8

11.6

13.5

14.5

16.2

0 2 4 6 8 10 12 14 16 18

Foreign currency regulations

Crime and theft

Government instability/coups

Inflation

Poor work ethic in national labor force

Inadequate supply of infrastructure

Policy instability

Access to financing

Inadequately educated workforce

Restrictive labor regulations

Corruption

Inefficient government bureaucracy

Tax regulations

Tax rates

2007-2008

2006-2007

Source: World Economic Forum, Global Competitiveness report

The Most Problematic Factors for Doing Business, percent of respondents

35|

The prices of necessities picked up most significantly

19.417.5

16.1 15.4 15.2

10.79.1 8.3

5.1

1.90

-3.3

-8

-4

0

4

8

12

16

20

Ho

usi

ng

, w

ate

r,e

lect

rici

ty,

ga

s

Foo

d a

nd

be

ve

rage

s

Tra

nsp

ort

Ho

tels

an

dre

sta

ura

nts

Alc

oho

licb

ev

era

ges,

tob

acc

o

He

alt

h c

are

Ed

uca

tio

n

Oth

er

Furn

ishin

gs

Re

cre

ati

on

an

dcu

ltu

re

Co

mm

un

ica

tio

ns

Clo

thin

g a

nd

foo

twea

r

2000 2004 2007 2008 August

HICP, annual changes, end of period, %

Source: Statistics Lithuania