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Lithuania’s economic horizon looks uncertain, with increasing chances of falling into a recession. This potential downturn is expected to be longer and deeper than the one experienced during the COVID-19 pandemic but milder and shorter than the 2009 financial crisis.

Overview

Lithuania’s economy thrived post-COVID until early 2022, driven by exports and global integration. However, Russia’s Ukraine conflict darkened the outlook, causing slower growth and high inflation. The nation severed energy ties with Russia, assisting Ukrainian refugees and addressing energy challenges. Structural unemployment and skills gaps persist, requiring reforms, including reducing state-owned firms and improving education-labor market alignment. Embracing digital tech and environmental initiatives are vital for sustained growth and achieving net-zero emissions by 2050.

Public investment

Lithuania’s government has made regional development a top policy priority, recognising that municipal public investment can attract both domestic and foreign private investment, stimulate growth, and enhance the well-being of its residents. Furthermore, such investments could play a pivotal role in mitigating the economic fallout of the COVID-19 pandemic. Nevertheless, in Lithuania, municipal governments account for a mere 33% of public investment, significantly lower than the 46% average for sub-national governments in the OECD. This disparity is primarily attributed to limited own-source revenue and stringent fiscal regulations, which hinder municipalities’ ability and willingness to invest. This report scrutinises Lithuania’s framework for municipal public investment funding and financing, drawing insights from Denmark, Finland, Ireland, the Netherlands, and New Zealand to propose policy options that can bolster local governments’ capacity for public investment, ensuring project quality and municipal financial sustainability.

Growth or recession?

During the COVID-19 pandemic, governments and central banks worldwide implemented unprecedented economic stimulus measures, enabling economies to rebound swiftly once virus fears abated and lockdowns were lifted. However, this time around, central banks are taking coordinated and aggressive steps to tighten monetary policy to combat rising inflation. Higher interest rates, though effective at curbing inflation, can also stifle economic growth. Energy price shocks are also hindering economic growth, especially in countries like Lithuania, heavily reliant on energy imports. Thus, Lithuania’s economy finds itself caught between the surge in energy prices and rising interest rates, potentially pushing it into recession in 2023. However, despite various headwinds, the recession is likely to be shallow and relatively short-lived, followed by a rapid “U-shaped” recovery. During this period, fiscal policy will play a significant role, striking a balance between mitigating the impact of energy price shocks on vulnerable individuals and maintaining fiscal stability. We forecast a contraction of 1.2% in Lithuania’s economy in 2023, followed by an acceleration of growth to 5.5% in 2024. Inflation is expected to slow down from 17.2% in 2022 to 4.5% in 2023, possibly turning into deflation in 2024.

Gross domestic product (GDP)

Lithuania’s economy began the year on a high note, with a 4.4% year-on-year GDP growth in the first quarter of 2022. This rapid growth was primarily driven by export-oriented manufacturing and high-tech service sectors, including information technology and fintech. Lithuania’s exports grew impressively by 18.8%, surpassing pre-pandemic levels by 28%, making it the second-fastest export growth rate in the entire EU (after Ireland). Domestic sectors also showed strong growth, with private consumption surging by 6.6% in the first quarter of 2022. Rising incomes, increased employment, and the release of accumulated savings from the pandemic contributed to this growth. The ongoing boom in the housing market further boosted consumption as it increased demand for furniture and other long-term consumption goods.

Russian invasion consequences

The Russian invasion of Ukraine disrupted consumer and business confidence, but Lithuania’s economy managed better than expected in withstanding the initial shock. In the second quarter of 2022, Lithuania’s GDP only contracted by 0.5% compared to the first quarter, and annual growth remained positive at 2.6%. Retail trade did not experience a significant decline, and the housing market partially recovered after a brief dip in March 2022. The manufacturing sector also demonstrated resilience as it had already shifted its markets away from Russia to Western markets between 2014 and 2015. Thus, despite the complete disruption of EU-Russia trade relations, it had no noticeable negative impact on Lithuania’s economy. Furthermore, Lithuania achieved not only economic but also energy independence from Russia, enhancing macroeconomic stability and improving its international image. Nevertheless, despite the initial shock of the Russian invasion of Ukraine, Lithuania’s economy faces stronger headwinds, which could potentially push it into a recession in 2023.

Energy prices

The strongest headwind facing Lithuania’s economy is the energy price shock caused by the ongoing Russian energy war against the EU. Russia initiated this energy war in 2021 by depleting gas storage facilities in Germany, Austria, and the Netherlands (controlled by Gazprom), causing a surge in gas and electricity prices as early as autumn 2021, well before the Russian invasion of Ukraine. Additionally, Russia unilaterally reduced gas supplies to certain EU countries, such as Poland (through the Yamal-Europe pipeline), in December 2021. These actions led to significant spikes in gas and electricity market prices. The prices of natural gas (TTF trading point in the Netherlands) skyrocketed to €115/MWh in December 2021, seven times higher than in December 2020. Similarly, electricity prices (Nord Pool Lithuania price zone) reached €212/MWh in December 2021, nearly five times higher than in December 2020.

The Russian invasion of Ukraine further fuelled global oil prices, along with a weakening euro and a diesel fuel shortage, resulting in record-high fuel prices in Lithuania. Future contracts for natural gas and electricity suggest that energy prices in Europe will remain high at least until mid-2023, as Russia continues to use energy as a hybrid warfare tool against the EU. Although the EU aims to reduce its dependence on Russia, this is a challenging task, given that Germany and several other EU countries have increased their energy dependency on Russia over the years. Thus, it is likely that Lithuania will need to reduce energy consumption, potentially leading to an economic recession this winter.

Lithuania’s heavy reliance on energy imports, including oil, gas, and electricity, makes it one of the most vulnerable EU countries to energy price shocks. These shocks reduce household purchasing power, weaken local businesses’