Lithuania was the only euro area member state to not having recorded a decline in real GDP in the first quarter of the year. Measures to stem the Covid-19 pandemic and general uncertainty came into force in the second quarter, when real GDP contracted by 5,9% and where the drop in domestic demand weighed the most. Private consumption was significantly affected by the closure of most retail stores and the catering sector during the lockdown, while a decline in investment was already recorded in the fourth quarter of 2019.
At the same time, net exports decreased less than imports: one of the reasons for the resilience of exports comes from the relative stability of foreign demand for products with lower added value which represent a considerable share of Lithuanian industrial production. In general, it can be said that the timely containment measures of the virus at the beginning of the pandemic helped the economy as a whole. In response to the Covid-19 crisis, the government adopted a large stimulus package last March and added further measures later in the year.
Coface projects that the additional expenditure, mainly represented by various grants, benefits and investments, will amount to almost 6% of GDP in 2020. Overall, the increase in expenditure and automatic stabilizers for the general government deficit are expected to .8,5% of GDP. While most of the Covid-19-related measures expire at the end of this year, the 2021 draft budget contains new spending measures equal to almost 2% of GDP. For example, the government has decided to increase wages in the public sector and has also suggested some legal changes that would allow for the indexation of pensions, which is not covered by current rules.
Overall, due to the gradual reduction of the stimulus, the deficit in 2021 is expected to be 6% of GDP, of which 1,5% should eventually be financed by the recovery and resilience instruments. Due to the large projected deficits, the debt/GDP ratio is expected to increase from 35,9% in 2019 to around 47,3% in 2020 and then further to 50,8% next year.
Private consumption started to recover as early as May, while industrial production recorded a considerable recovery in June. This positive trend continued in the third quarter and is confirmed by improvements in confidence indicators. According to the forecasts of the European Commission which speak of good results expected in the agricultural sector, real GDP in the third quarter should rebound again. However, the recent increase in Covid-19 infections and the measures taken to combat it are bound to weigh on economic indicators: real GDP is therefore expected to decrease by around 2,25% this year.
Exports, including transportation services, have been a major growth driver for the economy over the past three to four years. However, the fragile international trade situation and the requirements of EU road transport reforms should ease this trend in the coming years. Slower increases in the minimum wage in the public sector and restrictions related to Covid-19 are the reasons for the lower dynamism of consumption in the short term. However, accelerating investment from the EU and further projects initiated by the government in response to the crisis are expected to lead to an increase in overall gross capital formation. Overall, Lithuania's GDP growth is expected to reach 3% in 2021 and then remain above 2,5% the following year.
In 2020, the current balance of payments is expected to show a small deficit: although moderating domestic demand will limit imports, falling EU demand will worsen the goods deficit. The trade surplus (2,3% in 2019) generated by the high level of exports of services, especially tourism and road transport, is therefore expected to decrease. The transfers (2,2% of GDP), composed mainly of remittances and European funds, while remaining constant, will not compensate for the income deficit (5,3%), attributable to the high stock of direct investments in the country (25% of GDP). No major changes are expected with regard to foreign portfolio investment.
Net migration was positive for the first time in 2019 and is very likely to be positive again this year, although it is still early to talk about a trend reversal. At the same time, the lockdown and the epidemiological situation are relatively better than in many other European partners could slightly reduce emigration in 2020. The pandemic has nonetheless put a number of jobs at risk, especially in the services sector: unemployment is rising from 6,1% in January to 9,6% in August. To mitigate the situation, the government has introduced a series of measures to protect employment and provide further support for jobseekers: according to forecasts it is set to decrease from 8,9% in 2020 to 8,0 % next year and is expected to continue declining in 2022.
Overall, inflation is expected to settle at 1,3% this year, to rise to 1,5% and 1,7% respectively in 2021 and 2022 thanks to the economic recovery. According to the budget approved by the government, revenue is set to increase significantly (9%), almost at the same pace as spending (8%). The bill provides for an increase in excise duties on hard liquor, tobacco and fuel, with exemption from excise duties on diesel used for heating; at the same time, the real estate tax base is widened and a tax on polluting cars is introduced. The tax package also includes proposals to tax the activities of credit institutions and retail chains to slow down the increase in the non-tax threshold.
The stated goal is to accumulate reserves (up to 1,6 billion euros in 2020, equal to 3,3% of GDP) and reduce public debt, 75% of which is held by non-residents and almost 30% is denominated in foreign currency. This composition of Lithuania's gross external debt (75,7% of GDP in 2018) must be considered in the light of its composition: State (39%), Central Bank (27,5%), banks (11%), companies non-financial (26%), assets held abroad by the country (84% of GDP).
After a brisk performance in 2019, growth is expected to slow down in 2020 as it starts moving towards its potential level. Private consumption (two-thirds of GDP), the main contributor to growth, is expected to remain strong thanks to the increase in income, indexation of pensions, higher minimum wages and a vibrant labor market. The labor market benefits from the improvement in the historically high level of immigration, which is expected to exceed the equally high level of emigration. At the same time, the tightening of the labor market and the increase in the minimum wage, which is high compared to productivity, will have a negative impact on the competitiveness of businesses and consequently on exports (80% of GDP) in a scenario which sees an increase in international trade tensions.
Investment (almost 20% of GDP), including EU-funded investment, is expected to continue at a similar pace in 2020. Private investment in equipment and intellectual property is expected to remain an important driver of growth, as companies continue to face labor shortages and high capacity utilization rates. It is expected that residential construction will contribute to growth of investments to a lesser extent due to less favorable financing conditions.
